For some time, I've been writing and talking about my concern with the economic path we're walking, the growing role of the U.S. Federal Reserve in the capital markets, and the wealth and income gaps spawned by misguided policy. Such policies, derived over the last 25-30 years, are generally well meaning and well intentioned. In the moment, they seem appropriate, even necessary. But collectively they take us down a dangerous path. Slowly but surely policy creep desensitizes us to more action and more stimulus, until we arrive at a place where the size of the numbers just doesn't seem to matter anymore. The U.S federal debt to GDP ratio was 107% in 2019. The Congressional Budget Office says 136% next year. And it will get worse - even with economic recovery - as entitlement program spending becomes more problematic.
I won't delve into the social implications here, but they are enormous. Maybe we're just starting to wake up those implications. Maybe we're just starting to see that the systems we put in place can embed racial inequality, for example (read the last third of this piece from Ben Hunt at Epsilon Theory if you're not sure what I'm talking about). Maybe the monetary system we have in place is promoting wealth inequality. For more than a decade (and arguably longer), monetary policy did little to support economic growth or wage growth but was incredibly successful in keeping bond yields down and stock prices up. Clearly the wealthiest members of our society, the owners of financial assets, have benefited significantly. Yet for the average worker real wages have been stagnant for some time. Ray Dalio has been particularly vocal on this point over the last 18 months, as you can see from his research and charts.
Instead, I’ll highlight that the economic system today is not capitalism the way that most Americans think of capitalism: free markets; little government involvement; creative destruction. No - it's an increasingly distorted version of those things. Many speak of the pandemic accelerating certain trends – count deterioration of capitalism among them.
Look at the way the financial markets are functioning now, as the Treasury and Federal Reserve use facilities established in March to support all kinds of bonds, from Treasury bonds, agency bonds, asset-backed bonds and commercial paper (similar to the financial crisis) to corporate bonds, municipal bonds, and other assets. As Jim Bianco noted in March, the federal government is essentially nationalizing large portions of the US bond market, and the Federal Reserve is providing the money to do it, with money manager BlackRock taking care of the trades.
And then this yesterday, from our friends at Cove Street Capital: "One thing that HAS changed over the last 30-odd years of investing is the "de-value" of securities pricing and market moves and what they suggest for the future, thanks to the legions of federal dollars under a myriad of asset classes and the massive amount of indexed assets. Did the panic of March really "mean" a long and painful recession or was it more of a massive short-term illiquidity event? Is the subsequent rally suggestive that all is well if it is the Fed that is doing the buying - or standing right underneath me saying buy or I will?...Do the prices of stocks, bonds, loans and real estate have less to do with the conceptual earning power of their respective assets than with federally funded liquidity? WWBRD [what would BlackRock Do]? BlackRock's global chief investment officer of fixed income Rick Rieder awesomely announced: "We will follow the Fed and other developed market central banks by purchasing what they're purchasing, and assets that rhyme with those.""
So…BlackRock's investment people have decided to ride along with the Fed. Is that how we want private actors in the capital markets making decisions about how to allocate capital?
Earlier this week it was announced that those special facilities now own bonds of AT&T, Comcast, Coca-Cola, Nike, ExxonMobil…why?
CalPERS announced on June 14 that - due to low interest rates for the foreseeable future - the famous pension plan will use debt in an effort to improve returns. Is that what we want from our pension plans?
It's not just the direct involvement of the Treasury and the Federal Reserve in the financial markets. It's that their activities seem to have ever growing influence on the actions of private, economic actors. Which means - to Cove Street's point above – those private actors are no longer making investing decisions based on the characteristics of individual securities. Instead, they are simply doing what the government is telling them to do.
These are not your parents' financial markets. And that should concern every one of us.