David Merkel – Page 18 – The Aleph Blog

How Much Should I Save?

Posted on 16 October 2019 by David Merkel

Photo Credit: Images Money || Saving is a good thing, don’t let the Keynesians tell you otherwise. After all, Keynes saved and invested.

When I started Aleph Blog my oldest child (out of eight) was 17. At present, my youngest child is 17. My view on saving is that you should save as much as you can. Why?

Much consumer spending is not needed. It is done to compete with other people for bragging rights, rather than meet basic needs. Many people in the US and other places are spoiled, and think that they need to have the best in the goods that they consume.

Learn from your great-grandparents who you never met, or were too little to understand: Deferred gratification. Don’t maximize the joy of your youth. Rather, save when you are young, and look to have a happy life from middle age to the end of life. That would be more happiness than if you had not saved when you were young.

What I have seen from my own children is that the savers are he happy ones, and the spenders are miserable… chased by the debt collectors and the repo men. It is a poor kind of happiness for me that those who listened to me are doing well, and those who ignored me are doing bad.

My basic advice for you is this: save 10% or more of your income. If you think you can’t do it, you are right. But I will tell you that you can do it, regardless of what your think. It is a question of will, not ability.

True saving means cutting expenses that are pleasant but not necessary. It means searching over your credit card statement for things you agreed to once, but no longer need. It means living with the old clothes that are just fine, but a little out of date. It means eating common food at home, and learning how to cook delicious food yourself. In this era of the internet, with rated recipes, this is not hard.

The main thing to fight is the attitude that you need to spend now. Think and plan. What is the best way that you can organize your life for the next 30 years? When you think long-term everything becomes more rational.

Summary

Save and invest. Your life will be happier if you deny yourself when you are younger, and enjoy life more when you are older. I have been debt-free for over 15 years now. Not having to make a mortgage or rent payment is a sweet thing. Having a valuable asset like my home (free and clear) is a sweet thing.

On average, in my life I saved more than 10% of my income, and I gave away more than 10% of my income. I do not regret the deprivation. At present, I have more than I need, and I give to charities.

I am not telling you to be like me. I am telling you that there is an alternative to the typical consumer mindset. Like your great-grandparents, defer gratification and save. You will be happier in the long run.

Post 3000 — I’m glad to be back!

Posted on 15 October 2019 by David Merkel

Photo Credit: Stephan Caspar || In Roman numerals 3000 is MMM… and thus the yummy picture that will make some people go “mmm….” As for me Mmm… I’m glad to be back.

Every 100 posts (except that I did not do it at the 2900 milestone), I take a moment to reflect. I started blogging back in February of 2007. I was 46 years old then; I am 58 now.

I resisted starting a blog for some time. When my editor at RealMoney asked me (she was asking all the contributors) “Are you going to start a blog?” I answered, “RealMoney, particularly the Columnist Conversation is my blog.”

I loved writing for RealMoney, but in some ways I was not the best fit for RM. I wrote more about theory, and less about actionable ideas. My main reason for that was that beyond holding a CFA charter, and at the time, a dues-paying life actuary, I have a code of ethics in addition to those from CFAI and the SOA. Aside from that, feedback is lopsided, like on Yelp. You get disproportionate feedback when you make a mistake, but little praise when you get something right.

But the reason I decamped from RealMoney was that I wanted more editorial freedom. It is the same reason that I tried writing for The Balance, and gave it up because I needed more freedom to write what I was thinking. (Also, writing for The Balance involved rewriting old articles, many of which were average for the web, but way below my standards. Rewriting those took a lot of time, and did not satisfy the other requirement of writing new articles on topics the the editors wanted, most of which were decidedly niche.)

How Aleph Blog Changed Over Time

When I began, I was writing two small articles per night. I morphed into writing articles that were relatively long, and one per night. I had a goal: to express all of the main ideas that I had come to regarding finance, economics and investment. A major part of that was The Rules posts, which mostly stemmed from insights I had between 1999 and 2003. There were a few that came after that, but not many. When I finished the last of the original Rules posts, I breathed a sigh of relief, because one of the major goals of the blog was complete. I had written an article on all of the “Rules.”

Now, one other thing that changed was the financial crisis. During the crisis, I resolved to write about all of the issues that I thought my distinct view could help explain. But I did not want to be a “crisis blogger.” There are some bloggers that are locked into writing about disaster, which is problematic when we have been in a very long though shallow recovery. Some commenters criticized me for not being like Zero Hedge back in 2009 or so. I ignored it because I want to be an “All Weather” blogger. I will write when the sun shines. I will write when it rains.

I do want to make one comment from the crisis era, when I was one of the bloggers invited to the first US Treasury / Blogger summit. In my 7-part coverage of the event, I never mentioned what I said during the main portion of the event. I was not the most outspoken at that event. Those that were “crisis bloggers” dominated the conversation.

There were only two things I got to say during the meeting. The first was my telling them that they could learn something from the way Canada regulates their banks, and also that the US state-regulated insurance companies were regulated better than the depository institutions in the US, especially for solvency.

The second thing that I said was that the US should lengthen maturities for Treasury issuance, and issue fifties, centuries, and consols. Also, they should issue floating rate debt. I told them that the US government would face a crisis when there is too much debt to roll over, so stagger the maturities, and pay up to borrow longer.

Back to the Present

I wrote a lot of book reviews in the past. I am unlikely to write a lot more of them, though there will be some. Part of that is Amazon favoring reviewers that bought their books at Amazon. I got most of mine from the publishers.

I have maybe 40 article ideas to work on now. Many of them will require significant work. Many of my best articles required that level of work, but it will mean that my output will slow down. If you have something you would like me to write about, send me an email. My address is on the Contact Me page. I don’t guarantee that I will write about it, but reader letters have led to more articles at my blog than most others.

Thanks to my Readers

There is one post that is especially dear to me, the one entitled Learning Leadership. It describes a time when I effected a huge change in the business that I worked for, and got little to no reward for doing so.

I thank all of my readers for reading me, wherever you are. One-third of my readers are outside of the US. I try to write for a global audience, but living in the US, I know that it will be somewhat US-centric. All the same, I invite those outside the US to write me and ask me questions.

And with that, I close this piece. Not that I will answer every question, but I will read everything that is written to me. My readers help make my blog better. Keep writing to me and helping me; I appreciate it.

Dividends Can Lie

Posted on 12 October 201913 October 2019 by David Merkel

Photo Credit: Simon Cunningham || Not paying a dividend does not create an enforceable claim, as happens when an interest payment is not made.

Don’t get me wrong, I love dividends. I even have a money management strategy based off of them. But I know that dividends are more fickle than most of their fans admit. The infatuation that some money managers have with dividends is misplaced. To say that “Dividends don’t lie,” is an overstatement. Yes, the check will clear, and you get money, but that does not mean that the next dividend will get paid.

I have always said that reliable dividends flow from businesses with predictable free cash flow. As such, I don’t look for dividends, but free cash flow. As a check on that, I watch debt levels in the companies that I own. If the debt levels are persistently increasing as a fraction of assets, it is likely a sign that the company is borrowing to pay the dividend.

Borrowing to pay the dividend — an old phrase, dating back to the 1970s and prior. Companies know that a consistent and growing dividend attracts investors. They are reluctant to not grow the dividend, much less cut it, lest massive selling take place. But businesses have their limits, and paying a dividend beyond those limits leads to an eventual dividend cut.

No management team will admit to being uncomfortable with its dividend payout. The Fed may as well admit that they don’t know what they are doing. It’s not gonna happen. But prior to a surprise dividend cut, the company will borrow more, probably hoping that business will rebound, and that the increased dividend will be sustainable.

In the 1970s, there were many dividend cuts. At the end of the 70s there was no cachet to dividends. With interest rates so high, income was to be found in bonds, even if inflation was going to the sky.

I remember the 1970s even if I was a teenager then. I was gifted two bits of stock in the 1960s, and the companies paid their dividends until they failed. I remember taking my dividend checks to the bank to add to my savings account. I still knew that the two stocks I had been gifted, Magnavox and Litton Industries, were disappointments that had given me less than the value of when the stocks were purchased.

In a significant recession, many companies will cut their dividends in order to avoid bankruptcy. Dividends are subject to the boom/bust cycle as much as any other aspect of corporate behavior.

This is why I say be careful regarding dividends. We are in a bull market now, with prices near the recent peak. Financing is plentiful and cheap. As Buffett has said:

Only when the tide goes out do you discover who’s been swimming naked.
brainyquote.com/quotes/warren_buffett_383933

Summary

My main point to you is this: don’t assume that dividends are automatic. Test the companies whose stock you want to buy to see that they have adequate capacity to pay the dividends, and that they are not borrowing to pay them.

I like my dividend portfolios. They are roughly half as volatile as the market, and have had decent returns. But I don’t blindly trust the dividends that companies pay as if they are an obligation. Be wary and analyze the safety of the dividends that you are paid.

On Stock Market Games for Children

Posted on 12 October 2019 by David Merkel

Photo credit: https://boardgamegeek.com || I probably played Jate 100+ times with my friends as a kid. Even at the time, I knew the market did not behave the way it did in Jate, or any other stock market game that I played.

All of the common board games that I have run into on the stock market are unrealistic. The stock market does not work the way the board games say that it works.

Nonetheless, I think that board games, and other games that involve money are useful for children. Why? Because they encourage kids to think in terms of budgets (money is limited), and in terms of using money to gain returns.

Business is a large part of life, and it is difficult to get children to appreciate what goes on there. Business games, though not realistic, promote curiosity regarding business and investing. Nothing is ever as easy in business or investing as in a game, but nonetheless the concepts of budgeting, compounding, and diversification (or lack thereof) appear.

I am not endorsing any particular game. My view is that game that involve money as a major aspect of the game are good for children, as it teaches them about goals, investing, and limits.

Issue Longer Treasury Debt

Posted on 11 October 2019 by David Merkel

Picture credit: DonkeyHotey || Should bonds get longer?

When I visited the US Treasury during the first Treasury/Blogger summit I encouraged the US Treasury to issue debts longer than 30 years, and also floating rate debt. I said the insurance companies, pension funds and endowments would be willing buyers, and that it would be cheaper than issuing 30-year bonds. I thought that the yields on (say) 50-year bonds would be lower than 30-year bonds, because the yield curve for most of my life (at that point) had the yield curve peaking out at around 22 years or so. 30-year bonds usually yielded less than 20-year bonds.

The case for issuing longer debt was easy when 30-year bonds yielded less than 20-year bonds. That is no longer true, and has not been true since the financial crisis. In a low interest rate environment, 30-year bonds yield more than 20–year bonds. In a higher interest rate environment, the relationship flips.

So, should the US treasury issue 50-year, 100-year, or perpetual bonds? I still think the answer is yes, and for three reasons.

1) It’s an experiment. The market doesn’t always know what it wants until you offer an option to it. No degree of discussion with the advisory committee can beat an actual offering to the market. There used to be callable T-notes, and even a Treasury note denominated in Swiss Francs. Experiments are worth trying on a small level just to see what happens. Knowledge is a valuable thing — theory is worth less than tangible data.

2) Rates are low. Why not lock in the low rates? Even if 50-year bonds have a premium yield to 30-year bonds, those yields are likely lower than what you might get when interest rates are high.

3) It would be genuinely useful for life insurance companies and pension funds to have a benchmark for 50-year bonds, which would encourage the corporate market to issue debt as well. Those who make long promises need others who will make similarly long fixed commitments.

Then there are the speculators, who I don’t care much about. They would appreciate longer debt as well, as it would give them a greater place to speculate.

My advice to the US Treasury is this: issue longer debt as an experiment. If there is additional cost in the short-run, see if it is cheaper in the long run. There is a market for longer debt, even if your advisory committee thinks differently.

The Asymptote of Joy and Woe

Posted on 9 October 2019 by David Merkel

Picture Credit: David Merkel / Aleph Blog || I call the middle of the graph “the slope of hope,” but really, it depends what side of the graph you are on…

This is one of my basic pieces on personal finance. The shape of the graph is illustrative, and the units don’t mean anything. It’s meant to motivate a simple concept that everyone should maintain at least a minimum savings buffer.

It is as Solomon said in Ecclesiastes 9:11:

I returned?and saw under the sun that?
The race?is?not to the swift,
Nor the battle to the strong,
Nor bread to the wise,
Nor riches to men of understanding,
Nor favor to men of skill;
But time and?chance happen to them all.
https://www.biblegateway.com/passage/?search=Ecclesiastes+9%3A11&version=NKJV

Accidents happen, both bad and good. We also will grow old, and get weaker. We may meet untimely deaths. Alternatively, we may live a comparatively long period of time, and find we didn’t lay enough aside for our old age.

Even the best of us may not plan well enough for the contingencies of life. That said, there is adequate preparation for most emergencies. First comes a buffer fund of 3-6 months expenses. Second comes basic insurance coverage: health, property and liability. Third comes insurance coverages for others that need your support: life and perhaps disability insurance. Fourth and last is planning for long term goals like retirement and perhaps some help for kids going to college.

This article is meant to deal with the first of those preparations — the buffer fund. It is meant to show how difficult life can be when you don’t have it, and how not having it likely means you may never have it. On the other hand, if you have the minimum buffer fund you may find that bit-by-bit, you get better off.

There are two reasons for this: first, both saving and not saving are usually habitual. This correlates partly with income, but more with your degree of future orientation. I’ve known managing directors on Wall Street that were living paycheck to paycheck. I’ve also known immigrants that earn little, but save half of it. Are you willing to sacrifice some of the present to gain a better future? Are you willing to consume the future through borrowing for expenses in order to have a temporarily better time in the present?

This is one reason why people with the buffer fund tend to keep going upward — they keep saving and investing. And, many without a buffer fund always find themselves in debt. Stuck in debt.

Then there is the second reason: accidents. Those with the buffer fund can handle most bad accidents, and can take advantage of most good accidents. We can call the good accidents “opportunities.”

When the person with the buffer fund faces a bad accident, it is typically a “speed bump.” Nothing notable happens to family life. If no bad accidents happen, he may find that he possess valuable options for the use of excess cash:

1) Pay your insurance premiums in annual installments?
2) Buy your next car without financing it?
3) Pay off your credit card bills in full each month?
4) Ask for a discount for cash when buying big ticket items?? (You?d be surprised.? I drove quite a deal with my orthodontist for my wife and eight kids. I?m the only one that hasn?t had braces.)
5) End the escrow account on your mortgage?
6) Pay tuition bills in full, rather than a payment plan?
7) Take advantage of financial crises, and extend credit at tough times?? (I am still receiving 13% from a business associate that I lent money to in March of 2009, with warrants.)
8 ) Retain cash in your corporation to reduce financing costs?
9) Not worry about the minor disaster that recently hit?
10) Raise your deductibles on your Auto, Home and Health insurance premiums to save money?
11) Receive discounts on services that you want to receive, by getting a discount for buying years ahead?
12) Fund your 401(k), IRA, HSA, whatever, to the fullest?
13 And more?
http://alephblog.com/2011/09/01/build-the-buffer/

When others are offering great deals in the rare times where they need fast cash, the man with the buffer fund (and more) can take advantage of the situation and become even better off.

He can also take advantage of the flexibility that has has to start a business, or, work for a startup that he thinks is particularly promising.

For those without a buffer, at best it can be treading water. But an accident can force someone underwater. Most of the avenues for borrowing with those not having assets who are borrowing to meet expenses are expensive in terms of the rate paid, and onerous in terms of the terms demanded.

Once enslaved to onerous debts, it becomes very difficult to get out of the slimy pit. Note also that credit scores affect all manner of economic affairs, and can affect insurance pricing (wealthier people are better risks on average), job applications, rental opportunities, and much, much more… consider this a minor third reason why my graph above applies. Penalties from banks and credit card companies are stiff, and further entrench debts.

And to those that are really bad off, driving uninsured, not keeping up with payments to the motor vehicles department of your state, not paying on auto debts can find their car repossessed, with the possible loss of employment if he can’t get there. At worst the person can lose the ability to rent and be out on the street. These thing don’t happen overnight, but I have seen them happen piece by piece. It is desperately difficult to reboot a life once you no longer have a place to live. Predators hire people like that, and find ways to cheat them. Those with no assets and many debts have no means of defense. In some cases friends and family may help, but even they cut their losses when things seem hopeless.

This is pretty glum stuff. Aleph Blog is first realistic, and second optimistic. Bad things like these happen, and the people who hit the bottom are typically not only poor money-wise, they are poor relationally as well. Typically they have offended most family members and friends on the way down, and are simply surviving in shelters and tent cities, maybe working, maybe begging, maybe stealing. It’s tough, and for those that work with them, it is exceedingly tough to rebuild the habits and conditions that modestly successful people have.

Closing

So is this just “The rich get richer, and the poor get poorer?” No, it is only partly that. For those that are starting out, make it you goal to be a saver and have a buffer fund of at least three months expenses. For those that are in debt and trouble, fight as if your back is against the wall, and pay off the debts. As you succeed, maybe some friends and family will see the change in your life and help you. For those that are working, but hopelessly behind on debt, declare bankruptcy with the firm determination that you will find a way to make it different in the next phase of your life.

Those at the very bottom need personal help to reboot their lives. Government programs won’t do it. Some churches and focused charities succeed slightly at it. It all depends on whether habits will change or not, and that is the toughest nut of all, humanly speaking. I have seen it happen. I have seen it fail. It comes down to the willingness to sacrifice to create a better life later, which is where this article began. Will you give up some of the present to get a better future? That is where the rubber meets the road.

PS — David X. Martin’s book Risk and the Smart Investor is an engaging way to deal with this topic for those that are better off.

Always Late

Posted on 8 October 2019 by David Merkel

Photo Credit: Brendan Ross || When policy is late it becomes procyclical. Better to do nothing.

Start with four premises.

1) One of the things everyone acknowledges about monetary policy is that it works with long and variable lags. It’s kind of like dealing with an unmanned space vehicle a long way away. You have to make choices taking into account the lag for the signal to get there, and the lag for the craft to send back data on what is happening. Fortunately with this the length of the lags are known.

2) Another thing that most economists acknowledge is that employment is a trailing indicator of the economy as a whole. Thus employment can misrepresent the strength of the economy. The economy can be strengthening rapidly, and employment has barely budged, or like now, the economy can be weakening and employment can seem really strong.

3) Then there is the Fed’s dual mandate, which means the Fed must try to aim for low consumer price inflation and low labor unemployment.

4) Further confusing matters here is the Phillips Curve, which posits negative correlation between consumer price inflation and labor unemployment. The key assumption of the Phillips Curve is that there is a fixed relationship between wage increases and price inflation. It is dubious that this theory ever worked. If it ever worked, it was during an era when closed economy macroeconomics was a reasonable approximation for how the US economy worked. This might have been true in the 20 years following WWII.

In an open macroeconomy like today, as the US economy strengthens, labor can be sought in many other countries than the US. The key assumption of the Phillips curve is wrong. Whatever modest effects exist are likely accidental and not structural.

I’m no fan of stimulating the economy. If you regulate the banks tightly to keep them solvent, the economy will largely self-correct. Booms and busts will still be there, but not as big.

But that’s not the way our culture views things. They want the government to manage the macroeconomy, even if that management won’t work so well. They want to believe in Oz. (Which, given that Oz was about the so-called failure of the gold standard, this has come full circle.)

Here’s how Oz can function better. The Fed can focus on GDP rather than employment, arguing that by focusing on GDP employment will follow for the most part — and that where it doesn’t follow so well, tell the truth that the Fed doesn’t have much influence over employment.

The opposite of this argument is like this article in the Wall Street Journal, where it says:

Referring to the latest Fed two meetings, Ms. George said, ?with moderate growth, record-low unemployment and a benign inflation outlook, maintaining an unchanged setting for policy would have been appropriate, in my view.?
Fed?s George: U.S. Economy Is in ?Good Place?

George is driving through the rearview mirror. GDP looks a little further forward, and the yield curve looks more forward still. The yield curve is a discounting mechanism, and predicts future movements in lending, GDP and employment, in that order.

So long as the controlling members of the Fed say things like “We couldn’t need to loosen, the economy or employment is strong,” amid an inverted yield curve, or ” “We couldn’t need to tighten, the economy or employment is weak,” amid a steep yield curve, it will always be late, and exacerbate booms and busts.

The Fed likes to trumpet its independence, but more than fearing Trump or Congress, they fear public opinion, and don’t want to take right moves that have bad optics. They would rather get there late, and pretend that the heroes have arrived on time. Going back to Oz, the Fed is a mishmash of the scarecrow and the lion.

Summary

My solution is that the Fed should look at forward-looking indicators, and educate the press and public about what they are doing. If they do that, policy will work better until the forward looking indicators lose their value. Oh well… search for new ones.

Postlude

I know some people tire of my musings on Central Banking. Personally, I hope this is my last post on it for a long time.

ETFs Increase Correlations, but not Overall Amplitude

Posted on 5 October 20196 October 2019 by David Merkel

Photo Credit: Steve @ the alligator farm

Recently in a tweet, I said:

Index Fund Investment Strategy: Michael Burry Warns of Bubble @Bloomberg https://bloomberg.com/news/articles/2019-09-04/michael-burry-explains-why-index-funds-are-like-subprime-cdos? The most this would do is increase the correlation of the movements. Unit creation & liquidation serve the same role as futures arbitrage programs that have existed since the mid-80s
https://twitter.com/AlephBlog/status/1179927420884983809

I am not in the crowd that thinks that indexing or ETFs will create a crisis. As I have said before, long-term performance of assets relies on the underlying productivity of the businesses issuing the assets. Short-term performance is also affected by the behavior of secondary market traders, but those effects get eventually washed out by the underlying productivity of the businesses issuing the assets.

And there you have it in slightly different garb: Ben Graham’s weighing machine versus the voting machine. The voting machine is transitory. The weighing machine is permanent. After all, think of a private business — it only has the weighing machine, and it does well enough producing cash flow for the owners, creditors, etc., without the sideshow of the price of its stock and bonds being publicly estimated each day.

In this case, the voting machine has people buying and selling bundles of stocks. But what does that replace? People owning equivalent amounts of individual stocks. People have varying propensities toward panic and greed. Those who would have sold their stocks in a panic or bought stocks in a bullish frenzy will do the same with the ETFs that they hold. It will be the same amount of selling pressure in aggregate.

Now, it is possible that some stocks are misrepresented in the ETFs in which they reside. My favorite example is refiners in the Energy Select Sector SPDR Fund (XLE) . The economics of most stocks in XLE are positively geared off of crude oil and natural gas prices. Refiners, unless they are gambling on their hedges, usually don’t hedge fully, and the economics are negatively geared to energy prices. Ever since XLE became popular, the refiners often trade in tandem in the short run with the rest of the Energy stock complex.

So what happens? Refiners then correct after a bull run of energy prices when their earnings don’t reflect the stock price. Vice-versa for positive earnings surprises in a bear phase for energy prices.

Summary

ETFs do present some anomalies for the markets, but they are localized to the sectors or strategies that are being pursued. For the market as a whole, they are simply pass-through vehicles that have little to no macro effects, aside from increasing short-run price correlation between stocks in the largest ETFs.

The Stock Market is not the Proper Measure of Politicians

Posted on 4 October 2019 by David Merkel

Photo Credit: ?Yiyo! || Politicians as a group are mortal; they might move the market in the short run, but in the long-run they have no impact

Whether Trump boasts over how well the stock market has done over his tenure, or Bloomberg notes how little the stock market has done over the last few years, both are wrong in placing emphasis on the stock market as a guide to evaluating a President or Congress. Why wrong? A number of reasons:

Time Measurement Problems

Though it is lost to the computer system at theStreet.com, in the Columnist Conversation, we once had a discussion over Presidents and the stock market. Measured by inauguration date, I provided a total return figure for each president back to FDR. Then we all proceeded, myself included, to explain why it was wrong.

Assuming a president does have a permanent effect on the market, when does it start and end? Markets are discounting mechanisms, and the changes in likelihood of being elected prior to the election might affect the market, as might the actions of the existing president, even if he is not on the ballot. How to separate those would be a challenge. Perhaps in hindsight we could make guesses when the eventual winner first polls over a majority of electoral or popular votes, but there would be troubles with this as well.

For another example, consider when a President is polling so badly that the market concludes he is a lame duck, and they expect the next president will be better or worse for the market. Who gets that performance?

Difficult to Separate President from Congress, and the Fed as well

The president isn’t the only actor that affects economic policy. Congress can propose its own agenda if it is united. It can help and/or hinder the agenda of the President.

Some analysts make a lot over a divided government, were neither of the main parties has full control. Divided governments come in two flavors: cooperative and hostile. Nixon, Reagan and Clinton were able to get a lot done in a divided government. For Obama and Trump, the hostility between the parties inhibited getting many new bills passed.

It’s also rare when the President has a Federal Reserve that cooperates fully with what he wants. There are a few Fed chairs that were like that: Greenspan, Burns and Miller. Given the lags in the effects from monetary policy, their actions left problems for the Presidents after their terms as Fed chair. The opposite was true for Fed chairs that took hard actions. They tended to hurt the current president’s economic agenda, while benefiting the next president.

My main point here is even if you measuring a president using the stock market, he’s not the only one affecting the stock market — it would be difficult to say what he was responsible for.

Factors outside of the government often affect the market more

Demographics, social change and technological change are things the President has very little effect on, and yet they have a large impact on markets. He should not receive the credit for things outside his control, positive or negative.

Policy has fleeting impacts and is often undone — all policy is temporary

Even if a President can enact policies that change things, the longest he will be in power is eight years. Given the frequent changes of what party the President comes from, even policies that are announced as permanent changes will likely be temporary. If you need proof of this, look at the tax code, which undergoes significant revision yearly.

Worse yet, many aspects of tax and spending laws are deliberately temporary in order to comply with deficit constraints. Don’t get me wrong, I am in favor of the constraints, just not temporary laws. You may as well not bother, and reduce the level of complexity. Predictability of laws and regulations tends to be an aid to planning, which aids growth.

Who cares about the market, anyway? A higher stock market isn’t necessarily better for the nation as a whole.

Just because the market is higher, or interest rates are lower does not mean that the nation as a whole is better off. A low cost of capital benefits future securities issuers, and reduces nominal income to future security purchasers. Warren Buffett has said that younger people should be rooting for lower security prices because it will give them higher returns for future investment.

For example, think of the State and municipal defined benefit plans that are choking on the lack of returns relative to what the sponsors imagined they would earn when they made the too expensive promises. On net, they would benefit from lower stock prices and higher interest rates.

The President doesn’t have that much effect on GDP either, but at least GDP is a little more neutral, taking into account all sources of returns not just interest and profits.

The Comment of Peter’s Grandfather

In the children’s music classic “Peter and the Wolf” at the end, Peter’s Grandfather who was proven wrong makes a statement to salvage a little pride, “Vot if Peter had not caught the Vulf. Vot den?” The question here would be, “Would Hillary have done any better as President? Would the stock market be lower or higher under her efforts?”

Even under conditions of perfection, we don’t have a “2017 Test Earth” to send Hillary Clinton to to see how well she would have fared as President. The stock market might have been higher under her than under Trump. After all, the Clintons were viewed by many Democrats to be pawns of Wall Street. On the other side, Trump is not much of a fan of Wall Street, being more of a borrower, rather than an investor in public securities.

And thus one of my points: there are so many things going on that we can’t tell whether the stock market would be higher or lower with Trump vs Clinton. Thus I will tell you that trying to analyze Trump or any other President via the stock market is a waste of time.

Summary

My points are threefold:

We can’t tell how much impact a President has on the stock market.
Even if we could, the stock market does not measure most of what a nation does, the happiness and security of its people, etc. It would be a poor measure of success for a President.
We don’t even know whether the stock market being higher or lower is better.

If I could change the minds of my fellow Americans, I would tell them that politicians are ineffective in dealing with the economy. The government should set basic rules of fairness, and then not interfere much. The government can better spend its time on public health, internal security, defense, and its court systems. Then let the states handle variable local affairs.

If we did that, government could work on things that they can have an impact on. The economy is not one of those things, so don’t evaluate your politicians off of pocketbook issues. They can’t do anything about those. Rather, ask if they are the right people to take care of matters of justice.

Easy In, Hard Out (IV)

Posted on 1 October 2019 by David Merkel

Photo Credit: Fabricio Olivetti || Beware situations where some governmental entity thinks that they have unlimited power…

This is the fourth in a series of posts regarding the Fed’s balance sheet, and quantitative easing. Unlike the first three, I’m not going to do the graphs of the composition of the Fed’s balance sheet that I did before, because I’m not sure it’s relevant to the present argument.

I want to quote a few passages from prior articles, because it has been so long. From the conclusion of article 3:

My main point is this: even with the great powers that a central bank has, the next tightening cycle has ample reason for large negative surprises, leading to a premature end of the tightening cycle, and more muddling thereafter, or possibly, some scenario that the Treasury and Fed can?t control.
Easy In, Hard Out (III)

The main thing that I got wrong in the prior parts of this series was assuming longer interest rates would rise, leading to a tightening of short-term interest rates. I expected my scenario 2 ( Growth strengthens and inflation rises), and we got scenario 3 ( Growth weakens and inflation remains low). Regarding scenario 3, I said:

3) Growth weakens and inflation remains low.? This would be the main scenario for QE4, QE5, etc.? We don?t care much about the Fed?s balance sheet until the Fed wants to raise rates, which is mainly a problem in Scenario 2.
Easy In, Hard Out (Updated)

I also thought that the Fed would have a hard time taking back the policy accommodation:

But when the tightening cycle comes, the Fed will find that its actions will be far harder to take than when they made the ?policy accommodation.?? That has always been true, which is why the Fed during its better times limited the amount of stimulus that it would deliver, and would tighten sooner than it needed to.
Easy in, Hard out

Back to the Present

The hullabaloo over raising the fed funds rate over 3% has passed. A debt-laden economy slowed down faster than expected, leading long rates to fall, and the yield curve inverted. The Fed has been loosening amid an economy that is middling-to-weak, grudgingly, because unlike most other loosening cycles, nothing has blown up yet.

(An aside: The Fed could have fought back via a balance sheet-neutral swap of all their bonds longer than 10 years for an equal amount of T-bills,and short T-notes. That would have steepened the yield curve.)

But we are in an environment where the Fed is trying to deal with everything, like an overworked superhero. Repo markets having trouble? Flood the short-term lending markets with liquidity, and reverse the shrinkage of the Fed’s balance sheet.

By removing risk from the repo markets, it incents players there to get more aggressive, because they know the Fed has their backs. Better to let the players know that the repo market is subject to considerable volatility. They need to consider liquidity conditions like any other prudent investor, realizing that losses are indeed possible.

Summary

The Fed needs to return to the days of Volcker and Martin, where they let risk markets go their own way, and focus on the real economy only. They won’t do that, because past Fed easy accomodation has led to a lot of debts, both public and private.

Monetary policy accommodation is “easy going in, but hard going out.” The financial markets now think of low rates and ample liquidity as a birthright, not a temporary accomodation, partially because servicing the debt in a low interest rate environment is a lot easier. It is also partially because rates were so low for so long that expectations have adjusted.

I don’t see how the Fed gets out of this situation. Sitting and waiting, swapping away the long Treasuries would not be the worst idea in the world. But when there is a lot of debt, it tends not to get paid down in a orderly way during a recession. Defaults will come cheaper by the dozen.

I don’t think avoiding financial fragility at this time is the best long-term option. The banks are in decent shape, despite the repo market. Corporate bonds and loans and low-end consumer loans will bear most of the losses in the next recession. Best to take the hit, and let everyone know that the Fed does not exist to facilitate speculation, but to restrain inflation, and promote labor employment.

Then maybe, post recession, we can get a growing economy, a normal-shaped yield curve, and a less-indebted economy… excluding the indebted US and municipal governments, which truly are hopeless.