End Financial Repression Now

Amen of the Week:

"If it don't make dollars it don't make sense."

- Chris Brown and Tyga - Ayo

End the repression now!

The Fed’s zero interest policy is literally stealing from grandmothers. How is this not considered theft of the highest order? How is the term “financial repression” not repeated daily on the front page of the New York Times? This would surely catch readers’ attention: "Fed Staffers Caught Stealing $1 Trillion." By my napkin calculus, that’s the approximate magnitude of the offense. That’s like stealing a couple of Apples -- and I’m not talking about the fruit (Apple's market capitalization is ~$600 billion).

No one is affected more than retirees who depend on interest for income. We can attempt to quantify it with the following hypothetical. Assume the natural rate of interest in an open, free economy was approximately 5% (as has been the case over centuries). Then assume that the Fed artificially pushes down interest rates to about 1% (a blend of long and short term treasury maturities). This means a retiree with life savings of $1,000,000 could draw only $10,000 in income from a high quality fixed income portfolio rather than the $50,000 income she’d otherwise draw. What happened to the $40,000 difference? It’s a “transfer” to subsidize borrowers, especially Washington, which has doubled its debt load since 2008. My hypothetical here is not so hypothetical. It describes the rough state of affairs over the past seven years. Each year compounds the damage. The retiree in our hypothetical would have lost $280,000 in income since 2009.

So much for “temporary”. Initially, the Fed’s policies were an emergency measure to prevent banks from collapsing. That accomplished, rates were kept low to stimulate a recovery by tempting businesses and individuals to borrow more so they’ll spend more. (Lesson not learned.) Yet another objective of financial repression has been to prod us all into stocks, bonds, real estate, or any form of risky asset. Retirees lose either way: They either endure with almost no interest on their savings, or they’re tempted to shift into risky investments that may ultimately lose in principal when these asset inflations ultimately deflate.

This continued repression is unjustified. It’s unfair. And it will end badly. Repressions always do.

What’s an investor to do in the meantime? There's no easy way to navigate the paradox of these times. Rule #1 is to resist the temptation to take more risk. Don’t take the Fed's bait. The valuation of nearly everything – stocks, bonds, Brooklyn condos – are at or near all-time highs. If the risk/reward of most securities is upside down today, what else is there to do? Cash is one option. It is an under-owned, unloved asset class, and though I don’t know how to price it, the optionality value of cash is worth quite a bit. By that, I mean that when this historic asset inflation inevitably deflates, cash will then prove to be of enormous value. You’ll be the bargain hunter amidst a chaos of sellers.

However, cash isn’t the only thing to be doing today. There are compelling investments out there. Just be selective. Avoid own-a-bit-of-everything portfolios. Even if most stocks are now overvalued, there will always be a handful of great companies run by great managers trading at reasonable prices. Owning high quality assets, be they shares of great businesses or plots of income-producing dirt, will be good for your mental health and long-term wealth.

Yours in the Field,

Frank Byrd, CFA

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