I was recently asked questions about what the IMF is and what debts do we the US owe to the IMF? I share my reply here:
To explain the International Monetary Fund (IMF), it is
helpful to understand its beginnings. The IMF was established, as well as the
World Bank, during one of the most important set of meetings in world history:
those in Bretton Woods by 44 nations in 1944.
Those two organizations have different functions, but both serve towards
the common goals central to those meetings of fostering stability in exchange
rates and in the global economy. Though
the framework of currency exchange stemming from Bretton Woods has long since
collapsed, these organizations remain with us today.
Coming out of World War II, these 44 powers knew they were in a different world. A world that was going to be more linked with
one another and therefore benefit from greater levels of coordination. Keep in
mind the time frame where, in addition to going through a major World War, the
nations were also exiting a decade where they learned the devastation that can
come from isolation and halting trade from one another.
From a practical perspective, the IMF is funded by member
countries (now 189 strong) who contribute to the fund and receive Special
Drawing Rights (SDR) – which are a quasi-currency. As of March 2019, the IMF’s total resources
are about SDR 975 (about $1 trillion). The fund is there to assist countries who
essentially are in crisis and make low interest loans to the poorest of countries.
Besides their role in fostering stability in global exchange, they have the
duty of helping to coordinate policy among member nations. That may sound a bit like herding cats, and
it is. But in times of extreme stress like we have seen recently, the $1T of
firepower can provide some comfort against thoughts of the worst of the worse
outcomes.
So, the US doesn’t owe the IMF money from a debtor’s
standpoint, instead we contribute our portion based on quota formulas to keep
the fund alive and kicking. If the topic interests you, I highly recommend “The
Battle of Bretton Woods” by Benn Steil.
It is a fascinating (to a money nerd) read that pulls heavily on
personal narratives of the central characters behind the scenes of the meetings
and is crucial to understanding the US & Britain’s respective roles in the
world ever since.
Earlier this year, I opened up and talked about my personal
path and how I got here. A few weeks later I ask just where in the hell “here” is.
On one hand, consider me thankful for being four decades ahead of the curve on
social distancing and also thankful for living in such a geographically sparse location. But we are far from excluded from the
pandemic, all the associated concerns, and undoubtedly just days away from confirming
that state of Indiana is infected with the virus from corner to corner.
You all know where we are with stocks, so I will skip right
over that (this was never intended to be an outlet to keep people posted on
financial market status, but rather what is hopefully some helpful context from
time to time from my view of the financial world). But, beyond the carnage in
the stock markets, I point you to what has transpired in the market for
government inflation protected bonds.
This sleepy little corner of the market paints the gloomy picture of
what financial market participants have come to project.
Investors have two choices when purchasing a government bond. She can buy one that is completely fixed in nature or one that is protected from inflation (but the cost of that protection is a smaller interest rate). The difference between these two rates provides a pivotal piece of information (called the breakeven spread) for financial market participants, including the Federal Reserve which watches it very closely.
As you can see in the chart, this figure has had a recent tendency to be in the vicinity of 2%, which should make sense, given that actual inflation rates have also been in that territory. But the recent bloodbath in markets has taken break even spreads to nearly 0.5% at one point. This suggests that the market has come to forecast an inflation rate of 0.5% for the next 10 years. A projection that is so startling because it is almost 1% lower than any rolling 10-year period in the post WWII era! This harsh view gives ample motivation for the Fed to do whatever it takes (including adding zeroes to the stimulus checks coming) to at least restore those expectations.
Source: Ycharts/BLS Capped at 5% to take out the skew of the hyperinflation ’70s
It’s a devastating blow to have such a stark mentality. And here is the essence of why: the mentality itself can slow things down. A large chunk of how we measure inflation is going to be comprised of things that are for the most part stable and consistent risers (cell service, health care, housing, utilities, etc.). So, for the overall inflation expectation to be so low, it is signaling the belief that more discretionary purchases will be falling rather sharply (cars, electronics, etc.). What do people do when they believe prices are falling? They wait. What happens when people wait? A negative feedback loop commences and is difficult to stop. Again, I say, this stunning drop has the Fed’s attention (among the more immediate financial market concerns) and they will wage war.
I mentioned briefly above the words “among other things”
that have the Fed’s attention, which it turns out, are no small such
things. Those concerns are the crucial facilities
that function as the mission critical pipelines of our financial system (such
as the commercial paper market). I am
not going to go into a deep dive into those here but if you are interested and
have not yet, I encourage you to further investigate one of the many good write
ups on those markets. I only point them
out to mention how crucial the Fed actions were this past Tuesday (3-17-20).
Yes, the big headlines were the big 1.5% drop in Fed controlled
interest rates in the two steps taken between their formally scheduled meetings.
That caught investors by surprise and their doubters are correct that the Fed can’t
save us from a virus or even a recession. However, the Fed knows (knew?) that
massive amounts of support are (were?) needed in the financial system from this
becoming a crisis. But the rate cuts were only the appetizer. What they did
Tuesday was the (five star in my opinion) main course with 2 key entrees (both
essentially from precedents set in the great financial crisis).
These two actions were: a) Allowing more securities as
collateral (which prevents banks from having to sell riskier stuff to gain
funding) and b) By jumping all in as essentially THE bank to keep American
corporations liquid and functioning. In
the coming weeks – I believe it quite likely that at least these key markets will
become functional. As functional as we’d like? Time will tell, perhaps not. But
I see the odds in their favor of thawing the most crucial of markets. Keep in
mind this thawing, should it occur, is no guarantee to have an immediate positive
impact on stocks, or the economy, but I do have a higher level of confidence
that the bond market returns to normal which is needed above all else (in finance)
to keep us in the game for a future recovery.
My investing thoughts from here:
Don’t try to be perfect. I mean this in a backwards sense as you take stock of where you are. In most cases, I’m sure you can find some things that went well and some things not so much. Hopefully there is enough positive with which to hang your hat. If not, don’t beat yourself up. But also don’t lose any golden chances to learn and how to improve going forward. Now is not the time for any big changes, but it is the time for big lessons. I also mean not seeking perfection in a forward sense either. It’s a messy business, so don’t waste energy trying to either to time the bottom or avoid all future losses. Investing takes place between the ears, and that will likely take some grace and wiggle to ourselves.
Survival – it’s the core purpose of our lizard brain for a reason. You must take care of survival first and make sure to have enough cash and resources for the weeks/months ahead. Hopefully, you have been planning for days like this and stayed maintained that readiness. Remind yourself of this and the steps you took to survive. If you are behind the 8 ball, again, be kind to yourself but you don’t have a choice – it is never too late to have yourself set up first for making sure you make it through this crisis.
Make no mistake about it – this is a great time to invest (not to be misinterpreted as a 0% probability of future loss). I’ll even give you a couple of examples to hang your hat on. Examples that are in stocks, but plenty have recently emerged on the fixed income side as well. For anyone with excess liquidity, this is one of those rare times where you can make a shiny penny supplying the fixed income market with liquidity (again for brevity sake, sparing the gory details).
Small cap us stocks: Our “safer” indices like the S & P 500 comprised of larger stocks has had its ~30% hit. But small caps have been hit even harder and were under performing entering the crash. At present, the price to earnings ratio on the S & P 600 (small stocks) is nearing 10, a level rarely seen and last hit only briefly in 2008. It can go lower and it can stay low for a long period of time. But history suggests that 5 or 10 years out will reveal this as having been a great time to invest.
Dividend yields: Take the iShares
High Dividend ETF (DVY). It currently
has a dividend yield that is 4% higher than treasury yields. This also occurred in the GFC when the
situation persisted for about half a year.
However, investors were eventually rewarded by having an income stream
from that ETF that became substantially more by 2018 than it was in 2008.
Don’t forget steps one and two. This is a crisis with no precedence. It has unknowns to all of us. But you also
won’t get a “save the date” in the mail letting you know when a bottom is going
to occur in financial markets.
