Cliff Asness On The Inflation Imputation

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Cliff Asness On The Inflation Imputation
Image Source: Bloomberg Video Screenshot

great economic benefits. The Fed clearly wanted this money lent by banks and spent by companies on investment and by people on consumption. They didn’t get that, and we didn’t get the inflation we feared. This is not to say that low interest rates, real and nominal, and high prices for risky assets (and the supposed “wealth effect” that comes with them) were not Fed goals. They clearly were. But it seems these intermediate goals have not had their desired effect on the real economy.

Quantitative easing (QE) and other inventive forms of loose monetary policy have simply been less than hoped or feared. Some may declare Fed policy a great success as we’re not in a depression, but they can’t show any counter-factual, and given that this money has largely sat dormant, albeit presumably lowering risk premia (raising asset prices), it’s likely we’d have a similar record-weak recovery with or without it. How this is a victory for one side of the debate or another is beyond me, but obviously clear to Paul and his back-up singers. Of course, it’s also clear to Paul that the 2009 stimulus package saved us from this same second Great Depression (but more stimulus would of course have been much better). Yep, and if we traded good cash for just one more “clunker” we’d be growing at 5% per annum by now with a normal labor participation rate.

By-the-way, ignored in the critics’ review of the original letter was the line, “In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program…” On this I’m unapologetic. We were right, we’re still right, and thanks to people like Paul we’ve moved in the wrong direction. But that’s a fight for another day.

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In a field without a broad set of counter-factuals we all stick too much to our priors and ideologies, and perhaps I’m doing that now. But at least I see it, and that’s always step one. Paul is stuck on step zero (if he ever gets up to “making amends” I will be around but given his history he might never get to me). But, if you’d like to advance past step zero, Paul, we’re still waiting on why Keynesianism failed to fix the Great Depression (no doubt not quite enough stimulus; just one more Hoover Dam would have done it, or, as they called it back then, “Dams for Clunkers”), strongly predicted a deep post-WWII depression, didn’t predict stagflation, and generally was on a the downward spiral to the intellectual dustbin until the great recession resuscitated it, not as a workable intellectual doctrine, but as an excuse for politicians to spend on their constituents and causes.

Also remember, much like when the Germans bombed Pearl Harbor, nothing is over yet. The Fed has not undone its extraordinary loose monetary policy and is just now stopping its direct QE purchases. When monetary policy is back to historic norms, and economic growth is once again strong, a normal number of people are seeking and getting jobs, and inflation has not reared its head, I think we can close the books on this one, still recognizing that forecasting a risk and having it fail to come to bear is not a cardinal sin. But which one of those things has happened yet? Paul, and others, should by now know the folly of declaring victory too early.

At the risk of enraging a whole different group (I promise I’m not denying anything I’m just making an analogy, and one I know is very far from dead on) I’m amazed that a Paul Krugman can look at 15+ years of the earth not warming and feel his beliefs need no modification or explanation, but 4 years of the CPI not inflating is reason not simply to declare victory, but to decry those who disagree with him as “Knaves and Fools.” In fact, rather than also anger Mr. Gore and Steyer, I hope they find this paragraph supportive as I’m saying these debates are rarely settled in either direction in short time frames. Now, if I were cheekier (cheek is not denial!) I’d ask if perhaps our letter was right and the inflation we predicted is in fact occurring in the depths of the ocean? Or, maybe we should ex post relabel our letter a warning of the risk of “extreme price action” including of course the extreme stability we have experienced in CPI these last few years.

Now, while not pointing to the actual ocean it is fascinating where inflation has shown up. Don’t limit your view of inflation to the CPI. No, this isn’t a screed where I claim to have invented my own consumption basket showing inflation is rising at 25% per annum – though some of those screeds are interesting. It’s the far simpler observation that we have indeed observed tremendous inflation in asset prices since this experiment began (of course this was part of the Fed’s intent – but it was meant to stoke real activity not an end unto itself!). Stocks, the spreads on high yield bonds, real estate, you name it. Inflation is hard enough to forecast, but where it lands is even harder. If one counts asset inflation it seems we’ve indeed had tremendous inflation. While admittedly difficult to prove, as is any of this if we’re being honest as economics rarely offers proofs, you’d be hard pressed to find many economists or Wall Street professionals who don’t see current extremely high asset prices, and low forward looking returns to investors, as at least a partial consequence of the cocktail of QE, loose monetary policy, and financial repression. I understand Paul and others wanting to avoid this as not only does it show that they have no right to crow on inflation, but that the policies they advocate, and we decried, have had little effect on the economy but instead have, at least partially intentionally, exacerbated the inequality Paul spends the other half of his columns excoriating (while of course living himself off the global median income in protest and solidarity).

By-the-way, again the critics somehow manage to skip another prescient forecast in this same short open letter. We explicitly worried that the Fed’s policies “will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.” That’s econo-geek for “will drive financial market prices up and prospective returns down, and create financial instability when the Fed tries to stop.” Again, while this would perhaps not surprise the Fed, which actively desired low interest rates and a “wealth effect,” it seems that a fair reading shows that this much maligned letter wasn’t as wrong as the critics say, and was very right in ways the critics ignore.

Moving on, please recall that many, not all, supporters of QE and very loose monetary policy in general, did so exactly because they thought it would create some inflation, and they thought (and many still think) that’s what the economy needs. We, we the letter signers, are responsible for our own forecasts, but you might forgive us a bit for taking the other side at their word!

Bottom line, the half mea culpa above was not a throw away. When you go out of your way to warn of a risk and after a suitable period that risk has not come to bear, at least where everyone, including you, expected it, you should admit some error, and I do. But there is a still a big difference between pointing out a risk and making a forecast (hence the half admission!). A big reason this risk hasn’t come to fruition is, while not as dangerous so far as we thought, it appears QE was only mostly useless. To the extent even that is only mostly true, where effects did show up, it actually caused rather a lot of inflation, but inflation that went straight into the pockets of those who needed it least and whom Paul wouldn’t swerve his car to avoid. That is, it inflated financial assets, benefited the rich, and enhanced inequality.

So, to those who’ve been waiting for one of us to say it, you can have half the mea culpa you clearly want, but mostly Paul is wrong, and twisting the facts, and doing so as rudely and crassly as possible, yet again. The rest of the JV team of Keynesians who have also jumped on board are doing the same thing, just with more class and less entertainment value than the master.

Now for a real prediction: Paul will continue to be mostly wrong, mostly dishonest about it, incredibly rude, and in a crass class by himself (admittedly I attempt these heights sometimes but sadly fall far short). That is a prediction I’m willing to make over any horizon, offering considerable odds, and with no sneaky forecasts of merely “heightened risks.” Any takers?

Cliff Asness is Founding and Managing Principal of AQR Capital Management, LLC

Dear Saver, May You RIP

By Peter Boockvar, The Lindsey Group LLC

Dear Saver,

To the forgotten and misunderstood soul, may you rest in peace. There just seems that nothing can save you now. You were bloody and battered after the stock market bubble crashed in 2001 and 2002. Afterward, you stuck with stocks but also decided to play it safe in real estate. That was ok for a few years but your stock portfolio fell again by 50% and while you have a great new kitchen and wood paneled library, the value of your house is now worth much less than your mortgage. I know, renting can be so much easier! But some guy named Greenspan said something about a wealth effect.

Finally you said enough is enough. You wanted a safe, conservative place for your savings where living off fixed income of mostly CD’s and bonds was possible. Maybe you’d buy an occasional stock again but maybe not. You called your local branch banker and were told that for the privilege of being a Platinum Honors client that you would be able to secure a better rate on a money market savings account. Nice! You were told that you’d be able to get .10%, more than triple the standard rate of .03% that the average person gets! Disgusted, you went online and saw this great add on the Bank of America website, it said “With a Featured CD I can earn a fixed rate on my nest egg.” Sounds enticing until you scrolled down the page and saw it paid .08% for a fixed 12 month term. It had to be a typo but unfortunately it was not.

Questioning now how you can ever retire on your savings after working hard for the past 40 years, you decided to find out who can possibly be responsible for these pathetic yields when you know your cost of living is rising well above the 1.5-2% that these statisticians at the government keep telling you. You ask what an hedonic adjustment is? Don’t worry about it because the purchasing power of your money relative to inflation has been declining day after day for at least 6 years now. This is madness you say. I agree.

You started to read the papers and watched the news and learned that the men and women that work at the Federal Reserve, mostly economists who call themselves central bankers, sit around a large table and decide what the right interest rate should be. Ok you say, they are smart, they have models created by people that likely did really well on their SAT’s, they know what they’re doing and this can’t last. Well, I’m sorry to say to you, we’re 6 years into zero interest rates and these people have no intention of ever saving your savings. You’re screwed and even though they say it’s in your best interest because zero rates and money printing will help the economy, don’t believe them anymore because the strategy has failed. After all, If these policies actually worked, I wouldn’t be writing this letter to you.

I wish I had good advice for your savings but I can’t advise buying stocks that have only been more expensive in 2000 on some key metrics right before you know what and I can’t recommend buying any long term bond as the yields also stink relative to inflation. With the Fed now saying that the dollars in your pocket are now worth too much relative to money in people’s pockets overseas and thus joining the global FX war maybe you should buy some gold but I know that yields nothing either. You are the sacrificial lamb in this grand experiment conducted by the unelected officials working at some building named Eccles who seem to have little faith in the ability of the US economy to thrive on its own as it did for most of its 238 years of existence. Borrowers and debt are their only friends. To you responsible saver that worked hard your whole life, may you again rest in peace.

Sincerely yours,

Peter Boockvar
Managing Director
Chief Market Analyst
The Lindsey Group LLC

Calvin the Super Genius

By Ben Hunt, Ph.D., Salient

People think it must be fun to be a super genius, but they don’t realize how hard it is to put up with all the idiots in the world.  – Bill Watterson, “Calvin and Hobbes”

Here is the most fundamental idea behind game theory, the one concept you MUST understand to be an effective game player. Ready?

You are not a super genius, and we are not idiots.  The people you are playing with and against are just as smart as you are. Not smarter. But just as smart.  If you think that you are seeing more deeply into a repeated-play strategic interaction (a game!) than we are, you are wrong. And ultimately it will cost you dearly.  But if there is a mutually acceptable decision point – one that both you and we can agree upon, full in the knowledge that you know that we know that you know what’s going on – that’s an equilibrium. And that’s a decision or outcome or policy that’s built to last.

Fair warning, this is an “Angry Ben” email, brought on by the US government’s “communication policy” on Ebola, which is a mirror image of the US government’s “communication policy” on markets and monetary policy, which is a mirror image of the US government’s “communication policy” on ISIS and foreign policy. We are being told what to think about Ebola and QE and ISIS. Not by some heavy-handed pronouncement as you might find in North Korea or some Soviet-era Ministry, but in the kinder gentler modern way, by a Wise Man or Woman of Science who delivers words carefully chosen for their effect in constructing social expectations and behaviors.

The words are not lies. But they’re only not-lies because if they were found to be lies that would be counterproductive to the social policy goals, not because there’s any fundamental objection to lying. The words are chosen for their  truthiness, to use Stephen Colbert’s wonderful term, not their truthfulness.

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