March 20, 2024

Trading Air

I was walking up Steamboat Springs’s Emerald Mountain with my friend Charlie last week and he said, “Trading volatility is like trading air.” 

Charlie was a hedge-fund guy. He knows. Coincidentally, new VIX volatility options trade today.  Since everyone has been selling volatility, don’t be surprised by a bad day (not saying it will be, just that it could be!).

The Federal Reserve chairman speaks today after the monthly FOMC meeting. He’s constantly talking. Ben Bernanke was the first Fed chair to hold an FOMC press conference. We were in crisis. Now we do it every month. Larger crisis?

dreamstime m 6563143

Illustration 6563143 © Wd2007 | Dreamstime.com

Which brings me back to air.  I’m writing this because it seems nobody else will.  Inflation is also air in our money. 

The VIX is an index of prices of options on the S&P 500 Index. That index in turn is derived from stocks comprising it. The VIX thus measures the volatility of volatility.

It’s a terrible predictive tool, though it’s called the “Fear Gauge.” The VIX languishes when everyone sells calls or puts to keep the premium – profits from selling something nobody will use.

Volatility explodes when everyone is using what nobody hoped would be used. Volatility tends to fall as stocks rise and rise as stocks fall.  It’s harder to get out than in.

Enter the dollar. Without air in it, it’s boring. The Consumer Price Index equivalent from 1800-1900 tracked by the Minneapolis Federal Reserve declined from 50 to 25.

Declined, you say? 

Yes. Prices fell by half. And pay didn’t rise. You could get $30 a month as a cowboy throughout the century. Congresspersons earned roughly the same per diem in 1900 that they received in 1800, congressional data show.

But money bought 50% more. Economists thus struggle to measure economic growth in 19th century America, because growth metrics derive from higher prices and wages.

In 1800, data from the US Treasury show, the federal government owed $83 million in debt. That fell by 1835 to $34,000 – half today’s mean household income, less than the price of a new car.

The Civil War exploded government debt to $2.8 billion in 1866. By 1893 it had been paid down to $1.5 billion.

There was inflation in the 19th century too, but only episodically. From 1862-64, inflation exploded consumer prices by 60%. The government was frantically spending on war.

All that inflation reversed. By 1896, consumer prices were down more than 60%.  During that time, the United States became the world’s largest economy, data compiled by British economist Angus Maddison say. 

Lessons? The Fed’s 2% inflation target is bad. Keep the value of money level as technology improves output and distribution, and prices can decline even as the country gets richer and keeps debts low. History proves it.

So why does the government now embrace inflation?  Because of a faulty read on history. Ben Bernanke, Fed Chair during the financial crisis, determined that the reason for the Great Depression of the 1930s is that prices fell.

If prices fall, businesses don’t generate enough revenue, and they have to lay people off.  Unemployed people buy less stuff, so prices fall further, and more people are let go. And a recession becomes a depression – severe economic contraction.

Ben Bernanke thought that at the extreme, government should helicopter-drop money to keep prices from falling. Enter inflation as economic policy de rigueur.

What’s left OUT of that analysis is that between 1912-1926, the USA had its longest inflationary cycle ever to that point. Cumulative inflation topped 70%. It was a product of a sudden influx of currency from the brand-new Federal Reserve Bank (est 1913).

During the “Roaring Twenties,” things appeared to boom. Inflation LOOKS like growth because prices rise rapidly.  Money flows in. Businesses hire people.  Everyone is driving new cars and wearing fur coats and drinking cocktails like the Great Gatsby.

Then people run out of the new, excess money. Consumption stops. Prices fall.  People lose their jobs, the economy contracts.

That fifteen-year inflation run was offset by a 13-year contraction during the Great Depression. Consumer prices fell more than 30% between 1927-1933, then reversed course and rose by 11% in four years, and then the country repeated the cycle.

Only World War Two’s destructive effects on capacity – boosting productivity – reset the currency balance (beware that claxon of war after inflation even now).

To me, the lesson is clear. The longer the inflationary cycle, the harder the reset. The Civil War’s three years of inflation did damage, but it didn’t last.

Since 1941, Minneapolis Federal Reserve data show, inflation has averaged 3.8%, not 2%.  Only in three years have prices declined at all – 1949 (-1%), 1955 (-0.3%), and 2009 (-0.4%).

We’ve had unremitting inflation.

Rather than wealth, it’s given us colossal debt. We buy everything on time, households creak under record credit-usage, our federal government’s debt has risen from $3 billion in 1913 to $35 trillion today.

Chasing wind has been a bad idea since a wise king first said so three thousand years ago.

Air inflates stock markets and currencies, leading to steep falls, and debt, and hopelessness, and demoralization. We’re better off with far less air in our money and our markets.  

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