- Benny Bernanke

Can you remember whose lifestyle is most seriously affected by inflation? Its people on a fixed income; typically pensioners. But the longer the Fed keeps rates at minimal levels as a reaction to a lack of inflation, the more financial trouble there is for the pensions themselves.

Most defined benefit pensions have made promises of payment which require them to make roughly 8% per year on their assets. In a market environment where a ten year treasury bond yields a paltry 2.5%, that is not going to be possible. So for them this low interest rate environment is like getting caught in a rip tide. They can paddle like crazy but in the end they’ll still end up farther from shore.

There is more trouble further up the ‘risk curve’. Hedge funds are riskier than pensions. And while they haven’t given hard promises of a 20% per year absolute return, it is a widely held expectation. The problem though is that with the implied correlation of stocks and indexes at or near all time highs, there isn’t enough difference between stock A and stock B to get anything like that. Some high frequency trading strategies are doing pretty well, (particularly those that are really just institutionalized front running) but those strategies are all constrained with regard to capacity. You may make 30% per year with very little risk, but if you can only do it on 30 million dollars, it’s not much help to you when you manage a total of 2 Billion.

Anyway, the long and short of that is that hedge funds overall are providing a much lower return in this environment than they have in the past, so their investors are feeling the pain too. And who are their investors? In many cases, pension funds. In fact, all investment classes and virtually all investment strategies are yielding substantially less than they used to, and that spells bad news for anyone who has firm commitments on their payouts. So the low risk bets pensions have made on US Treasures have fallen off a cliff and their high risk bets on hedge funds and other strategies are just limping along, but promises still need to be kept and payments made. The money is going out at the same rate as always, but it’s coming in slowed than ever. So what is a pension manager to do?

If you believe that the market is a fixed game, then in an environment like this one, you should be able to chart the progress of the S&P based on demographics. If inflation stays low the pension funds are in trouble but the pensioners are fine. Inflation gets higher the pensions will be fine but the pensioners will suffer. And that means that so as long as there are more future pensioners than current pensioners the need for inflation is greater, and policy should reflect that. Once we reach the tipping point, and current pensioners outnumber future pensioners, the policy should switch back. If you believe the market is a fixed game.

Personally I don’t buy into conspiracy. I think stupidity and incompetence explains the world more effectively than conspiracy ever does. And unlike conspiracy, hard evidence of stupidity and incompetence is everywhere we look. But the incompetent typically respond more to political pressure than the highly skilled, so the result may be the same. We may still end up with a monetary policy that looks essentially like mob rule.

That conjures all sorts of colorful images for me. First, running to the left at high speed like 1970’s British TV comic Benny Hill, is Ben Bernanke. His shirtsleeves are rolled up, his slide rule is in his hand, and his pocket protector is firmly in place. While the music plays, he’s being chased by mobs of lobbyists, union chiefs, political campaign managers and bi-coastal liberal congressmen, while he tosses gobs of money into the air like confetti. Then moments later, he’s running back to the right being chased by tennis racket and golf club wielding geriatrics pushing their walkers and wheelchairs, while he scoops the money back up off the pavement as the credits roll by. Maybe somewhere along the line a Ron Paul look alike pops out of a doorway and slaps Benny Bernanke repeatedly on his balding head.


I guess I watched too much TV as a kid.