I would love some more actual recommendations other than buying bitcoin and gold, which is difficult to do with a 401k. Dalio is reticent to recommend anything but he’s held to a different standard when giving investment advice too. Thanks for another amazing post.
As a CPA (certified public accountant), my skills are mostly related to US corporations. I’m in a red state so I feel physically safe. I do wish I had enough tech skills to join that tribe. I’ve learned sql and Java to test the waters and get more remote opportunities even if I don’t need them.
For allocation, I have enough cash to buy a house but I plan to take out a loan anyway and put a lot of the remaining cash in bitcoin.
I'd rather live in rural Texas than SF, Chicago or NYC.....I'd check those stats because I guarantee they are biased to get a result the people want to publish. What I am saying is they aren't objective.....at all.
Not quite. According to current statistics, four out of the top ten are blue states, see below. In those remaining red states, if you remove the blue cities, such as Memphis, New Orleans, Little Rock, St. Louis, Columbia, the violent crime rates for the state plummet. It isn't the pro-gun, stand-your-ground people who are committing the violent crimes, it is the urban gangs and druggies. Give me a suburban or rural home in a red state any day.
Dalio is a China shill so he will sell China whenever he can and rant against US. Balaji has sort of become an anti-US pro-India pro-Singapore pro-everywhere else shill
Inflation is a tough one to hedge. Gold sucks as an inflation hedge. It was a thing back in the 70s, not today. Land is a good one if you can find the right piece of property. Assets that cash flow so cash can be reinvested are good (like a company). Hard assets might be good depending (thinking food, etc). Startup companies can grow far faster than the rate of inflation but obviously are a super risky hedge. I don't see Bitcoin as a hedge yet. It's a risky asset that trades up with risk on, and trades down with risk off. Go to TradingView.com and check out a chart on GSCI. I'd be curious if it went a lot higher over the last couple of years because logically it should have but logic doesn't rule in markets.
Enjoy your point of view and see that you’re clearly well researched and smart. This isn’t my world so a few questions: 1. Wouldn’t the value of these bonds rise if the feds simply lowered rates again? Assume it would take a year or two, but if new 10 yr T’a are low again, the T’s issued in 2021/22 would rise? 2. It seems like much of inflation was supply side and demand side - the 6-7 trillion Trump printed/added to national debt in his short time certainly hurt, but much of the price increases seem to be due to tons of demand for limited goods. People like Raoul pal continue to say it was mostly transitory. There is some “sticky” inflation though.
Really curious to get youryy thought on the 1st question though. Thanks
> 1. Wouldn’t the value of these bonds rise if the feds simply lowered rates again?
1a) Yes, this is what many banks are hoping for. That the Fed will just hit a button, drop rates, and undo their losses. Of course, if that happens, then the Fed is giving up on inflation.
So what the Fed has instead chosen to do is what some have polarizingly called "rate apartheid". You get stuck with high rates, but the financial institutions they like get printed money via the BTFP program.[1] Foreign buyers of devalued bonds are out of luck though.
This allows them to pretend to keep hiking rates and fighting inflation, while also temporarily staving off a wave of bank failures. This is actually their core competency: kicking the can while hiding the numbers. But these losses are of a civilizational scale, so we'll see how long they can hide them.
1b) Zooming out, the question is: at the end of empire, who pays the bills? Is it the bondholders, is it the dollar holders, is it the taxpayers, is it the banks? What entities are suddenly bankrupted? The decisions about interest rates, BTFP, printing, and the like all have to be seen in that light. The least aware constituencies will be saddled with the losses.
> 2. It seems like much of inflation was supply side and demand side - the 6-7 trillion Trump printed/added to national debt in his short time certainly hurt, but much of the price increases seem to be due to tons of demand for limited goods.
Yes, the supply chain shocks also contributed here. But in part that was also due to policy — unnecessary lockdowns, trade wars, and the like.
I guess the question is, where do we go from here and how bad is the catastrophe?
It seems to me, all this was done to attempt (idiotically) to prop up the system. Ultimately, I don't see any outcome that doesn't end in very strict austerity.
With regard to the cadence on your content, I would prefer:
1) Daily content posts on your various social accounts, which are likely highlights from your longer form content from the week and real-time content.
2) Weekly email digest of your longer form content from the the week that I might want to check out.
3) Monthly roll-up email newsletter that has what you feel are the best of the best content pieces from the month - in case I missed something. This is also where you can re-promote some of your best of the best historical content if it’s evergreen.
The above would ideally allow me to control the volume on you and participate in all three or just a subset. But, just like the news, you have to be consistent so I can get into a rhythm of consuming what you’re putting out.
Balaji, I subscribe and listen because I find most of your analysis mind expanding. This post feels pointed, personal and (unfortunately) political.
Who didn’t know rates we’re going up -- had to go up?! I’m a total noob, but happened to be buying a house at the time and was in a race against the clock that entire summer.
The fact that you stand with these poor feckless bankers and insurers so you can score points against the Fed is...a bummer.
If it makes you feel any better, think of the central bank as the Great Satan and many of the individual banks as the Little Satans :)
For example, after the Fed surprised the banks by mass-devaluing the bonds that Treasury had just sold them, the banks decided to surprise their customers by hiding their literal insolvency in a footnote[1].
“Surprise” is the word I find objectionable (and political). The Little Satans knew what was coming (literally their job), but didn’t want to corrode profit by adjusting. They are the ones stacking massive personal fortunes and then seeking bailouts.
0) Through 2021, endless statements from the Fed on how they won't hike rates
1) Nov 3, 2021 — Powell still says he's patient on rate hikes
2) Nov 22 2021 — Powell is renominated and feels politically secure
3) Dec 2021 — Powell **suddenly** signals a complete turnaround
4) March 2022 — surprise hikes are the fastest in modern history, and destroy everyone who bought long-dated bonds in 2021
Result: long-dated US Treasuries, the supposedly "safest asset in the world", became the riskiest asset in the world.
Why did Powell delay till after he was renominated? Probably for political reasons. Presidents don't like rate hikes[5], especially running into the election year of 2022. And Powell thought he could wait and just be like Paul Volcker, who was "firm" and then defeated inflation.
But the world isn't an 80s rerun. Hiking from ten years of near zero interest rates in the 2010s was a surprise attack on every bond buyer. Economics isn't politics - the kind of insane flipflops we see in politics don't work when there are actual contracts involved.
I agree- I was in the same spot and raced the clock against rates rising..... that was March and I’m not in the Financial space- how did they miss that? Bought the house and not budging- banks/insurance/investors should have been able to do the equivalent
For financial people this one is over the top. An insurance company should have the duration of assets close to the duration of liabilities (you know when you pay a life or health policy, that's why we have actuaries). It's pretty easy to be well within a standard deviation.
For banks, a majority of the liabilities are demand deposits. The demand deposits are exactly that, due on demand. Common sense says a duration of a year for a bank portfolio should be about a year. Much like a money market. Runoff plus time decay of even days helps in the event of a run. Selling short term assets does not cost much (minimal losses) and banks should look at this vs. their reserves when running a portfolio. That regulators let these banks (there are others) buy 10 year bonds and did nothing after years is double incompetency.
For pensions, again the principal of duration of assets and liabilities is the same as an insurance company. They will have losses on their books but those as vs liabilities they booked knowing the interest they would receive is enough to pay the liability. Additionally, insurance companies will be actively taking losses vs. income going forward by selling loosing bonds and buying current coupon bonds thus deferring paying taxes. This will force yields of deep discount bonds wider temporarily and cause a short term opportunity to pick up a little yield and arbitrage them if you think a little.
While saying the fed devalued bonds is true, you had to be asleep to miss the multi- month prelude they gave to raising rates. They talked about it more than I have ever seen. It was weird. These people running portfolios buried in duration mis- matches let their ego get in the way. They had plenty of time to sell and take small losses, realistically offset by gains. I told everyone I knew not to buy bonds for years before they raised rates. What good is a 3% bond?
The real crime in my opinion is the misrepresentation of inflation. It was said to be ~2% forever while the basket of goods changed. Oh well, if you want to see real inflation, wait for the worlds China manufacturing dependent economies come to terms with doing what they tell you. If the USA has an economic war or physical war with them expect 30% increases in costs for everything at Walmart and home depot to start.
So, no. There wasn't plenty of time. There was no time to adjust massive multibillion dollar bond portfolios bought under false pretenses.
> They had plenty of time to sell
As shown above they didn't have plenty of time to sell. And even they did sell, who will they sell to? Someone has to hold Treasuries, the new toxic waste. The Fed caused a systemic crisis in the "safest asset in the world".
That isn't solved by simply shifting it to someone else.
When they pivoted and said they are raising rates people had more tine to square up their portfolios than I have ever seen. The market literally did not react. It was like people did not believe them.. Spreads, indexes barely moved. Their first rate increases were not enough to destroy portfolios. People had time to react, but they didn't want to take the losses when they were small because they wanted their bonus.
Even though the fed said they were going to keep raising rates.
Like I so much respect you for saying regularly, 'it's not just the policy, you have to look at how people react to it.'
Human nature in the interaction of markets is the biggest factor imo. I think AI is currently running some programs to take advantage of it. US markets (what I watch) do not trade like they used to.
- Hadn't they just said that inflation was nonexistent?
- And then they said inflation was transitory?
- And they said vociferously that they *wouldn't* hike rates?[1]
- So, why would you suddenly believe them in early 2022?
Sure, it turned out that *that time* they weren't lying. But think about what you're saying. The Fed and Treasury are so unpredictable and/or insane that they will casually whiplash the multi-trillion dollar bond market.
You can't trust a word they say, yet they regulate your banking license, set the rates, and have enormous control over the global financial system.
2) This is the optical illusion at the heart of the system.
On the one hand, the Fed Chair is more powerful than the President and we hang on every word.
On the other hand, the Fed isn’t responsible for anything and if you die following their guidance it’s your fault for believing them.
This puts us into the bizarre situation where a random insurance company is held responsible for going bust after buying “the safest asset in the world”…but Jerome Powell is responsible for nothing.
If the Fed is more open about intentions then it leaves less opportunity for the Pelosi type traders to make trillions from government approved government insider trading.
With all due respect to Balaji (I love the guy), this sounds like total BS propaganda. We were at the end of a 40-year bond bull market. Bond rates were at an all-time low and had only one direction to go: up. Even I knew to buy short-term bonds. As for Powell, he did exactly what Volker did 40 years ago when faced with a similar inflationary situation: raise rates. Since then, Volker has been hailed as a genius. I’m sure Balaji knows all of this.
1) If it's not hindsight, show your detailed, timestamped, public writeup from 2020 or early 2021 proving that you knew that "we were at the end of a 40-year bond bull market and bond rates were going to go up." Because this was hotly denied by the people in charge of actually setting interest rates.
2) Also, why buy short-term bonds? Why buy bonds at all? Short-term bonds had even lower rates of return in 2021.
3) Even if you knew the Fed was probably wrong on inflation, could you make that trade at a financial institution in 2021? Against Yellen and Powell telling you that they weren't going to hike rates? It wouldn't get past your board.
4) Regarding Powell doing what Volcker did, that's what he *thought* he was doing but it's a single parameter model of the situation. The economy hadn't been at ~0-1% interest rates for 10 years when Volcker hiked rates. The world is also completely different (eg digital bank runs, China's rise).
I'm not surprised however that he tried the same thing as the 80s — that's why we have Top Gun reruns, 80s-style foreign policy, and leaders who were first famous in the 80s. But he only tried it after trying to deny it, by saying inflation was transitory.
I don’t have any posts from 2021. Furthermore, this is fact, easily verified, and I’m sure anybody reading your post is smart enough to know this already.
Here you go…Warren Buffett’s letter to investors 2021: https://www.berkshirehathaway.com/letters/2020ltr.pdf. Obviously, with bond rates at an all-time low, Buffett was not the only one saying this. Do a quick search for Ray Dalio, Stanley Druckenmiller, or almost anybody, and you will find the same. Regarding why I had bonds, I owned them as part of my balanced portfolio. Not unusual.
As I noted in the article, institutions couldn't disobey the Fed like a few famous individuals could.
Some were required by statute to hold a certain % of bonds in their portfolios (look up so-called HQLA, high quality liquid asset regulation). Others that depended on loans found themselves cut off by all the pandemic-era printing.
This is on top of the factors I mentioned in the article.
"Banks Are Bingeing on Bonds, but Not Because They Want To
...Banks are awash in deposits, and their customers are taking out fewer loans. So they have little choice but to buy up government debt, even if it means skimpy profits."
"It is 10 years since the Basel Committee on Banking Supervision (BCBS) published its rules on the liquidity coverage ratio (LCR) designed to ensure that banks hold sufficient reserves of cash or cash-like instruments to survive the first 30 days of a systemic or bank-specific stress.
...By its own definitions, US Treasury bonds no longer meet the standard for high-quality liquid assets."
Can back up Balaji in institution versus individual. When you’re a giant corporation you’re a giant target for retribution. You don’t tug on Superman’s cape.
One of the core premises of this post is disingenuous. If you watched the government print trillions fo dollars, money supply go through the roof, and inflation climb to levels not seen since the early 80s.... and believed that rates would never rise.... you live under a rock.
I'm sorry, I get it that Powell, Biden, and Yellen said its was transitory. Everyone with half a brain called them liars on this point.
I don't know why you harp so much on this particular point when I'm not sure it changes anything. I don't know that banks had time to respond to inflation and rate rise risk even if they wanted to.
Furthermore, the Fed has never wavered from its commitment to 2% inflation. Everyone knew that once it became obvious that inflation was going to settle north of 2%, the Fed would take decisive action. This is dogma, and every banking and insurance exec knows this. And the Fed acted entirely predictably on that point in the end.
This point is accurate, the US government has made it a point to financially harm people who speak against them.
You are the first person to cite what they did to S&P while Moody's and Fitch watched and figured out not to down grade. By every metric I know that the rating agencies use, the USA is not even a BBB-, Baa- company. Debt > GDP precluded any country from being BBB- when I spoke with their analysts years ago. May be they changed their rating metrics like they did to get the business of the securitizers back in the day (2004-2008)???
If your point is that regulations prevented institutions from operating correctly, then let's cite those regulations and make that point. I'm not an expert on it but what I do know makes me more sympathetic to that angle then the one you presented here.
What would have been a realistic hedge option for these institutions that would comply with coverage ratios and capital requirements? Were there counterparties willing to take that risk at a reasonable price? Even if they were, we can't hedge away the actual losses - they have to exist somewhere. The real question is could we have foisted them on private billionaires instead amirite? A more interesting discussion is how our current regulatory system basically guaranteed this outcome the second Trump's administrative pumped money supply by 20% in 12 months.
At the end of the day Powell's public facing words need to be seen in light of Powell's goals. Inflation is heavily controlled by animal spirits, and keeping those spirits in check through your words is part of the game.
What I am not sympathetic to is the concept of bank and insurance executives, extremely well compensated for their expertise, being "fooled" by a speech where Powell or Yellen says this inflation is transitory. I find that concept ludicrous given the general fact pattern and other forms of communication put out by the fed (it's inflation target, for instance).
> If your point is that regulations prevented institutions from operating correctly, then let's cite those regulations
It is indeed in part regulations. Consider the requirement to hold "high quality liquid assets", like Treasuries — except these HQLAs weren't actually high quality, because they suffered enormous unexpected losses in 2022 thanks to the Fed faking out the entire market.
> "It is 10 years since the Basel Committee on Banking Supervision (BCBS) published its rules on the liquidity coverage ratio (LCR) designed to ensure that banks hold sufficient reserves of cash or cash-like instruments to survive the first 30 days of a systemic or bank-specific stress...By its own definitions, US Treasury bonds no longer meet the standard for high-quality liquid assets."
This is so well said and I would love Balaji to respond to the last two paragraphs, if you would? Why are you keen to foist their guilt and malfeasance in the Fed? The Fed has plenty to answer for, but a blank check of responsibility for private banks is a ‘red flag’ position.
1) I already did — institutions were forced by things like Basel III to buy "high quality liquid assets" like bonds. See Euromoney article above.
2) I do blame the central bank more than the banks, for the same reason I blame a general rather than his mere subordinate, the lieutenant. Fed and Treasury are upstream of the US financial system, full stop. They can try to throw execs in jail or freeze their company's accounts, but not vice versa.
3) In general, banks aren't great, but the central bank is much worse. The central bank controls what banks can do.
- it sets rates
- it approves (or disapproves) master account access
- it extends sweetheart deals like BTFP to some favorites but not others
The Fed has been granting master accounts to favorite banks, often in apparent violation of written statutes, and covering up that they did this. They were finally forced to release the list. But this shows the extent to which the central bank is upstream of the banks.
5) Finally, the pattern matching of 2008 doesn't apply to 2023. This is a self-bailout by the central bank. The government devalued its own government bonds, so they're printing to cover up the losses they caused.
The market was consistently pricing in rate cuts the entire way up. So the average market participant literally thought that higher for longer was a farce.
Plus, if this was so obvious then why didn’t you go net worth long interest rates?
There certainly was a lot of turmoil in the market and there remains some interesting rate pricing out there. That said the Fed has done exactly what they've said they'd do for decades now: everything in their power to keep inflation ~2%.
if you did then that's great (but if you did i'd expect you to be commenting from a yacht ;)), but just realize that doing so was *contrarian* to what the market was pricing in. expecting *regional banks* take contrarian hedges (eating into their margins) to me is unreasonable. at that point they're acting more as a hedge fund than a bank. And ultimately it doesn't even matter whether the blame should be on the Fed or the banks-- what matters is that the banks, insurance companies, etc etc are deeply in the red.
> That said the Fed has done exactly what they've said they'd do for decades now: everything in their power to keep inflation ~2%
you're misremembering history ;) CPI breached 2% in March 2021 and accelerated for a year before they started hiking rates
Playing this out a bit, if we do see a mass event happen that causes systematically important institutions who are over allocated in long duration government bonds. What do you think is more likely:
1) The Fed to rapidly drop rates in order to increase the value of these impaired bonds. (Possibly impacting inflation/currency value)
2) Setting up a program to buy back bonds at par, or choose close to it (TARP v2)
3) Let them fail and build back better
We are going to see "bigger and better" bailouts because the moral hazard created by corporate socialism for losses has made it irresponsible to individually manage risks.
Overall you are correct but small issue with Point 2., Technically hedging tails is possible although maybe not feasible. The futures markets provide such a mechanism. The problem is unlike Hold To Maturity accounting, the futures markets requires squaring the books with cash on a daily basis. By their nature, the tails are improbable and so hedging them makes those costs impractical compared to peers and the rest of your industry, and so infeasible.
Good article. It's unfortunate that we are stuck with banks and insurance companies, all of the leaders of which should be in prison. As Doomberg said in a nearby article, "Money is what the government says it is." So, also, is the value of that money, to the detriment of us all.
Florida is becoming uninsurable because of climate change related risk. No matter how stable bonds are it can't compensate for the wildly increased chances of unpredictable flood risk. This is what is breaking the models.
One way of looking at it Balaji, another way is that just maybe, maybe Powel is destroying the broken system we have in a last ditch effort to reconstitute and save the fragile remains of the actually working system? To do that you would have to break the leverage cycle, purge the zombies, break a bunch of countries.
Will not be fun, but the system was broken already. Somebody eventually has to pull the trigger.
I would love some more actual recommendations other than buying bitcoin and gold, which is difficult to do with a 401k. Dalio is reticent to recommend anything but he’s held to a different standard when giving investment advice too. Thanks for another amazing post.
I think this one isn't just about allocation.
It's about allocation, location, and organization.
Your financial choices, where you move to, and what tribe you're part of.
1) Tweet version
https://twitter.com/balajis/status/1654159324204396544
2) Longer version in this podcast
https://twitter.com/WilfIntheNight/status/1665150620397862915
Thank you. Im listening now.
As a CPA (certified public accountant), my skills are mostly related to US corporations. I’m in a red state so I feel physically safe. I do wish I had enough tech skills to join that tribe. I’ve learned sql and Java to test the waters and get more remote opportunities even if I don’t need them.
For allocation, I have enough cash to buy a house but I plan to take out a loan anyway and put a lot of the remaining cash in bitcoin.
You should look up violent crime rates - top 10 are red states. Not so safe to be pro-gun, stand-your-ground.
I'd rather live in rural Texas than SF, Chicago or NYC.....I'd check those stats because I guarantee they are biased to get a result the people want to publish. What I am saying is they aren't objective.....at all.
Not quite. According to current statistics, four out of the top ten are blue states, see below. In those remaining red states, if you remove the blue cities, such as Memphis, New Orleans, Little Rock, St. Louis, Columbia, the violent crime rates for the state plummet. It isn't the pro-gun, stand-your-ground people who are committing the violent crimes, it is the urban gangs and druggies. Give me a suburban or rural home in a red state any day.
Rank State Violent Crime Rate (per 100,000)
1 Alaska 885.0
2 New Mexico 702.5
3 Tennessee 623.3
4 Nevada 606.6
5 Louisiana 573.8
6 Arkansas 550.9
7 Missouri 523.2
8 South Carolina 519.0
9 Delaware 505.7
10 Maryland 492.4
Dalio is a China shill so he will sell China whenever he can and rant against US. Balaji has sort of become an anti-US pro-India pro-Singapore pro-everywhere else shill
Inflation is a tough one to hedge. Gold sucks as an inflation hedge. It was a thing back in the 70s, not today. Land is a good one if you can find the right piece of property. Assets that cash flow so cash can be reinvested are good (like a company). Hard assets might be good depending (thinking food, etc). Startup companies can grow far faster than the rate of inflation but obviously are a super risky hedge. I don't see Bitcoin as a hedge yet. It's a risky asset that trades up with risk on, and trades down with risk off. Go to TradingView.com and check out a chart on GSCI. I'd be curious if it went a lot higher over the last couple of years because logically it should have but logic doesn't rule in markets.
Really enjoy your posts and thinking.
Enjoy your point of view and see that you’re clearly well researched and smart. This isn’t my world so a few questions: 1. Wouldn’t the value of these bonds rise if the feds simply lowered rates again? Assume it would take a year or two, but if new 10 yr T’a are low again, the T’s issued in 2021/22 would rise? 2. It seems like much of inflation was supply side and demand side - the 6-7 trillion Trump printed/added to national debt in his short time certainly hurt, but much of the price increases seem to be due to tons of demand for limited goods. People like Raoul pal continue to say it was mostly transitory. There is some “sticky” inflation though.
Really curious to get youryy thought on the 1st question though. Thanks
-Tyler1729
> 1. Wouldn’t the value of these bonds rise if the feds simply lowered rates again?
1a) Yes, this is what many banks are hoping for. That the Fed will just hit a button, drop rates, and undo their losses. Of course, if that happens, then the Fed is giving up on inflation.
So what the Fed has instead chosen to do is what some have polarizingly called "rate apartheid". You get stuck with high rates, but the financial institutions they like get printed money via the BTFP program.[1] Foreign buyers of devalued bonds are out of luck though.
This allows them to pretend to keep hiking rates and fighting inflation, while also temporarily staving off a wave of bank failures. This is actually their core competency: kicking the can while hiding the numbers. But these losses are of a civilizational scale, so we'll see how long they can hide them.
1b) Zooming out, the question is: at the end of empire, who pays the bills? Is it the bondholders, is it the dollar holders, is it the taxpayers, is it the banks? What entities are suddenly bankrupted? The decisions about interest rates, BTFP, printing, and the like all have to be seen in that light. The least aware constituencies will be saddled with the losses.
> 2. It seems like much of inflation was supply side and demand side - the 6-7 trillion Trump printed/added to national debt in his short time certainly hurt, but much of the price increases seem to be due to tons of demand for limited goods.
Yes, the supply chain shocks also contributed here. But in part that was also due to policy — unnecessary lockdowns, trade wars, and the like.
[1]: https://twitter.com/balajis/status/1638731349489238017
Thanks for the thoughtful response Balajis!
I guess the question is, where do we go from here and how bad is the catastrophe?
It seems to me, all this was done to attempt (idiotically) to prop up the system. Ultimately, I don't see any outcome that doesn't end in very strict austerity.
With regard to the cadence on your content, I would prefer:
1) Daily content posts on your various social accounts, which are likely highlights from your longer form content from the week and real-time content.
2) Weekly email digest of your longer form content from the the week that I might want to check out.
3) Monthly roll-up email newsletter that has what you feel are the best of the best content pieces from the month - in case I missed something. This is also where you can re-promote some of your best of the best historical content if it’s evergreen.
The above would ideally allow me to control the volume on you and participate in all three or just a subset. But, just like the news, you have to be consistent so I can get into a rhythm of consuming what you’re putting out.
Hope this market feedback is valuable.
Balaji, I subscribe and listen because I find most of your analysis mind expanding. This post feels pointed, personal and (unfortunately) political.
Who didn’t know rates we’re going up -- had to go up?! I’m a total noob, but happened to be buying a house at the time and was in a race against the clock that entire summer.
The fact that you stand with these poor feckless bankers and insurers so you can score points against the Fed is...a bummer.
If it makes you feel any better, think of the central bank as the Great Satan and many of the individual banks as the Little Satans :)
For example, after the Fed surprised the banks by mass-devaluing the bonds that Treasury had just sold them, the banks decided to surprise their customers by hiding their literal insolvency in a footnote[1].
[1]: https://archive.is/0Jww3#selection-811.0-811.40
I love you Balaji- but you are not answering the question
“Surprise” is the word I find objectionable (and political). The Little Satans knew what was coming (literally their job), but didn’t want to corrode profit by adjusting. They are the ones stacking massive personal fortunes and then seeking bailouts.
> “Surprise” is the word I find objectionable
You shouldn't. Here's the timeline.
0) Through 2021, endless statements from the Fed on how they won't hike rates
1) Nov 3, 2021 — Powell still says he's patient on rate hikes
2) Nov 22 2021 — Powell is renominated and feels politically secure
3) Dec 2021 — Powell **suddenly** signals a complete turnaround
4) March 2022 — surprise hikes are the fastest in modern history, and destroy everyone who bought long-dated bonds in 2021
Result: long-dated US Treasuries, the supposedly "safest asset in the world", became the riskiest asset in the world.
Why did Powell delay till after he was renominated? Probably for political reasons. Presidents don't like rate hikes[5], especially running into the election year of 2022. And Powell thought he could wait and just be like Paul Volcker, who was "firm" and then defeated inflation.
But the world isn't an 80s rerun. Hiking from ten years of near zero interest rates in the 2010s was a surprise attack on every bond buyer. Economics isn't politics - the kind of insane flipflops we see in politics don't work when there are actual contracts involved.
--------
[0]: https://www.cnbc.com/2021/06/18/feds-kashkari-opposed-to-rate-hikes-at-least-through-2023.html
[1]: https://www.bloomberg.com/news/articles/2021-11-03/fed-to-start-tapering-asset-buys-by-15-billion-later-this-month#xj4y7vzkg
[2]: https://archive.is/NWb25
[3]: https://archive.is/DiMiS
[4]: https://www.visualcapitalist.com/interest-rate-hikes-1988-2023/
[5]: https://archive.is/Aiayr#selection-7099.213-7099.330
I agree- I was in the same spot and raced the clock against rates rising..... that was March and I’m not in the Financial space- how did they miss that? Bought the house and not budging- banks/insurance/investors should have been able to do the equivalent
For financial people this one is over the top. An insurance company should have the duration of assets close to the duration of liabilities (you know when you pay a life or health policy, that's why we have actuaries). It's pretty easy to be well within a standard deviation.
For banks, a majority of the liabilities are demand deposits. The demand deposits are exactly that, due on demand. Common sense says a duration of a year for a bank portfolio should be about a year. Much like a money market. Runoff plus time decay of even days helps in the event of a run. Selling short term assets does not cost much (minimal losses) and banks should look at this vs. their reserves when running a portfolio. That regulators let these banks (there are others) buy 10 year bonds and did nothing after years is double incompetency.
For pensions, again the principal of duration of assets and liabilities is the same as an insurance company. They will have losses on their books but those as vs liabilities they booked knowing the interest they would receive is enough to pay the liability. Additionally, insurance companies will be actively taking losses vs. income going forward by selling loosing bonds and buying current coupon bonds thus deferring paying taxes. This will force yields of deep discount bonds wider temporarily and cause a short term opportunity to pick up a little yield and arbitrage them if you think a little.
While saying the fed devalued bonds is true, you had to be asleep to miss the multi- month prelude they gave to raising rates. They talked about it more than I have ever seen. It was weird. These people running portfolios buried in duration mis- matches let their ego get in the way. They had plenty of time to sell and take small losses, realistically offset by gains. I told everyone I knew not to buy bonds for years before they raised rates. What good is a 3% bond?
The real crime in my opinion is the misrepresentation of inflation. It was said to be ~2% forever while the basket of goods changed. Oh well, if you want to see real inflation, wait for the worlds China manufacturing dependent economies come to terms with doing what they tell you. If the USA has an economic war or physical war with them expect 30% increases in costs for everything at Walmart and home depot to start.
> While saying the fed devalued bonds is true, you had to be asleep to miss the multi- month prelude they gave to raising rates.
No, even as late as November 2021 they said they weren't going to raise rates.
https://twitter.com/balajis/status/1665016667582132224
You can see the degree of hairpin turn from the dot plots:
https://twitter.com/balajis/status/1634805724164542473?lang=en
They hiked rates faster than at any point in modern history:
https://www.visualcapitalist.com/interest-rate-hikes-1988-2023
...after selling historical quantities of bonds:
https://archive.is/CtW1B
So, no. There wasn't plenty of time. There was no time to adjust massive multibillion dollar bond portfolios bought under false pretenses.
> They had plenty of time to sell
As shown above they didn't have plenty of time to sell. And even they did sell, who will they sell to? Someone has to hold Treasuries, the new toxic waste. The Fed caused a systemic crisis in the "safest asset in the world".
That isn't solved by simply shifting it to someone else.
When they pivoted and said they are raising rates people had more tine to square up their portfolios than I have ever seen. The market literally did not react. It was like people did not believe them.. Spreads, indexes barely moved. Their first rate increases were not enough to destroy portfolios. People had time to react, but they didn't want to take the losses when they were small because they wanted their bonus.
Even though the fed said they were going to keep raising rates.
Like I so much respect you for saying regularly, 'it's not just the policy, you have to look at how people react to it.'
Human nature in the interaction of markets is the biggest factor imo. I think AI is currently running some programs to take advantage of it. US markets (what I watch) do not trade like they used to.
1) > It was like people did not believe them..
- Hadn't they just said that inflation was nonexistent?
- And then they said inflation was transitory?
- And they said vociferously that they *wouldn't* hike rates?[1]
- So, why would you suddenly believe them in early 2022?
Sure, it turned out that *that time* they weren't lying. But think about what you're saying. The Fed and Treasury are so unpredictable and/or insane that they will casually whiplash the multi-trillion dollar bond market.
You can't trust a word they say, yet they regulate your banking license, set the rates, and have enormous control over the global financial system.
2) This is the optical illusion at the heart of the system.
On the one hand, the Fed Chair is more powerful than the President and we hang on every word.
On the other hand, the Fed isn’t responsible for anything and if you die following their guidance it’s your fault for believing them.
This puts us into the bizarre situation where a random insurance company is held responsible for going bust after buying “the safest asset in the world”…but Jerome Powell is responsible for nothing.
[1]: https://www.cnbc.com/2021/06/18/feds-kashkari-opposed-to-rate-hikes-at-least-through-2023.html
If the Fed is more open about intentions then it leaves less opportunity for the Pelosi type traders to make trillions from government approved government insider trading.
With all due respect to Balaji (I love the guy), this sounds like total BS propaganda. We were at the end of a 40-year bond bull market. Bond rates were at an all-time low and had only one direction to go: up. Even I knew to buy short-term bonds. As for Powell, he did exactly what Volker did 40 years ago when faced with a similar inflationary situation: raise rates. Since then, Volker has been hailed as a genius. I’m sure Balaji knows all of this.
No, I believe this is hindsight :)
1) If it's not hindsight, show your detailed, timestamped, public writeup from 2020 or early 2021 proving that you knew that "we were at the end of a 40-year bond bull market and bond rates were going to go up." Because this was hotly denied by the people in charge of actually setting interest rates.
See:
https://twitter.com/balajis/status/1634604829007036416?s=46
2) Also, why buy short-term bonds? Why buy bonds at all? Short-term bonds had even lower rates of return in 2021.
3) Even if you knew the Fed was probably wrong on inflation, could you make that trade at a financial institution in 2021? Against Yellen and Powell telling you that they weren't going to hike rates? It wouldn't get past your board.
4) Regarding Powell doing what Volcker did, that's what he *thought* he was doing but it's a single parameter model of the situation. The economy hadn't been at ~0-1% interest rates for 10 years when Volcker hiked rates. The world is also completely different (eg digital bank runs, China's rise).
I'm not surprised however that he tried the same thing as the 80s — that's why we have Top Gun reruns, 80s-style foreign policy, and leaders who were first famous in the 80s. But he only tried it after trying to deny it, by saying inflation was transitory.
I don’t have any posts from 2021. Furthermore, this is fact, easily verified, and I’m sure anybody reading your post is smart enough to know this already.
Here you go…Warren Buffett’s letter to investors 2021: https://www.berkshirehathaway.com/letters/2020ltr.pdf. Obviously, with bond rates at an all-time low, Buffett was not the only one saying this. Do a quick search for Ray Dalio, Stanley Druckenmiller, or almost anybody, and you will find the same. Regarding why I had bonds, I owned them as part of my balanced portfolio. Not unusual.
As I noted in the article, institutions couldn't disobey the Fed like a few famous individuals could.
Some were required by statute to hold a certain % of bonds in their portfolios (look up so-called HQLA, high quality liquid asset regulation). Others that depended on loans found themselves cut off by all the pandemic-era printing.
This is on top of the factors I mentioned in the article.
1) https://archive.is/CtW1B
"Banks Are Bingeing on Bonds, but Not Because They Want To
...Banks are awash in deposits, and their customers are taking out fewer loans. So they have little choice but to buy up government debt, even if it means skimpy profits."
2) https://www.euromoney.com/article/2bfifkov9pvzcixa6pn9c/opinion/regulators-must-review-the-liquidity-coverage-ratio
"It is 10 years since the Basel Committee on Banking Supervision (BCBS) published its rules on the liquidity coverage ratio (LCR) designed to ensure that banks hold sufficient reserves of cash or cash-like instruments to survive the first 30 days of a systemic or bank-specific stress.
...By its own definitions, US Treasury bonds no longer meet the standard for high-quality liquid assets."
Can back up Balaji in institution versus individual. When you’re a giant corporation you’re a giant target for retribution. You don’t tug on Superman’s cape.
If this was so obvious then why didn’t you go net worth long interest rates? ;)
One of the core premises of this post is disingenuous. If you watched the government print trillions fo dollars, money supply go through the roof, and inflation climb to levels not seen since the early 80s.... and believed that rates would never rise.... you live under a rock.
I'm sorry, I get it that Powell, Biden, and Yellen said its was transitory. Everyone with half a brain called them liars on this point.
I don't know why you harp so much on this particular point when I'm not sure it changes anything. I don't know that banks had time to respond to inflation and rate rise risk even if they wanted to.
Furthermore, the Fed has never wavered from its commitment to 2% inflation. Everyone knew that once it became obvious that inflation was going to settle north of 2%, the Fed would take decisive action. This is dogma, and every banking and insurance exec knows this. And the Fed acted entirely predictably on that point in the end.
Because inflation is INCREDIBLY destructive.
If you are saying that “everyone called Powell, Biden, and Yellen liars” that is incorrect.
Institutions specifically couldn’t call them liars.
For the same reason, institutions can’t hedge against de-dollarization and debasement today.
This point is accurate, the US government has made it a point to financially harm people who speak against them.
You are the first person to cite what they did to S&P while Moody's and Fitch watched and figured out not to down grade. By every metric I know that the rating agencies use, the USA is not even a BBB-, Baa- company. Debt > GDP precluded any country from being BBB- when I spoke with their analysts years ago. May be they changed their rating metrics like they did to get the business of the securitizers back in the day (2004-2008)???
If your point is that regulations prevented institutions from operating correctly, then let's cite those regulations and make that point. I'm not an expert on it but what I do know makes me more sympathetic to that angle then the one you presented here.
What would have been a realistic hedge option for these institutions that would comply with coverage ratios and capital requirements? Were there counterparties willing to take that risk at a reasonable price? Even if they were, we can't hedge away the actual losses - they have to exist somewhere. The real question is could we have foisted them on private billionaires instead amirite? A more interesting discussion is how our current regulatory system basically guaranteed this outcome the second Trump's administrative pumped money supply by 20% in 12 months.
At the end of the day Powell's public facing words need to be seen in light of Powell's goals. Inflation is heavily controlled by animal spirits, and keeping those spirits in check through your words is part of the game.
What I am not sympathetic to is the concept of bank and insurance executives, extremely well compensated for their expertise, being "fooled" by a speech where Powell or Yellen says this inflation is transitory. I find that concept ludicrous given the general fact pattern and other forms of communication put out by the fed (it's inflation target, for instance).
> If your point is that regulations prevented institutions from operating correctly, then let's cite those regulations
It is indeed in part regulations. Consider the requirement to hold "high quality liquid assets", like Treasuries — except these HQLAs weren't actually high quality, because they suffered enormous unexpected losses in 2022 thanks to the Fed faking out the entire market.
See for example:
https://www.euromoney.com/article/2bfifkov9pvzcixa6pn9c/opinion/regulators-must-review-the-liquidity-coverage-ratio
> "It is 10 years since the Basel Committee on Banking Supervision (BCBS) published its rules on the liquidity coverage ratio (LCR) designed to ensure that banks hold sufficient reserves of cash or cash-like instruments to survive the first 30 days of a systemic or bank-specific stress...By its own definitions, US Treasury bonds no longer meet the standard for high-quality liquid assets."
This is so well said and I would love Balaji to respond to the last two paragraphs, if you would? Why are you keen to foist their guilt and malfeasance in the Fed? The Fed has plenty to answer for, but a blank check of responsibility for private banks is a ‘red flag’ position.
1) I already did — institutions were forced by things like Basel III to buy "high quality liquid assets" like bonds. See Euromoney article above.
2) I do blame the central bank more than the banks, for the same reason I blame a general rather than his mere subordinate, the lieutenant. Fed and Treasury are upstream of the US financial system, full stop. They can try to throw execs in jail or freeze their company's accounts, but not vice versa.
3) In general, banks aren't great, but the central bank is much worse. The central bank controls what banks can do.
- it sets rates
- it approves (or disapproves) master account access
- it extends sweetheart deals like BTFP to some favorites but not others
- the list goes on and on
4) See for example this:
https://twitter.com/CaitlinLong_/status/1669771735712034817
The Fed has been granting master accounts to favorite banks, often in apparent violation of written statutes, and covering up that they did this. They were finally forced to release the list. But this shows the extent to which the central bank is upstream of the banks.
5) Finally, the pattern matching of 2008 doesn't apply to 2023. This is a self-bailout by the central bank. The government devalued its own government bonds, so they're printing to cover up the losses they caused.
The market was consistently pricing in rate cuts the entire way up. So the average market participant literally thought that higher for longer was a farce.
Plus, if this was so obvious then why didn’t you go net worth long interest rates?
Who says I didn't?
There certainly was a lot of turmoil in the market and there remains some interesting rate pricing out there. That said the Fed has done exactly what they've said they'd do for decades now: everything in their power to keep inflation ~2%.
if you did then that's great (but if you did i'd expect you to be commenting from a yacht ;)), but just realize that doing so was *contrarian* to what the market was pricing in. expecting *regional banks* take contrarian hedges (eating into their margins) to me is unreasonable. at that point they're acting more as a hedge fund than a bank. And ultimately it doesn't even matter whether the blame should be on the Fed or the banks-- what matters is that the banks, insurance companies, etc etc are deeply in the red.
> That said the Fed has done exactly what they've said they'd do for decades now: everything in their power to keep inflation ~2%
you're misremembering history ;) CPI breached 2% in March 2021 and accelerated for a year before they started hiking rates
Playing this out a bit, if we do see a mass event happen that causes systematically important institutions who are over allocated in long duration government bonds. What do you think is more likely:
1) The Fed to rapidly drop rates in order to increase the value of these impaired bonds. (Possibly impacting inflation/currency value)
2) Setting up a program to buy back bonds at par, or choose close to it (TARP v2)
3) Let them fail and build back better
We are going to see "bigger and better" bailouts because the moral hazard created by corporate socialism for losses has made it irresponsible to individually manage risks.
Thanks for a great piece- in middle of re-listening to your Portal pod with Eric Weinstein.
How has your thinking around his key point shifted on the context of this bond issue?
Do you still believe in burn it down?
What’s the real politick approach to fixing the core issues here that has a shot of a non-apocalyptic result?
How does that end for Powell, etc?
I've never been a burn it down guy.
But neither have I been a fruitless reform guy.
Starting new institutions is the third alternative...
https://thenetworkstate.com
How is that not burn it down?
The current powers that be are not going to just hand off power or let everyone exist the current “network”
Overall you are correct but small issue with Point 2., Technically hedging tails is possible although maybe not feasible. The futures markets provide such a mechanism. The problem is unlike Hold To Maturity accounting, the futures markets requires squaring the books with cash on a daily basis. By their nature, the tails are improbable and so hedging them makes those costs impractical compared to peers and the rest of your industry, and so infeasible.
out of the money options are a nice cure for tail hedging. The de minumus cost if forgone for the bottom line ultimately.
Good article. It's unfortunate that we are stuck with banks and insurance companies, all of the leaders of which should be in prison. As Doomberg said in a nearby article, "Money is what the government says it is." So, also, is the value of that money, to the detriment of us all.
Florida is becoming uninsurable because of climate change related risk. No matter how stable bonds are it can't compensate for the wildly increased chances of unpredictable flood risk. This is what is breaking the models.
Balaji, what would falsify your view that Powell destroyed or is destroying the economy?
One way of looking at it Balaji, another way is that just maybe, maybe Powel is destroying the broken system we have in a last ditch effort to reconstitute and save the fragile remains of the actually working system? To do that you would have to break the leverage cycle, purge the zombies, break a bunch of countries.
Will not be fun, but the system was broken already. Somebody eventually has to pull the trigger.