It’s Not About The Fed

Financology doesn’t exist because there’s a shortage of financial information in the media. It’s because the information is so bad. Three major television networks, and countless print and online sources, much of it free and worth even less. There would be little point in just rehashing mainstream data and views, so we don’t do it. This isn’t mere generalities … we cite specific examples.

Most of the time the bad coverage is just bad interpretation. Sometimes it’s outright factual slop. Just minutes ago for example a guest expert on Bloomberg, apparently trying to give viewers a reason to buy stocks, informed them that the “average S&P stock is 15% below its 52 week highs.”

This is a verifiable statement of fact. A quick check reveals it fails. The equal weighted S&P ETF, RSP, practically defines “the average S&P stock”. Its 52 week high is 155.77. It closed today at 147.27. Dividing the former by the latter yields 0.9454. That’s 5.46% … uhm … not quite 15%.

Yet the more serious misinformation lies in the area of narratives. Today’s poster child: The story that bonds and stocks are selling off because the market perceives the Fed will hold rates higher for longer. You heard it … it’s that grinchy, hawkish Fed spoiling all our market fun. 

Just one thing that might pique our skepticism is the lack of attribution. On what factual data is this based? We have previously noted the noteworthy inflection in markets that occurred with the change of calendar from July to August. No need to take my word for it, just pull up a chart. Stocks peaked on July 31, then began to sell off on August 1.

A popular semi-explanation is that stocks are reacting to higher bond yields. Perhaps to burnish it with a pseudo-intellectual patina, it’s sometime cast as higher “real yields”. Okay, now we understand. Real yields went higher. Never mind why … we’re just supposed to think we’ve been gifted a genuine insight into underlying cause. We’re evidently also not expected to wonder how a difference in a few months or so of Fed policy could have such an outsized effect on ten-twenty-thirty year yields.

As you may have guessed by now, we have a better explanation for lower Treasury prices. And we won’t hold you in suspense … it’s staggering Treasury supply.

And we won’t skimp on attribution either. Our smoking gun, straight from the United States Treasury itself:

Readers will really want to check our source, but the upshot is that Treasury announced plans to go to the capital markets to borrow over one trillion dollars in a single calendar quarter. Note the date: July 31, 2023.

Meanwhile the mainstream (read Wall Street Establishment) media would have you believe that, after the Fed has spent the better part of a year telling us it intends to hold rates higher for longer, that it has finally just dawned on markets, inexplicably, on August 1, 2023.

Why would Wall Street want to mislead us? Alas, here we have to depart the domain of hard facts and logic for mere speculation. Possibly Wall Street has a vested financial interest in deficits and inflation. But rather than dwell on speculation, let’s return to the hard stuff, where we can state with certitude that every unit of purchasing power spent by the Federal government comes from somewhere. It’s not manna from heaven. Some is collected through direct taxes. The remainder is collected through the financial system.

If anything, the pressure of such borrowing demand may drag the Fed’s rate policy higher. 

Another story making the rounds for instance is the historic unaffordability of homes. First prices soared, then mortgage rates skyrocketed. In other words, first the dollar lost purchasing power (inflation), then the cost of borrowing dollars rose. This one-two punch of lost purchasing power is depriving millions access to affordable housing. Where did it go? After all, it’s been said that deficits don’t matter.

Until they do. Folks, there may be an unlimited supply of dollars, but the supply of real, actual, capital is finite. What is taken by government is not available to the private sector. The Fed can only influence the form in which it is taken … either through deceased purchasing power of the currency, or though an increase in the cost of borrowing it. Or, as is presently the case, both.

Just don’t expect your favorite corporate news media to connect those particular dots…


14 thoughts on “It’s Not About The Fed

  1. Finster says:

    This isn’t to completely exculpate the Fed. To the contrary, excessive deficits started there. The short version is the Fed’s decade and a half of ultralow rate policy was what led to the ultralarge deficits in the first place. In a system where money is created by being lent into existence, rate cuts “work” to expand money supply (induce inflation) by making borrowing cheaper. Politicians respond like everybody else … by increasing borrowing. It’s no accident that deficits began to explode in the 2010s, and went nuclear in the 2020s.

    The trouble is … getting out of it isn’t as easy as getting into it.

  2. jk says:

    i”m wondering about the effects of demographics here, and whether funding the debt will be less of a problem than we all think.
    in my own post, i blamed a good part of the 70’s inflation on the baby boom entering its household formation phase. now that same large cohort is retiring.
    a lot has been made about the low number of active workers per retiree as this progresses. another consequence, though, is a shift in asset allocation and investment behavior by the boomers who, after all, have all the money.
    the target fund model captures the essence of that shift: it increases its bond allocation as the owner ages. even baby boomers with more imagination than the owners of such a fund will become increasingly risk averse. they can’t afford sequence of returns risk when they have a limited number of years to possibly make up losses.
    i’m an experienced investor but at my age i’m very concerned about risk. i think of my commodity, precious metals and real estate investments as DEFENSIVE, though some might view it otherwise. i say this because i think of those as a defense against a loss of purchasing power. and, even so, i chose to put 25% of my assets into [crappy] tips – government bonds of a certain sort. and i currently have about 12% in cash – short duration treasury paper. so i’ve got about 3/8 of my assets in gov’t paper.
    how many boomers are doing something similar, either through target funds or on their own? i said the gov’t would at some point mandate a portion of ira’s goes into treasuries. i’m already there, sans mandate.
    another thought about demographics goes to the balance of supply and demand. all the retired boomers will still be consumers. and the producers will have to produce for both themselves and the non-productive. all the boomer assets will represent excess potential demand, excess paper claims on future goods and services. this seems like a setup for continued inflation irrespective of other factors like gov’t spending.
    [i’m wondering how to incorporate international flows into this thinking]
    in sum it looks like decent demand for treasuries along with inflation until the boomers have passed on, and in the process passed on their assets by spending, gifting or bequeathing them. and given the inflation, we’re looking at high interest rates for the foreseeable future.
    i’d be very interested in others’ thoughts about whether this argument makes sense.

    1. Finster says:

      Just to clarify, my use of the term “inflation” to refer to a decline in the value of the currency has some possibly nonobvious implications. Not all price increases are inflation … I distinguish between inflationary price increases and real price increases. One consequence of this is that in my economic framework, inflation has nothing to do with many of the factors it’s often blamed on. Technology and demographics for instance have nothing to do with inflation. Technological advance may lead to real price declines. Demographics could possibly lead to real price increases or decreases. This may seem theoretical or esoteric, but it has practical implications. Changes in the real price level aren’t the responsibility of monetary policy, only inflationary ones are. The central bank can do nothing about technology or demographics or supply chains, but the value of the security it issues is patently its business. How can you tell them apart? The true measure of value isn’t things, it’s human time.

      So though it may seem a bit of a cop out, I don’t expend any time thinking about demographics in relation to inflation. If anything I think it’s often used as a scapegoat for bad policy. “The ship may be headed for an iceberg, but it’s not our fault!”

      This extends to the fiscal area as well. Is the problem really that the real world changes? Or that as it does, government programs remain rigid and inflexible?

      I look at investing in much the same defensive way. I have a sizable allocation to stocks, but view it as defensive. It’s a defense against inflation. Stocks are an excellent inflation hedge. So are commodities, including gold. But they each work best in different phases of the inflationary cycle. This is simply just not recognized in conventional canon, because it erroneously identifies “inflation” in terms of consumer prices. No. Consumer prices are near the end of the inflation pricing chain. By the time you see it there, it’s already getting old.

      This misunderstanding of inflation leads to all sorts of rubbish opinion, for example “gold is not a good inflation hedge”. Nonsense … what they really mean is it doesn’t correlate well with the CPI. Of course it doesn’t. By the time the CPI is making headlines, policymakers are on the case and the risk is waning.

      Investors that ran for gold when the YOY CPI was hitting 9% are like people trying to buy home insurance once it’s already on fire. Gold took off when inflation did, in March 2020 when the Fed hit PRINT. The early bird got the worm.

      That doesn’t mean I don’t invest in bonds. Some allocation to bonds is necessary just to offset the short position embedded in stocks. Most companies have debt on their balance sheet. If I think the risk of deflation outweighs inflation, I keep even more.

      The bottom line is that my investment process is also dominated by defense. We’re in good company … Warren Buffett, considered by many to be the world’s greatest investor, has two rules of investing: 1) Don’t lose money. 2) Don’t forget Rule No. 1. I just translate “money” in real terms.

  3. jk says:

    i don’t follow you, bill. if demographics could lead to “real” price increases for all or most goods, hasn’t the numeraire decreased in value? what’s “real” in that scenario?
    it’s too many paper claims and not enough goods and services to fulfill those claims at current prices. thus prices must rise or, mutatis mutandi, the dollar must fall.

  4. Finster says:

    There’s a hidden premise in your argument that needs to be exposed for examination.

    It’s a near universal assumption of conventional economics … that value is defined by things. It isn’t even stated, let alone debated. It’s not just that popular measures like the CPI invoke some dodgy methodology, it’s the whole premise that goods and services are a value invariant. Things.

    What if that’s wrong? What if human time is the real basis of value, the fundamental invariant? If it is, then the entire conventional enterprise of conceiving and measuring inflation operates on a foundation of sand. And everything else built on it.

    A foundational tenet of economics isn’t even scrutinized. For a field pretending to the status of science, that’s just not very good. Its track record is hardly a ringing endorsement either. So I take nothing in conventional economics for granted. Everything has to be rebuilt on a strictly first principles basis.

    So to your specific point, suppose human time represents real value. If, in the aggregate, it takes more of it to produce and market a given body of goods, their real price has increased. Currency value doesn’t even enter the equation.

  5. jk says:

    technology and the increase in all factor productivity lead to a diminished time input into everything i can think of. so in time terms, we have continuous deflation. but producing a good doesn’t mean the producer can, in fact, claim that good. given other inputs into production [do we have to back-calculate all the time inputs into those: the time to dig and refine any material inputs, the time to produce the machinery to do that, the time to accumulate capital, and so on?] the nominal compensation to the producer will in general be less than the nominal cost of the object produced.
    so the producer must spend more time to accumulate nominal claims in order to purchase his/her own product. [let’s skip a detour into the marxist labor theory of value and marx’s concept of alienation.] i suppose we can say this reflects compensation for all the time put into the other inputs i mentioned above.
    i know that your dollar index is based on human time, so you must have addressed these complexities in some fashion. and as i look at your dollar index i think it does a pretty good job, at least given my intuitive sense of what’s happened to the value of a nominal dollar over time.
    i live my life in the nominal economy. i earn and save and invest nominal dollars; i purchase goods and services with nominal dollars. of course, you may choose not to call a change in the general price level [as conventionally defined] “inflation” or “deflation,” and choose instead to define what you call “real” changes in cost in terms of the time involved in obtaining them. nonetheless, the value of nominal dollars viewed as claims on goods and services is a matter of importance to me and i suspect to other readers as well.

    1. Finster says:

      “technology and the increase in all factor productivity lead to a diminished time input into everything i can think of. so in time terms, we have continuous deflation”

      If real price declines are deflation, then what do we call a collapse of money and credit? What do we call it when prices fall due to an increase in value of the currency? My point is we can’t rationally talk about things like inflation and productivity and such unless we’ve first dealt with the issue of the basis for measuring value. Economics hasn’t done that yet, just skips right over it and carries on as if it’s settled. Again, in no kind of real science would such sloppiness be acceptable.

      So we wind up with practically universally accepted notions like “technology is deflationary”. Or “demographics is inflationary”. I say, no, you can’t just say that without first addressing what these things mean and how you define value.

      Whether we “live in a nominal world” doesn’t touch on it. That invokes currency value, which doesn’t even make sense until you can articulate a basis of value.

      I could make a case that human time, not things, defines value. But is it even called for? After all, conventional economics has never bothered to justify its assumption that things define value.

      But let me at least show that it’s an issue. If things define value, then a buggy whip is worth the same in 2023 as in 1923. An an iPhone was worth the same in 1923 as it is in 2023. Absurd, no? And what would the world’s body of goods be worth with no humans around to observe it? Meanwhile the one thing that never changes is how much of our time we have. Every human being has the same. The same in 2023 as in 1923 … 365 days, 24 hours each day. Technology doesn’t change it. Productivity doesn’t change it.

      I think if economics wants to define value in terms of things, it has some work to do.

  6. jk says:

    here’s an essay you might like; “wealth is the control of time”

    1. Finster says:

      Interesting … I wouldn’t go so far as to claim that it endorses my axiom of human time as fundamental value invariant, but it’s consistent with it.

      1. Finster says:

        It’s also worth noting that even as some things decline in real price over time due to technological advance, other things increase. Take for example miles of oceanfront real estate. The quantity of such stays essentially constant while population increases. On a per human hour basis, it grows scarcer. You could say the same for land or any units of the earth’s surface area in general, or even elementary commodities.

        What are the policy implications? Should policymakers focus on the price effects of technology and productivity and inflate money and credit to compensate for their supposed deflationary effects? Or deflate money and credit to hold nominal prices of finite resources steady?

        If you’re Alan Greenspan, you might just focus exclusively on the former while incanting your “productivity” mantra and blow bubbles with easy money.

  7. jk says:

    i don’t think your buggy whip and iphone examples work, since the value of a “thing” is dependent on the context of all the other things around it, i.e. there’s a network effect. no buggies, no value in buggy whips. no cell towers, no value in iphones. so one kind of value of a thing is thus dependent on its utility within its social and physical environment.
    and what is the personal value of some object or service? i’d say it’s the work required to purchase it. and in that sense i’d agree it’s human time, but then i have to recognize that society compensates people at differnt rates. a 5 hour cost for one individual might be a 50 hour cost to another, and perhaps worth it to the former but not the latter.

    1. Finster says:

      “i don’t think your buggy whip and iphone examples work … one kind of value of a thing is thus dependent on its utility within its social and physical and physical environment.“

      Utility to who? What if there were no people?

      No human time ⇒ no value.

      “and what is the personal value of some object or service? i’d say it’s the work required to purchase it. … society compensates people at differnt rates. a 5 hour cost for one individual might be a 50 hour cost to another …”

      Let’s apply the same logic to the “things” standard. Things vary wildly in value. A buggy whip is not the same as a smart phone. Therefore the things standard of value is invalid.

      We could do the same with time as with things; look at aggregates. But first let’s recognize that I have nowhere proposed human labor as a standard of value. It’s invariably been human time. Of which everyone has exactly the same endowment, each hour, each day, each year. How they spend that time is their ultimate expression of value.

      Work is only one option. They might choose to spend it with family or friends, make art, or enjoy the fruits of their labor and go shopping. That too is an expression of value. They might choose to go to school, in which case they’re expending many hours in advance to increase the economic value of subsequent hours of labor, which has to be counted as part of the time they spent earning their pay. But wait

    2. Finster says:

      … we’re getting ahead of ourselves. My examples don’t have to work. Let’s suppose, for the sake of argument, that I’ve made no case for human time as the true standard of value. Let’s weigh that against the case conventional economics has made for its things standard.
      [… crickets …]

      Then so far in the contest between things and human time, the score would be an uninteresting 0 – 0. I’d be satisfied with that … in fact I haven’t really even tried to make the case for time yet … it’s not my turn. Having built an entire edifice of doctrine on the former, don’t you think it’s incumbent on conventional economics to make the first move? How does it fall to anyone to make an affirmative case for any alternative until conventional economics bothers to make its own?

      It could make a case based on first principles. Crickets. Next best might be pointing to a successful track record of policy based on its doctrine. For example, widely shared prosperity, free of bubble and bust dynamics, stable currencies, world peace, no inflation, deflation, anyflation…

      Come to think of it, it’s more like -1 – 0.

      Let’s face it, JK. Conventional economics is a mess. It’s high time it started examining its own premises. As the opening paragraph of this post hints, our job here is to help it get started.