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Comment by greeneggs | Hacker News Reader

I don't buy this analogy. Bankruptcy isn't the only market discipline. If a firm is underperforming, then it will be bought up and sold for parts. This happens all the time, and low interest rates only make it easier.

Anyway, the article's main mistake is in thinking that the Fed controls interest rates. It can only control nominal interest rates, not real interest rates (adjusted for inflation).

Like any other competitive market, real interest rates are set by supply and demand. If companies, entrepreneurs, and investors see few ways of investing cash to increase revenue or improve efficiency, then interest rates must be low. Better investment (real) returns can come from new technologies and innovations, or from demographic surges.

Yes, we all want better investment opportunities, in real dollars. But the Fed can't control this.

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> Yes, we all want better investment opportunities, in real dollars. But the Fed can't control this.

Better means an optimal risk-reward profile, meaning that you don't lose principal while looking to allocate that capital in search for yield.

The Fed controls the rate of the safest investment there is: money held at the Fed AKA the Fed fund rate. Every interest rate is calculated using that fundamental rate as the point of reference because literally every entity in the world has a higher risk of default rate than the U.S. Federal Government.

So yes they control the most important thing in global markets: the price of safe money backed by 5000+ nukes, largest air force, 2nd largest airforce, 3rd largest airforce, largest navy, largest economy...

Your principal is safe only if you demarcate principal in dollars. This is only a reasonable way to measure principal when inflation is negligible. With inflation widely exceeding interest rates, it is unreasonable to consider the only risk of US debt to be default and you have to consider the inflation loss.

Another angle is that all of the military defense backing the USD is coming from dilution of the USD (monetary inflation), or at least that is true as long as we continue to run a deficit.

> it is unreasonable to consider the only risk of US debt to be default and you have to consider the inflation loss.

The Fed mandate says "stable prices AND maximum employment". It says nothing about setting the fed fund rate in a way that enables investors to earn money from lending to an entity which has a zero default risk.

They set the rate and investors use that as a reference point to calculate the rate of everything else, starting from the security which mostly resembles the overnight Fed fund rate : the US. Treasury with the shortest duration which if I recall correctly is the 4 weeks US Note.

When investors are very scared it happens that they get very defensive and pay the Fed govt. for the privilege of parking their money in US Treasuries. It makes sense even, you only have to get rich once and if you are born in America you are essentially already rich the moment you are born (on a global basis), the desire for capital and wealth preservation has steadily increased over time and the Federal Govt. like any borrower is taking advantage of this thirst for safety from investors at home and abroad, this phenomenon actually reduces the Federal Debt which was a huge topic of concern circa 2011-2014.

> The Fed mandate says "stable prices AND maximum employment". It says nothing about setting the fed fund rate in a way that enables investors to earn money from lending to an entity which has a zero default risk.

I was not saying that the Fed mandate says that the fed must do this. I was challenging YOU who said that investors should consider treasuries capital preserving and default risk free. Neither is true-- inflation rate is meant to characterize the buying power of dollars. Whenever inflation rate exceeds the overnight interest rate, then the purchasing power of anyone holding cash or short term treasuries is by definition losing principal in a guaranteed way. Defaulting on a pure fiat system is also basically pointless, dollar denominated debts can always be met with money printing, so inflation is really the only way a default happens. And we did actually default in 1971 when Nixon ended convertibility of dollar to gold.

> When investors are very scared it happens that they get very defensive and pay the Fed govt. for the privilege of parking their money in US Treasuries.

I think you have something inverted here in your understanding (unless you are talking about negative interest rates?). You pay to borrow, you get to collect interest if you park capital. If you want to park money in US treasuries, that's a long treasury position and the government is paying you for the privilege of being able to use your dollars for a while. How it would work is you start with your asset (say a stock) sell that for dollars, then sell the dollars for a treasury, which pays a coupon upon maturation (gives you back more dollars than it started). So investors with a parked cash position are not paying the government, the government is paying them. When there is a panic, I agree the demand for treasuries goes up, and that is why you see the long term rates go down-- as demand for treasuries goes up, they start to be auctioned at a lower premium. The only people paying the government interest on the treasuries are those who are borrowing money, for example banks.

> I was challenging YOU who said that investors should consider treasuries capital preserving and default risk free

I am up for the challenge, but promise to read the whole thing because it took a while to write :)

It is risk free and also think that it's capital preserving in the long run. Every 3-4 years there is a big crisis (health/military/economic) and when fecal matter hits the proverbial fan everything that is not USD gets torn to pieces, like it happened in March 2020. And if you are into any investment that is not USD and need the money (for any reason) or just panic sell...then you take a gigantic loss.

Again, risk/reward. You'll never find an entity with a lower default risk than the U.S. Govt so, by definition that is (for all practical purposes) zero-risk and every other investment entails a non-zero risk of default

As I said, you only have to get rich once, and if you are an American you are already in the top 1% of the world when you are born, so losing 5% or 6% to inflation... that fits the definition of capital preservation much like subbing all the starters and letting the other team score when you are up 72-0 in the 4th quarter of a football game fits the definition of football roster management.

It's also important to stress that you are not really losing 5-6% either, you as an American are a shareholder of the Federal Govt. and as a shareholder you also benefit form the fact that the organization that you "own" can borrow money at a rate lower than inflation.

> You pay to borrow, you get to collect interest if you park capital

If the interest rate of a loan or a bond is lower than inflation you as a lender are essentially paying the borrower for the privilege of parking money with them because by the time they pay you back, inflation ate up your profit and diluted their debt, so they are the ones who come out ahead from the transaction, not you. Big entities with low default risk (zero in the case of the Federal Govt.) and very low for blue chip companies have the advantage of getting loans/issuing bonds at a lower rate compared to inflation expectations.

Leaving aside inflation expectations, if we just look at the past and see what was the rate of inflation in Q1_2022 there are various entities which had the advantage of having borrowed money at a rate lower than inflation, and thus they were de-fato being payed by the lender for the privilege of parking money with them, that's because again...you only have to get rich once. Powell said that inflation wasn't transitory but people decided to lend to those solid entities at below inflation rates anyways in the name of capital preservation because as I repeat again, you only have to get rich once.

I generally agree with you in that historically treasuries and USD have been the lowest risk asset and thus the place to go in a panic. But markets are forward looking and people will always try to predict what will perform better, rather than just rely on past data. The current conditions in terms of the gap between inflation rate and interest rates, and in terms of total debt to GDP ratio have never been seen before. Bond and Treasury holders have never lost this much of their principal before.

I don't see a path for the dollar to regain the credibility that it had before. It might take a long time to transition because much of the market is forced buyers (either the fed itself, or funds that are mandated to hold a percentage of bonds, for example) but the trajectory is clear. As monetary inflation looks more and more unavoidable, fiat as a safe asset will look less enticing. Instead, assets like commodities, real estate, gold, or even bitcoin will look more desirable. Everyone now knows that in the next crisis, the fed will go hard into money printing and monetary inflation will follow. The market will front run that by buying the assets and driving up the price ahead of inflation, which takes a while to slosh around the entire economy.

> you as an American are a shareholder of the Federal Govt. and as a shareholder you also benefit

I'm not sure how I'm a "shareholder". I'm a citizen yes, but there is no equity. There is however an incredible amount of debt relative to GDP (about 130%). If we were a public company, the equity would be worthless and we would be insolvent, as such a high amount of debt relative to a slowly growing revenue (GDP) is impossible to overcome. But as a fiat based country, we can avoid bankruptcy with money printing and monetary inflation.

> Powell said that inflation wasn't transitory but people decided to lend to those solid entities

It isn't PEOPLE who are doing the lending, for the most part these days. The Fed itself was buying $120 billion a month on the open market of treasuries and mortgage bonds plus 4 trillion or so to kick things off. This action is to create new credit and liquidity for the people. The general trend is the the percentage of debt held by the central bank goes higher as the currency gets weaker and debt becomes more of a problem. In the past, when rates were more attractive and debt was lower, then yes, people made up a larger portion of government debt holders.

> I don't see a path for the dollar to regain the credibility that it had before

On the contrary, March 2020 demonstrated that USD is the only game in town, everything collapsed except that. Then the USD "decided" to collapse via tons money printing and zero interest rate. Both policies enacted by the Fed in order to support recovery and its double mandate of stable prices and maximum employment. But there is a huuuge difference between collapsing due to market conditions and actively deciding to debase in order to support market functioning, prices and employment. This seems a subtle difference but it is not, it's the same difference that exists between genuinely losing a boxe match or going down on purpose for the good of the boxing business.

> I'm a citizen yes, but there is no equity

There is equity and also dividends, you just don't see it your portfolio because it's impossible to split the ownership of a bridge or an airport or a port.

> the equity would be worthless and we would be insolvent

A debt of 130% income is actually not even that serious, and besides the US can make that go to 10% or even 5% if it uses all its military might to anness and acquire land and GDP from other countries. The possibility of selling federal land is also priced in.

> It isn't PEOPLE who are doing the lending, for the most part these days

If you read balance sheets you actually see it's not just the Fed, also surveys say that the 60-40 equity-bonds portfolio is still the most popular for family offices, pension funds and even retail investors The 40% is mostly treasuries, so again it's not just the Fed

> On the contrary, March 2020

I'm talking about credibility going forward. I said I agree with you for past events, and you again cite past events. The consequences of that intentional choice going forward are what matters.

> There is equity and also dividends, you just don't see it your portfolio because it's impossible to split the ownership of a bridge or an airport or a port.

Splitting the ownership of things like that to share in profits is literally how equity financing works. I'm not entitled to any profits that the government earns, should it ever actually have profits. Sure, I get to use the publicly owned land and airports, but to call that a dividend or equity is ridiculous. Your analogy would be like saying that since I am a google user, I therefore am a google shareholder. Similarly, a foreign citizen can also use our airports, it doesn't make them a shareholder of the nation.

> so again it's not just the Fed

You are reading past what I'm saying. I never said it was just the fed, what I meant is that the fed at that time was probably the largest market participant and the force that kept rates low, manipulating the entire market despite there being other participants. That's the point of QE-- to entice people to take debt in an environment when the free market can't provide sufficient lending. Note also as I said, many of the 60-40 portfolios are forced-- managers contractually must keep a 40% allocation of bonds.

> The consequences of that intentional choice going forward are what matters.

An entity which is invulnerable to market deterioration and solely decides to handicap itself on its own will for the the greater good so the speak...will always attract the majority of investors. Much like everybody wants to be the manager of the best boxer who is also a showman and decides to go down for the good of the boxing business. People who know, do understand that he is the fundamental part of the equation, not the various prop opponents which are matched against him and that manage to win a fixed match from time to time.

> Sure, I get to use the publicly owned land and airports, but to call that a dividend or equity is ridiculous

Quality of life is obviously a dividend, at the end of the day money is meant to be spent to get quality of life. Only serial accumulators get excited about accumulating zeros and ones in the bank account.

> manipulating

Would you say the US engaged in manipulation after 9/11 when 2 wars were started in 3 years?

A country will always do what is necessary to protect its citizens AKA its shareholders. Especially the most vulnerable ones . They will lower interest rates and engage in QE and do money printing etc. It's their job, and besides in a world and a country which is exceptionally partisan , the Fed approval rating is very high [0]. Actually much higher than every POTUS , except Bush in the aftermath of 9/11.

If we look at data I don't see the erosion of trust in the Federal Reserve that you are seeing

[0]https://www.pewresearch.org/politics/2020/04/09/public-holds...

> Fed approval rating is very high [0]

The fact that your source for this is April 2020 makes me conclude you are trolling

> The fact that your source for this is April 2020 makes me conclude you are trolling

Fed has been doing QE ever since 2008 if you haven't noticed, and interest rates trailed inflation ever since

> the price of safe money backed by 5000+ nukes, largest air force,

  ... and an increasingly fringe electorate.

"I don't buy this analogy. Bankruptcy isn't the only market discipline. If a firm is underperforming, then it will be bought up and sold for parts. This happens all the time, and low interest rates only make it easier."

The cheap financing allows these firms to disguise the fact that they are underperforming.

So whatever form of "market discipline" might occur, these firms are shielded from it because they can just keep rolling over their debt obligations while continuing to pretend they are competitive in the marketplace.

There is this customer who isn't buying anything for the next 10 years, ergo there must be a company that isn't producing anything over the next 10 years. The fact that they roll over their debt tells you nothing about the company, only about the customer.

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