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Not Your Parents' Financial Markets

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