First Quarter Investment Commentary 2023

Dennis O'Keefe |

"Yet another problem with loose monetary policy reared its head this quarter."

Wow! What a way to start a conversation.  You can use that line with your friends at your next cocktail party.  Now let’s talk about what the heck that means.  

Monetary policy is what the Federal Reserve does.  It usually has one role - control interest rates.  In the last 15 years, it had another role - to purchase Treasury bonds and other securities - something that was unprecedented and likely unnecessary after 2009.

Loose policy means they were too free with their efforts without considering the consequences.  Think of an eight year old child with free rein in a candy shop or a slightly inebriated adult in a casino.

Our first problem with loose monetary policy is inflation.  In order to “buy” Treasury bonds, the Federal Reserve whips up money out of thin air. Quite literally. It just decides that it has more money and buys the Treasury bonds.

As we've seen with countless banana republics in the last sixty years, fabricating money out of nothing can cause rampant inflation within a country and devalue its currency rapidly in many cases.

So how much money did they “whip up” since 2008?

How about eight trillion dollars?

That’s excessive in anyone’s book.  

The Fed also kept interest rates artificially low for 14 years.  This created other inefficiencies within the markets that can cause inflation.

Coupled together, these policies led to the inflationary push we’ve seen over the last 2 years.  But this quarter, we saw another consequence of bad policy - bank failure.

I won’t bore you with all of the details.  I’m sure you’ve read them before.  Banks purchase Treasury bonds with depositor funds.  The days of a bank taking in deposits from you and lending them to me to buy a car or a boat or a house like in "It's A Wonderful Life!” are over.  There are far more deposits than loans at virtually all US banks.

When interest rates rise, depositors withdraw money for better rates elsewhere.  Unfortunately, the bank’s “portfolio” of Treasury bonds falls at the same time.  

That may not make sense on the surface.  Higher interest rates are good for bond owners, right?  

Think of it this way:  The bank owns bonds paying 2%.  Everyone can buy a brand-new Treasury bond paying 3%.  No one is paying the bank 100 cents on the dollar for a lower interest rate than they can get elsewhere.  The bank now owes depositors $100 and maybe only has $90 in investments to back those deposits.

The biggest banking failure this quarter was Silicon Valley Bank.  It had the unique experience of growing by about 5x in the last 3 years.  This meant they owned mostly these low interest Treasury bonds.  

A bank that was established long ago likely owned bonds that ranged in interest rates - providing a better yield for depositors and controlling any problems related to withdrawals.

Other banks have experienced issues.  Surprisingly, the majority have occurred in the same part of the country - in and around San Francisco.  It is unclear whether there was just a massive influx of deposits into these banks in the last few years or the San Francisco Fed was not properly monitoring these banks and assessing the risks.  

I would suspect that the vast majority of banks in the US are fine.  As mentioned, they have varied portfolios and can weather this interest rate change better.

But this whole situation has led me to a startling conclusion.  Maybe it’s not that startling.  It certainly isn’t talked about.  But it is an important topic.

Who is Really In Power?

What I’ve come to realize is that the Chair of the Federal Reserve is the second most powerful person in the world.

We would all agree that the President of the United States is the most powerful person in the world.  Often people would consider the Vice President or maybe Speaker of the House or some important General is the second most important.  Maybe they’d consider the leader of another nation, such as Russia, to be a close second.

But they aren’t.  The Chair of the Federal Reserve is the second most powerful person in the world.  Bar none.

How have I come to this conclusion?  It’s taken over twenty years or so to reach it.

I think back to the last two recessions - 2001 and 2008.  Both times, financial crises in the US drove the developed world into recession. More importantly, both times the US was the model for global direction of interest rates as well as other monetary policies.

This is a vastly different environment than I experienced when I graduated college 32 years ago. Back then, the US central bank was one of many central banks that led the world economy.

How is it different today? Let’s take 2008 for example.  During the Fall and Winter of that year, the Federal Reserve lowered short-term interest rates to practically zero in order to shore up the economy.

During this time, much of the developed world watched with disdain.  “That can’t happen here.  It’s a US problem.”  

Unfortunately, the problem rippled across the world.  What was the reaction by central banks in many other countries?  To lower their rates past zero into negative territory.  

From 2009 until last March, the Fed has kept interest rates artificially low.  In addition, it purchased trillions in government bonds and other securities to ensure interest rates remained low.

And other central banks followed right along.  

Suddenly in March of 2022, the US Federal Reserve began a major interest rate adjustment to address the inflation issues.  The developed world followed along - raising interest rates from historic lows to combat this inflationary pressure.  (Remember, this is pressure that was created by the Fed and their loose monetary policies.)

Today, the Fed is slowing their interest rate increases and talking of peak interest rates.  And what do we see from other nations?  The exact same talk.  Smaller increases.  Talk of a peak.

Ultimately, because the US economy drives the world economy, the Chair of the Federal Reserve doesn’t just set US interest rates, it sets interest rates and monetary policy for the entire world.

And maybe that seems obvious and that’s why it’s never discussed.  Yet here is my issue:

If this is such a critical role in the world economy, why don’t we treat it as such?

Long gone are the days when just anyone can be Fed Chair. It is a critical role that requires a true leader who can discern between long and short term goals as well as have the courage to make difficult calls.

As I look back on the historic nature of this position, I notice that the "modern" era lists mostly bureaucrats in the role of Fed Chair. Prior to the 1970's, it was a role bestowed on a captain of industry. Ironically, the first of the "whiz-kid" economists was appointed by conservative Richard Nixon and possibly the best Federal Reserve Chair ever, Paul Volker, was appointed by Jimmy Carter.

It may be time to take more seriously the role of the Fed Chair. I worry that it will take possibly decades for the Washington machine to realize the importance of the position and set aside politics to pick the best possible candidate to be the second most powerful person on the planet.


Economic Outlook

Looking into the remainder of 2023, I suspect we will continue to see large swings within the various markets.  There continues to be conflicting economic data.  Job growth continues to be strong.  Corporate profits were healthy last quarter.  Yet there are signs of an impending recession.  On top of this, we have interest rates and inflation and banking issues that are top-of-mind for many investors.

I expect that the news machine will calm down as we progress through the year.  This will likely lead to higher stock market values.  We are still well below the early 2022 stock market highs.  It would be nice to return to those days and beyond.

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This blog is the opinion of Successful Money Strategies, Inc. and is provided for informational purposes only and is not intended to provide any investment advice or service.  Statistics and other figures are accurate at the time of original publishing.  Any advice herein should not be acted upon without obtaining specific advice from a licensed professional regarding the reader's own situation or concerns.  Always count your change.