Saturday, February 26, 2011
A big pension fund manager goes to school, Mike Norman style
I had a conversation with a large pension fund manager recently on the subject of "Quantitative Easing" and deficits. This guy runs a portion of a $100 billion public worker retirement fund. (I leave him and the state, nameless.)
In the portion of money that he runs, he's heavily invested in gold because he basically thinks that the Fed is printing "too much money" and there's gonna be hyperinflation. BTW...by "heavily invested," I mean that the guy has about 0.2% in gold out of that $100 bil. (I guess his bosses don't share his concerns.)
I tried to explain to this guy that there's nothing really different between a Treasury security and a reserve deposit (except for duration) and when the Fed conducts QE, all it's doing is stripping the public of one asset (a Treasury) and replacing it with another (a reserve deposit). No new money has been created and therefore, it shouldn't be inflationary let alone hyperinflationary. All that happened was that the composition of the public's financial assets changed, with a shift in duration from positive duration more toward zero duration.
He couldn't get it. Didn't wanna get it.
We didn't even go into the discussion about how there is so much slack capacity: in labor, industry, housing, etc. Where's the inflation going to come from unless it's a case of the market being manipulated (which I think it might be, but that's a whole, other story).
On the subject of gov't spending he said, "What if the Fed didn't buy Treasuries?"
The question was posed in a way that seemed to suggest that he thought the Fed was some kind of "enabler." That the Fed "funded" the government by buying Treasuries. By the way, a lot of people have this impression. I heard Schiff (gag) talk about this on Freedom Watch recently.
First let me say this: the Fed is PRECLUDED BY STATUTE from buying from the Treasury. The Fed buys bonds in the secondary market. Moreover, primary dealers, who do business directly with the Fed are OBLIGATED to participate in auctions, but granted, that does not mean they necessarily have to buy what the Treasury is selling.
But let's examine his question..what happens if the Fed went on strike and didn't buy Treasuries?
Well, as far as the government is concerned, nothing at all. The Treasury would keep right on selling bonds just the way it always does and that would drain reserves in the banking system causing the Fed funds rate to rise.
Hey, wait a minute! Cause the Fed funds rate to rise??? Well guess what? That's the same thing as the Fed having made a monetary policy move to raise interest rates, right? By not buying bonds the Fed has, de-facto, raised its target rate.
The only problem is, the Fed doesn't raiise or lower rates unless it wants to. That's why everyone waits around until 2:15pm ET on FOMC meeting days...to see what the Fed's GONNA DO!
The FOMC decides on the rate it wants in accordance with its dual mandate of low inflation and high employment (the latter mandate may soon be taken away by Congress, at least that's how it seems from Republicans like Paul Ryan).
Why, then, would the Fed not buy bonds? That would essentially cede monetary policy directly to the Treasury and create a wonderful reason for the Fed not to exist. And unless the Fed is intent on committing institutional suicide, I don't think that happens. The Fed likes being the Fed.
Okay, what if nobody bought the bonds? I mean NOBODY! (This was actually the next question this money manager asked me.)
Then rates would probably rise to a level where risk free returns were available for below the cost of what someone could borrow money for. In other words you could go to the the bank, take out a loan for, let's say, 5% interest and invest in risk free Treasuries at, let's say, 6%? The world would be doing that all day long and soon enough that interest premium would be wiped out.
No doomsday. No end of the world, no hyperinflation.
That's how it works, Mr. Billion Dollar Money Manager. That's how it works.