To be quite honest, we are weary of talking and writing about the U.S. budget saga. We share the general disappointment in the conduct seen over the past two weeks, and there are important issues here and overseas that have been crowded out by the circus in our Capitol. Nonetheless, here are some final thoughts on the American fiscal situation.
Markets have consequently pushed out their expectations for changes to monetary strategy. The 10-year U.S. Treasury yield, which is quite sensitive to the outlook for quantitative easing, has dropped by more than 40 basis points since early September.
It may fall, therefore, to Janet Yellen to contemplate initiating the tapering program as she begins her watch. The pressure will be high from the very start.
Debt Ceiling Double Jeopardy
The United States is the only nation with a debt ceiling. In our view, this is not a claim to fame.
The federal debt ceiling, put into place in 1917 as the country was preparing for war, was originally designed to place limits on specific borrowing instruments. In 1939, Congress enacted the aggregate limit on overall public debt. Disagreements about the debt ceiling are a part and parcel of Congressional practice, but the debt ceiling stand-offs in 2011 and 2013 were particularly severe.
At first blush, the notion of a debt ceiling is peculiar because Congress passes bills that determine spending and taxes. When combined with economic developments, these decisions influence the federal budget deficit. How much the nation borrows is really determined by the budget process, and adding a debt ceiling on top of the process can be viewed as somewhat redundant. From a rational standpoint, the debt ceiling should be tied to the budget passed for each fiscal year, if we need to have a debt ceiling at all.
Further, the debt ceiling has been raised 75 times in the last 50 years, which begs the question of whether it is truly a ceiling.
Arguing to cap the debt at a certain level is not a sign of thrift if spending and tax bills are not consistent with it. All that the debt ceiling seems to have done in the last several years is create an artificial brink that raises risks for the markets and the economy. While politically unlikely, eliminating the debt ceiling has a lot of attraction.
Nobel Laureates: Bringing Science to Portfolio Management
When I was a graduate student at the University of Chicago, it was said that one went there to seek Fama and fortune. At the time, Eugene Fama was breaking new ground with statistical work into the performance of assets, earning him the moniker, The Father of Modern Finance.
On Monday, Fama shared the Nobel Prize in economics with Lars Peter Hansen and Robert Shiller. All established great reputations by studying data to better understand market function; this technique was revolutionary at the time they started but has become second nature today.
Among Famas contributions is the efficient market hypothesis, which is often misunderstood. There certainly have been questions raised since the 2008 financial crisis about the collective wisdom of markets, but that experience may actually bolster Famas conclusions.
At its root, the efficient market hypothesis says that investors collectively analyze and incorporate news into asset prices quickly. As conditions change, so do markets. The speed of adjustment, and the rewards that accrue to those with better information, make it very difficult for individual investors to beat the market with stock-picking.
This finding gave rise to index funds, which simply mirror market aggregates as opposed to managing actively to earn incremental returns. Index funds have become a huge part of institutional and personal portfolios.
During the crisis, new information much of it unfavorable was coming at a very rapid rate. Distributions of expectations were moving to the negative. And so from this perspective, the market correction that ensued was not entirely irrational. The fact that markets have recovered since then is likely the result of more uplifting information as opposed to investors regaining their poise after losing their heads.
Reading Famas seminal text, The Foundations of Finance, was not pleasant at first. It is dense with Greek letters. But the concepts within have proven immensely powerful. Our congratulations go out to all of this years winners and to the Swedish Academy for making an enlightened set of selections.