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  • Eric Cinnamond

Hard Work and Sacrifice

<October 23, 2019>

In his book, The Greatest Generation, Tom Brokaw profiles numerous Americans who lived through the Great Depression and World War II. Although I’m not an expert on this generation, I’d describe most of those I knew who lived through this period as hard-working and willing to make tremendous sacrifices.

My grandfather was part of The Greatest Generation. In addition to his unrelenting work ethic, he was selfless and always looking towards the future—and not necessarily his future. When his grandchildren were born, he set aside funds that grew over time and eventually paid for their college tuition. As a result of his commitment to save and the Federal Reserve’s commitment to sound monetary policy (thank you Paul Volcker!), I was able to attend Stetson University and graduate without student debt. I’ll be forever grateful for my grandfather’s generosity, hard work, and sacrifice.

In an attempt to follow my grandfather’s footsteps, our family has saved and made sacrifices that we hope will be enough to fund our children’s education. With the cost of college rising significantly over the past two decades, how much is enough is an upwardly moving target. According to U.S. News, the average tuition of a private college has grown from $16,294 in 2000 to $39,513 in 2019. In-state tuition has also increased during this period, rising from $3,508 to $10,655.

Given the sharp increase in tuition over the past 20 years, I’m not surprised student debt has also increased. I’ve often found that by following credit growth, one can also find inflation. The last cycle's housing bubble is a good example, with the boom in mortgage credit also being accompanied by rising home prices.

The relationship between student debt and tuition inflation is similar—an almost perfect correlation.

My wife and I recently had a conversation related to our children’s education. Specifically, we discussed the rising cost of college and the possibility of not saving enough. I asked my wife, “Should we be saving more for college?” Surprisingly, my wife responded, “I don’t think so.” She explained, “By the time our kids are in college, the rules will have likely changed and those who saved may be penalized and those who have not, rewarded.”

With a growing number of politicians and pundits proposing that student loans be forgiven, my wife’s response shouldn’t be surprising—in fact, it’s quite rational. During the next recession or financial crisis, I can’t think of another stimulus plan more popular and politically friendly than eliminating the growing burden of student debt.

How would student debt forgiveness be funded? Although some politicians have argued higher taxes would be needed, given the size of student debt outstanding ($1.6 trillion), I expect any debt forgiveness program to rely heavily on central bank asset purchases or debt monetization—also known and quantitative easing (QE). During debates, supporters of student debt forgiveness will likely ask, “If the Federal Reserve can monetize mortgages and federal debt, why can’t it monetize student loans?” Although I’m not in favor of monetizing debts, it’s a valid question.

Proponents of student loan forgiveness and debt monetization are in luck. On Friday, October 11, 2019, the Federal Reserve announced it will once again be expanding its balance sheet. Considering there is no limit to how large the Federal Reserve’s balance sheet can grow, in theory, student debt forgiveness, along with rising fiscal deficits, can be easily funded without increasing taxes.

Since the 2008-2009 financial crisis, the Federal Reserve’s balance sheet has grown considerably. Through the purchase of financial assets (mortgage-backed bonds and U.S. Treasuries), QE has coincided with a period of extraordinarily low interest rates and record high equity prices. While many members of the Federal Reserve and Wall Street view such an outcome positively, it’s becoming increasingly clear that QE has disproportionately benefited the wealthy and has raised concerns related to inequality.

As the Federal Reserve restarts its balance sheet expansion, investors appear to be dusting off their old QE playbooks of chasing yields lower and asset prices higher. Meanwhile, the general public and a growing number of politicians appear to be writing a new playbook, potentially redirecting how billions, if not trillions, of newly created money will be spent. And then there is the Federal Reserve refusing to label its latest round of asset purchases “QE”, possibly because they feel the backlash of growing wealth inequality and the inability to exit past rounds of debt monetization.

Whether you’re a professional investor or a parent trying to save for college, it’s a very unique and challenging time to be an asset allocator. Should you save and take the time and effort to thoroughly research each investment under consideration? Or should you rely on central bank policy, debt monetization, and the belief that one way or the other, the flow of newly created money will come your way either through broad-based asset inflation or direct subsidies? One path is easy (passive) and one path is not (active). While each asset allocator will need to make their own determination on how to act, I’m confident how my grandfather and The Greatest Generation would respond. They would do the work and make the sacrifice.

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For more information on our investment outlook and positioning, our Q3 quarterly letter is now available. And for those interested, the Palm Valley Capital Fund was recently added to two fund platforms. As always, if you have any questions feel free to email or call us at (904) 747-2345. Thank you for your interest in Palm Valley Capital!

eric@palmvalleycapital.com

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