Buttonwood

Do physical assets offer investors refuge from inflation?

Property, infrastructure and farmland have their attractions. But they could prove victims of their own success


Like penguins and the melting ice cap, investors’ natural habitat is changing. 

Inflation is typically bad news for mainstream assets such as stocks and bonds, because it reduces the present value of future earnings and coupons. 

Yet this is where, after a decade of slow growth and sluggish inflation, investors have parked much of their trillions. 

As consumer prices rise uncomfortably fast in much of the world, they are scrambling to protect their portfolios from the changing economic climate.

A growing cohort is placing its faith in “real” assets—the physical sort, including property, infrastructure and farmland. Could these prove a haven in times of change? 

Investors certainly have good reasons to deem them safe places to perch. 

Inflation often coincides with rises in the prices of these assets. An economic expansion tends to fuel consumer-price growth as well as demand for floor space and transport or energy infrastructure.

Moreover, these assets produce cash flows that usually track inflation. 

Many property leases are adjusted annually and linked to price indices. 

Some—those of hotels or storage space, say—are revised even more often. 

The revenue streams of infrastructure assets are typically tied to inflation, too, through regulation, concession agreements or long-term contracts. 

Meanwhile, the rising maintenance or energy costs associated with these assets are often either passed through to tenants (for property) or fixed for long periods (for infrastructure). 

And debt raised against them—often fixed-rate, and in copious amounts—becomes cheaper to repay.

As a result, real assets have done well during inflationary periods. 

A recent report by BlackRock, an asset manager, suggests that the total returns of privately held property and infrastructure assets globally have beaten those of main stock and bond indices when inflation has exceeded 2.5%. 

David Lebovitz of JPMorgan Asset Management reckons that a typical pension fund should start off by allocating 5-10% of its assets to them, with the share rising to 15-20% over time. 

Some big funds are in fact bolder: Ontario Teachers’ Pension Plan, which manages C$228bn ($182bn), wants to lift its allocation from 21% to 30%.

That might all sound very alluring, but it should come with health warnings. 

For one, performance has become harder to predict: think of retail space and office blocks (under threat from e-commerce and remote work), airports and power plants (exposed to decarbonisation) and even farmland (vulnerable to climate change). 

The asset class may require a greater appetite for risk and more homework than its backers are used to.

Another difficulty is that real assets are hard to access. 

They are typically private, meaning that only the most sophisticated investors have the resources and patience to find gems on their own. 

The rest might gain exposure in public markets, through real-estate investment trusts, infrastructure stocks or exchange-traded funds. 

But these tend to be closely correlated with equities, defeating the point of investing in them. 

Institutional investors also have access to private funds, but these tend to deploy capital only slowly and come at a cost, as their managers typically charge high fees.

In any case, real assets cannot insulate an investor’s entire portfolio against inflation. 

Their merit is that they preserve their own value when inflation is high. 

But to protect all of their capital investors must seek assets that do not just tread water, but gain value more quickly during inflationary bursts than their other holdings depreciate. 

And there is not a lot of consensus over which ones fit the bill. 

Gold, commodities, inflation-linked bonds, derivatives: each has champions and detractors.

Perhaps the biggest danger, though, is that real assets fall victim to their success. 

Many investors already turned to them over the past decade as they hunted for stable yields and sought diversification. 

Between 2010 and 2020 private real assets under management more than doubled, to $1.8trn. 

Finding things to buy is getting harder. 

Some $583bn raised by funds since 2013 remains unspent. 

A bubble is possible, says David Jones of Bank of America Merrill Lynch. 

The definition of a real asset may become stretched. 

Already some argue for it to include exotic fare such as non-fungible tokens—digital media recorded on a blockchain. 

Rather like penguins that huddle ever closer on a shrinking bit of ice, some investors might find themselves falling into treacherous waters.

The Bretton Woods Credibility Crisis

The World Bank and the International Monetary Fund play a critical role in the global economy precisely because their independent research is universally trusted. But following a scandal involving the World Bank's flagship report, urgent action is needed to regain the public's confidence.

Anne O. Krueger


WASHINGTON, DC – Despite setbacks like the Great Recession and the COVID-19 pandemic, the world economy has had a massively successful run since World War II. 

That success was underpinned by the post-war global economic system and its central institutions: the International Monetary Fund, the World Bank, and the World Trade Organization (previously the General Agreement on Tariffs and Trade). 

In joining the Bretton Woods institutions, countries around the world agreed to subject their economic behavior to an international rule of law.

These institutions all have governing bodies with representatives from member states, as well as highly qualified technocratic staff to carry out their work. 

The periodic reports they produce have been essential sources of information and analyses. 

But one of these reports, the World Bank’s annual Doing Business index, has become the source of enormous controversy.

The point of Doing Business was to report on each member state’s regulatory environment, elements of which include legal procedures, wait times, start-up costs, the efficiency of the judicial system, and the accessibility and reliability of basic utilities like electricity. 

These and many other factors determined each country’s overall ranking. 

In the 2018 report, for example, New Zealand ranked highest, and Somalia the lowest.

While no measure is perfect, the procedure for determining the rankings was transparent, and the indicators in each report were as objective as possible, even if they did rely also on anecdotal evidence. 

The Doing Business reports were highly respected and thus widely used, not only by national policymakers as an indication of how their country’s regulations and performance compared with others’, but also by independent researchers and firms and financial institutions contemplating investments abroad. 

It was not uncommon for a head of government to instruct his ministers to pursue policies geared toward climbing the rankings.

Many observers, including me, regarded the Doing Business reports as the World Bank’s single most important publication. 

The Bank published the individual results alongside the overall ranking, so anyone who questioned the weights could apply her own. 

While some governments instituted Potemkin reforms – all façade and no substance – there were many more instances of Doing Business-inspired policies that reduced costs and increased productivity. 

As with all publications from international economic institutions, Doing Business’s credibility was the key to its success.

But following the 2018 report, there were complaints about the data that had been used, leading the World Bank to commission the highly regarded law firm WilmerHale to investigate. 

Its report, issued last month, found serious irregularities with respect to China’s ranking in the 2018 report. 

The investigators report that Kristalina Georgieva, the Bank’s then-CEO (second in command) who has since become managing director of the IMF, urged staff to reconsider the results for China, and then “explored … ways to change the methodology to raise China’s ranking.” 

The report also points out that the Bank had an interest in placating China, because it was seeking Chinese support for a capital increase at the time.

All told, the investigators provided sufficient evidence of Georgieva’s involvement to raise serious doubts about Doing Business’s credibility and integrity. 

The current president of the World Bank, David Malpass, has suspended publication of the 2021 report and discontinued future ones. 

The Bank will surely examine and amend its procedures to prevent similar efforts at manipulation in the future.

Credibility is essential for the critical work the IMF and World Bank do. 

Both employ highly respected researchers, world-class economists and statisticians, and dedicated officials. 

They know they are civil servants and not politicians; all are highly committed to their jobs. 

True, in some cases (some of which are known to me), there has been pressure at the political level to support a certain lending program or policy position. 

But a central part of the leadership’s job is to shield staff from undue interference in their reports and analyses.

Attempting to massage the ranking for one country in a cross-country report is egregious not only because it undermines the credibility of the report but also because it harms the other countries whose rankings are changed as a result. 

When a country falls in the rankings, its ability to attract foreign investors and businesses can be diminished.

Like Caesar’s wife, IMF and World Bank leaders must be well above suspicion in overseeing these institutions’ work and safeguarding the integrity of the data on which that work relies. 

Georgieva’s reported actions certainly raise serious doubts about her commitment to the integrity of the data, including in the context of her new role.

If an IMF managing director is thought to be amenable to pressures to alter data and analyses, the credibility of the Fund’s work will be greatly diminished, if it is believed at all. 

It is one thing for the managing director to urge the Board to approve a program of questionable merit based on a report providing an honest account of the situation. 

It is quite another thing to pressure staff to alter the numbers.

Should Georgieva remain in her position, she and her staff will surely be pressured to alter other countries’ data and rankings. 

And even if they resist, the reports they produce will be suspect. 

The entire institution’s work will be devalued. 

That prospect alone should be enough for the IMF’s political masters to find a new managing director whose commitment to the integrity of the work is not in question.


Anne O. Krueger, a former World Bank chief economist and former first deputy managing director of the International Monetary Fund, is Senior Research Professor of International Economics at the Johns Hopkins University School of Advanced International Studies and Senior Fellow at the Center for International Development at Stanford University. 

Nothing is Real: A Visual Journey Through Market Absurdity

By Matthew Piepenburg


When it comes to modern markets, risk assets and the now normalized yet twisted tango of fiscal and monetary policy gone wild, it’s safe (rather than sensational) to simply confess that nothing is real.

As I recently watched BTC drop by 16% in one hour from $50K to $43K, only to reach back up to $46K in 20 minutes, my 20+ years of Wall Street experience watched with bemused yet experienced awe at what amounted to just another day of leverage, emotion and institutionalized front-running as the big money whales in crypto pulled off yet another media and SEC-ignored pump-dump-and-pump trade. 

In short, the unreal has simply become business as usual.

Real Education vs. Surreal Facts

By 1997, I had graduated from a steady, iconic and expensive list of higher educational institutions which emphasized critical thinking, objective data, historical context and basic math.

But had I told a single professor back then that one day we’d see the simultaneous occurrence of Treasury Yields at 1.35%, and


Negative treasury yields occur when nothing is real in the economy. 

….an “official” YoY CPI (inflation) growth rate of 5.4%, and


Inflation is soaring. 

…an S&P reaching all-time highs above 4000,


Traders announce "Nothing is real!" as equity valuations repeatedly hit record levels. 

…despite negative annual GDP rates, and


GDP is falling

… consumer sentiment tanking,


Consumer sentiments tank as consumers catch on that nothing is real. 

… it’s likely they’d ask me to return my diplomas.

Why?

Because everything I (and all the rest of us) had been taught long ago was that rising risk assets reflect healthy economic growth, vigorous natural demand and a robust confidence in continued productivity and hence free-market price discovery.

That, at least, was the “reality” that nine years of secondary (post high-school) education gave me before I began my first toe-dip into the public exchanges (i.e., asset bubbles) of 1999.

Experience vs. Theory  

What did I learn after watching the NASDAQ rise to the moon in 2000 before puking by greater than 80% in 2003, and a sub-prime bubble that had investors giddy in 2006 yet on their knees by the autumn of 2008, or far more recently, a decade+ bull market hitting needle-peak highs on the backs $28T in national debt and a Fed balance sheet that had bloated from $800 billion in 2000 to over $7 trillion by 2020?

The answer is simple: Nothing I learned in school was “real” and nothing about our current moment in time has even the slightest resemblance to anything remotely characterized as natural, free-market or fair-price-driven.

Nothing. Not even close.

Instead, we live in a dystopian world of engineered markets, centralized economies and dis-information in which extreme money creation by 5 central banks have increased their balance sheets by 12X like this


Central banks grow their balance sheets to counteract the forces of nothingness. 

…leading to un-natural (i.e., “accommodated”) credit markets in which sovereign bonds offer negative (and technically defaulting) yields like this


Negative yields are possible when nothing is real. 

…which makes the cost of debt free for a select minority, allowing corporations and their grossly advantaged and over-paid executives to live (and bloat) off their own stock buy-backs at levels this


Buybacks reinforce nothing being real. 

…which directly results in central-bank-created risk asset bubbles like this


…in which greater than 86% of that market wealth is enjoyed by just the top 10% of the population, leading to wealth disparity at record levels like this


Wealth inequality is rampant when nothing is real in the economy. 

…while the self-serving central bankers like this


Greenspan

…who directly caused this historical distortion of capitalism, congratulate themselves on hubris-saturated book tours like this


Ben Bernanke The Courage to Act

… or subsequently become the directors of Treasury Departments like this.

Janet Yellen

Mass Media, Mass (and Deliberate) Hysteria

Meanwhile, a feckless media owned by just a handful of corporate boards with direct ties to governments, tech billionaires, bad Davos skiers and Wall Street, and which more resemble the “nothing is real” propaganda profiles of Joseph Goebbels and Pravda than the “truth to power” stewards of Woodward and Bernstein, continue to headline tweets from crypto front-runners likeMusk or fear-porn mask mandates for children from a locked-down Sydney to a head-down New York.

All this, despite the confirmed science that children present near zero risk of serious illness from a global flu whose case fatality rates are less than ½ of 1 percent.

Crazy.

But as every tyrannical, autocratic and corrupt regime has always perfectly understood, when the truth is a threat, feed the masses fear, anger and lies instead.

This is history 101 for anyone who reads a book rather than tweet.

But rather than rage against the architects of so much distortion of honesty, math, science and social contracts, the media and policy makers distract the masses with bread, circus, fear and anger, stoking the fires of racial division and invisible death from above, pointing their woke and increasingly sanctimonious fingers at everything from a rapidly defunded police force to the “criminally selfish unvaccinated” who apparently live in caves and don’t believe in science or their fellow man.

Meanwhile, that oxymoron otherwise known as “modern culture” (rich in opinions but poor in questioning or earning them) cancels everything from Little House on the Prairie and Dr. Seuss to Robert E. Lee’s statue in Richmond, Virginia.


Confederate statue 

Sadly, however, if the broke and legitimately angry masses in the new feudalism now somehow passing for capitalism or constitutional democracy (at least the kind I studied in law school) were informed rather than just frustrated and manipulated, then instead of blaming these angry and easy-to-denounce faces


MAGA protesters 

…they could simply blame the smug and harder to justify faces of anti-heroes like this

The faces of "nothing is real."


…or this:


Returning to the Nonsense

For now, the pablum and doublespeak from these so-called experts continues to float like jetsam from the polluted currents flowing out of an increasingly discredited FOMC as the markets pretend to brace themselves for a potential “tapering” of the otherwise blatant money addiction (and counterfeiting) still masquerading as policy support.

Angry crowds, however, typically have no time for hard policy facts, economic history or founding father ideals; instead, they are educated by 50 word-count tweets and the latest celebrity wisdom or virtue-signaled headline. 

It is easier to live as though nothing is real

Unknown to many in those angry crowds gathering around Robert E. Lee or Dr Seuss, for example, the Atlanta Fed just cut its q3 GDP forecast by 50% in matter of days.


From where I sit in terms of both history and economics (at least until these subjects are equally “canceled” from the modern curriculum), falling GDP as indicated above effects all our lives far more than falling statues or controversial children’s books.

But as we’ve written so many times, the powers-that-be are clever little foxes, and even crashing GDP and skyrocketing debt, which are objectively time-proven cancers for society, can be a boon for their false narrative of governmental or central bank “guidance,” which is nothing more than increasing social control hiding behind a Covid mask.

Debt to GDP: The New Distortion

After all, one way to address the appalling 135% debt to GDP ratio in the U.S.  is to simply reduce the productivity component rather than debt component of the ratio, akin to telling a man with only one arm that his shirts will fit better if we remove the remaining arm.

A “bad” debt to GDP figure is just veiled anchoring for more QE “stimulus” and more ludicrous fiscal spending of money which governments don’t in fact have but which a mouse-click at the Eccles Building can produce in seconds.

In simple speak, this latest GDP “bad news” looks like an open as well as carefully planned piece of “good news” for a QE-addicted, fully Fed-supported and ultimately rigged to fail stock bubble.

The Pointless Taper Debate

As for Fed tapering, even the hawks at that same Atlanta Fed can’t keep their message or ethics straight for more than a week.

Nothing at all shocking or new there…

Another Fed Two-Step

Back in August (8/27), for example, Atlanta Fed President, Raphael Bostic, bravely declared: “Let’s start the taper and let’s do it quickly.”

But fast forward just a few days to September 2, and that same Fed President, like so many other fork-tongued masters of doublespeak within the FOMC, back peddled with fabulous elan, declaring instead that “we’re going to let the economy continue to run until we see signs of inflation.”

The amount of “duplicitous dumb” within this single sentence defies both belief and this report’s word count, but for simplicity’s sake, and despite “signs of inflation” literally everywhere, Bostic’s latest semantic two-step translates to this: Don’t expect a “taper” of the free money spigot anytime soon.

Besides, and as we wrote last week, even if a “taper” in Fed QE were to occur, such hawkish optics won’t stop the Fed from dumping ever-more dovish liquidity into the system via clever little tricks up the sleeves of its Reverse Repo Program.

In short, the Standing Repo Facility (or SRF) is just QE by another clever acronym, so please: Don’t let the headlines or double-speak from above fool you.

Taper or no taper, the dollar in your wallet is about to drown under even more currency-killing liquidity from on high.

In short, nothing is real. 

The Reality of Climate Financial Risk

Those who argue that climate change has little to do with macroprudential risk management are offering a counsel of despair. If the 2008 global financial crisis revealed anything, it is that regulation matters, even if it isn't always politically popular or easily optimized.

Karl Schmedders, Rick van der Ploeg



LAUSANNE, SWITZERLAND – In a recent commentary, John H. Cochrane, a senior fellow at the Hoover Institution, argues that “climate financial risk” is a fallacy. 

His eye-catching premise is that climate change doesn’t pose a threat to the global financial system, because it – and the phase-out of fossil fuels that is needed to address it – are developments that everyone already knows are underway. 

He sees climate-related financial regulation as a Trojan horse for an otherwise unpopular political agenda.

We disagree. 

For starters, one should acknowledge the context in which regulation emerges. 

With respect to climate policy, the Intergovernmental Panel on Climate Change has set the stage with its sixth assessment report, which concludes with a high degree of certainty that the Earth’s climate is changing, and that human activities are the cause. 

Ecologist William Ripple, the co-author of another recent study of planetary “vital signs,” goes further: “There is growing evidence we are getting close to or have already gone beyond tipping points associated with important parts of the Earth system.”

Unlike the 2008 global financial crisis – when banks that took excessive risks were bailed out, and global financial regulation was overhauled in light of our new understanding about interdependent financial markets – unmitigated climate change will lead to a crisis with irreversible outcomes.

The question, as Cochrane puts it, is whether climate-related financial regulation can do anything to help us avoid such outcomes. 

Although the answer is complex and currently incomplete, we would argue that it can. 

Financial regulation to mitigate climate risk is indeed worth pursuing, because the stakes are too high to let the perfect become the enemy of the good.

Consider some of the arguments about systemic financial risk and extreme climate events. 

First, we are told that the risk of “stranded assets” – particularly fossil-fuel assets – will become a fact of life, to be borne only by investors. 

Here, Cochrane points out, correctly, that fossil-fuel investments have always been risky. 

But can we reasonably say that the prevalence of this energy source should be left to market players alone, or that only investors will bear the costs?

Though per capita fossil-fuel consumption in countries such as the United States and the United Kingdom has declined since 1990, total consumption has grown dramatically elsewhere, rising by 50% globally over the last 40 years. 

In 2020, China and India were the planet’s two largest coal-energy producers, relying on coal for 61% and 71% of their electricity, respectively. 

Their economies, and those of many other developing countries, simply would not sustain a precipitous reduction in fossil-fuel energy.

Cochrane also suggests that there is no scientifically validated possibility that extreme climate events will cause systemic financial crises over the next decade, and that regulators are therefore stymied from assessing the risks on financial institutions’ balance sheets over a five- or ten-year horizon. 

But the sheer scale of the challenge should make us reconsider the temporal dimensions of regulation.

If temperature increases are to be kept within 2° Celsius of pre-industrial levels this century, about 80% of all coal, one-third of all oil, and half of all gas reserves must be left unburned. 

All of the Arctic’s oil and the remainder of Canada’s oil sands – the world’s largest deposit of crude oil – must be left in the ground, starting almost immediately.

Finally, it is said that the technocratic regulation of climate investments cannot protect us against un-modeled tipping points. 

But this view simply ignores the extensive literature in climate economics. 

In this field, the work of Nobel laureate economist William Nordhaus is widely referenced. 

His Dynamic Integrated Climate-Economy (DICE) model has influenced many scientists’ and economists’ own modeling of tipping points, and the US government already relies on these “integrated assessment models” to formulate policy and calculate the “social cost of carbon.”

This interdependency between economics, policy, politics, public opinion, and regulation should be familiar from the crash of 2008. 

The dangerous over-leveraging that generated that crisis was an open secret; but those in a position, politically and culturally, to do something about it were willing to deny the systemic risk it posed. 

One can find the same denialism in the climate debate. 

According to the Center for American Progress, 139 members of the current US Congress (109 representatives and 30 senators; a majority of the Republican caucus) “have made recent statements casting doubt on the clear, established scientific consensus that the world is warming – and that human activity is to blame.”

Cochrane makes an eloquent case for why policymakers should focus on creating coherent, scientifically valid policy responses to climate change and financial systemic risk separately, rather than pursuing climate financial regulation. 

But this isn’t an either/or choice. 

We need both kinds of policies, and we need coordination between the two domains.

We therefore should welcome the approach being taken by US Secretary of the Treasury Janet Yellen’s Financial Stability Oversight Council, which has brought together leading regulators and tasked them with preventing a repeat of the 2008 Wall Street meltdown. 

Yellen has said she will use this multi-regulator body as her principal tool to assess climate risks and develop the disclosure policies needed to shift to a low-carbon economy.

Counterintuitive though it may be, climate-related financial regulation could usher in a new form of political accountability, by putting governments and individuals (elected and unelected) on the hook for their decisions. 

Such accountability was notably absent before and during the 2008 crisis. 

With political will, serious thinking about regulating climate financial risk could open up a fruitful debate for similar action on all neglected policy fronts.


Karl Schmedders is Professor of Finance at the Institute for Management Development.

Rick van der Ploeg is Professor of Economics and Research Director of the Oxford Centre for the Analysis of Resource-Rich Economies at the University of Oxford.