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When I worked in mainstream finance, I came across a lot of people (men, mostly) with big-sounding job titles and hefty salaries to match.  Frequently, they would claim, or at least imply, with great confidence that their success was evidence of the meritocratic nature of the financial services industry: they were smart, they had worked hard, their efforts had been recognised and rewarded.  As things go in milk-making, so they go in business: the cream naturally rises to the top.  Once, I was foolish enough to say to my CEO that the problem with senior managers at our firm was that all the people at the top thought they owed their position to merit but almost no-one who worked for them shared that view.  I added that this was also true in most comparable firms.  I doubt my career trajectory improved after that conversation, but it was probably already too late.  Nonetheless, I still stand by what I said then: if you really want to know how good a manager is, don’t ask them, talk to their junior staff instead. 

Mohandas Gandhi was once asked his opinion about Western civilization, and replied, “I think it would be a very good idea”, which nicely sums up my view about meritocracy.  What we have in the West is a system that encourages people at the top to believe they deserve to be there, without paying much attention to whether there is any evidence to support that belief.  We are born with nothing and we die with nothing (the Book of Job reminds us), so we convince ourselves that what we make of our lives is down to us, and that consequently we should bear responsibility for our failures and take credit for our successes.  Except that we are not born into nothing: we are born into a complex socio-economic world, which supplies advantages to some and disadvantages to others, and what we are able to make of our lives is significantly constrained by the place of our birth, our sex organs and skin colour, and the attitude our parents take towards our education.

Continue reading “Lucky, lucky, lucky”

The Financial Times ran an opinion piece today that posed the question “who gets to create a dollar?” which is a common thought of mine, or at least one way to frame my favourite question ever, which is “what is money.” The topic has been covered several times on this site, but the world at large remains blissfully unaware, really, of the existential nature of money, and as a result, we find new ways to panic about it or, alternatively, to build incredibly silly castles in the air around it.

The latest panic, of course, comes from the failure of a bank on the West Coast, Silicon Valley Bank, which blew itself up in what was frankly one of the most avoidable ways to fail as a bank: they bought a lot of really long duration fixed income securities using deposit money that was highly uncertain to stick around and had only come around to them in the last couple of years. Lots of other banks have bought really long duration fixed income securities, but they did so with very stable retail deposits that had proven their “stickiness” as customer relationships. Silicon Valley Bank’s deposits came from venture capital firms and the startups they financed. The startups themselves should never have been viewed as “sticky money”: 70% of all startups fail in their first two years, and when they do, they famously “burn” through their funding. Thus most of SVB’s startup deposits should have been expected to go away quickly – certainly before their portfolio of low coupon mortgage backed pass-through securities would ever pay off. And a large portion of the rest of their deposits came from rich VC types and their fund vehicles who parked their cash at SVB while they decided what to do with it. With new funding on hold in a rising rate environment, and with VC people famously as interested in buying real estate and Maseratis as they are in keeping robust deposit balances at their friendly VC-oriented bank, again, any kid with a year out of college and the opportunity to take four hours of online banking training would have known that the deposit book was flighty – or “hot”, in the industry parlance.

So SVB’s depositors – predictably – drew down their balances starting late last year – nothing panicky, mind you, just startups burning through cash as they do and VC folks making poor luxury good purchasing decisions as they do. But SVB quickly ran out of its cash-cash, and had to start selling its really long dated fixed income securities. The trouble was, they had been bought at yields around 1.75%, and yields were inching up towards 5.00%. With an average duration of around 8 years or so, that meant these securities were trading at around 80 cents on the dollar – not because there was a risk that they wouldn’t pay, mind you, it’s just that they’d pay you back at a very low interest rate, so people buying them today aren’t willing to pay par for them in the way SVB paid par for them in 2021 and early 2022.

SVB then had to tell the market “hey, we just had $21 billion in additional deposit run off, no big deal right, sort of normal, but we took over $2 billion in losses when we sold our Treasuries and agency bonds to cover it, wow, sorry, and oh yeah, if we have more deposit runoff the losses on the rest of the book are even bigger in percentage terms, like, a lot more than all of the capital we have, sorry.” Unsurprisingly, other depositors thought “wait, if their capital is less than the current losses on their securities, they might not be able to pay off our deposits – after all, we’ve got a lot more than the $250,000 insured by the FDIC – so let’s get our money out now” and last Thursday, $42 billion of deposits were withdrawn, and sure enough, SVB ran out of value: they could not place enough collateral at the Fed to enable the Fed to release the withdrawn deposits, and the State of California – who regulated SVB – announced that the bank was closed.

As a banking professional, I thought “wow, dumb treasury guys over at SVB – or at least, dumb treasury strategy” and literally thought nothing of it. The good folks at the Fed and FDIC, though, thought “huh, a few other banks are in a similar position” and moved quickly to tell large depositors (not bond holders, and importantly, not all depositors – just ones with deposits that can immediately be called) not to worry, their money was safe, don’t go withdrawing it to put it in money market funds or with JPMorgan Chase, it’s all okay. And they told the folks at SVB that, no matter how much they had on deposit, they’d get their money back – effectively backstopping those uninsured deposits, although in practice, the FDIC will charge for any losses incurred after it figures out what to do with SVB’s bond and loan portfolios, which could easily involve a massive exchange of long dated securities for short dated securities with the Treasury Department in what’s called a debt management operation, normally kind of tricky but since the FDIC is just an instrument of the Treasury Department actually kind of just a paper exercise in this case.

As I mentioned, this happened because SVB did something terribly foolish – namely, pretend that their really “hot” deposit book that was always at risk of fast runoff was somehow stable enough to justify investing in very long dated fixed income securities. What they arguably should have done was invested in short dated securities – say, two years or less – and then if the depositors needed their money back, hey, in any quarter, a decent chunk of securities would be maturing anyway, and no need to sell and produce losses against capital. Had SVB done that, though, those dollars would have stuck around, chasing some new thing to buy. Oddly, by investing in long dated securities, SVB did the economy a huge favour: it destroyed value.

Wait a second, Freilinger – I can hear you say – why is value destruction a good thing? Well, simple: we have too many dollars in “the system” right now. The Fed and the US government created them, beginning back in 2008 during the last crisis and with a huge spike during the pandemic when all the stops got pulled because people were worried about a plague-induced general zombie economic apocalypse; now they need to be destroyed because they are, in essence, the real zombies created by the pandemic: zombie dollars that have nothing, really, to buy, and thus simply chase up the price of all goods through a monetary effect called inflation.

Really, any time someone who bought a long term fixed income security at par in 2021 or early 2022 – when the amount of excess dollars was at its height – was helping the Fed by creating an almost automatic forward destruction of value. In fact, the Fed did this by expanding its balance sheet at the time to buy such securities; it’s now sitting on a gigantic paper loss, but as the central bank, it doesn’t care about paper losses; it’s retained earnings account is utterly meaningless, so it can sit on its losses forever and the economy won’t notice (or it will, but it will be happy about it, because it will limit momentum towards price inflation). Banks who did so are generally a bit annoyed: they’ll have lower earnings for years to come, but as long as they didn’t overindulge – or invest hot deposit money that is unlikely to stick around – it’ll just be a drag on capital accumulation. But that’s also a good thing: bank capital accumulation at least somewhat results in more lending, which results in more dollars being created. Since the Fed wants to bleed all of the excess zombie dollars out of the economy, bank earnings drags are a good thing as long as it isn’t too much of a drag – and viewed across the banking system as a whole, it really isn’t, in fact its a long way from being too much of a drag.

But individual banks may have made poor decisions. Indeed, having taken a look at data from all banks at the end of December 2022, only a couple of other banks with assets above $25 billion or so were even close to the level of “whoa, what a terrible decision to buy so many long dated fixed income securities” of SVB. Signature Bank, which was seized and put into receivership last Friday as well, was one of those. The other half dozen had much, much larger insured, small retail depositor bases, or in one case, had the majority of deposits in forms of trust accounts, which aren’t really at risk for either withdrawal or loss on withdrawal as the purchases are made largely at the direction of specific trustees.

Those individual banks should fail. Perhaps the odd decision on the part of the FDIC was to backstop the uninsured deposits, but taking a look at SVB and Signature Bank’s capital position, it’s not that odd: they each had enough equity and subordinated debt capital to absorb the securities portfolio losses, meaning the actual financial risk to the FDIC was quite small. Indeed, it’s smaller today, as the markets acted predictably against their own interest but directly in line with the Fed’s zombie dollar killing strategy, selling risky assets at a loss and buying government bonds, reducing the amount of money chasing price inflation and making it more likely that banks will just burn off the excess via earnings drags for the next decade or so.

Which brings me to my ultimate point. What is money?

To begin with, money is different in aggregate than it is in quantum – which makes it a lot like physical reality. Describing quantum behaviour gets into all sorts of weirdness which, when you describe physical systems on a macro level, you don’t see, and indeed you observe certain macro impacts which can’t directly be observed or even proven to exist at the quantum level. So if you think a lot about quantum mechanics, and specifically the boundary conditions between gravity and quantum mechanics, this stuff will probably be like “oh right, I get that”. If not, continue with me.

Money in aggregate is the instantaneous sum of all expressions of value in a given closed human exchange system or what we can call Value, using upper case and bold letters the way mathematicians do when they define special sets like R, the set of all real numbers, and I, the set of all integers. By “closed system”, I mean a system of human value expression and translation – or a “market” in the Adam Smith sense – which allows for fungible instantaneous exchange. A Unit of Money is 1/nth of that Value at a given moment in time, which by convention we describe as a dollar or a pound or what have you. And Units of Money can be created or destroyed, but Value is always an integralised construct of both real things – primary goods, secondary goods – and virtual things – desires, ideas, services, threats, shames. Value is changing constantly based on things like productivity but also based on social and personal sentiment.

Units of Money are also changing: in a world of gold, it changed based on discovering new gold mines and melting down prior gold that had been locked into jewellery and losing gold by having ships get sunk in hurricanes. In a world of fiat or “declared” money, it changes based on what central banks and their agents, private banks, create or destroy – and now in a world of crypto, fiat money can be destroyed by being siphoned into buying nothingness in the form of bitcoin or ethereum, which themselves can be created or destroyed (or rather, for bitcoin, lost to the world of the living due to misplaced passwords). Oh, and Units of Money are the discrete mechanism by which Value_N in a given closed exchange system can be exchanged for Value_M in a separate closed exchange system. At some point, if enough instantaneous exchange takes place between two systems, Value_N and Value_M, the systems can be considered simultaneous and undifferentiated, but that takes time to realise and because human beings are rooted in time and place, usually isn’t recognised until well after it occurs. In any event, back to our story in the Value space of US dollars.

The Fed created more units of money back in 2008 at a time when banks were rapidly destroying it; their desire was to keep the number of Units of Money constant so that psychologically, the observance of deflation – the drop in prices of items of value in the exchange marketplace – wouldn’t accelerate what was already happening in consumer and business sentiment, which itself was destroying Value. This largely worked, although the destruction of Value was severe enough that, for most of the next ten years, central banks and banks themselves found it difficult to restore the ability to grow Value such that people felt good again (remember Value is partially a function of sentiment, not entirely based on actual items). By 2019, though, that long slog was largely over, such that central banks and banks could begin to see a path towards restoring a normalized balance between how Value grows (with population, with innovation, with productivity, with the growth of humanity’s conception of what can be value-able) and the number of Units of Money in existence across the world’s various and not-entirely fungible exchange markets. Then the pandemic hit, which did more than cause a Value crisis – it fragmented the world’s exchange markets in a fundamental way that really hadn’t happened since the 1930s. Central banks sort of panicked – though in fairness, there was no playbook – and they stimulated the production of massive amounts of new Units of Money as a palliative.

We’ve learned since then that this wasn’t as necessary as was thought; Value did not plunge as a result of Covid, and if anything, humanity has used the experience to expand its language of exchange and of how to create value and meaning, even as certain real asset markets have detached from one another. But there are too many Units of Money around even for that expansion, and now prices are climbing as too many Units chase not enough Value. So the central banks need to destroy Units without causing a parallel (but false) psychological or sociological sense that Value is actually contracting, instead of the Units of Money contracting while Value remains constant.

In this exercise, ironically, the failure of banks is a good thing. It destroys Units of Money in that the failed bank will liquidate securities and loans that were created at par for a value below par; the lost Units of Value literally evaporate. It would be less disruptive if the banks just limped along for awhile – zombie banks actually consume zombie Units of Money over time – but that can take a very long time (just ask the Japanese). Arguably – and the US argues this despite much of the rest of the world disagreeing – it’s better to just allow for failure to be clean and simple, to rip the band-aid off quickly and destroy the zombie dollars in one go. We will, on a certain level, play out that thesis over the coming weeks and months, but past banking crises in the US as compared to their evolution in other regimes suggests the US has got it right.

In that sense, even taking emergency measures such as a quick “guarantee but not really” of uninsured deposits at SVB and Signature is quite clever. In a stroke, the Fed and the FDIC wiped out the substantial equity and subordinated capital of the two banks – in aggregate around $40 billion – while the failures themselves made it more unlikely that any further immediately recognised losses would be required. As a counterpoint, Credit Suisse will probably limp along forever, keeping something like $80 billion of zombie dollars trapped inside a balance sheet that someone, really, should shoot with a twelve-guage, a la Woody Harrelson in the B-movie classic Zombieland.

The more pieces I read about money, the more I’m convinced that people feel a need to address it as though it were a real thing. As I hope is clear from this essay, I don’t think it is “real”, certainly not in a classical sense. Money is a purely human construct, and exists simply to fulfil a human need. As such, we should be prepared for its “nature” to transform over time and space, as the needs we experience change and as we charge the thing we designate as “money” with different tasks. I think, though, that at its heart, money is our way of expressing our need to explore how and what we value, and how we desperately hope that we are creating Value across the entirety of our very social species. The special secret of money is that it is nothing more than our purest and very much most human attempt to see whether we’re worth anything at all.

When a bank blows up, therefore – even if it’s your bank, and even if some dogmatic deposit insurance bureaucrat limits your claim to the statutory maximum – you shouldn’t really feel anything, any more than you “feel” anything when you drop a vase and it breaks. Your sentiment and your emotional state may change, but the world in its vastness has not, and if anything, the act of destruction – of a vase or of dollars – is the world giving you, and itself, and opportunity to change the function of what meaning is and can be. Pick up the pieces, tear up the checkbook, and create anew.

I like Gary Lineker.  Not only was he a great goal-scorer for the England men’s football team, but he was also played for my team – Tottenham Hotspur – the last time we won the FA Cup, in the summer of 1991.  Since then, he has reinvented himself as the best presenter for football shows and various other sports programmes on British television.  He is as good in front of a camera as he was in front of goal.   Famously, during his football career, he was never “booked” (nowadays, shown a yellow card) for foul play or dissent, which is an impressive record for someone who played at the top levels of club football in England and Spain, as well as at international tournaments, for many years.   Last week, however, he was shown a red card by the head of the BBC and forced to stand-down from his presentation duties.  Chaos ensued – full documentation widely available on all British media outlets – until his red card was rescinded and we are now assured that he will be back in the television studio next weekend.  All’s well that ends well?   Alas, no. 

I will provide a summary of the brouhaha that erupted at the BBC, for sake of context, but my focus in this text is less Lineker’s right to express his opinions about matters of public interest, and more about what this tells us about the sad decline of traditional conservative thought in England.  Those who know me well will be aware that I have little sympathy for traditional conservative thinking and might therefore be surprised that I mourn its passing.  As I will argue, the problem is what has replaced it.  True conservatives are instinctively suspicious of radical change and, at least in their own case, that suspicion seem justifiable. 

Continue reading “Red card (rescinded)”

I recently visited the north German city of Lübeck, which was, a millennium ago, a leading member of the Hansa League that dominated the shipping-trade in the Baltic and North Sea, and, much more recently, the birthplace of Thomas Mann, one of my favourite novelists and to whom I had come to pay homage.  A scholarly friend tells me that Lübeck was also the adopted home of Dieterich Buxtehude, the Danish composer and celebrated organist from the Baroque period and that when Johann Sebastian Bach was a young man, he walked from Arnstadt to Lübeck – a distance of 400km – to hear Buxtehude play.  Unlike Bach, I took the train from Hamburg, a journey of merely seventy-five minutes, and I spent several enjoyable hours walking around the city, stopping briefly to sample some kaffee und kuchen in a café owned by Niederegger, a local company that has been making marzipan flavoured confections for the past two hundred years.  I can confirm that the cake in Lübeck is excellent.

I discovered Thomas Mann’s work as a teenager – Death in Venice plus some short stories – and during my twenties I worked my way through several of his major books, including The Magic Mountain, The Holy Sinner, and Buddenbrooks, his famous early story which was set in Lübeck.  In recent years I have read Dr Faustus and re-read most of the earlier novels, and this year’s challenge is Joseph and His Brothers, the tetralogy set in Biblical times.  First question: why is Thomas Mann’s four volume novel referred to as a tetralogy, whereas Laurence Durrell’s and Elena Ferrante’s four volume novels are always called quartets?  Is there a reason or is this simply convention.  Second question: why do I find Mann’s work so impressive and engaging, always a pleasure to be reacquainted with?  It was this latter question that preoccupied me as I strolled around Lübeck in the winter sunshine.

Continue reading “Lübeck”

I was speaking to some old colleagues not long ago about hedge funds, in the context of how many fund managers had fallen for the siren song of “investing” in crypto and, given the open nature of their fund mandates (which can in many ways be boiled down to “make money in ways that aren’t boring so investors feel justified paying higher fees than in a mutual fund”), there were effectively no brakes on them piling in. One lamented the fact that he had never been given the opportunity to have such an open investment policy; he had been an equity fund manager and was limited to buying public common stock, listed on major exchanges, with limits as to single name concentration and industry concentrations and minimum holding periods. Another guy (alas, we were all men) talked about how fixed income was quite different: sure, you could take credit bets here and there, but ultimately, the general level and shape of the yield curve drove your returns, and since the Fed was essentially “the house” and could whipsaw the curve at will, he felt like his decisions were always just different shades of lipstick on the proverbial pig.

I took a somewhat different stance. I’ve never run a full-bore hedge fund, but back when I started my career, I had a somewhat hybrid experience of running a general purpose arbitrage fund. The mandate was to beat the return of money market funds, with the same risk profile (ie., effectively none). But there were no real constraints on what we could do in pursuit of that goal. A core strategy, for example, was futures arbitrage: we bought the underlying stocks or bonds of a given futures contract and shorted the futures against it – or at least, we did so when the market implied a carry rate on the contract in excess of regular money market returns. As long as we held on to the underlying and delivered into expiration of the futures, we had a “guaranteed” return – although I was taught, both formally and by experience, that the guarantee required holding the position to maturity, required confidence that the underlying you had bought was, in fact, properly deliverable, that your futures broker didn’t go under during the life of the contract, and that you and your management had full faith and confidence in the Chicago clearinghouses to make good on the contracts at expiry.

What I explained to my friends, though, was that it was the constraints – the career maintenance requirement that at no time would I lose money relative to just buying and rolling overnight time deposits – that made the job incredibly fun. I was supposed to find what in markets should be imaginary creatures – riskless performance superior to the performance of a riskless asset – and do so with billions of dollars, over and over again. And for seven years, I did it. Indeed, what eventually ended that halcyon period was being given the reins of a higher risk fund, which by definition would take bigger risks and would thus theoretically potentially have losses in excess of that theoretical money market fund comparator. I took bigger risks; I lost a bit of returns; and it turned out that management didn’t really buy into the idea that losses were okay and I found it expedient to look for employment elsewhere.

Subsequently to that, I managed bank balance sheets, and having brought the experience of that first career stint with me, I took pains to understand exactly what the constraints were – in other words, what losses were acceptable and what losses were not. I quickly realised that banks, in managing their balance sheets, don’t worry so much about whether a single investment loses money, especially due to changes in rates. They worry about the net gain or loss between what the bank is earning on its assets and what it pays on its liabilities. My job was to balance those two with the broader objective of increasing the net return over time. The constraints, moreover, were orders of magnitude more complex that what investment managers face in the “regular” funds world. I was using maybe 20% of the balance sheet to augment and diversify the other 80% of the assets – mortgages, credit card loans, lines of credit – and was trying to raise about 50% of the balance sheet in institutional funding markets while keeping a strong eye on what the deposit people were doing to bring in customer funds. When times were good, it felt like ice skating blindfolded on good smooth ice, but you always knew the ice might start getting chewed up – and you were never sure how thick the ice was and whether it would hold your weight if you fell down. I loved it, but to be sure, the ice broke more than once.

I’ve thought about this quite a lot recently, though not so much for what I do – I consult with banks on how to manage their balance sheet, but I’m no longer doing the skating, and I manage a small hedge fund, but it’s simpler conceptually than any investing I’ve ever done, even if what I’m buying and selling is intricate and complex to value and trade. Where it’s come into my thinking has been in thinking of the Fed and how it’s managing the money markets these days.

It should be noted that every bank treasurer I’ve ever met who’s worth his or her salt ultimately wants to be either a Fed governor, ideally the Chair, or running the open market operations desk for the New York Fed, essentially the head of portfolio management for the largest and most significant bank balance sheet on earth. I’m no different; that latter job, in New York, from an investor perspective is actually a bit boring – the market knows how you need to trade before you do – but it’s the interaction with the market, and the influence of being the go-to person for the rest of the Fed on the constant question of “so what’s the market really thinking about us?”. My fellow traveler here on the site, Mark, once served in that role for the Bank of England on their short term money desk – admittedly a bit of a junior currency regime relative to the US dollar system, but still, a part of me will always be green with envy that he had that desk for a period of time. I think often about what I would be doing today, at 9am on a Wednesday in February 2023, if I were sat at the screens in lower Manhattan instead of in front of my laptop on holiday in the Hamptons.

The Fed doesn’t just operate the largest single balance sheet on earth; it also sets the price of overnight money for the rest of the US dollar banking system. It is, after all, both the marginal buyer and seller of dollars to all other parts of the market – either directly, through its discounting and repo operations with banks and primary dealers in the US Treasury markets, or indirectly, as the rest of the market ultimately transacts with those banks and dealers and their capacity is set by what the Fed demands of them or they demand of the Fed. But in operating the rest of the balance sheet – funded by deposits from member banks, by currency outstanding, and by excess government balances – it creates ongoing indirect impacts on the demand for money and, thus, for the stability of the rate which it sets on money. If the balance sheet gets too big, the Fed can inadvertently distort the long term price of money, which then creates pressures on the short term demand for money depending on how they set the overnight rate. If the balance sheet gets too small, banks may be forced to place excess deposits in riskier assets, which can result in inflationary pressures which ultimately may require an increase in the short term rate, which in turn can stifle economic growth.

And the Fed has two missions. The first – to maintain long term stability in the value of US dollars – gets the most press, or at least it does for me because I’ve lived in the financial markets for going on thirty years now. The second, though – to enable monetary conditions consistent with the maintenance of full employment in the US economy – is the real kicker. Those objectives aren’t always in alignment, even if over the long run, there’s good reason to believe that economic systems engender optimal employment conditions when price stability is maintained. In the short run, however, Fed governors get appointed, confirmed, reappointed, and retire; in the short run, there are elections of the presidents who choose the governors and of the senators who confirm them; in the short run, the financial and popular press (and in today’s world, social media) interpret for the voters whether there is or is not alignment and regularly tell the Fed just what they think of the balancing act. If, back in the day of running a short-term arbitrage fund, I was ice skating blindfolded, then the Fed (and its system manager) ice skates blindfolded, with a rhino strapped to their back, as the warm springtime sunshine is starting to melt the ice.

Twelve months ago, as inflation started to spiral upwards, plenty of commentators (and politicians) blamed the Fed for “waiting too long” to rein in inflationary pressures in the monetary system as the economy returned to normal after COVID lockdowns and as the cumulative impact of $5 trillion in fiscal stimulus started hitting the economy with full force. Such criticism was ridiculous: most of the nattering nabobs of the publishing classes found it convenient to forget that there had been quite recently a pandemic which resulted in the largest two-quarter decline in GDP in history; anything the Fed would have done would have been at least somewhat wrong, and to have gotten it “wrong” in a way which maintained broad employment stability should have been cause for celebration, not whinging. But even beyond that, the short term blinders which focused on “inflation surging higher” ignored the prior decade of below target inflation, which had led the Fed to attempt monetary stimulus that led to the disruptive asset bubbles in real estate and other long-term assets which were beginning to harm household balance sheets. If anything, it was to the good that the Fed let inflation run up a bit – especially since the resulting sectoral decline in real and financial asset prices which we’re still observing is doing much to normalise wealth imbalances in the US domestic economy.

Now, with unemployment at historical lows – so low, in fact, that wage pressures continue to build – and with inflation still running well above historical averages, let alone its own target, the Fed is being criticised for potentially “overshooting” on rate hikes. Or worse yet: some observers believe the Fed will be “forced” to engender a recession in the US in order to get to the long-term target inflation level of 2%, with a number of articles in the past couple of weeks suggesting that the Fed should do away with the 2% target and allow inflation to run higher, longer, so as to ensure no job losses.

This all serves to remind me of that first job I had, running derivatives arbitrage strategies. There was one objective, well understood: beat the returns on overnight deposits. There was one iron clad constraint: don’t lose money, ever. That meant the returns were rarely stellar, but management also didn’t have to ever go back to investors and explain a loss. Then I was given what in theory was a “more fun” job: beat returns on overnight deposits by a lot – clear enough – but the constraint got squirrelly. It wasn’t “don’t lose money, ever”; rather it was “try not to lose money, but you’ll only know that a loss was too big after the fact”. That second job sucked.

At the banks I managed as treasurer, the objectives were actually quite tricky: some mix of meeting risk targets, “optimising” net interest margin, maintaining adequate ready liquidity, but the constraint was back to iron clad: always make sure your capital levels exceeded minimums with a cushion, and always have enough cash to pay the bank’s obligations on demand. I love that world of hard constraints – even if they are multi-dimensional, even if they sometimes were contradictory. The lack of ironclad objectives meant that there was always room for someone – a head of commercial lending, say, who thought they were being charged too much to fund their loans – to complain about how well I was doing my job, but with hard constraints to fall back on, I could find a way to navigate the bank with firm knowledge of, as it were, where the ice was getting thin.

The Fed has its constraints, loosely worded as they are, and the very size of the Fed and of the US dollar economy at which it stands at the centre mean by definition the job of managing their balance sheet is impossible to get right. Indeed, as the press reminds us (in particular with its own lack of memory), if you get it right in one period, it’s assumed you’ve planted the seeds of failure in the following one. Managing with such background noise as that must be intensely stressful, but the Fed’s governors have done an admirable job, and show no signs of cracking or falling prey to obvious mistakes. And arguably, they’ve done better than most other central banks – Japan, Canada, UK, the EU – despite the external noise, and despite being the obvious magnet for global monetary criticism. I think, though, it’s the fact of their constraints that enables such success.

Hedge fund managers often seem like the ubermenschen of the capital markets. The press avidly tracks their yacht and real estate purchases, and hangs on their pronouncements, whether it be on corporate governance or management style or talent selection. But in reality, most hedge funds die and fold quietly, and for every Citadel, there’s a dozen crypto and meme fund blowups. On the other side of the coin, the constraints we place on banks, on money market funds, and on our central bank are the unspoken key to their long term sustainability and success.

As we think about what may be required to face larger global challenges – global warming, for example, regardless of what you think its origins may be, or pollution control, or demographic changes – it’s worth reminding ourselves that the constraints are what bring out the most creativity and, ultimately, the most consistent success. We might miss out on the next upside trade, but knowing how to skate the thin ice is what will keep us alive.