Here we present a history of the Fed in charts. As you’ll surely glean from the below — the Fed has degenerated from a by and large passive institution (dealing only in high-quality self-liquidating commercial paper and gold) to an active pursuant of junk, an enabler of wars, a ‘benevolent’ combatant of the depressions of its own creation, a central planner of employment & prices and of course a forgiving friend to inconvenient market follies.

Update: You can now buy the data behind these charts.

The Fed’s Assets from 1915 to 2012 – Hover & Click to View Each Time Period…

1915 to 1925

Click to enlarge. The Federal Reserve's Assets from 1915 to 1925. Source: St Louis Fed, FRASER

Back to the original chart.

1925 to 1935

Click to enlarge. The Federal Reserve's Assets from 1925 to 1935. Source: St Louis Fed, FRASER

Back to the original chart.

1935 to 1945

Click to enlarge. - The Federal Reserve's Assets from 1935 to 1945. Source: St Louis Fed, FRASER

Back to the original chart.

1945 to 1955

Click to enlarge. - The Federal Reserve's Assets from 1945 to 1955

Back to the original chart.

1955 to 1965

Click to enlarge. The Federal Reserve's Assets from 1955 to 1965. Source: St Louis Fed, FRASER

Back to the original chart.

1965 to 1975

Click to enlarge. - The Federal Reserve's Assets from 1965 to 1975. Source: St Louis Fed, FRASER

Back to the original chart.

1975 to 1985

Click to enlarge. - The Federal Reserve's Assets from 1975 to 1985. Source: St Louis Fed, FRASER

Back to the original chart.

1985 to 1995

Click to enlarge. - The Federal Reserve's Assets from 1985 to 1995. Source: St Louis Fed, FRASER

Back to the original chart.

1995 to 2005

Click to enlarge. - The Federal Reserve's Assets from 1995 to 2005. Source: St Louis Fed, FRASER

Back to the original chart.

2005 to 2012

Click to enlarge. - The Federal Reserve's Assets from 2005 to 2012. Source: St Louis Fed, FRASER

Back to the original chart.

See here for Edward Griffin’s excellent book about the history of the Federal Reserve.

See here to buy the data behind these charts.

The majority of the Fund Management Industry identifies the geographic exposure of an entity by headquarter location, place of primary listing or place of incorporation. In a globalized world where a company receives revenue streams from around the world this obscures country risk. This calls into question the reliability of industry asset allocation and diversification strategies and the prediction capability of conventional portfolio risk modelling techniques.

Background

Fund Managers are primarily in the business of managing risk and it is essential that they understand the risks they face in managing assets within their chosen portfolios. They are, therefore, duty bound to identify, measure, manage and control the risks in their portfolios and construct their portfolios in the full knowledge of the identifiable risks and the likely returns they expect to achieve. Using the twin concepts of asset allocation and diversification as their building blocks, they then construct portfolios aimed at maximising return for any given level of risk or to reduce the risk for any given level of return. They achieve this by allocating capital to different types of assets. Thus, diversification through asset allocation in different and, hopefully, uncorrelated asset classes and sub-classes, investment styles, size, sectors and geographies, is key to managing investment risks.

None of the above is controversial and there is general agreement and acceptance amongst portfolio managers of this reality. Why then does the majority of the Fund Management Industry and their data providers who serve them, choose not to measure geographic exposure correctly?

In an increasingly global world (notwithstanding the events of 2016) companies are doing and will continue to do business across the globe. Materials, goods and services are often produced and sourced in one region of the world, processed in another and sold in a third. All of these actions incur risks which are broadly covered under the over-arching concept of country risk (of which geographical exposure is the foundation). The primary listing, the place of incorporation or headquarters of the company provide no mitigation or ability to control or minimise the risks associated with doing business, and, therefore, reliance upon them, especially in an increasingly global world, is inappropriate and improper.

When companies choose to invest internationally, they have to make a careful assessment of a host of risks: political, economic, financial, legal, tax, security, reputation, financial transparency, money laundering, terrorist funding, public transparency and accountability, corruption etc. Based upon their analysis and understanding of these factors, they take investment decisions. Thus, over the past 30 years, based upon assessment of risks and cost of doing business, the world has witnessed a growing trend of global expansion by businesses outside of their home territories. This has helped open new markets for their products as well as enabled them to establish manufacturing and servicing hubs in countries which offer lower costs of production and attractive infrastructure and technological advantages when compared to their home markets.

So, if the companies in which the Funds Management Industry invests have changed, why is the Industry (and its data providers) still stuck in the past and using the old fashioned method of measuring geographical exposure?

Is this because the Industry can’t be bothered?

Or is it because the Industry considers the geographic and country risks in their portfolios to be insignificant?

Or is this perhaps based upon the false premise that what the investing public isn’t aware of does not need to be explained? But then, why are institutional investors not raising this as an issue? Why have the regulators not picked up on this gap?

Or is it that the industry believes it is too difficult to do and so (apart from a select few exceptions like Capital Group) prefer to bury their collective heads in the sand?

I raised this issue with Morningstar in October 2016 but, other than thanking me for my analysis, they have neither accepted nor rejected my argument that the industry needs to rethink how they go about identifying geographical exposure.

Whatever the reasoning of the Fund Management Industry (and its data providers) for their failure to change, what is apparent to me is that theirs is an abject failure to recognise the risks in the portfolios they manage and get paid for. The Industry has a duty of being transparent and is required to disclose sufficient information to its investors to enable them to make investment decisions. In turn, it has sufficient regulatory backing to demand the same level of transparency from the companies that they invest in. Regulators also mandate that decision-making by the Fund Managers is supported by robust risk management policies, systems and processes with clear linkage into the asset valuation process. So risk management processes used should enable the Fund Manager to monitor and measure the risks of the positions they take and the contributions of the assets to the overall risk. This requires risk limits and systems that enable risks to be accurately measured on the basis of sound and reliable data.

When the Fund Management Industry has no realistic idea of the geographic exposure in their portfolios, the risks they do actually identify and the measurement of these risks cannot be considered reliable, as they ignore the operating environment in which companies operate. This, in turn, calls into question the reliability of their asset allocation and diversification strategies and the prediction capability of their modelling of portfolio risks. If the risks cannot be predicted, how can they be reduced, mitigated or controlled?

Identifying the environment in which the target companies operate is a key building block of any risk assessment before an investment decision is taken. The geographical spread of these operations is, therefore, a key early enquiry that needs to be made. If this is not done, or is only limited to the target company’s domicile base, the risks and rewards of the international strategy of the target company and the Fund Manager remain unknown, as is the impact upon the share price and potential value of the target.

Thus, using the domicile or the primary listing of the target company to identify its geographical exposure is fundamentally incorrect as it turns a blind eye to the sovereign and country risk exposures that businesses are exposed to in trading internationally.

Governments in the developed world do not provide any implicit or even explicit mechanism to guarantee the solvency of corporations. The only exceptions to this are major banks of systemic importance and certain companies in the crucial defence sector. Moreover, country risk is not merely an issue for financial institutions lending to, and corporations trading in or with, emerging market countries. Nor is it simply a question about the foreign exchange holdings of the host country. It, if ignored, has serious repercussions for the investor, as it can seriously impact on share price and not just in emerging markets as BP PLC learnt at huge expense in relation to the Macondo spill some years back (Management lost sight of the highly litigative nature of American society, compared to other nationalities. This became toxic for BP PLC when it mixed with politics and environmental risks.). The fund management industry, therefore, ignores country risk at its peril.

If further proof is required of the importance of assessing country risk, I draw the attention of readers to the innumerable times the Oil & Gas Industry has faced losses through the nationalisation, confiscation or expropriation of their assets. Mexico (1938), Iran (1953), Sri Lanka (1962), India (1973), Bolivia (2006), Venezuela (2007 & 2010) are just some of the many examples. Some countries such as Russia, Kazakhstan, Equatorial Guinea, Bolivia, Venezuela and Ecuador have, in recent years, all sharply increased tax rates and royalties on oil & gas assets. Exxon, Conoco Phillips, BP, Royal Dutch Shell, Total and many other big players have all been the victims of these actions.The Oil & Gas sector is not the only sector that has felt the impact. The banking & financial sector too has seen its fair share: India (1969), Mexico (1982) and Venezuela (2009-10) are just a few examples. In fact, Venezuela under Chavez nationalised a wide range of industries in sectors ranging from Agriculture, Oil & Gas, Finance, Glass containers, Gold, Steel, Power, Telecommunications, Tourism and Transport.

How should geographic exposure be identified?

The first step for assessing country risk is the need to accurately measure the geographical exposure. The correct way to identify the geographical exposures should necessarily be based on one or more of the following methods:

1. Domicile of the Sources of Revenue: Revenues being less
   capable of being massaged than net profits and operating profits are, therefore, more reliable.
2. Domicile of the Revenue Producing Assets.
3. Domicile of the legal system upon which reliance is placed to recover revenues and assets in the event of bankruptcy.
4. Domicile of the legal system upon which reliance is placed when damage to licensing, royalties and patents are seen as the principal risk to the success of the business.
5. Domicile in which key personnel and systems are based and supported when the risk of loss of key personnel and systems is identified as the key risk to the success of the business.

The Risk Manager and the Risk Committee of the Fund Manager must, based on careful investigation and consideration, decide which of the above listed options is best suited to identifying and measuring the geographical exposure of the target company to be incorporated into the investment portfolio. There is no single best option and the decision must be taken by identifying the key ingredients that ensure the success of the target company. However, if a single choice must be made, then, in my opinion, the one based on economic exposure (i.e. revenues) is perhaps the best of the above listed options because companies are already providing this information in some form within their annual report and accounts.

How much do the results of measuring geographical exposure by the above mentioned methods differ from those produced by the industry’s approach?

This is best shown by way of some examples. As I am a UK based small investor, let me show you some examples from within my own portfolio. This necessarily focuses on individual companies and not an ETF or a mutual fund.

I. Arm Holdings PLC

Arm Holdings PLC is incorporated in the UK and its principal listing (prior to it being acquired by Softbank) was also in the UK. This led Morningstar to categorize and count Arm Holdings for purposes of geographic exposure as a 100% UK based company.

However, when one examines the sources of revenues of Arm Holdings PLC (taking year end 2015 data), the following picture emerges:

This data clearly shows that an investor buying shares in Arm Holdings PLC is not being exposed to the UK but has a broad international exposure. This data was available to Morningstar and displayed in the stock report PDF it published but still it chose not to apply this information to the geographic piece. While the Revenues analysis provides a useful tool for assessing the geographic spread of Arm Holdings’ business, the nature of the company lends itself to at least two other ways for assessing the geographic exposure of the company:

i. If its employees and systems are viewed by the Risk Manager and Risk Committee to be key to its success then an analysis of the domicile of the 3,975 strong workforce (at the end of 2015) could provide guidance. The information contained in the following table has been extracted from the 2015 Annual Report & Accounts:

Here, the data needs further granularity so that the number of people domiciled in the Eurozone, Europe ex Euro Zone, Emerging Europe, Developed Asia and Developing Asia (data by country would be better but even data by region is useful) can be more clearly identified. Fund Managers and institutional investors should not find it too difficult to ask and get this information. Even data providers like Morningstar are well placed to do so.

Notwithstanding the gaps in the table above, it does clearly show that on the basis of the strength of the workforce, an investor buying stock of Arm Holdings will have just under 40% exposure to the UK.

ii. There is yet another choice available to the Risk Manager & Risk committee to investigate: As Arm Holdings’ revenues come principally from licensing and royalties and they have a large number of patents in place, the need to protect these may be considered critical to its continued success. If so, then the fact that all these are protected under English law, the Risk Manager and Risk Committee may choose to identify the geographic exposure as entirely UK.

It hardly needs to be stressed here that there is an active choice that has to be made and based on an analysis and understanding of the risks. This,in turn, should be reflected in the stock report.

II. Experian PLC

Experian PLC has its headquarters in Dublin, Ireland, but its principal stock listing is in the UK. Hence Morningstar and the Fund Management Industry categorizes Experian PLC as 100% UK exposure. However, if we analyse its 2016 revenues, the following picture emerges:

It shows that categorising Experian PLC as 100% UK exposure is misleading and clearly wrong. The USA is,by far, the biggest market for the company. The troubles of the Brazilian economy have resulted in it slipping below the UK & Ireland contributions in this year.

The business of Experian PLC lends itself to three others ways of determining its geographical spread. These are:

i. If we look at where Experian’s non-current assets are domiciled, their latest annual report as at 31 March 2016 shows the following distribution:

Here too the message that comes through is that Experian PLC’s fate is not dependant upon the UK. It is clearly more reliant on North America while Latin America (primarily Brazil) due to its growth potential is also more critical to its success.

ii. Experian states that its expertise lies in data, analytics and technologies. It uses this expertise to give customers the power to assess, predict and to plan to achieve their goals. It also counts its brand as a key strength. Given this information,the Risk Manager and Risk Committee may wish to determine the domicile of its employees. Taken from their 2016 Annual Report, the picture that emerges is:

This, again, highlights the fact that Experian PLC cannot be considered to be wholly geographically based in the UK. There is nothing to stop the Risk Committee to choose a subset of the whole employee count to arrive at their answer. Their reasons must be supported by demonstrable facts and reasoning.

iii. The amount of capital deployed to each region of the world also offers us another means of determining the geographic mix of Experian PLC. The 2016 Annual Report gives the following information for our benefit:

Here, again, it is clear that North America and Latin America are key to the success of the company and that the UK & Ireland, despite being the domicile of the company, is third in the pecking order as far as capital employed in the business is concerned.

The choice of method to be used for determining the correct geographic exposure must be decided by the Risk Committee. This decision should be explained and form part of the final investment decision.

The Result

Both the examples of Arm Holdings PLC and Experian PLC show that the results of the alternative methods of identifying geographic exposure are very different to the results achieved by relying on country of primary listing or domicile of a company’s headquarters. It also shows that plain reliance on country of primary listing or domicile of a company’s headquarters is not a useful criteria for identifying the geographical mix of the business and that the alternative means available are better at determining the right answer. It is disappointing that neither the Fund Management Industry nor the data providers like Morningstar make an effort to get this right. As the data is incorrect, how can investors rely upon it while taking decisions to invest? This raises the question whether Fund Managers are failing to meet their undertakings to the Regulators who expect them to provide accurate and reliable information in a transparent and accountable fashion to the end investor.

If the geographic exposure is wrong, as I have shown above, it is highly unlikely that the Fund Management Industry has a proper handle on what country risks their portfolios contain. This means that while doing their due diligence, the Fund Managers are unable to ask the right questions that should be asked to determine and understand the risks. It also means that once the investments have been made, there is no active process to manage the country risks that are out there in the portfolio.

Am I alone in raising my voice on this issue?

Happily, mine is not the lone voice on this issue. One voice is from within the Industry itself – the highly respected fund management giant, Capital Group. It makes the point that a company’s domicile provides little information about its potential success or its future share price and believes that far more meaningful is a company’s economic exposure, with revenue being the best available measure.

It has also pointed out that over two-thirds of companies that are constituents of the MSCI All Country World Index provide country-by-country revenue data while the remaining provide regional breakdowns. However, they do admit that notwithstanding enhanced reporting requirements introduced by accounting standards, much work needs to be done to get the broader corporate world to voluntarily provide data in usable form. Here, I would like to suggest that the Fund Management Industry (and its data providers) needs to fully acknowledge this issue and use its position and influence to mould behaviour of companies so that they provide this information.

The EDHEC – Risk Institute¹ too has questioned the usefulness of analysing geographic equities exposure based on the stocks place of listing, incorporation or headquarters. Like the Capital Group, they too prefer to identify geographic exposure by disaggregating sales (i.e. using economic exposure i.e. revenues) by their geography. They studied the geographical exposure by sales of the constituents of several developed market indices (e.g. S&P 500) over a 10-year period: 2003-2012, and found these to have a significant exposure to non-domestic regions and by the end of the 10-year period this exposure had increased significantly². The same finding was reinforced when the constituents of the S&P 500 and STOXX Europe 600 were weighted by percentage of sales in foreign markets³. They further found that the emerging market exposure of these indices was already material in 2003 but almost doubled by 2013.⁴

MSCI has also recognised the benefit of identifying geographic exposures⁵ through the use of economic exposure and produced some indices based on economic exposures for use of investors who wish to “tilt” their portfolios accordingly. However, they take the view that the original market-cap is the pure index and, therefore, they do not advocate a wholesale shift to indices based on economic exposure. I have an issue with this. Market capitalisation is a reflection of the economic value of the business as perceived by the market and incorporates all information that is known. Thus, any positive or negative impact of activity outside of the home market would feed through into the market capitalisation of a company that has cross-border activity, while one that has purely domestic activity will not be impacted. If that is accepted to be true, then wouldn’t the indices using economic exposures to identify the correct geography of their portfolios be the real “pure” index instead of one based on domicile or primary listing? In other words, I believe MSCI should actually ask investors to shift to economic exposure based indices. This will no doubt mean that they will have to swallow a bitter pill while accepting their original indices were flawed; I do believe this is part and parcel of being a highly professional organisation and would not do any harm to their reputation. It may, on the other hand, enhance it.

Country Exposure

Once the geographic exposures of the company are correctly identified, the Fund Manager must ensure he understands the likely impact on his investment from the manifold factors that constitute country risk. This would normally include periodic review with company to identify the risks and understand the steps taken by the company to mitigate the risks. Purchasing political risk insurance, hedging currency risk, and settling legal disputes through international arbitration are just some of the available options to the company. Where the company has a local presence in an emerging market, working with local partners, hiring local staff, providing security detail to protect to fixed assets and key foreign employees, borrowing local funds from a local bank are just some of the options available to the company to safeguard its interests and for the Fund Manager to remain informed about.

The Fund Manager, armed with knowledge of the cross-border exposures contained in his investment portfolio, is better placed to take corrective action when adverse events have the potential to hurt its value. He may be able to buy a “protective-put” on stocks or a subset of the portfolio of stocks to prevent potential loss in capital invested.

Summing Up

The Fund Management Industry and its data providers are, by ignoring the real geographic mix of their portfolios, failing to recognize the real risks in the portfolios they manage and get paid for. It is time for the industry, its data providers, trade bodies and regulators to heed this wake-up call for change.

^{1. [Accounting for Geographic Exposure in Performance and Risk Reporting of Equity Portfolios.]↩}

^{2. [S&P 500 had exposure of 19% to ex-Americas region in 2003 and increased to 27% in 2012.]↩}

^{3. [S&P 500 % of sales rose from 29.9% in 2004 to 38.7% in 2013. STOXX 600, 41% to 53.3%.]↩}

^{4. [STOXX 600 exposure increased from 10.7% to 22.7% in the period.]↩}

^{5. [Economic Exposure in Global Investing: Tilting Portfolios based on Macroeconomic Views.]↩}

This was a guest post by Jaskaran Singh, a risk management professional with over 30 years experience in the finance industry.

Any feedback / suggestions would be happily received as always (you can catch me on aftab@greshams-law.com).

Hope you find it useful.

]]> http://greshams-law.com/2014/09/06/real-interest-charts-page-interactive/feed/ 1 http://greshams-law.com/2014/06/28/statistical-games/ http://greshams-law.com/2014/06/28/statistical-games/#comments Sat, 28 Jun 2014 08:30:56 +0000 http://greshams-law.com/?p=9961 It’s fair to say that among those of us buried deep in the paranoid depths of the alt-finance community, a certain suspicion exists when it comes to government economic statistics. I don’t think it’s too much of a stretch to claim that among the broader population, cynicism about such stats is also increasing. We have after all seen a senior policeman testify in parliament to the corruption of official crime stats, just as rigorous studies have shown grade inflation in school exam results. Why should economics be immune from this malign trend?
 

Still: suspicion is one thing; hard evidence another. Given the convoluted maths and assumptions built into economic stats, it’s hard for lay observers to point to smoking guns showing clear manipulation. But just occasionally we get insider commentary offering pretty good confirmation; in this instance, Mike Bryan, vice president and senior economist in the Atlanta Fed’s research department:

“I remember a morning in 1991 at a meeting of the Federal Reserve Bank of Cleveland’s board of directors. I was welcomed to the lectern with, “Now it’s time to see what Mike is going to throw out of the CPI this month.”

His article on the subject is worth reading.

Then there is the convenient timing behind some methodological changes. Recently it was announced that some European governments would soon be including criminal activities such as drug dealing and prostitution in their GDP figures. For years – nay decades – this wasn’t deemed necessary, back when these governments weren’t running perpetual deficits for as far as the eye could see, and weren’t faced with the grisly combination of rapidly aging populations and unaffordable welfare schemes. But now, faced with these problems, they suddenly decide that they’ve been under-counting GDP all along. Nice coincidence.

The most obvious objection to including drugs and whoring in stats is that there’s even more guesswork involved than with measuring legal activities. Pimps and dealers aren’t always that upfront about reporting their transactions to Inland Revenue. They don’t pay tax on their work, so the government isn’t gaining from their business. So why does it make sense to include such ill-gotten gains when measuring say, the government’s deficit as a percentage of GDP?

If the government were planning to legalise these activities then a good case could be made for these adjustments. But as it is, it looks like another dubious attempt by the state to paint a rosier picture of reality than is actually the case.

Last year the US miraculously increased its GDP by $500bn – equivalent to around a 3% increase in the size of the economy – thanks mainly to redefining R&D spending on “intangibles” like music and films as “investments”. Peter Schiff offered a good critique of this:

“In essence, the new methodology is an exercise in double accounting. For instance, suppose a company employs an accountant who works in the sales department, who is then transferred to the R&D department at the same salary. He still counts beans but now his salary will be billed to the R&D budget rather than sales. In the old methodology, the accountant’s impact on GDP would come only from the personal consumption that his salary allows. Going forward, he will add to GDP in two ways: from his personal consumption and his salary’s addition to his company’s R&D budget. The same formula would apply to a trucker who switches from a freight company to a movie production company (for the same salary). If he moves refrigerators, he only adds to GDP through his personal spending, but if he hauls movie lights, his contribution to GDP is doubled. It makes no difference if the movie bombs.”

This isn’t quite as blatant as the Nigerian government’s recent changes to its GDP computation methods, which resulted in a 90% increase (as a result Nigeria is now statistically the biggest African economy), but still. Accounting bodies can spend years debating changes to GAAP and IFRS standards that affect private companies – and rightly so: consistent accounting standards are a basic, vital requirement for any functioning economy. The same consistency in GDP standards – both across time and across countries – seems lacking, perhaps because whereas GAAP and IFRS are administered to private companies by outsiders, GDP amounts to governments marking their own homework. It’s not surprising that when the going gets tough, they find ever-more ingenious methods of giving themselves “A” grades.

Sometimes the official numbers involve such large adjustments that no belief in subterfuge is necessary in order to call the process into question. Take the Q1 GDP print for the US economy. Initially this was reported as 0.1% in the advanced estimate released in May. Then it was marked down to -1.0% in the second revision, and finally -2.9% in the latest revision released on June 25. Perhaps more changes are to come (see the chart below for the same period in 2008) by which time of course the media will be reporting the latest initial GDP estimates, with little-to-no attention given to old data adjustments.

We live in a strange world where the government can report misleading, substantially inaccurate growth data that appears to be based on a fair amount of wishful thinking and questionable methodology – and which is then taken at face value by media, so influencing countless business and investment decisions. As The Return of the Great Depression author Vox Day notes, back in 2009 average GDP revisions were larger than the delta that distinguished growth from recessions. Now the revisions are nearly three-times larger.

Everyone has heard of the butterfly effect. Individuals would surely have made different investment decisions had for example, Q1 2008 GDP been reported as negative from the start, rather than 13 months down the line. All of which could have resulted in substantial difference in capital market prices as opposed to what actually transpired.

It’s time to privatise national statistics.

Mainstream economists tend to belittle the significance of this subject. Monetarists and Keynesians regard an elastic money supply, manipulated by central banks, as a desirable weapon to be used in smoothing out the business cycle. Some economists even go so far as to argue that with interest rates at record lows and inflation tepid, central banks should be directly monetising government infrastructure projects.

An expansion in base money will mean that a central bank’s balance sheet grows. It will be acquiring assets (mostly public debt, but some private as well – see the Fed’s purchases of mortgage-backed securities since 2008) which will of course be matched by equal dollar liabilities (or whichever currency it “prints” to buy said assets. All currency – whether the coins in your pocket or your online bank deposit – are liabilities of the issuing central bank).

Of the more established economic schools, Austrian economists are the only ones who are hostile to such ideas, on the grounds that such meddling will lead to inflation and moral hazard. When both government and large banks enjoy an “open bar” at the expense of everyone else, they grow disproportionately in relation to the parts of the economy that don’t enjoy first access to newly printed money. The impoverishing effects of high inflation hardly need spelling out.

This new study appears to offer some support for both positions. Contrary to a lot of Austrian, hard-money rhetoric in recent years, central bank asset purchases don’t look particularly significant when set against total credit levels over the last half century (page 10). A collapse in private credit post-2008 has been offset by a big rise in public debt – funded by central banks. This is why countries like the USA, UK and Japan are enjoying nice simulated recoveries, whereas nations without such money printing capabilities – the “Club Med” eurozone – continue to suffer depressions. It is also why inflation has remained fairly muted: the deflationary force of private credit contraction fighting the inflationary forces of government deficit spending and central bank money printing.

The authors note that central bank balance sheets (CBBS) did contract significantly over certain periods. But these contractions were relative to GDP, and seldom in nominal terms. In the US, the Fed’s balance sheet contracted steadily relative to GDP from the late 1940s until the late 60s, during the postwar boom. The same was true for other countries over roughly similar periods. So the concerns some have about how central banks are going to sell all the bonds they’ve bought post-2008 appear somewhat misplaced: most of these assets will never need to be sold in order for central banks to deleverage.

The fly in the ointment

All of this comes with a rather large caveat in the form of the final sentence of the study: “near-term inflation risks from CBBS expansion seem low, but the threat to long-run price stability is real when fiscal deficits are persistent and central bank independence is compromised.”

Fiscal deficits are certainly persistent in the US, UK and many other developed countries. They are likely to get worse owing to unaffordable welfare schemes (not to mention occasional, costly military adventures in far flung lands). So the question we have to ask ourselves is: has central bank independence been compromised?

The chart above (from page 12) offers hints. Note how the last year of expansion is entirely accounted for by the “Demand stabilization” category, with orange bars increasingly frequent during the last decade. Given that “Demand stabilization” involves artificially boosting government spending, the boundaries between it and “Government financing” don’t seem that clear-cut.

Consider the decision in November 2012 to reallocate the interest the Bank of England had earned on bonds bought via QE (then totaling £35bn) to HM Treasury. As the Telegraph’s Jeremy Warner argued, this crossed “the line into straight government financing.” And though the other two big QE nations – the US and Japan – also have the same tidy interest arrangement between their central banks and government, few believe in the latter’s case that the central bank is anything other than the pawn of a government that is desperate to boost exports and deal with a chronic debt problem.

Central bank independence has been compromised. Governments continue to go deeper into debt. As Jim Rogers says in this interesting (73 minute) interview, a lesson of history is that countries don’t generally recover from such situations without enduring a serious crisis first.

Though perhaps as PIMCO’s Paul McCulley argues, the “Big One” was in 2008, and we don’t have to worry about another one. He argues that thanks to central bank largesse we’re on the verge of exiting the post-crisis liquidity trap, and are currently enjoying “a once-in-a-lifetime revaluation of assets.”

We’ll see.

Rule changes announced by Chancellor George Osborne in his March budget mean that retirees with private pensions will no longer be compelled to buy annuities. This has been uniformly welcomed by those on the Right of the British political spectrum – their views well summarised by CityAM Editor Allister Heath: “Labour would be mad to jump on its paternalistic, nannying high horse and to oppose Osborne’s pension liberation.” For many neoliberals, eliminating the coercive requirement to buy an annuity is akin to Thatcher’s Right to Buy legislation, which enabled council house tenants to buy their homes at discounts, based on their years of tenure.

As Harris argues, however, there is a world of difference between granting people the right to buy a house, and giving people control over a large sum of money and asking them to invest it wisely. The latter obviously being much riskier and mentally demanding than the former.

This is doubly so when the Bank of England – backed by the government – continues to keep real interest rates in negative territory, meaning you cannot get an above-inflation return on simple, easily understandable savings products. Combine this with the fact that people are living longer and spending longer as retirees, and we arrive at a situation where investing in shares, property, high-yield, high-risk bonds and alternatives like commodities will become the only rational options for new retirees looking to protect their capital from inflation.

Some will manage to do this, just as some young people successfully deal with Mr Market. But it doesn’t seem a stretch to imagine that most won’t manage well, given general ignorance of high finance and investment products, and the sad fact that mental faculties decline with age.

Call it an unfortunate irony of central planning: when one policy of the leviathan state (encouraging spending and discouraging saving) complicates another policy from the same state (giving people greater freedom to spend their retirement funds).

Peter Schiff and Nouriel Roubini, two of the original “Doctor Dooms”, go at it hammer and tongs in the video above, in a discussion on the state of the US economy and the perennial inflation versus deflation debate. Not much love lost between them, though they keep the discussion civil.

What interests me is Roubini’s continual references to the Great Depression and Japan’s experience since 1990 as evidence that deflation is always bad. Yes, this is one side of the story. No one, not even Schiff, is arguing that debt-deflation – when falling prices increase the real burden of debt – is good.

But there is another side to deflation – the one that Schiff describes: when a relatively fixed money-supply combines with pro-growth, low tax policies, encouraging saving, investment and hence industrial expansion. In this scenario, lower prices are not a symptom of collapsing demand, but a reflection of greater industrial efficiency and productivity.

The US slipped briefly into deflation in the mid-1950s, during the postwar boom. It also experienced persistent deflation during the late 19th century – a period of rapid industrialisation. In Britain, wholesale prices were at the same level in 1900 as they had been 200 years earlier, with prices falling steadily over the course of the 19th century.

Heavily-indebted modern governments rightly fear deflation (in comparison, consider that from 1815 to 1900, the UK government ran an annual deficit on just four occasions). But, contra Roubini and as Schiff says, this does not mean that deflation is always a sign of trouble with the economy.