Eugene Fama – A Life in Finance | #455

Episode Summary

Executive Summary: Meb Faber interviews Eugene Fama on inflation, Fed policy, market efficiency, global diversification, ESG, crypto, and taxes. Fama argues the Fed has far less control over inflation than markets assume, favors starting from the market portfolio, warns about political/expropriation risk in global investing, criticizes ESG return claims, sees little future for crypto, and prefers simpler tax systems and low-cost diversified investing.

Main Topics: Fed policy and inflation control (Priority: 5/5): Fama argues that the Fed's power over inflation is overstated, especially after years of quantitative easing, and says current tightening is an experiment whose effectiveness is uncertain. Market portfolio as the default investing framework (Priority: 5/5): He repeatedly returns to the idea that investors should begin with the market portfolio and only deviate with strong reasons based on risk tolerance or constraints. Global diversification and political/expropriation risk (Priority: 5/5): While acknowledging diversification benefits, Fama emphasizes that international investing carries risks not captured in historical data, especially war, capital controls, and expropriation. ESG and return tradeoffs (Priority: 4/5): He rejects the notion that ESG constraints can magically improve returns, arguing that restricting the investable universe should reduce expected returns unless investors are willing to accept that cost. Crypto skepticism and monetary usefulness (Priority: 4/5): Fama argues cryptocurrencies lack a stable real value and therefore are poor mediums of exchange, implying their long-term value proposition is weak. Taxes, dividends, and simplicity (Priority: 3/5): He prefers simpler, single-level taxation at the firm level and is broadly supportive of minimizing tax inefficiencies such as dividend taxation. Research, citations, and unexpected influence (Priority: 3/5): Fama reflects on how citation counts matter more than paper count, says the phrase 'efficient markets' stuck almost accidentally, and notes that the eventual influence of papers is hard to predict.

Key Arguments: The Fed does not control inflation as directly as many believe; after QE, it is operating in an untested regime and the effect of rate hikes is uncertain. A practical default for investors is the market portfolio; deviations should be deliberate responses to risk tolerance, not performance chasing. Historical data understates international risk because it omits wartime expropriation and capital controls, making global investing less safe than it appears. Short-term bonds were historically good inflation hedges, but that relationship weakened when rates fell near zero. ESG is fundamentally a social/policy choice, not a mechanism for superior returns; constrained investing can be valid, but expected returns should not be marketed as higher without justification. Crypto is unlikely to have durable value if its use depends solely on others believing it has value; volatile assets are poor money because merchants will not want to hold them. Single-level taxation at the firm level would be simpler and reduce gamesmanship versus taxing both corporations and individuals. Most academic or investment ideas should be judged after the fact by evidence, not by early reactions or predictions about which papers will matter.

Data Points: Recording date: October 12, 2022 - Used to frame the discussion around imminent CPI data and the inflation environment. Federal funds rate: around 4% - Fama cites the rate as part of his argument that policy may still be too loose in real terms relative to 8%+ inflation. Inflation: 8 plus percent - Used as the contemporaneous inflation rate when discussing Fed tightening and real rates. Real policy rate: minus 3 to minus 4 real - Fama estimates the federal funds rate remains negative in real terms given inflation. QE time horizon: last 15 years or so - He says the Fed has been in quantitative easing for roughly this period, creating an untested policy regime. Short-term bond hedge history: 1970s and 1980s papers - He notes his earlier research found short-term bonds were historically a good inflation hedge. Negative interest rate period: brief period in many places, including sovereigns - He discusses how rates below zero challenged the old view that cash set a zero lower bound. Market portfolio longevity: 60+ years - Meb notes 60/40 was already established when Fama entered the field more than six decades ago. Former students' asset management influence: in the trillions - Fama estimates direct former students collectively manage trillions in assets. Tobacco poll response: 70% said no - Meb cites a poll showing respondents initially opposed tobacco stocks. Tobacco poll with performance caveat: vast majority said yes - When told tobacco stocks would beat the S&P, most respondents reversed their preference. Crypto market value reference: about 200 trillion (global market portfolio rough scale) - Meb references a rough global market portfolio scale while discussing crypto's relative size and significance. Tax structure: one level of taxes - Fama advocates either firm-level or individual-level taxation, not both.

Pivotal Quotes: "I think the world focuses too much on the Fed and their power over inflation." — Eugene Fama: Opening discussion on inflation and whether the Fed can truly control price levels. "You really have to talk yourself out of the market portfolio." — Eugene Fama: Core investing principle he returns to repeatedly across questions on 60/40, global portfolios, and alternatives. "It all depends on what he does or what the people right around him allow him to do. So you have to be very wary of that." — Eugene Fama: On political risk and expropriation in international investing, especially in countries led by concentrated power.

Implications: Listeners should expect less certainty from central banks, greater attention to political risk abroad, and skepticism toward ESG and crypto return promises. Fama's framework favors broad diversification, low-cost market exposure, and simple tax/investment rules.