The wrongest thing ever? My defence of multi-billionaire hedge fund inflation truthers

I recently bought a copy of the 1958 Radcliffe Report, prompting Lorcan Roche Kelly to ask whether I was ‘trying to find the wrongest thing ever?’. I have yet to read this 350 page report that I so enthusiastically purchased, but the phrase sprang to mind when thinking about what to call this defence of a hedge fund billionaire inflation truther that I have somewhat weirdly written.

QE was expected by many to result in higher levels of inflation. It is generally understood by most researchers that QE boosted inflation versus the counterfactual.

Some people – generically speaking, those who believe the quantity theory of money is a reasonable way to understand the world (and understand that: a. money to equal central bank reserves, and also that; b. the velocity of said money should be stable over the medium term rather than just be a flexible residual in a pretty silly identity) – feared that massive levels of inflation – even hyperinflation – would result from QE. Despite these fears, inflation has been so far conspicuous mainly by its absence.

Paul Singer had a bit of a rant recently arguing essentially that QE is delivering high levels of inflation that is best observed in contemporary art prices and Hampton real estate. Sadly, I am going to have to insert a link to ZeroHedge for people who might want to read the original rant. Paul Singer is a smart guy, but I’d be more inclined to agree with Alex Turnbull’s Twitterstorm takedown:
Singer’s client letter taps into the spirit of CPI truthers: a large and disparate group who believe that the government is manipulating reported inflation numbers to hide the truth of spiralling prices that any thinking person can see if they look.

The truth is that CPI truthers are generally nuts. Their number and the persistence of their message speaks to the collapse in trust in the most basic government functions (which is appropriate in some EMs, and most autocratic regimes). If you think that ONS is doing something poorly thought out, go and have a flick through the ONS’s CPI Technical Manual before kicking up a fuss. Besides anything else, it is a really surprisingly interesting and thoughtful document (with discussions of things like plutocratic versus democratic weighting methodologies).

Despite all this, I have some sympathy with Singer and a qualified sympathy with the underlying sentiment of the truthers. My sympathy is, however, based on an idea of mine that I recognise as somewhat more fruity than Singer’s: the under-reporting of pension saving costs in the CPI.

If there was one thing that most people who think for more than a second about the CPI would probably agree on, it is that savings have absolutely no place in a consumption index. Too stoopid even for me you might think.

If we think of pension contributions as regular savings into a piggy bank that is smashed upon retirement, with whatever happens to be in there then spent, I would agree that pension contributions do indeed have no place in any CPI. But I don’t think that this is really what pension contributions are. Instead, when you put money into a pension (I’m thinking really of making a Defined Contribution Scheme contribution in this instance), you are purchasing a series of claims on other economic agents (typically through company profits that will need to be siphoned off to meet your debt, rental or dividend payments, or – in the case of government bond purchases –taxes on the general population to fund your debt interest, absent seigniorage).

These various claims (or assets as most people call them) will have estimated internal rates of return (or discount rates). For bonds these would best approximate redemption yields to worst; for equities these would be dependent on your equity risk premia model, etc. Changes in discount rates would make a pension payment that you are aiming to deliver post-retirement cheaper (if discount rates went up) or more expensive (if discount rates went down).

This change in the cost in purchasing your future pension is completely absent from the CPI. And, as a reminder, if you are looking for a retirement income of say £20k per annum, you should – according to this rather out of date but easily Googleable Guardian article, be spending about a quarter of your income on the purchase of claims that can be accessed in retirement (eg pension contributions). So this is not a little missing component.

To simplify, let’s imagine all pension contributions go to buy claims that looks like a 20yr zero coupon government bond. In making a DC pension contribution of £100 in June 2007 you would have been buying a future cash flow (pension payment) due June 2027 of £259.78. In 2014, how much would it cost to buy a pension payment in 2034 of £259.78? The answer is £131.77. The annualised ‘inflation’ of this form of pension contribution was 4.0%. This is somewhat higher than the 3.1% level of inflation associated with the CPI. To be clear, this is not the return of zero coupon Gilts over the period, but rather the difference in cash contributions required to buy the same series of terminal cashflows. It should be said that I have not deflated these terminal cashflows to keep them constant in real terms, just nominal terms. The rate of inflation attached to purchasing the same real cashflows is somewhat higher, but things do get a bit more complicated (and this example is supposed to be simple).

And so despite being a bleeding heart liberal, I can sort of understand where Singer is coming from when he talks about asset price inflation mattering for reasons more than those that Turnbull is clearly right to identify (problem credit created for bubbly stuff). But for this to be true we might need to do something whacky in the way that we think about inflation. Which is probably going to be a bit of a stretch for most. It is still a bit of a stretch for me. But I can see the argument and find it hard to dismiss.


@T0nyYates wrote a thoughtful reflection on this blog that I think is worth directing people to here.


7 thoughts on “The wrongest thing ever? My defence of multi-billionaire hedge fund inflation truthers

  1. Wow! Just wow! As if pension fund deficiencies have all to do with central bank policies and not with excessive fees and compensation for incompetence to the financial management industry, including fund managers. I can’t believe you wrote this without any hint of irony…

    • Hmm. I think I must write extremely poorly. The post was not on pension fund deficiencies.

      It was an observation that the cost of future cash flows intended to fund retirement and purchased during someone’s working life are variable. In a DC world, households bear the risk of this variability (just as they bear the risk of other price variabilities).

      This is not to say that the subject of fees and financial management industry competence/ incompetence is not important. I’m just not sure how it is directly related. This may reflect incompetence on my part?

      • Well, no, obviously I should have been clearer as well. The cost of funding future cash flow depends on the ROIs the contributed funds would generate. In a world where the financial management class pretty much blatantly steals from these funds, the costs for funding the future cash flow becomes much higher: you have to not only cover up your future pension, but the financial management “leech” fees, plus the incompetence penalty in investing the funds by the same managers.

        In a better world, where the financial management class is held responsible (dare I say, they share in the downside not only the upside, to see if that sharpens the focus) the contributed funds will be invested in productive vehicles, will generate healthy returns, and the present day costs of future cash flows will be reasonable.

        In that regard, blaming the central banks – who are trying to heal the economy to create a better investment climate for investing your pension contribution – while defending fund managers who gorge on and waste said contributions is plainly hilarious.

        (bTW, it is not just direct contribution systems. DB pensions also require certain ROIs in order to be fully funded and in many cases there are shortages. I’ve known a fund manager who cost millions in damages (fees + incompetence) to the Washington and Oregon public employee pension funds, both defined-benefit systems. He eventually retired leisurely on a ranch in Montana, while leaving a hole in the funds. Is that a central bank problem somehow?)

  2. Very good post. I hadn’t thought of this particular way of looking at things, but it makes sense.

    That said, Singer’s arguments strike me as unnecessarily complex, just as the triumphalism of QE enthusiasts is premature. We are not that far removed from experiencing a a debt-fueled asset bubble that misallocated resources toward certain sectors – primarily residential housing – and then popped in 2007/2008, causing serious damage. Excessively loose monetary policy – at least in the U.S. – was a major cause of said bubble. (That is not to say the only cause – but one of them.) The question is whether QE is inflating a similar credit bubble in certain sectors and, if so, what will be the ill effects when it pops. There’s also the related question of when and how central banks transition back to a more neutral monetary policy – both interest rates and balance sheet size – and what if any ill effects that will entail. For example, an increase in long-term interest interest rates toward average levels over the past 20 to 30 years would imply large present-value, mark-to-market losses for holders of long-term bonds – what would be the follow-on effects, if any, of these losses? We just experienced a huge financial crisis without any hint of hyperinflation, so I don’t see why the defenders (or critics) of QE focus on hyperinflation rather than broader risks.

  3. Keep in mind that hedge fund managers are generally net long and their earnings are linked to performance, so unsurprisingly the vast majority love asset price inflation whyever it happens. The QE critics are a small and quirky club of dissidents and in-their-spare-time deep thinkers about where it’s all going in the long term, or posing as such for marketing purposes.

    A lot of the arguments they come up with are muddled. Asset price inflation isn’t consumer price inflation. Hedonics actually were a methodological improvement not a conspiratorial shenanigan.

    But though pension savings surely don’t belong in the CPI, and it’s not clear that rates wouldn’t be rock bottom without QE anyway, they are part of the lifetime cost of living. it’s good to see a bleeding heart liberal bucking the trend and realizing that higher asset prices aren’t always good for everybody. Few people think it through far enough to realize that when you own your own home, you aren’t actually helped by a general rise in home prices unless you plan to downgrade, or sell and rent, or take out a loan against your property. Asset price rises are transfers of wealth to those who will sell from those who will buy. Those who will buy are somewhat more likely to be doing something to make the economy grow. Gouging them does is not really liberal or bleeding-heart.

  4. Your main argument seems correct to me. That is, as I understand it, that the cost of pensions is going up and that that matters in the same way that, say, the cost of petrol, or cheese, or books going up does. It’s something people need to pay for now, if it costs more they have less to spend on other things.

    That said, your differentiation between piggy bank saving and buying shares or whatever is, with respect, nonsense. It doesn’t matter whether you need to put more in a piggy bank to save for retirement or you need to pay more for shares, bonds etc. The relevant point is that you need to spend more to get the same back.

  5. Pingback: Inflation truthing, asset prices, discount rates, QE | longandvariable

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