Back to Basics

At the Fed, for pension investing, and for our civilization

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Photo by Scottsdale Mint on Unsplash

Hello,

Welcome to Known Unknowns, a newsletter that is not betting on the end of humanity.

He looks the part

When 35-year-old Kevin Warsh was nominated to be a Fed Governor, I—a mere graduate student—thought it was absurd. It’s not like he had a strong academic or finance background, and it struck me as overtly political. But hey, sometimes weird people end up on the Board, and I think he did OK in the job. The people who think he did a bad job take issue with his concerns about QE and inflation—two issues he was eventually proved correct on.

I suppose there is a valid argument that inflation was not the pressing concern from 2008 to 2011; it was a slowly recovering labor market. But what more was the Fed supposed to do? It seems it did everything in its power, and then some, to boost demand, but the depth of the recession was too much.

And fifteen years later, the Fed manages this enormous balance sheet that creates all sorts of financial risks and makes it subject to more political attacks or demands (from both parties), and it all really messed up the housing market. And for what benefit? It never did much to boost employment.

Also, the Fed “learned its lesson” and decided unemployment was more important than inflation, and changed its framework in 2019. And then it let inflation run hot for more than a year—it’s still high! Because the Fed does not have great tools to deal with unemployment, but inflation expectations are forever (or just very persistent).

I say 2011 Kevin Warsh has been redeemed. He had some foresight, and I take back my earlier skepticism. Is he a great monetary policy thinker? No. But we could do worse, and if he scales back QE, gets the Fed refocused on inflation, and away from more political pursuits, he could even be what the Fed needs.

I understand the concern that he’s found low-rate religion to get the job. I don’t love that either. But Jay Powell also held off on raising rates while waiting on his appointment from Biden, and inflation was already running hot—so maybe that’s not unforgivable.

New era of institutional investing

Fed chairmen tend to have that job for a long time. Odds are some freaky stuff will happen during the Warsh regime, and we’ll see if he’s up to the task. I already see some big shifts in markets that will make the job harder.

Institutional investing already is looking very different. I wrote for Bloomberg about how the job is different now for pension fund managers. They used to have a fairly straightforward job: invest assets to pay benefits. This required balancing risk and reward—though it seems they often forgot that.

Certain truths emerged to guide them: Treasuries are risk-free, ESG is the best way to deal with long-term climate risk, and private investment offers higher returns and lower volatility. The last two were always a little silly. Nothing against climate risk, but how to invest for it is not clear, and it became an arbitrary and political exercise. Also, pension fund managers should know basic math (even if they often don’t behave like they do)—and a constrained portfolio will never outperform an unconstrained one over the long run. They seemed oblivious to the idea that they were taking on more risk and giving up returns. Did they not know better? I assume they did, but let’s be honest: this is becoming a political job.

Though I do get the motivated reasoning behind private investment enthusiasm—their pay structure encouraged it, even if it was starting to be less than prudent.

The Treasury issue is more interesting. A bunch of Scandinavian (and Dutch, who aren’t technically but kind of are Scandinavian) funds have declared Treasuries “no longer risk-free”—though so did BlackRock, to be fair. This feels more political than sensible. What other hedge is there?! Swiss bonds? (too thin), Gilts? (please), Gold? (no duration and lots of volatility).

That said, with more debt and persistent inflation, Treasuries aren’t what they used to be. The risk-free asset maybe should be a basket of stuff—but Treasuries will still be in there for the foreseeable future.

Boomer resentment is about all the wrong things

I really don’t get the Boomer hate. Or I do, but for different reasons. There is so much resentment that they had it easy (they didn’t) or ruined the climate (generations before them did), but almost none for national debt. If people take to the streets, write books, and New York Times columns to complain about seniors, why not advocate for something productive like debt reduction or entitlement reform? There is so much energy around intergenerational resentment, but always about the wrong things.

Maybe because most people get old too. Or my theory is this is less about intergenerational strife and more about expanding the government. We live in strange times. Somehow people believe the state’s capacity for spending is infinite, but markets can only offer finite resources that are unfairly distributed. Actually, the opposite is true.

Don’t take retirement advice from Elon Musk

I am not an Elon Musk hater. No one can deny he makes the world a more interesting place. But he is wrong about retirement. One thing I kind of like/hate about these Silicon Valley guys is their sense of importance. They are important—they are coming up with the innovations that will change the world, provide the growth we need, change humanity, etc. But come on. AI is a big deal—but it’s not fire. I am not even sure it is the steam engine. Maybe you have to believe all the hype to do the job, but the rest of us don’t.

So when Elon says this will be so big you don’t need to save for retirement, he is wrong. Even if market expectations are met or exceeded, you still need money when you retire.

You will definitely need all the wealth you’ve got if AI does not turn out to be steam-engine-worthy. And if you invest in markets, you are already long AI working out. Don’t stop saving too.

To be fair, the other alternative is AI kills us all. In that case, you don’t need to save. But that’s a tail case.

Until next time, Pension Geeks!

Allison