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Welcome back. Today’s letter consists of a draconian (but I think correct) proposal on monetary policy, followed by a slight bitcoin skepticism. Food for thought, I hope, for a sunny autumn weekend. Email me: email@example.com
The Fed is still in conflict
It is good that senior Federal Reserve officials are no longer allowed to own individual securities or derivatives, or actively trade their portfolios. This is what the Fed said on Thursday:
The new restrictions apply to Reserve Bank policymakers, directors and officers, prohibiting them from buying individual stocks, holding investments in individual bonds, holding investments in agency securities (direct or indirect) or the conclusion of derivatives.
Policymakers and officers are generally required to give 45 days notice to buy and sell securities, obtain prior authorization to buy and sell securities, and hold investments for at least a year. In addition, no purchases or sales are permitted in times of heightened financial market stress.
It is a good idea not to let people who are aware of the Fed’s rate policy considerations take action because stocks and bonds are sensitive to rate policy. It is strange that such rules did not exist until now.
The reason things have changed is because the heads of the Fed banks in Dallas and Boston were very active in individual stocks last year. Eric Rosengren, the president of Boston, had significant investments in mortgage real estate investment trusts. This is particularly bad since, as part of quantitative easing, the Fed is buying the very same mortgage-backed securities that Mortgage Reits invest in. In general, mortgage riders are very sensitive to interest rates that the Fed is influencing. Worse still, Rosengren likes to talk about the real estate market. Both he and Robert Kaplan of Dallas have resigned. All of this looks like hell.
But the new regulation does not go far enough. Both investors and the Fed itself need to think more seriously that the Fed’s top management positions are mostly wealthy people with many assets. This fact, and what types of assets they own, must influence their policy decisions.
Owning certain specific securities – like Mortgage Reits – can lead to particularly outrageous conflicts, but as any investor knows, it is the overall mix of assets that determines the policies one would most like to see implemented.
In this context, four asset classes are important: cash, bonds, stocks and real estate (or other tangible assets). Liabilities, particularly mortgage debt, can also play a role. Ensuring that two of these asset classes, stocks and bonds, are held through diversified indices and not actively traded does not change the fact that the composition of officials’ portfolios will change the way they think. Like most people, they will prefer getting richer than getting poorer.
To put it simply, the Federal Reserve Open Markets Committee meets to discuss when to reduce asset purchases or raise interest rates. It’s perfectly clear that a committee member whose fortunes are mostly cash, bonds, and real estate has different prejudices than someone who invests mostly in stocks (such as Jay Powell). Officials who overweight bonds and cash will fear inflation more than those who invest primarily in stocks or physical assets, or have large houses and fixed-rate mortgages. The latter officials will inevitably lean on the employment side of the mandate.
The public deserves to know exactly what the senior officials’ wealth mix is in real time. In addition, the wealth mix of all FOMC members should be the same, and they should be chosen to align with the Fed’s dual mandate of price stability and maximum employment over the long term. The portfolios of officials should reflect our national priorities.
Not sure what mix I would order if I was in charge. But I’m absolutely certain that if you invested FOMC members 100 percent in fixed-rate denominations and forced everyone to fund their homes with adjustable-rate mortgages, we would get a very restrictive Fed. Likewise, I think if every FOMC member were fully invested in the S&P 500, you would see a very cautious approach to rate hikes no matter what the inflation data looks like.
Now, you might think that, unlike, for example, every single person I have known, Fed officials’ decision-making is not very much influenced by what is likely to make them richer and what is likely to make them poorer. But I don’t think that’s the case. If not, and we all agree that Fed policy matters, the fact that we leave these people’s portfolio composition to their personal discretion is pretty insane.
Blind trusts wouldn’t help. Fed officials will be able to pretty much estimate what is in the trust, as most trusts look the same. These are highly diversified 70/30 stock / bond portfolios with some minor tilts. But do we want a 70/30 monetary policy? I don’t know, but I think we’d better talk about it. Transparency and predictability would both be better served if everyone knew exactly where the interests of the monetary mandarins lie.
How senior Fed officials’ cash is invested should be a political decision, not a personal one. The only alternative I see is to make monetary policy a rules-based, non-discretionary matter. Otherwise, we are allowing a significant part of our national monetary policy to be made by the FOMC members’ financial advisors, which seems like a very bad idea.
Bitcoin, gold and inflation
From the FT on Thursday:
Investors are dumping gold for cryptocurrencies as inflation picks up, fleeing a metal historically touted as a store of value to buy digital assets that are barely more than a decade old.
According to Bloomberg data, the largest exchange-traded gold fund rose more than 10 billion this year. Gold prices fell 6.1 percent this year to $ 1,782 an ounce on Wednesday.
Bitcoin has now doubled to a record high of more than $ 67,000 this week. . .
Seasoned gold traders know times change. “There is currently no interest in our strategy,” said John Hathaway, senior portfolio manager at Sprott Asset Management, a precious metals investment group. He added, “The Bitcoin crowd sees the same things that I see in relation to the risk of inflation when printing money.”
. . . Paul Tudor Jones, the hedge fund manager, told CNBC on Wednesday that he preferred cryptocurrencies to gold for inflation protection.
I’m sure this article describes exactly how many investors are thinking right now. But both sides of the argument – that gold once existed but is no longer a good protection against inflation and that Bitcoin is a good protection against inflation – are wrong. This is worth highlighting as we are likely to hear quite a bit more of this type of gossip in the months ahead. So:
Point 1. The price of gold follows CPI inflation slowly and erratically, if at all. Both increase over time, but the relationship is uneven. Gold is a real asset, and there are a fixed amount of it, and people have liked it for millennia, and that’s how it has kept its value. However, it is unlikely to be a reliable protection against inflation over the time horizon of most investors.
Point 2. What the gold price has been tracking closely lately are real rates, i.e. the opportunity cost of owning a non-yielding, inedible shiny metal with limited industrial uses:
point 3. Bitcoin has not shown any obvious relationship to inflation in its short lifespan (other than both rising), which one might expect from something that could be a currency at some point in the future, but is currently primarily a vehicle for speculation:
Point 4. However, Bitcoin is a real asset, and there are a fixed amount of it, and people have been liking it for a couple of years, and so for all we know, it could hold its value. However, there is no particular reason to call it an inflation hedge. If it correlates with anything, it broadly correlates with speculative appetite like the one we see with meme stocks like AMC. AMC is unlikely to be a good inflation hedge either:
Talking about gold as an inflation hedge is sloppy. Talking about Bitcoin as a protection against inflation is pointless.
The NBA has a tricky business problem while trying to grow its audience in China. Its owners and players have opinions and don’t always shut up. This story, I predict, will go and go.
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