All people are driven by incentives, including senior officials at the most powerful central banks. A look at Jerome Powell's portfolio shows what incentives might drive the chairman of the Federal Reserve.
«You show me the incentives, I’ll show you the outcome.»
Charlie Munger (*1924, Vice Chairman of Berkshire Hathaway)
James M. Buchanan won the 1986 Nobel Prize in Economics for his pioneering work in public choice theory, the systematic study of the efficacy with which representative organizations act on behalf of those they represent.
Its starting point is simply that the presumption of some kind of higher benevolence or public-spiritedness on the part of political agents is a bad one.
Decades before Nassim Taleb had written «Skin in the Game», and without so much of the literary flair, Buchanan argued that agents should be expected to accommodate their own interests pari-passu with those of the group only to the extent that their incentives were accurately aligned. To the extent that there was a misalignment, the agent’s private interests would trump those of the public. The challenge of designing institutions to efficiently achieve that alignment was one Buchanan made his life’s work.
When it came to central banks, Buchanan, writing in 1984 in «Can Policy Activism Succeed? A Public Choice Perspective», when the inflation of the 1970s loomed large in the rear-view mirror (and therefore in most people’s forecast of the imminent future), was clear on what had to be done:
«There is relatively little to be gained by advancing arguments for «better informed» and «more public-spirited» agents, to be instructed by increasingly sophisticated «economic consultants» who are abreast of the frontiers of the «new science». All such efforts will do little more than provide employment for those who are involved.»
Instead, the circumstances faced by central banks must be aligned with those destined to live with the consequences of central banks actions. Thus, for example, Buchanan believed that anyone working in a central bank should be paid in a fixed nominal salary, ensuring their purchasing power would decline inversely and proportionately to each years’ rate of CPI inflation. Such an arrangement would give central bankers skin in the game in the delivery of price stability.
Today’s Federal Open Market Committee (FOMC) also has skin in the game, albeit in a perversion of Buchanan’s original notion. According to disclosures required by the Orwellian-sounding «Office of Government Ethics» (OGE), FOMC-chair Jerome Powell’s private incentives are for continued inflation of asset prices.
The OGE requires members of the executive to file 278e forms disclosing the source of all income and assets beyond their public pay. The precise dollar value of holdings isn’t disclosed in the reports, but broad ranges are.
For example, we don’t know exactly how much the Chairman has invested in Goldman Sachs’ Tactical Tilt Fund, but we do know that it’s somewhere between $1.45m and $6.2m. Similarly, we don’t know Powell’s exact net worth as it stood at the end of 2019, but we do know that it was somewhere between $18m and $55m.
For the avoidance of any doubt, we have no problem at all with people doing well for themselves, or having done well for themselves prior to their public-sector careers provided the gains were earned legitimately – which in the Chairman’s case is clearly true. Neither do we have a problem with public servants having private interests, provided that those interests are fully disclosed which, commendably, they are in this case.
In other words, the magnitude of the Chairman’s individual wealth is of little interest to us. However, the composition of that wealth is, and so the following chart shows our calculations of the ranges given in the OGE filings for the calendar year 2019.
We find it noteworthy that around 60% of Powell’s net investable worth is in (primarily US) equities, a share which is likely higher today given the stellar performance of said equities since the filing (+39% for the S&P 500).
Equally noteworthy is what is absent from the portfolio. In particular, we find it interesting that Powell owns no Treasuries. True, there’s an exposure to a more tax-efficient version – municipal bonds –, but if Powell’s portfolio is a variant on the classic 60-40, there’s a very clear underweighting of nominal assets relative to that framework.
If actions speak more truthfully than words, then the chairman of the FOMC is telling everyone to protect themselves from CPI inflation.
To put it another way, he’s telling everyone to get exposure to financial asset inflation. Consider that as the stock market was wilting by more than one third in March of 2020, Powell’s net worth was falling somewhere between $3.5m to $7.5m, or around 20%. He would have felt the pain of the panic acutely and, if he’s like the rest of us, would have been looking for ways to relieve that pain.
Aside from whether or not one agrees or disagrees with the Fed’s actions then and since, it’s difficult to see how Powell’s thinking at the time could possibly have been unbiased. In the same vein, it’s difficult to see how they could be unbiased today.
Powell has been consistent in his communication to the market that the Fed expects the current CPI surge to be «transitory», to use its recently coined watchword. Rest assured, he and other senior policy makers like Treasury Secretary Janet Yellen have repeatedly affirmed, the Fed had the tools to act should its benign view of inflation prove incorrect and will not hesitate to use them should the necessity arise.
Yet in his July 14th semi-annual report to the Congress, after three consecutive CPI prints in excess of market expectations there was no use of the word «transitory». The emphasis instead was on a quiescent inflation market. Unemployment, meanwhile, had «a long way to go» before meeting the Fed’s full employment goal, and the Fed stood to deliver «powerful support to the economy until the recovery is complete.»
Nassim Taleb says that as a species we’re not so much «rational» as «rationalizing». The head is merely the heart’s stooge. We surmise, therefore, that the Fed’s oft-stated rationale for leaving policy looser for longer – its desire to first see unemployment at record lows – is a trick of the frontal cortex. The real driver of the Fed’s super-accommodation is that tight policy will lead to a significant and emotionally painful hit to the Chairman’s and his family’s net worth.
It’s difficult to see where Jerome Powell’s incentive is to – paraphrasing William McChesney Martin Jr – remove the punchbowl as the party is getting started. It's very easy, in contrast, to see his incentive to add an extra kick to it.