Allison's Ode to the Second Moment


Welcome back to the 55th edition of Allison’s Ode to the Second Moment, a newsletter that got a fat tail this summer.

Have We Traded Volatility for Tail Risk?

I don’t know about you, but I spent August editing my book and thinking about the state of the business cycle. The economy has been growing at a slow and steady pace since 2009, as has the stock market. The bull market has been remarkable for low volatility and fairly low annual growth. It makes me wonder if long, lackluster, low volatility periods of growth are the new normal. It makes sense that they might be. Monetary policy is on its game in terms of managing inflation expectations. More globalization and better financial tools mean more diversification, which normally reduces volatility.

But here’s the rub: Maybe we will also face more tail risk—big, deep recessions, and spectacular drops in the stock market becoming more common. Globalization may mean less risk most of the time, but if we have a sudden pullback and more inter-dependency, there is also the risk of deeper downturns.

It feels like everyone is whispering about when the other shoe will drop. I find it interesting that few people are considering the possibility of a stock market correction and a mild recession. It seems we expect nothing less than a full-on financial crisis. Granted, no one pays journalists or market analysts to wonder when a typical, unsexy, inevitable downturn might occur.

Or maybe there is something to the idea that we now live in a low-volatility, fat-tail risk world. If so, is that so bad? I am not sure, if on balance it means we grow more, perhaps that is a cost worth bearing or maybe our policy tools will find a way to soften the blow.

No Sense of Any Kind of Risk

I really enjoyed this story in the New York Times by Jim Dwyer. He reports gubernatorial candidate Cynthia Nixon would like to double annual state spending in New York to $345 billion—almost four times as much as spending in New Jersey, Connecticut, and Pennsylvania combined. Dwyer ponders the size of this number and its place in the universe—and why not? After all, there is no earthly way to pay for it.

Nixon’s response drives a stake through the heart of Pension Geeks everywhere, “Pass it and then figure out how to fund it,” she says.

Is it just me or are we hearing this more at the federal level, too? I think we’ve become victims of our own success. Inflation is under control, so people think debt can be paid by seigniorage. The world regards treasuries as a safe haven, so people figure the government can issue as much debt as it likes without fearing that rates will increase.

This is not a good strategy if we now live in a fat-tailed world. Leverage is always great until it isn’t.

Don’t Even Think of Retiring Unless You Have a Kazillion Dollars

I understand that a self-financed retirement is a scary prospect. I also understand that baby boomers, the first generation with significant DC assets and few DB plans, are now retiring. Before these things existed, people just worked until they got too sick or died. We’ll soon see the results of this grand DC experiment. People are worried.

But I am not sure that scare articles of a retirement apocalypse are helpful. One of the latest suggests retirees need a 130% replacement rate! Who can save that much?

We used to think it was only 70%, so what has changed? Well, the authors of the story conducted a survey of workers on their ideal retirement. These workers thought of all the travel and entertainment they’d like to do after they retire. Yes, it is true that retirees spend more on travel and entertainment, at least early in their retirement.

BUT they spend a lot less on everything else. For example, they spend less on food, not because they have to, but because the opportunity cost of going to the grocery store and cooking meals goes down. Retirees also spend less on clothes, dry-cleaning, housing, taxes, and they don’t need to save. Not working saves money.

The survey is flawed because the researchers asked people who are still working and they just added on extra spending to their current lifestyle. Studies of people who are actually retired show retirees spend less.

And really? Paying $21,600 a year to maintain a car? That figure alone makes this whole survey highly suspect.

Because the fact is that people aren’t so screwed for retirement, unless they need to spend $22,000 a year on their cars.

Monetary Policy

I am confused. Monetary policy appears to be working well. So why is there a debate to revisit the mandate, and I don’t mean NGDP?

Fed Presidents Raphael Bostic and Neel Kashkari both think it is the Fed’s job to keep the yield curve from inverting. Why? It seems several times an inverted curve was followed by a recession for reasons we don’t fully understand.

I expect more from monetary policy. If we are going to base rate decisions on a single indicator, I think we should at least understand the mechanism of how that indicator causes or is caused by a recession. Maybe this time is different—have you seen the size of the Fed’s balance sheet or the funded ratio of pension funds?

New York Fed President John Williams agrees and is not worried about the yield curve. But seriously, why is this even a discussion smart people are having?

In Other News

Until next time, Pension Geeks!