Arnold Kling  

A Thought to Ponder

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From Jeremy Siegel:


The major reason for the dramatic drop in these real yields is the unprecedented - and in my opinion unwarranted - level of pessimism and risk aversion that has gripped investors since the financial crisis.

Siegel argues for stocks, as he typically does. The problem is what to buy in a world of low real interest rates. In principle, anything that will increase its nominal value ought to do well. But commodities are already high. Real estate? I can understand why some hedge fund managers are looking at farmland, which seems like a safer bet than commercial real estate.

Relative to the market, I would describe myself as less pessimistic but more risk averse. For me, I have an unusually high share of my portfolio in money market funds. That share was much lower two years ago. If I were reasonably risk tolerant, I probably would take Siegel's approach and load up on stocks.

I would note that if the general pessimism were to lift and interest rates were to rise, the Fed would be stuck with huge embedded capital losses on the long-term bonds it is buying as part of QE2. Freddie and Fannie probably would take big hits as well.


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COMMENTS (5 to date)
fundamentalist writes:

Is it possible for the Fed to lose money when it can print all it wants?

rpl writes:

Arnold,

I second fundamentalist's question. We often hear about the possibility that the Fed might take losses on the assets it holds on its balance sheet. I understand why this is a concern for a regular bank, but as I understand it the Fed can act as an infinite-capacity source or sink for money, so I can't understand why it would care whether it takes a loss (or makes a profit) on its assets. Can you shed any light on the subject?

Adam writes:

Farmland? It's been a longtime, standard investment for large investors. Seems a little worrisome these days--an awful lot of government risk with 1/3 of corn crop going to feed cars, not people.

I do like stocks, especially ones with scalable products, like networking and specialized chips, such as those in wireless.

fundamentalist writes:

Seems to me that if the Fed "loses" money on asset purchases that only means that when the Fed tries to soak up excess cash by selling those assets it will have to sell more to reduce cash than it had to buy to increase cash. But the Fed bought so much that I don't think it will run out of assets to sell when the time comes.

Arnold Kling writes:

The way I look at it, if the Fed buys $2 trillion in bonds and the value of those bonds declines to $1 trillion, then the Fed has lost $1 trillion. The fact that the Fed can print $1 trillion to cover those losses does not erase them.

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