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Prices Cannot Go Down

Back in 2013, Ben Hunt of Epsilon Theory published an article titled “A World of Guarantees.”1 To humbly summarize:

  • The Federal Reserve moved from implicit (or probabilistic) backstops under Greenspan to explicit guarantees under Bernanke (and BTW, the explicit guarantees continued under Yellen and now Powell)

  • That change in Fed policy is contrasted with changes in U.S. nuclear deterrence policy during the Cold War, from explicit guarantees (a few clear lines) to probabilistic promises (many fuzzy lines) thereby making the promises more effective

  • Governments and their agencies are drawn to explicit guarantees as a way to avoid outright failure and ensure their continued place in society

  • Explicit guarantees may “feel” better but make no mistake – there is a price to pay

Since the 2008-09 financial crisis the Federal Reserve (and the world’s other major central banks) has continued to communicate to financial markets that support will be forthcoming if and when needed. Worried about the federal debt and U.S. government credit rating? The Fed was there with Operation Twist (2011). Worried about interest rates increasing? The Fed was there to abruptly change course (2018). Worried about the pandemic? Some may say Covid-19 is a different class of problem, and the Fed needed to act…but did the Fed really need to buy the bonds of AT&T and Microsoft?2

What we’ve learned, over and over, is that prices cannot go down again. At least not for long.

“The future looms large today as a threat rather than as a promise, because the American regime (and by extension, the global regime) cannot withstand another nationwide decline in US home prices or a serious decline in the US stock market. Why not? Because the programmatic guarantees already made by the American regime (pensions, retirement insurance, medical insurance, poverty insurance, housing insurance, food insurance, banking insurance, etc.) cannot withstand a deflationary environment. It is politically untenable for asset prices to go down again, and so they won’t. If that comes at the cost of massively pulling forward demand for risk assets, of creating the mother of all crowding-out effects in Treasuries, of creating a $4 trillion balance sheet to fund an umbrella guarantee program, of lowering the structural growth potential of the country and the world … well, so be it. The goal of any regime, any organism, is to maximize its chances of survival. Deflation is the perceived existential threat of our age, and this is the dragon our Heroes will guarantee to slay.”1

Is there any doubt that financial markets reflect these programmatic guarantees? Is there any doubt that Hunt’s words in 2013 remain as true – if not more so – today?

As an example of where this leaves private investors, look no further than Berkshire Hathaway’s 2020 annual report and Warren Buffett’s letter. For the first time in many years Buffett didn’t talk about Berkshire’s “elephant gun” being loaded and ready for a large acquisition. Instead, Buffett talked about the insurance business, the energy business, the railroad business – and how Berkshire bought back stock in 2020 (about 5% of all shares outstanding according to Barrons3). And apparently those repurchases have continued, with another 1% snapped up in the first two months of 2021. This represents a significant change in capital allocation at Berkshire.

Yes, Berkshire will continue to find a few stocks here and there for the public stock portfolio. But large acquisitions at reasonable prices are not happening any time soon. And so Berkshire is left with few options for its large cash hoard than to buy back stock. No tears need be shed for Berkshire. Just a symptom of “prices cannot go down” policy.

Full faith and credit has its consequences. Distortions arise. Capital is misallocated.

The relationship between governments and markets has changed. This is not capitalism, and these are not private markets. In that respect, the game of business and investing has surely changed.



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