Archive for Q&A

Q&A…The Answers, Part Deux

Sorry to break the Q&A up like this (part 1 is here), but the site redesign and a bunch of other things really crunched my time over the last few days.  Here’s the second instalment of the Q&A:

CW:  I recently read “Currency Wars” by James Rickards which was a very provocative book and a good history lesson on international currency systems, however the conclusions did not flow from the premises in my opinion.

However there was a paragraph that stood out for me and I was curious about your opinion on it:

page 199, Behavioral economics possesses powerful tools and can offer superb insights..Exploration of the paradox of Keynesianism is one possibly fruitful area of BE research…Keynesianism was proposed in part to overcome the paradox of thrift…government spending was thought to replace this shortage of private spending..Today government spending has grown so large and sovereign debt burdens so great that citizens rightly expect that some combination of inflation, higher taxation, and default will be required to reconcile the debt burden with means available to pay for it. Government spending, far from stimulating more spending, actually makes the debt burden worse and may increase this private propensity to save…The result may be the discovery that short-term austerity brightens long run economic prospects by increasing confidence and the propensity to spend.”

I think this is quite a profound insight. I found myself thinking about Canada in the 90′s which was a basket case until some austerity was put in place and confidence was regained in the economy. I am sure there are other examples.

Perhaps at debt levels in excess of 100%, government spending actually retards growth prospects contrary to the conventional wisdom.

CR:   Attaching a number to the debt:GDP figure just strikes me as such an arbitrary way to view these things.  It kind of reminds me of the idea that money printing = inflation.  Well, yes, if the money is used!   The same goes for government spending and debt levels.  How are they being used and what is the real impact of the spending?  Economies are not static systems.  You can’t just say “this economy has reached X% of debt therefore it is destined to fail”.  The more important understanding is that an autonomous currency issuer, like the USA, is not constrained by the amount of debt it issues, but rather by the inflationary effect of the spending.  So to me, focusing on debt:GDP ratios is the wrong metric.  Rather, we should be focusing on fiscal policy that most benefits the private sector and encourages optimal resource utilization.

KMAN:  To focus my previous question (about the 70’s stagflation). What I am looking for is the MMR explanation of the phenomenon of “stagflation” during that period. on the surface it seems to invalidate some MMR tenets. If you have high inflation this implies too much money creation for the amount of goods produced. High unemployment implies insufficient money in the system. How do both exist at the same time?

CR:  I don’t think the 70’s invalidate MR at all.  After all, at its core, MR is really just a set of understandings about the way the system works.  To me, the 70’s were a confluence of many moving parts.  The key drivers of the stagflation were the war spending, strong unions (leading to high wages), and oil prices.  Combine the three and you got an unusual mix of  demand push-inflation and cost-push inflation.

Bald Trader:  Cullen,2 questions:

1)Per MMT, a government does not need tax revenue to ‘fund’ its spending on social programs. So why does a socialist country such as Sweden or Denmark have such high taxes?

2)It seems like foreign denominated debt gets countries in trouble. They can no longer ‘print money’ to stimulate their economy, as this will devalue their currency and make foreign debt repayments more difficult. Why do countries borrow in foreign denominated debt?

CR:   I don’t use the MMT framework here any more.  Monetary Realism, which was created to clarify what many of us believe were errors in the MMT framework, shows that government’s really go have to procure funds from the private sector in order to spend.  It’s important to understand that an autonomous currency issuer can’t “run out of money” because it can always harness its banks or central bank as a funding source, but that doesn’t mean the government isn’t always a currency user in some aspect.  That is, government’s must achieve validation of the existence of their currency in order to use it.  This is done via taxes and bond sales.  A government that cannot tax has a dying currency on their hands.  Every single hyperinflation in history has proven this.  So it’s pointless to say a government doesn’t need to procure funds to spend.  It most certainly does.  As a user of OUR social construct, the government has elements of a currency user that must be understood or else you misunderstand the very essence of money as a social construct.

That said, countries that have highly socialized spending policies must tax more to procure funds for these programs.

On point two, not all countries can be sovereign in their currency due to real constraints or other factors.  So some countries just don’t have a choice in adopting the policies of other nations.  China is a classic example here.  China is not really autonomous in the RMB because they peg the currency to the USD.  Why do they do this?  Because their economy is not developed to the point where they feel comfortable letting the RMB float fully.  They choose not to be autonomous, but they are making the conscious decision to do this because they feel it benefits their citizens most to drive exports through keeping the RMB low relative to the USD.  So China has to accumulate USD’s to protect the RMB peg in essence making them a user of a foreign currency to some degree.

I would recommend reading this piece on currency autonomy by Brett Fiebiger for more.

Ben:  Cullen, Which market outcome in the next 6 months will cause you the most pain?

CR:  A Euro collapse would be really devastating for everyone.  Not only would it render many of my predictions wrong, but it would also inflict massive pain and suffering on the global economy.  This would inevitably impact me in many ways, but more importantly, it would hurt just about everyone in the global economy.

SB: This may seem like a silly question, but I’m curious why your recent post on money supply used M3, which doesn’t include treasuries. As I understand it, MMR holds that people treat treasuries an awful lot like money, so swapping them with dollars doesn’t really change anything, which is why QE isn’t really money printing. So should we really be using a monetary aggregate that includes treasuries? What am I missing here? 

CR:  I really just used M3 because it’s the money supply indicator that most people are most familiar with.  But if we want to gauge inflation there’s much more to that equation than just the money supply so any metric implying rates of inflation solely based on the money supply is lacking.

Calvin:  Why are women SO CRAZY?

CR:  They spend much of their lives trying to find a reasonably decent man, then he more often than not turns out to be a jerk, and by then they’re usually raising a smaller version of this jerk who will rinse, wash and repeat the cycle.  That would probably drive me crazy also.  Luckily, I am not a woman!   That should get me in trouble with just about everyone!  Please sense the sarcasm here!  

David:  1. Do you think that soccer would be more popular in the USA if they did away with offsides and penalized players for faking injuries to the point of embarassing themselves along with everybody in the stadium for being so lame.

2. Now that Obamacare is declared a tax;does this, along with current tax breaks expiring, adversely affect 2013 economic growth?

It is confusing to me how they insist the money comes from taxes to pay for this when it doesn’t have to. I am so confused….

CR:  I really enjoy soccer, but I do wish it was a bit more exciting.  The lack of scoring can make for a tough 90 minutes at times.  I wish they’d implement a blue line like hockey.  Or something similar.  You don’t want to eliminate break-aways (which are usually the most exciting style of play in any sport), but you also don’t want unrelenting cherry picking.   Hockey seems to have this figured out.  Soccer needs a better balance.  They’ve eliminated the slam dunk breakaway and anyone who has ever watched a Top 10 on Sports Center knows that without the breakaway slam dunk highlight there’s almost no point watching.

On the healthcare plan, I am not exactly positive what the deficit effect will be here, but I believe it will be a spending increase overall….Maybe someone else knows?

Basic:  For someone who does not have any economics background,

What are bank reserves?
If someone opens a new bank, how that bank gets their initial reserves?
Is there any connection between bank capital and reserves they have?

Thank you in advance for clarifying these very very basic (stupid?) questions.

CR: Reserves are deposits held at the Fed as well as cash reserves.  These are held to maintain settlement of payments and cash withdrawals.  Banks must have reserves in accordance with the specific regulatory requirements.  In the USA, there is a 10% reserve requirement.   Reserves are an asset.  Capital is assets minus liabilities.  So a bank can have plentiful reserves and still be insolvent.   Remember, banks don’t lend reserves!  The money multiplier is a myth.

JK:  Cullen, Are there any “Conspiracy Theories” that you belieive to be legitimate? (9/11 being an inside job, aliens have been visiting and governments are hiding it, etc.)

CR:  I’m not big on conspiracy theories.  But I’m not oblivious to the fact that our government probably hides some things from us.  I’ll just leave it at that.

JT26:   Are there more concrete metrics to gauge whether the federal debt matters or not? There have been many points of view:

(a) TPC view (hope I’m paraphrasing correctly): as long as the debt is productive it doesn’t matter. Question: how do we quantify this? (For example, most of the recent investments have been in real estate which is hardly productivity enhancing; what America is really selling is citizenship, not houses, but I guess you need the houses to begin with!)
(b) Krugman et al: it’s debt we owe ourselves, it never matters. There is no intergenerational debt; it’s just debt our children owe themselves.
(c) Rowe: intergenerational debt matters
(d) source??? federal debt doesn’t matter at all as long as private debt is productive. Federal debt is just grease for the wheels; the amount doesn’t matter as long as you have enough.

I’ve probably missed some as well. Thanks!

CR: The Federal debt certainly matters.  It just doesn’t matter in the same way it matters for a household.  Ie, we’re not going to “run out of money”.  I like to measure living standards.  This is a very difficult thing to measure since living standards are different to different people, but one way is to measure the real wage and salary disbursements per capita.  Other measures are more subjective.

Pierce Inverarity: Why do banks purchase deposits from other banks in a deleveraging environment?

CR:  Banking is a business of risk and earning a spread on one’s assets versus liabilities.  Banks want the cheapest liabilities they can find.  So banks are always trying to obtain the cheapest liabilities they can.  None cheaper than deposits.

Exertia:  Cullen, thanks for the recommendation about Jack Schwager’s books:

I am going through all 4 of the wizards series (cherry picking the managers I know of, and also going thru the author’s concluding remarks) and they are fantastic.

You had specifically called out Ray Dalio’s chapter (HFMW, Ch.2) and his analysis is brilliant. However he does strike a pessimistic note for the US concluding that we are in a stage of decline that may stretch 20 years into 2030. How do you reconcile this with your long-term, optimistic view of the US?

CR:  I might be naive, but I just don’t buy into the notion that the USA is going to suffer a Japanese style 20 year deflation.  I think we’re “Japan on fast forward” because we’ve implemented so many of the fixes so much more quickly than Japan did.  So the de-leveraging cycle is not likely to last as long as Japan’s did.  And in fact, we’re already seeing signs that the USA’s de-leveraging is ending….

Python:  Two questions regarding technical analysis:

1) Is technical analysis applicable when the market is
heavily driven by non-business news, or business news not
entirely relevant to U.S. business? Note: the market has
been heavily news-driven the past two months, but I would
argue that the direct relevance of most of that news
(i.e., regarding PIIGS sovereign debt and bank solvency)
to U.S. equities is questionable; nonetheless, several key
technical analysis support levels have been breached during
that time.

2) Technical analysis is really a set of statistical correlations,
but current market conditions, characterized by recovery from
a balance-sheet recession, are markedly different
from what would have prevailed when the preponderance of those
correlations were compiled. Would that not somehow mitigate the
effectiveness of technical analysis? Note: I’ve read many investors
complain on this and other investment websites that the market-
forecasting tools (technical and otherwise) they usually employ have
worked poorly since the balance-sheet recession started in 2007.

CR:  Technical analysis is really just a rear view data point form of fundamental analysis.  Anyone who collects historical data and technical analysis of any kind is just using past reference points to predict the future.  The past and present rhyme, but they don’t often repeat.  So technical analysis is useful in offering perspective, but not infallible.  Charting is not just TA.  It is a separate approach.  It is just the visual representation of these past data points.  I find both approaches useful, but only as complements to good fundamental analysis.

Anon:  There appears to be an optimism that the American government “debt” can be corrected. I do not hold that view. The American government “debt” is here to stay as is the Eurozone “debt” and the UK government “debt” and the Japanese government “debt”. I keep asking myself “how will all this government “debt” get resolved”. Can it stay around for ever….?

Can the HH debt stay around forever?

CR:  The US government is never going to “pay back” the debt.  That would entail the elimination of all US govt saving bonds.  Does your grandmother ever say “I wish Uncle Sam would pay off the national debt so I could get rid of these damn saving bonds!”???  Of course not.  The government’s debt is the non-government’s saving to a large degree.   The govt doesn’t need to “pay off the national debt”.  It needs to be harnessed by its users in a way that results in more efficient spending lading to the optimal allocation of resources.  Inflation is the true constraint for an autonomous currency issuer.  NOT solvency.

Andrew:  What do you think about this expedient option for Europe – a devaluation of the Euro?

I assume the ECB could do this by printing and would not need international coordination.

CR:  Devaluation does not solve the crux of the issue here.  Europe has a currency crisis.  They have created an incomplete union in which its nations are all currency users susceptible to solvency crisis.  This must be rectified by creating an autonomous currency system.  Devaluing might help bolster growth in the near-term, but it’s not a long-term fix.

Q&A…The Answers, Part 1

Looks like you all wanted to make it personal this week.  That’s fine.  But don’t complain when you end up hating me after this is all said and done.  I’m big on personal responsibility and I will fully blame you for asking the personal questions.

I was only able to get through half of the questions this time.  I’ll do part 2 tomorrow.

CCV – What’s your current opinion on bonds? I haven’t seen you offer an outlook in a while. Thanks.

CR – Depends on your time frame here.  I’ve long been warning about the exaggerated claims about the “bond bubble”.  So I’ve been a long-term bull for a pretty long time.  But I think you have to be careful trading the market at these extremes.  Long T-bonds are up 35% on a year over year basis.   That’s a gigantic move.  I’m a near-term bear on bonds, but that doesn’t mean you have to worry about yields surging over 4% on the 10 year any time soon.  As I’ve explained before, the end of the bond bull likely won’t come until Bernanke signals rate increases and he’s been pretty clear about his “extended period” language.  So, near-term bear, longer-term bull.

Bond Vigilante – Question: How many people from the US and from abroad believe in MMT and/or MMR ? Seems to me that the majority (if not all) of the MMT and MMR believers seem to be from the US.

My personal opinion is that folks visiting this blog believe we’re in deflation but use MMT/MMR to deny some of the more petulent/nasty sides of deflation.

C.R. has said that he sees more webtraffic when he posts negative news. That’s precisely the confirmation the US and other countries are in deflation. (See Robert Prechter’s “”socionomics””)

CR – BV, you know I don’t follow the MMT framework any more so I am not sure what MMT has to do with any of this.  Our debates and dissension from MMT were very public and based on what many of us believed were operational misunderstandings in the MMT framework.  We’ve done a huge amount of work to try to clarify the differences between MMT and Monetary Realism so I would recommend readers hunker down and dive into the details a bit more if they’re really interested in understanding our position on all of this.  My quest has always been to offer readers the most precise operational understanding of the way the modern monetary system works.  MMT is good here, but incomplete in my opinion.  I am not going to twist anyone’s arms into following our positions and understandings on this, but I would highly encourage readers take a look at the MR material.

Bernie – I understand the basics of the concept that The US government is not going to “run out of money”.

I understand the basics of the concept that the true constraint is always inflation. However, a lot of contracts and laws are written with automatic increases based on inflation. Examples are the Government (federal, state and local) pensions, government employees pay, people covered under public employee union contracts, social security, PPACA subsidy amounts and eligibility levels. If the government cannot go bankrupt, then there is no mechanism to change these contracts since the government always has the ability to pay.

Is there a danger that this will cause inflation will rapidly rise uncontrollably? Where instead of reducing buying power and making the country more competitive, the automatic increases cause a positive feedback loop?

CR – Good question Bernie. I am not sure I have a great answer for you.  I doubt that these automatic increases amount to such a substantial part of overall spending that it would actually result in the positive feedback loop that you mention.  But I can’t be certain.  Maybe you have some more details here?

Ville – What kind of music do you like and which are your favorite bands?

CR – I love most music.  If you looked at my music library (which is now on Google Music and not Itunes!) you’d find classical, country, hip-hop, alternative, reggae, etc).  These southern California beach towns tend to veer you towards the alternative/reggae style music so I’ve probably veered in that direction over the years as I fight the urge to become a lazy beach bum.  But it all depends on my mood/activity.

Conventional Wisdumb – How about your favorite books as well?

CR – Tough one.  I am embarrassed to say that I haven’t read a fiction book in 10 years.  I read a lot, but I guess I just don’t spend my free time reading fiction.  The best book I’ve read in the last few months was probably Meditations by Marcus Aurelius.  I’ve always had a secret love affair with the classics since my days as a latin student and Aurelius was one of the master philosophers/leaders of his time.  I’m big on self improvement related stuff and since I view myself as a work in progress I love these sorts of views from people who have “been there, done that”.  Aurelius has been there, done that.  He was a huge thinker and though I wouldn’t say I approve of all his positions I do think the book is important in helping offer perspective and guidance to anyone and everyone.

JK – might as well throw in movies too.

CR – Tough one here as well.   I don’t have a sexy answer here.  I think it’s really hard to beat Forrest Gump and Shawshank Redemption.

Mercator – Are we likely to get big down side surprises from Q2 earnings? By surprises, I mean no earnings warnings, just surprise misses that global companies didn’t see coming because of how rapidly conditions are deteriorating?

CR – I think guidance is going to be the key here and it’s going to be weak.  Companies are likely to report another decent set of figures because the estimates have been slashed so much in recent weeks, but the guidance is going to be very tepid given the uncertainty out into the end of the year.  No CEO wants to put his neck on the line by being overly optimistic so expect a lot of under promising.

Bob Barker – Cullen: What is your view on Obamacare in general and specifically now that the Supreme Court has construed that it is indeed a tax (to the dismay of Obama and his multitude of lies) given your view on implementing taxes during a balance sheet recession?

CR – Really putting me on the hot seat here, huh?  What a fascinating ruling.  The way Roberts phrased his decision was interesting.  I don’t think he was being as political as many have accused him of being.  Rather, I think he was playing this one by the book.  If the government expropriates funds from citizens that they might not have otherwise been required to part with, then the government is taxing them.  That’s potentially what this bill does.  But here’s where I don’t have the answer for you and maybe someone out there does.  I think you’d have to run a cost benefit analysis on all of this and find out what the real cost of not having national healthcare is?  How many people essentially free load off the current system and end up increasing costs for the rest of the country in the end no matter what.  And does a nationalized health system actually reduce that burden?  I don’t know.  I am inclined to believe that even if the government can save us a few bucks by making the system “more fair” then it still won’t result in large tax cuts in the future.  Instead, they’ll find some other way to spend the revenue or they’ll convince us they need the revenue because we’re going bankrupt.  So either way it’s likely to be a tax in the end.  But honestly, I haven’t followed all of this closely enough to give you a good enough answer.  I probably should be following it more closely….

freemarketeer – 1) What is your favorite Arnold movie?

2) Do you like the idea of tax cuts because they are faster to push and don’t allow for political direction? In a BSR, is it more important to push deleveraging or “growth”?

Generally speaking, I believe we should be using stimulus to fix infrastructure that is direly neglected, and also funding innovation. Tax rates anchor expectations (like dividend increases vs. share buybacks). The current tax structure matters more than the ideal tax structure. Money returned to the poor is also used much differently from the rich, and I think that complicates the tax cut effect.

CR – These are great questions!   So many good Arnold movies.   It’s hard to choose between Predator, T-2, and many others.  I’ll go with Predator.  Any movie that combines Mr Universe, Apollo Creed and a former Navy Seal/Congressman in an alien film that actually works, is hard to beat.

I prefer the tax cut because it doesn’t involve bureaucrats deciding to allocate funds on silly things like cash for clunkers, bank bailouts or home buyers tax credits.  Given the BSR and consumer credit woes, I think it’s better to let people keep more of their income and use it how they prefer.   I do wish there was a bigger spending push on some initiatives, but this government hasn’t proven itself capable of making very competent decisions so the stalemate on spending isn’t surprising.

Calvin – Cullen I am also a devoted saltwater fisherman, especially bottom fishing using bait like surf clams and squid. There is just something about lowering your bait to the bottom of the ocean, wait for the strike and then respond ferociously. What type of bait do you use? Do you like bottom fishing more than say trolling or using lures like pencil poppers?

CR – I’m a rookie here so you’re talking to the wrong guy.  I’ve only been fishing out here for a few years.  But I like using a double dropper loop rigged with a weight and live bait.  The halibuts and lingcods are more likely to go after the live stuff.   Here in San Diego the water is quite cold most of the year so bottom fishing is the only game in town since the pelagics just aren’t around when the water’s cold.  I’m hoping for warm water this summer and it looks like we might just get it.  If so, that changes the whole game to a surface fishing and a totally different approach as you know.  I’ll have to learn how to do that when and if it happens.

Me – Long time listener first time caller. Most overlooked topic in the world, high cost of dating.

CR – Here’s some advice.  Don’t take your date to an expensive restaurant the first time around.  This accomplishes two things.  It avoids spending a lot of money on someone you probably won’t end up with.  And it will also tell you more about their personality.  If you can’t go to a mediocre restaurant and have a great time with someone then you’re wasting your time to begin with.  Better yet, think outside the box and don’t go out to dinner.  Do something that normal boring people do.  After all, that’s what you’ll spend most of your time doing with this person anyhow.

Steve W – Cullen, You mentioned last week that you and Warren Mosler don’t quite see eye-to-eye on “demand leakage”. Would you expand on that a bit, or point me to one of your previous posts or scholarly papers on the subject?

CR – I could be misinterpreting his position on this, but I don’t see how global saving is a bad thing if he thinks current account deficits are a good thing.  But this disagreement is much deeper than just that.  I take the Wynne Godley position on current account deficits.  I just think MMT has this flat out wrong.  And they basically need to have it wrong otherwise their argument for perpetual budget deficits starts to weaken.  And in the end, MMT is really just a progressive policy approach towards their Job Guarantee.  So supporting current account surpluses and claiming that current account deficits are bad thing would be inconsistent.  But enough about that.  I shouldn’t be talking bad about MMT since I think it’s a better framework than most of mainstream economics.




So the questions got harder again this week.  Thanks for that.  There are a few softballs in there so let’s just cut to those and forget the rest.  Just kidding.  These are great exercises for us all and I love the fact that the Q&A’s are consistent with my desire to help create an environment of learning and better understanding.  Hopefully these Q&A’s are helpful to more than just the people who ask the specific questions.  So here we go….

SS –  I’d like to know if you’re still buying into this downturn. Thanks.

CR – Yes, I have been buying the recent equity market weakness.  More details below.

BenBCan you explain why QE isn’t money printing?

CR – This is a very technical point, but an important one.  The assumption that the Fed is funding the Treasury is based on the myth that there is not enough demand for US government bonds to meet the funding needs of the government.  It’s really important to understand how this all works so you might want to read this paper if you have some time.  The Treasury is operationally a currency user because it has an account at the Fed which must always be funded before it can spend.  But what the Treasury is able to do (with the help of the Fed and the banks) is harness the banks as funding agents.  This works via the Primary Dealers who are required to make bids at government bond auctions.  If you’ve ever wondered why bond auctions don’t fail you just need to understand the relationship between the dealers, the Treasury and the Fed.  The three entities are essentially in cahoots to ensure that these auctions go off without any issues.  Dealers enjoy many benefits from their relationship with the government here so they’d be wise to maintain this relationship.  And if the Dealers don’t live up to their requirements they can always be reprimanded or kicked out of this exclusive club.

Anyhow, the Treasury and Fed work in tandem with the Dealers to ensure there are bids at auctions so Treasury can always be funded.  But this works through the banks and not the Fed.  It doesn’t matter that the banks on-sell the bonds to the Fed because this idea of “monetization” assumes they wouldn’t be able to on-sell the bonds to anyone else.  This is total nonsense.  Treasury bonds are at record prices, demand for US government debt is through the roof and the secondary market for US government bonds is one of the deepest and most liquid in the world.  The idea that we need the Fed to buy these bonds because there isn’t enough demand is demonstrably wrong.  Despite this, we continue to see continual articles about monetization and how the Fed is “printing money”.

Theoretically, if we had a hyperinflation it’s likely that the PD’s would boycott the auctions because their bond buying would likely be guaranteed money losing transactions so it might make sense to forego participating in auctions for the sake of survival.   The Fed would then have to step in and fund the Tsy directly.  But it would likely be too late here.  We’d be on the verge of currency collapse if that’s the case.  Lots of people have misunderstood this dynamic here in recent years and just presumed that the Fed’s buying was this worst case scenario situation.  But it’s been nothing of the sort.  If anything, we’ve been on the verge of a deflationary collapse.  Not a hyperinflationary collapse.  Misunderstanding this was a colossal mistake over the last 5 years.

Steve WCullen, I can only imagine how much reading you do every day (and wonder if do “speed reading). I can’t seem to remember you ever commenting on articles in the WSJ (which is not to say you haven’t). I’ve read some interesting op-ed pieces in the WSJ that beg for commentary from the MMR crowd (and/or perhaps the MMT crowd). Do you bother reading the WSJ?

CR - Yes, I spend much of my day reading.  I do not read the print edition of anything though.  In fact, I don’t even read too many books.  I am embarrassed to say that the last fiction book I read was The Da Vinci Code about 10 years ago.  I just don’t read anything that is fiction.  Not sure why.  I used to love fiction, but I guess I spend my free time doing other things now (I lost a 40 inch Halibut at the surface this weekend so there’s my free time for you – rookie fishing mistake!).   I read the WSJ’s various blogs, but not the pages of or the print edition.  Real Time Economics is very good.  The blogs are more concise and almost always hit the big topics in the primary paper.  FT Alphaville is probably my favorite blog around and they almost always hit their best FT pieces.

Mike EWhat does the expectation ratio look like lately, and do you think you will post three things I think I think any more? Your commentary was one of the most valuable things on the site in my opinion…

CR – I stopped disclosing the ER.  It’s one of the indicators that goes into my trading algo so I stopped disclosing it when people became curious about the trading algo.  I keep some cards close to the vest.  Sorry.

AlessandroWould you kindly explain how Germany benefited from the Euro in the last decade?

CR – Europe is like the USA in that all of the nations are users of a common currency.  Within any construct like this you’re bound to have trade surplus and trade deficit nations/states because they do so much business with one another.  The difference between the USA and Europe is that there is a federal government that disburses funds to the states and eliminates the solvency risk at the state level.  That’s why the USA doesn’t have state funding crises once every 10 years.  Europe doesn’t have this.  So there is a strict funding constraint at the national level.  And they meet these needs by taxing and selling bonds.  When the crisis hit the federal govt in the USA spent billions into the states as their tax receipts dried up.  This was a massive boost to state governments.  In Europe, when the crisis hit, the national govt’s were told to hit up the private bond markets and tax.  But tax receipts collapsed and the solvency issue drove bond yields up making it hard to raise funds.

Germany has benefited from the Euro in that they’re the primary trade surplus nation in the region.  So they’ve been selling goods and services in this common currency without the ability of their competing nations to devalue and compete with them via floating exchange rates.  For instance, if Greece had the Draachma there’s no way it would trade remotely close to the D-mark.  It would likely be 70% or so lower and so goods and services in Greece would make Greek exporters MUCH more competitive.  But this rebalancing mechanism has been suffocated.  So the periphery nations have been forced to borrow to generate any growth because they don’t produce as much as Germany and they’re trade deficit nations.   And who did they borrow from?  Germany in large part!   The overall result is that business has remained relatively good in Germany as the single currency has been a boon to the trade surplus nations.  That’s why Germany has record low unemployment and a relatively stable economy in comparison to many of its nations who are being suffocated by the single currency.

jt26Hi TPC, this is a followup on last week’s Q&A discussion on CB/gov money vs. bank/private money.  First, just to make sure I got the MMR starting assumptions correct, and without getting into a debate on the broad definition of money, let’s just talk about USDs and specifically electronic USDs (not paper currency).
(1) USD = (private+Fed) bank money
(2) government spending is financed by (creating) bank money, but the operational details is a closely-coordinated “public-private partnership” (banks+Fed). The end result is a government bond and a deposit. Although, to be honest I was confused by your comment “…Fed as the currency issuer. We also believe the government needs to procure funds from the private sector in what is essentially a coordinated activity with the banking system”.
(3) the Fed is also a bank so it is, at least, on equal footing with private banks, but not necessarily in a vastly more powerful position (your words are the Fed doesn’t “sit at the top of the hierarchy”)

My questions are just to clarify (1) and the money creation process. Part of my confusion is I’ve previously read Mosler and others say, as examples, that the following can create horizontal money:
(a) credit card companies
(b) foreign entities issuing in USD (e.g. an Indian steel company issues USD bonds)
(c) anyone that issues commercial paper in USD
But, I don’t understand how the above is possible without the banking sector. Right or wrong?

Similarly, can “shadow banks”, e.g. money market funds, or foreign banks, create money without the intermediation of the (US) banking sector (i.e. banks regulated under US law)?

CR – Lots of moving parts here.  Let’s start with the credit card because this confuses some people and I’ve seen MMTers use examples like this all over the place incorrectly.  A credit card represents a line of credit extended by the bank.  The big credit card companies were actually first formed by banks, but have now come to be known as their own entities. But it’s best to think of them as nothing more than companies that facilitate electronic funds transfers approved by an associated bank.   So credit card companies don’t create money.  Banks create the money through a process very similar to walking in and getting a mortgage.  Credit card companies just facilitate the fund transfers which settle between banks.

When companies issue commercial paper or bonds they are essentially leveraging the credit of their institution to raise funds.  This is a form of borrowing that is really no different than you or I obtaining a mortgage.  Your credit is based on your income and payment history.  A corporate line of credit is based on a companies ability to pay based on many factors.  Corporations have the ability to sell debt on a secondary market (like the corporate bond market) because of their size and credit.   You can’t do that because there’s no demand for your credit.  So you have to go to the bank.  Banks prefer not to borrow from the banks because they can set the terms of their debt unlike the limited options that the banks offer.   So companies can borrow from banks or they can borrow from people like you or I.

The big difference between borrowing money from your neighbor and borrowing from the bank is that borrowing from your neighbor reduces his purchasing power and increases yours while borrowing from a bank increases your purchasing power and doesn’t necessarily reduce the purchasing power of the bank.  Banks are very much money issuers in this regard and in fact, in our credit based monetary system, they’re by far the most important money issuers as the vast majority of bank deposits are there thanks to bank issued credit.  They don’t issue net financial assets like the govt, but that’s a different discussion and has more to do with the sustainability of private debt rather than the importance of net financial assets vs bank money.  See here for more on this.

TheArmoTraderI have a question about the bailouts. I get what TARP did and how “taxpayer dollars” bailed out the banks. But I get confused when people talk about the Fed (fed reserve) bailouts.
What are they specifically referring to (you know, that 8/16/20 trillion number thats always thrown around)? Isn’t it the FED’s job to provide liquidity to the banks when they need it? Were the “FED bailouts” just short term loans (liquidity) at basically 0%? Was this QE1?

CR – These were all programs with slightly varying goals.  Most of the Fed’s programs were just short-term loans intended to stabilize overnight markets and bring back liquidity to a frozen banking system.  Programs like the TALF or CPFF fall under this category.  They’re all varying forms of collateral backed lending.  TALF for instance, was a specific program that lent to many different types of qualifying companies.  The terms on each program were very specific whereas something like QE just falls under the category of permanent open market operations.   QE is implemented through the banking system by buying assets.  Just like all open market operations.  Similar in their goals, but different in their implementation and specific terms.

dis737Cullen, What are you looking to see to call the end of the economic drain of the deleveraging cycle on the economy? Are you looking for a level at which nominal consumer debt levels stop falling, a certain debt to income ratio, debt servicing costs vs. income . . . . And how should we think about the Fed. gov. stepping in to keep consumer leverage higher than it probably should be with uneconomic lending thanks to HUD, Fannie/Freddie and Student loans?

CR – To understand my perspective here you have to understand that I think the de-leveraging is a process of gradual improvement.  It’s not an event.  So, as we’ve seen an improvement in incomes and a decline in debt we’ve seen a steady overall improvement in most trends that caused the balance sheet recession.   I’ve been saying for years now that the balance sheet recession in the USA will end more quickly than the balance sheet recession in Japan because we implemented all of our fixes much more quickly and much more consistently.  Is it good that the government is trying to prop up these debt markets?  Well, one could also say they’re just making the terms less stringent on the debtors though various policies so on the whole I think it’s been beneficial.

One of the indicators that has correlated highly with the improvement in overall consumer credit demand has been household debt:personal incomes.  As you can see below, this ratio has collapsed in recent years to the current reading of 0.97.  This means consumer credit trends are really improving.  And it’s important to understand the consumer credit trends because this was really a consumer credit recession.  I dislike the term balance sheet recession because it’s so broad.  I really never should have adopted Koo’s terminology because it’s too vague.


Double EagleI had a similar question. IIRC you’ve said that the effects of the BSR will recede sometime in 2013 or 2014. What makes you think so? The deleveraging following the Great Depression didn’t end until 1949 at 50% GDP consumer debt levels and we are far from those levels right now.

CR – As I explained above, I think the BSR is already receding.  But remember, this is a process.  We likely won’t see very strong consumer credit trends until the above ratio improves further.  That could be a few more years, but the important point is that it’s improving.   The difference between the Great Depression and Japan’s experience is that the USA has responded with massive stimulus which has helped the US consumer de-leverage without sending the economy into a depressionary tailspin as we’ve seen in many Euro nations.

The risk to this outlook is a major move towards austerity which would put pressure on personal incomes and could force a reversal in the above chart.  That would likely suffocate growth going forward and prolong the effects of the BSR.

whatisgoingon1. Care to comment on another unvetted comment often used in main stream media/pundits – “There is too much debt in the industrialized world”. The inference is to public debt (US) – so what is your position on this statement?

2. With no apparent “growth scenario” like the manufacturing revolution post depression when FDR devalued the currency to address the debt problem. And the credit/tech revolution post 70s when Nixon removed the gold backing to address the debt trade deficit issues, then why do you expect the world “grow” itself out of debt crisis?

3. What do you think of this solution to address debt/slow growth crisis: That is, what if the central banks of the developed world collectively devalued their currency 40% (or some %) relative to commodities/assets like FDR did during the depression. This would make debt payments “easier” but would increase inflation so it may make sense only if the world finds itself in a deflationary depression. [There are lots of questions like would emerging low debt countries also devalue or maintain a strong currency. And would this work if there is no “growth” driver like the manufacturing revolution benefited US post depression]. Comments could this work and what would be limitations?

CR – Remember, the true constraint for an autonomous currency issuer is not debt.  The US govt is not going to “run out of money”.  The true constraint is always inflation.  We can always afford to finance all the programs we want.  We could build 20 new cities in the USA if we wanted to.  We could build a high speed rail system connecting NY to LA.  These are political decisions.  Not affordability decisions.  But we’ve become convinced that we can’t afford anything because of some mythical level of debt that is supposedly hampering growth.  Sure, there are plenty of inefficient govt spending programs and I’d love to see the fat cut out, but that doesn’t mean we’re Greece.  There was a time in this country when we used to dream big and talk about landing on the moon and things like that.  Now we sit around finding ways to be scared about everything.  It’s a sad reality.

MatthijsQuestion about the fiscal compact treaty in Europe (starting jan 2013), which says that eurozone countries are not allowed more then .5% budgets deficits. Is that even possible? Without a semi permanent federal government/authority filling up the gap by spending a little?

CR – They’re trying to impose constraints that are entirely unrealistic.  Austerity won’t fix the root cause of the Euro crisis, which is the unworkable currency construct (see here for more on this).   These countries need a real fix.  Not goals they can’t meet.  The math just doesn’t work here.  They need to grow their way out of the debt crisis.  But they can’t grow because the domestic private sector is suffering a debt de-leveraging while the government imposes austerity and the foreign sector fails to grow.  So you have no sector that can spend and grow the economy.  Europe needs to either bring back the old currencies or move towards full unity and a US of Europe.  These unrealistic targets are pie in the sky.

perpetual neophytePick any of the softballs below:

How do you incorporate physical fitness in to your lifestyle?

How much sleep would you say you average?

Of the movies you have seen in the past 3 months, what was your favorite?

CR – I’ll do all three.   I run or run/lift 5 days a week.   I often bike at the gym because I can read the iPad on the stationary bike (yes, I am that guy).  This gives me 30 minutes or an hour of reading and working out.

I sleep about 5-6 hours a night and I love a 30 minute afternoon nap.

I haven’t seen a great movie in years.  I always complain about how movies today are just big action packed meaningless marathons and lack the depth and meaning that movies should have (at least the ones I’d prefer).  So I can’t really say I’ve seen a great movie in the last three months.  I thought The Help was a really powerful and important movie.  But that was more than 3 months ago….If you’ve got suggestions I am all ears.  I enjoy an action movie as much as the next guy, but I haven’t walked out of a movie and felt really moved in a long time….

Dunce Cap Aficionado – One more softball- Favorite restaurant in SD.

CR – Here’s one that’s off the grid.  Maybe not the best restaurant in San Diego (I could give you the standard ones that everyone knows), but I go to a tiny authentic Japanese restaurant called Okan that’s just fantastic.  If you love authentic Japanese this place is hard to beat.  It’s tiny so don’t go with a big group, but you get a real authentic Japanese meal here which is refreshing for a town with 1 million cookie cutter sushi restaurants.  If anyone has any other suggestions I am all ears.

eddyCullen, CNBC recently posted The World’s Biggest Gold Reserves. The US was number one by a wide margin. “Altogether, the total gold reserves of the U.S. equal 8,965.6 tons and would be valued at approximately $418.39 billion in today’s market.” Germany was #2 at $ $174.7 billion. While $418.39 B is a huge number, it’s relatively small compared to $15.7 T national debt. Knowing the dollar isn’t on a gold standard, what would be the expected ramifications on the dollar, interest rates, economy, gold prices, etc…if the US sold all or a majority their gold reserves?

CR – The USA owns a big chunk of the gold market so selling all of the reserves would obviously put a lot of downside pressure on the price of gold.  But it won’t happen.  I think most central banks hold gold in case of a rainy day.  As uncertainty about fiat currencies has risen in recent years this demand has jumped.  So we’re not likely on the verge of a big dump by the USA.

Joe in Accounting – Cullen, Picked up a market outlook in the men’s room at work this week by Brian Wesbury, whom I’ve seen you linked to occasionally. In it he described himself as anti-keynesian. His opinion was that government spending and regulation were the drag on the economy and tax and spending cuts would turn our plow horse economy into a thoroughbred. So my question is two part.

1. In light of the MMR articles regarding the Fed/Treasury relationship, does government spending “crowd out” private investment?

2. Isn’t a tax cut the same as an increase in spending when it comes to the deficit? What would cutting spending at the same time cutting taxes due to boost GDP?

CR – 1. Be wary of picking up financial tips in the men’s room!

2.  The traditional idea behind crowding out is based on the myth that government spending drives up interest rates by competing for debt.  This is a ridiculous notion.  The Fed can control the interest on government debt.  It can always set the rate on the debt.  So no, the traditional idea that government spending drives up rates and crowds out the private sector is utterly absurd and entirely proven wrong over the last 5 years.  Now, can govt spending cause a misallocation of resources and cause disequilibrium in the private sector?  Absolutely.  But that’s not crowding out in the traditional sense.  In most cases, it’s just good old fashioned political incompetence.

3.  Yes, a spending increase has the same exact dollar for dollar impact on the deficit as a tax cut does.  The difference is that this can impact the private sector differently.  Tax cuts let the private sector retain more dollars and spend them as the pvt sector prefers.  Govt spending let’s bureaucrats decides who wins and who loses.   This isn’t always bad, but it certainly can be.

exertia - Cullen, your thoughts on this Bloomberg article: Ex-Soros Adviser Fujimaki Says Japan May Default by 2017

CR – Japan is autonomous in the Yen.  So yes, they could default.  But it would be a choice, but a market decision like we see in Greece.  Japan can’t “run out of” Yen.  Greece can “run out of” Euro.  When the analyst makes the comparison between Europe and Japan he’s making a false analogy.  One’s a currency user while the other is a currency issuer.  Autonomous currency issuers don’t default in currencies they can produce unless they decide to.

Happy SwedeHave been struggeling with this one for a while..

From an MMR perspective, what if ECB just bought all outstanding sovereign debt in the EMU at current prices and then wrote it off?

1. Is this technically possible?
2. Would this be highly inflationary or just a form of QE?

CR – It’s technically possible, but not politically possible.   It would be inflationary only to the extent that it offsets current policies that are deflationary.  So the ECB could fund all the spending of govt’s, but if we impose austerity it’s not having much of an effect aside from eliminating solvency fears.  What the periphery needs is a currency rebalancing (via exchange rate changes brought about by competing currencies) or government spending to help the private sector de-leverage.  Would this spending be inflationary?  Yes.  And that would be a good thing just like the modest inflation in the USA over the last few years has been a good thing.  A moderate level of inflation is totally consistent with a healthy economy.

Ryan – What brought you to focus on equities investing/trading as opposed to fixed income, currencies, or commodities?

CR – Equities are the focal point of an economy.  They represent the ownership of everything that goes into building an economy.  The debt markets, forex markets, and commodities markets are all secondary to these massive businesses that use these instruments to operate their businesses.  As someone who has started a number of small businesses and is in the process of starting another one right now, I have a deep appreciation for the little things that go into developing companies.  And it’s the equity market that represents the blood, sweat and tears of the entrepreneurs and innovators who take the risk to implement their ideas.   I am not quite sure I understood all of this when I first started investing, but I am pretty sure I had an inkling from the start.  The equity markets are the centerpiece of all the action.  Yes, it’s crucial to understand the other markets, but if you’re a macro investor and you ignore equity markets it’s kind of like studying human anatomy without understanding the brain.

Jordan – If you were “king of the U.S.” for the day, (a) what would you peg the currenct necessary annual deficit at to push U.S. into an idle growth scenario? The current run rate is $1.2T, barely off the $1.4T max a few yrs ago when tax receipts were substantially lower during depths of crisis. What is your idle # now? $2T annual? $2.5T? $3T? I realize the full answer is more akin to “until all idle production capability is not idle” but what annual deficit do you guestimate that to currently be at so the U.S. generated say 4%+ growth – i.e. enough to take a serious bite out of unemployment.

Second question. Once you did this as king, I assume almost fully by tax cuts (as your general preference stated in many posts) and the economy was revving, and you had to reverse course and remove ‘stimulus’ who would you raise taxes on? What groups would be your first focus – especially knowing any tax reduction, once given, creates unrest among people once it is even hinted it would be taken away? i.e. you would be lambasted on CNBC for being a “job killer” once you take away tax cuts.

CR – 1.  A king needs a queen, right?  Can you elaborate how I would get to go about that process because I am not sure my decision making would be complete without that being taken care of.  Just kidding of course.  Making me a king wouldn’t change most women’s opinions of me.  Honestly though, the first thing I’d do right now is pass a sweeping tax cut.  It’s really hard to put an exact figure on this, but if we use Okun’s Law (which is not terribly accurate) we can assume that with an unemployment rate 4% above the traditional full employment rate of 4% we likely need another $800B in the deficit.  So let’s start with a tax cut that big and see how things progress over the next 2 years.  My guess is our economy would be well on the way to a sustainable recovery.

2.  I’d love to get in and cut some of the fat as well.  So some combo of tax increases and spending cuts would be necessary.  Given the current dynamics I think it only makes sense to focus on the rich.  I think we need long-term policies in this country that will restore the middle class.  Without a strong middle class the rich have no customers for their businesses to sell to.   We need to restore the middle class in this country.  So it doesn’t make any sense to constrain the economy at a future date by suffocating the middle class….There I am picking winners and losers.   Oops.  Good thing I’m not king!

Nick - Can you explain to a non american who’s election rhetoric so far is likely to stave off the fiscal cliff the most. Who will the market benefit the most from at the current juncture of the campaign. Thanks.

CR – It’s hard for me to answer these questions right now.  I think the presidential debates usually decide the elections in the USA so much of this will come out in the next few months.  Romney is talking tough about the debt, but he’s a closet Keynesian to some degree so I don’t know how much of this is just political rhetoric and how much of it is the truth.  To Obama’s credit, he’s kept the deficit large and fought hard for it at times and that’s been the single most important factor in keeping this economy from sinking into a depression.  Unfortunately, he backed some pretty silly spending programs.  Romney would likely go the tax cut route as opposed to spending so that’s a big change.  But I probably can’t answer this question fully for a few months because I just don’t know.

Jordan - There appears to be a sea change in how the Fed views the stock market as a wealth generator the past 3-4 years. It is now an explicit tool to stoke wealth creation and “animal spirits”. Knowing the Fed now targets the stock market, do you believe it will ever be possible for the market to sustain a serious selloff of 40%+ ala 2008 again? If yes, under what scenario? This under the guise that market participatants now have built into game theory that any serious selloff i.e. the previous 2 summers of 20%ish, will bring in central bankers, especially those in the U.S., to support markets. Which can in and of itself reduce overt bearish bets and selling pressure – see the past 4 weeks where people “know the Fed will step in sooner or later if things continue to get worse”. See your comments section day after day for examples. I ask this knowing that QE is just an asset swap and does little but effect pyschology but “animal spirits” is half the game in the market.

CR – The equity markets are driven mainly by profit trends.  And the Fed doesn’t have a lot of pull over corporate profits in the current environment.  The primary driver of profits has been the big budget deficit (see here).  So really, it’s the government as a whole who has been propping up equity markets.  Rightfully so in my opinion.   If the Fed kept QE’ing while the deficit contracted and massive austerity was imposed they’d be unable to maintain a sustainable upward trend in the equity market because collapsing profits would send prices lower.

troll - This is a bit on the philosophical side (What a shock! – coming from me).

With the present penchant for preventing another “Lehman’s moment”, it occurs to me that the corporate/political world is practicing a sort of “capitalistic socialism”. If failure of a corporation or bank is taken out of the picture, then true capitalism is also a failure.
My bent on the situation is that:
1. if we have socialism, I would rather have it for the benefit of the people, not the corporate structure.
2. the investment plain would be leveled to such an extent that (in true socialistic fashion) all investors would be “equal” (thus negating the benefit of investing).

How do you feel about this?

CR – I prefer to use the understanding that government is a construct of the people that can be utilized for our benefit.  This doesn’t mean we need public ownership of all resources, but it does mean the govt has strengths that can be leveraged to help us, particularly in times like now.   I don’t agree with the notion expressed by some that capitalism is failing the USA and the world.  I feel that the users of capitalism are failing to utilize it in the most efficient manner.  Socialism won’t solve our problems.  We just need a better understanding of the machine that is capitalism.

python – Cullen, could you please elaborate further on the reason(s) for your new-found, cautious optimism about the equity markets? The ongoing bank problems in the Eurozone aside, economic growth is slowing, worldwide, and will continue to do so for at least the next few months. Although many feel that central bank intervention is imminent abroad, and possibly at home, that probably won’t have much effect on economic growth, although it will certainly help with banks’ liquidity abroad, and provide short-term stimulus to equity markets everywhere. I agree with you that right now, the U.S. economy is still growing slowly rather than sliding into recession, but it’s far from clear if it’s growth rate is lessening or remaining steady, and unlike you, it’s not obvious to me that the U.S. will escape recession over the next year or so.

CR – I am certainly more fearful of a recession in the USA, but I still don’t see data that is consistent with that currently.  So it’s my contention that the equity markets have been getting ahead of themselves here by obsessing over Europe and potential contagion.  But if there’s one thing Europe has made clear it’s that they’re not going to let the whole thing collapse on their heads.  So Lehman 2.o isn’t happening despite the constant chatter (at least it’s not happening in the immediate future).   So I think the market is doing what it generally does and people are overreacting to potential risks.  This is the market for you.  When the market was surging earlier this year I said it was getting ahead of itself when no one else wanted to be bearish.  Now everyone is bearish and I have again been on the other side of the trade.  I am obviously not always right, but the market has a tendency to overshoot and mean revert and the psychology behind this plays a huge role in this phenomenon.  Right now we’re excessively pessimistic and mean reverting.  I’ll likely turn much more cautious in the next few weeks/months, but that’s an environment I’ll confront when necessary.

Kman – Sorry if this seems a little basic but I have not seen it discussed anywhere. If Eurobonds are issued as a part of the solution of the European mess, the intended effect is a significant decrease in yield on Periphery debt. However, as someone during the last QA pointed out another effect would be the increase of yield on German debt. So the result of the announcement of the formation of Eurobonds would be that everyone holding German debt would be facing a large mark to market loss? How would you operationally introduce this so as not to reward the speculator and punish those who are actively seeking safety?

CR – I am not so sure that Germany bonds need to decline substantially in the case of Eurobonds.   More likely, as we’ve seen every time the ECB steps in, periphery bond yields collapse and German yields barely budge.  That’s my guess at least.


Looks like the questions got increasingly detailed and difficult this week.  Not sure whether to shake my fist at you guys or thank you for the challenge.  We’ll see by the end of this I guess.   So here goes….

Andrew P – I want to gauge the probability of a true bank run in the PIGS States. A run is only possible if there is somewhere to run to and a real path to get there. How hard is it (in a practical sense) for an ordinary European to get their Euros out of Spain, Greece, Ireland, Portugal, or Italy? I know that in theory any EU citizen can open a bank account in any Eurozone State, and in the past that was true in reality, but The Economist said that German banks are now demanding proof of German residency to open an account. Is it possible for a non-German to open the German equivalent of a Treasury Direct account? If so, what are the operational hurdles to doing so?

CR -Aren’t some citizens already pulling their money out of some banks in Europe?  Quite technically, the bank run in Europe is underway to some degree.  The money doesn’t have to go anywhere.  If enough people pull enough money out of the banks then the banking system starts to freeze up.  The more likely scenario is that the strong will devour the weak here and we’ll see something similar to the USA in 2008 where the too big to fail become too BIGGER to fail.  It’s a lovely solution until the next big banking crisis happens.  :-)

Colin, S.Toe – Recent discussions on ‘federalism’ have reflected the traditional Hamiltonian (strong central government and a central bank; emphasizing and supporting financial/commercial growth) vs Jeffersonian (democracy with a small ‘d’; a nation of independent farmers and tradesmen) divide. I’m not sure either really foresaw the emergence of the ‘entrepreneur’ (particularly in his/her ‘start-up’ incarnation), the multinational corporation, and the dynamic between them.

What reflections would you have on this divide as it relates to economic developments? (This makes up for last week’s lob.)

CR – I discussed what I believe is Hamilton’s prescience and genius in a few posts last year (see here and here).   What Hamilton seemed to understand was that a national bank could help eliminate the solvency risk at the federal level which would actually filter through the monetary system and create increasing stability.  This is a double edged sword of course.  A nation that has its own bank can also abuse this great privilege.  But it works fairly well in a nation like the USA where there are checks and balances on the use of that bank.

In Europe, we see the lack of a central bank being tied to political entities as the major cause of the solvency crisis.  We don’t have this phenomenon in the USA because the states are all essentially backed by the full faith and credit of the US government.  So Hamilton’s bank was a very necessary evil.

whatisgoingon – Question regarding interest swaps/derivatives which reportedly make up over 90% of total derivatives.

1. Has anyone seen if these very large interest rate swaps/derivatives distort the yield spreads of treasuries(similar to how the size of JPM recent bet on HYG distorted the yield spreads)?
2. What risks do the 300 Trillion + interest rate derivatives pose – that is,
a. Is the risk only to the too big to fail banks if the interest rates move against them?
b. Are there risks to interest rates/yields if the bets move against banks and they need to unwind those positions?

I expect the Fed to support the banks if this type of event occurs by intervening to keep rate lows though I’m trying to understand what the likely risks.

CR – This is a tough one to answer.  Interest rate swaps exist for good reason – to help banks hedge their risks.  Ultimately, banking is all about managing risks.  But the unfortunate reality of the financial markets and our banking system is that most banks (and most anyone in general) are not necessarily very good at managing risks.  As you noted, the swaps market is enormous, but it’s really impossible to know whether these banks are utilizing these various instruments in a manner that increases their overall risks to the financial system or not.  There are a lot of different variables that come into play there.  I tend to fall on the side of requiring greater capital controls and tighter regulations on banking activities specifically because I think bankers are poor risk managers.  But that’s just me….

SS – Can you elaborate at all on your trading algorithm? Also, is there any way we can gain access to your trading approach? Updates on the site or something?

CR – I do not disclose my proprietary metrics.  Sorry.

MG – What is your prediction on the EURO a few years down the road?

CR –  I think the Euro will survive and even thrive.  I still think Europe must move towards fiscal union of some sort and when they achieve a completion of the union the Euro currency will continue its move towards a world reserve currency.

Sergio Mr. Roche, I never took Econ 101 and I may be presuming too much. What I don’t understand is:

If most equity investors have allocations in equities at any given time between 50% and 90%….. and many have left the market not to return. Who has been on the buying end from 2008 till now?
By looking at international markets charts that are trending down I might conclude that it was foreign investors taking up the slack. But that still doesn’t account for 08,09.
I assume that 401k buyers are generaly buy and hold. Money is created when it is loaned. Otherwise there is X amount in exsistance at any given time just sloshing back and forth.Yet hundreds of millions of shares trade hands every day and the price keeps going up.

Just can’t rap my head around it. Millions out of the market….. less new loans…..less people buying things……more people unemployed all over the world and the market keeps going up. I’m not sure this is economics… sounds more like magic to me. I have a migicians joke that might fit this situation but I won’t tell it because its pretty ronchy.
What are your thoughts?

CR – You have to remember the basics of any market transaction.  There is always a buyer for every seller.  So it doesn’t make much sense to say that the buyers have “left the market not to return”.  When you buy a stock someone else is selling you their cash.  And vice versa.  All financial assets issued on a primary market are always held in a secondary market until they’re retired.  So your question about who has been doing the buying could be answered with “well who has doing all the selling”?  Every time you buy a stock someone else is selling it to you….It takes two to tango.  And the financial markets are one huge tango.

Vincent – Eric Janszen, from, talks about high Treasury rates in the 1970’s, “The response I got [from MMT] is that the US government set the rates high intentionally. Well, no, at one point during the Great Inflation crisis foreign central banks of countries aligned with the US were the only buyers of US Treasury bonds. The US started to issue Treasury bonds in foreign currencies.”

“Markets force the US government to rely on the kindness of foreign central banks to buy UST in 1978. They did this buy (sic) choice? Really?”–-Part-I-Bang-or-a-whimper-Eric-Janszen?p=227292#post227292

Scroll to the end of Part II for his commentary.

Janszens believes in a sudden stop of Treasury funding by investors. Would you care to comment, as he takes a very different view from your explanation of how the bond market works?

I recall the Treasury having to issue “Carter Bonds” in the seventies payable in Marks or Swiss Francs to assist bond sales while inflation was rapidly rising.

Thanks for all you’ve done.

CR – I don’t see what Janszen is referring to.  I looked at the Treasury Direct website and the auctions look like pretty much business as usual.  For instance, here is the all-time high yield on a 20 year bond at a yield of 15.75% in 1981.  The auction went off without a hitch at a bid to cover of 1.8.  Remember, the Treasury only needs bids to cover at 1.0 for a successful auction.  The other auctions in 1981 (when rates were peaking) were all fairly similar.

Now, is it possible that the USA could lose control of the yield curve?  Of course.  We have to remember the dynamic at work here first. The government essentially uses the banks as agents to fund Treasury.  The Fed is always on watch to make sure payments clear and to help coordinate the whole process here so the Fed and Treasury work very closely on all of this.  It is completely possible that the banks could reject their requirement to bid at Treasury auctions.  But this would likely only happen in the case of hyperinflation and an environment in which holding Treasury bonds is frighteningly unprofitable (with yields skyrocketing most likely).  So the government could lose the ability to harness banks to procure funds and the government would turn to the Fed.  But that would likely only occur in a situation in which the currency is collapsing.  So yes, it could happen, but I don’t think this is what happened in the 70’s as far as I can tell.  Auction demand was just fine.

And remember, I am not using the MMT version of bond auctions where the Fed and Treasury are combined.  MMR sees the Treasury as a currency user and the Fed as the currency issuer.  We also believe the government needs to procure funds from the private sector in what is essentially a coordinated activity with the banking system.  If the banks reject the currency then we’re onto hyperinflation.  So the MMT idea that the Fed can just print money in this instance is a moot point.  If the government can’t procure funds from the private sector via taxes or bond sales then its monetary system is on the fast track to death.  Understanding that the demand for currency is a two sided coin here is absolutely crucial.  MMT essentially says “taxes drive money” and that the government can force us to use their currency via enforcement.  But money is a social construct and government is a construct of the people.  To assume that the government can force us to use the currency or that “taxes drive money” is a deeply flawed idea of the way money works.

John Wilkins – Cullen: I believe you are an expert on inflation and I would like you to comment on the causes of the severe inflation currently in Argentina.

CR – Hard to know what exactly is going on in Argentina since the government there is about as corrupt as they come.  They won’t even allow accurate reporting of independent inflation gauges.  I do know the government has been highly expansionary in recent years and while I am not an expert on Argentina the current bout of inflation sounds like a case of printing in excess of productive capacity and massive government incompetence.

Old Dog – Cullen: Do you think that Fiscal Policy is in many ways too important to be left in the hands of the politicians? (I know that is how the constitution set it up but the pols clearly do not understand how it works.)

CR – I would prefer that fiscal policy became increasingly automatic.  My MMR colleague, Mike Sankowski, has proposed his TC Rule, which I think is very innovative.   It essentially ties the govt budget deficit to inflation and unemployment.  The policy could easily reset automatically by lowering or reducing tax rates on occasion.  I personally prefer the tax route as that takes the bureaucratic decision making out of the process…..

Perpetual neophyte –

I’d like to hear your thoughts on Ed’s perspective of the expectations theory of interest rates. Specifically from an actionable investment premise: would you interpret it to mean that – if short term rates remain pegged towards zero by the Fed for longer than expected – there is still room for intermediate and longer bonds to move toward zero?

CR – I always like to think of the long bond like a dog on a leash.  We know the Fed sets the short rate, but the market controls the long rate to some extent.  And what the dog does (the bond traders) is try to front run the Fed and their actions at the short end.  So if the Fed were to come out later this month and hint at rate increases you’d see a massive rise in long yields as bond traders began to front run the Fed and a cycle of rate increases.  But what’s happened in recent years is the dog has run out in front every time the economy starts to look a little stronger and then the Fed yanks them back by reiterating that they will keep rates at zero.  Right now the Fed has been pretty clear that we have a few more years of low rates so the dog is being a good boy and sitting nice and close to his owner.  He’s been yanked at the neck so many times since 2008 that the lesson has apparently been learned….

Kostas Kalevras – I ‘d like to hear your suggestions for a poor man’s bloomberg terminal. My own recommendations are:

1) bloomberg account and using ‘market monitor’.
2) for various euro interest rates.
3) for bond prices.
4) for per ISIN price quotes.
5) GCF repo rates.

CR – You don’t need a Bloomberg terminal to do well in this business.  In fact, the data overload likely hurts a lot of people who aren’t in a specific niche where the data is a huge help.  For the average investor though, there’s nothing you need to access on the Bloomberg that you can’t access through most financial websites.  That said, there’s no replacing the Bloomberg terminal if you have it.  Reuters Eikon is probably its closest competitor, but I haven’t used it.

quaternion – I wave my wand and Angela Merkel relents and all problematic, PIIGS sovereign debt is swapped for eurobonds. Do equity markets worldwide snap back to their post-2007 highs (or higher) or do they continue to struggle because of underlying economic problems in the US and abroad?

CR – If we get Eurobonds we’ll see a massive convergence in all European yields.  This would be a huge risk-on event.  It won’t solve all of Europe’s problems, but it would eliminate the solvency risk which would take a huge risk off the table.  Stability in Europe will help stabilize the global economy.  So yes, huge risk-on event and I would go so far as to say the beginning of the end of the Euro crisis.

jjames – please explain how the fed creates money out of thin air.

CR – It’s best to think of the US Treasury as a currency user and the Fed as the currency issuer.   The US government as a whole is able to harness the Fed and the banks as agents of the government to create what is essentially a currency issuer at the government level.  That is, the Treasury can always procure funds by using the banks and the Fed in a coordinated effort.  So the government procures funds by taxing the private sector which results in credits in the Treasury’s account at the Fed.  When the government cannot procure enough funding through taxation they will sell bonds.  They do so by harnessing the banks as agents, who are required to bid at Treasury auctions.  The Fed helps coordinate these operations to maintain a healthy payments system and ensure that reserves are abundant to settle payments.  When the Treasury sells bonds net financial assets are created as reserves are swapped for bonds and the resulting spending from the procurement of bonds adds to the financial assets of the private sector.

Kman – I haven’t had a chance to read too much detail of the new “Spanish TARP” but my take away is that this is a 100Billion Euro Loan. This everyone has said. What I can’t find anywhere is what the interest rate on this loan is to be. If it is less then 6% then shouldn’t the Irish be really and legitimately pissed off? They were forced to accept this interest rate AND austerity as part of their bank recapitalization scheme while Spain gets a mulligan.

CR – The short answer is yes.  And they are pissed off.  See here.

Anonymous – I know this is a macro blog, but still what have been your personal thoughts / comments about the Facebook IPO? Do you see a trend?

CR – I wasn’t as disturbed by the Facebook IPO as everyone else out there.  Facebook IPO’d so they could raise money.  And the underwriters are there to service the issuer and ensure that the issuer raises as much capital as possible within a reasonable range of their expectations.   So I don’t think it’s all that crazy that they took Facebook public at $100B or whatever it was.  What was not okay was the allegation that some of the underwriters knew the stock was substantially overvalued and had actually downgraded their outlook while disclosing this to some clients.

Kamala – Cullen, Thanks for your site. Great info always. What do you think will happen with treasuries and equities after Operation Twist ends this month? Will the Fed announce another operation? Will they wait till after the Nov. elections? Will the market move sideways with a lot of volatility?

CR – I’ve been accumulating into this downturn.  I am not optimistic about the economic impact of QE3 or operation twist, but that doesn’t mean it can’t serve as a catalyst to keep a bid under the market.  It could turn out to be a typical buy the rumor and sell the news type of event….

Bill – Cullen, just curious if you have any correspondence with other market and econ writers outside the whole MMT community.

CR – I actually don’t talk to many MMTers.  Probably because I am not an MMTer.  MMR and MMT have really split ways this year (see here if you haven’t read the many differences).  I mostly correspond with my MMR colleagues.  Other than that my contacts are mostly in the banking and investment world.  Remember, I am an investment manager who plays an economist on TV.  :-)

freemarketeer – What are the important lessons you have learned since you began your career? What did you wish you knew when you were starting out?

CR – Gosh, that’s a broad one.  One of the more important lessons I’ve learned is that you can’t do everything on your own.  There really is no such thing as a “self made” person in this world.  That is, we all rely on support systems, customers, and other people to achieve the things we seek out to accomplish.  I spent the first few years of my career trying to do everything on my own without ever consulting other people.  Understanding that money is a social construct is important here.  When you realize that money is a tool that helps us all in the exchange of goods and services then you begin to acquire a better appreciation for the goods and services that back the entire economy.  We’re not just collecting pieces of paper.  We’re providing other people with goods and services they desire and we’re just keeping tabs by debiting and crediting bank accounts.     But the key thing to understand in all of this is that in order to acquire credits in your account you have to provide the world with something truly valuable.  And no one can do that without help.

whatisgoingon – One more question. Given the theory of fiat money as described by MMT and MMR, how do you reconcile that central banks are net buyers of gold? Why not sea shells? (From what I gather the central bank buyers are the developing/emerging economies rather than the developed ones).

CR – Central banks implement lots of weird policies.  Some of them are smart and some of them are not so smart.  Buying gold is more a rainy day policy than anything else.  I wouldn’t read into it too much.

jt26 – I’m thinking Pimco has got it right that QE3 will come soon and they will resume MBS purchases. First, it avoids your much-criticised like-for-like asset swap of buying gov bonds. Second, it will directly impact the largest part of consumer balance sheets (liabilities). Third, housing seems to be showing signs of life, and the Fed may think this could be the right leveraging point to spark a new mini-bubble in RE. What do you think?

CR – I don’t think buying MBS will make a huge impact over buying Treasury’s.  It worked better in QE1 when MBS was getting smashed and the Fed came in to calm markets and help bolster prices, but the current environment is nothing like that.  MBS doesn’t need the Fed’s support.  So I don’t know what this accomplishes.  It’s an asset swap with no real substantive effect on the macro economy…..The whole QE2 and QE3 policy response is a waste of breath in all honesty.  I’ve never seen a set of programs that did less, but garnered more attention…..

Exertia -  Your thoughts on the Economist cover and this rejoinder by a German website :-)

CR – Last I checked the Germany’s PMI was deeply in the contraction range while the USA’s was still expanding.  So it seems that image is a bit backwards.  It’s the Americans who are above water and the Germans who are sinking fast.   But I guess it’s nice that the Germans still have their sense of humor about the pain their indecisiveness is helping to cause.  :-)

Hangemhi – A recent polifact story explained that other than the stimulus bill, Obama hasn’t been spending. Annual gov spending increase is 1.4% or lowest of the past 10 presidents. However, deficits and the debt are very high. The question…. if deficits are due to lower tax revenues rather than new spending, does it have less impact on growth/GDP vs new spending? On one hand it seems like a dollar is a dollar is a dollar, but on the other one just doesn’t take old spending out, while the other injects new spending in. So isn’t the latter more stimulative?

CR – A deficits a deficit.  The govt can either take fewer dollars from us or they can spend more into existence.  Either way it results in a larger budget deficit.  So yes, we might not be spending as much, but we’re also not taxing as much.  So the net result is a big budget deficit.



No dating questions this week.  I am beginning to get the sense that the readership does not understand the breadth and scope of my understanding in this department.  Oh well.  Back to wonky questions about the monetary system I guess.  Here goes:

brazzo:  I have a simple doubt regarding the concept of Currecy issuer vs Currency user. The ECB can issue Euros at will so how does it differ from the FED?

CR:  The key point to understand here is that the US government can always essentially fund itself through its relationship with the private banking system and the Fed.  The Primary Dealers are required to make a market in government bonds and the Fed ultimately can serve as lender of last resort.  The existence of a printing press is not a secret as we all know.  Due to what the Fed has called a “symbiotic relationship” the only real risk of insolvency is through inflation or a self imposed default.  So there’s no such thing as the US government “running out of money”.  It just won’t happen.  Europe’s national central banks can also tap the ECB for funds (in theory), but there is no political will for this.  In essence, there is a political divide between the state governments and the ECB, which is essentially a foreign central bank.  So you have a real funding risk and a real solvency risk for each of these governments.  Getting Euros to them is not a matter of whether they can create the Euros.  It’s a matter of political unity.  And it’s not there….

FrankH:  I am interested in understanding why you felt the need to start MMR? Was it just so you can explicitly remove the politics from all these discussions?

CR:  I have always had just one intention regarding my work on the monetary system:  to teach the operational realities of the system to the readers in an unbiased and objective manner.  In this regard, I was very attracted to many of the operational realities of MMT.  Ideas like an autonomous currency issuer not being able to “run out of money” are potentially world changing ideas.   Unfortunately, as I’ve gotten deeper and deeper into MMT I’ve found that it is not just a description of the monetary system and in fact creates a completely alternate reality in some cases.  I’ve compared MMT to the movie Inception in which the dream sequences get increasingly blurry the deeper you get.  Now, there’s a lot of really great material in MMT and it’s far better than the neoclassical stuff we’re all used to, but it’s got some baggage I prefer not to carry around with me.  With MMR I am trying to truly create an unbiased and objective understanding.  Nothing more, nothing less.   It’s an unusual approach in economics….

I’d add that MMT’s descriptive components are directly intertwined with its prescriptive components.  It’s like most of modern econ.  The real goal of the thinking is creating a cure for economic woes, rather than just understanding the monetary system.  Market Monetarists use NGDP Targeting.  Keynesians use counter-cyclical spending.   MMTers use the Job Guarantee.  And in doing so they all try to conform a policy response to the economic reality.  MMT creates a description that fits their prescriptions and parts of these descriptions are just flat out wrong in my opinion.  Ideas like banks serving public purpose, the hierarchy of money and the money monopolist are all inaccurate descriptions of our reality, but help MMT explain why the Job Guarantee is necessary.

Some people think my split with MMT was political, but this is entirely wrong.  What irked me about MMT was its inflexibility in its stances on policy.  I naively believed that I could change 20 years of academic work on MMT and separate the descriptive from the prescriptive.  I was obviously wrong.  And in splitting off from the MMT crew I’ve discovered how their prescriptive ideas appear to have cluttered even some portions of the descriptive elements of MMT.

MMR takes a totally different approach.  In a recent article I described how Leonardo Da Vinci had a huge impact on medicine through his anatomical work.  He wasn’t performing surgeries and saving people.  All he wanted to do was understand how the human body worked.  And in doing so he gave the world a great gift.  Economists are always offering solutions to everything.  Which is great.  But I don’t even think the world understands how the monetary system works so we are getting ahead of ourselves.  How can you apply the right policies if your view of the world is based on an inaccurate foundation?   Obviously, I am no Da Vinci, but I am trying to copy his model here.  I want to offer a purely descriptive understanding of the monetary system.  How people use that in their politics and solutions for saving the world is up to them.  But get the operational realities right first….

In Accounting:  Is there a way for us iPad users to opt-out of being redirected to the ‘onswipe’ version of this site and instead receive the desktop version? I appreciate what onswipe is trying to do but the user interface is pretty rough at the moment and a lot of the “swiping” features they are trying to do dont really work that well at all.

CR:  Yes, if you swipe the bottom left hand corner on the iPad you can bypass the Onswipe page.  If readers really hate this format then please just complain en masse.  I’ll get rid of it.  No problem.

troll: Poetry?

Since the year two thousand and eight,
The debt has grown so very great,
By nine trillion dollars as a matter of fact,
So if there’s no inflation, where’s it at?

CR:  Inflation is a function of aggregate demand,
With slack so great, the economy has been less than grand,
A balance sheet recession has caused near depression,
Thanks to political ignorance, we risk further economic compression.  :-)

Seriously, that’s it in a nutshell.  With 8.5% unemployment, low capacity utilization and just a general malaise, you’re not going to get high rates of inflation.  The demand and pricing power just isn’t there because consumers are still way too weak, primarily due to the balance sheet recession and its lasting impact.

jaymaster:  I’m struggling a bit with this recent article published by some employees of the NY FED:

But I’m pretty sure I disagree with this line : “Loan growth (in percent). More lending by banks, much like higher reserves held by banks, requires banks to attract deposits or other liabilities to fund the loans.”

What’s your take on that? And if you have the time to dissect it, what’s your take on the whole piece?

CR:  Banking is a business of spreads.  So banks want to attract the lowest cost liabilities they can.  I wouldn’t use the same terminology the NY Fed uses.  Banks don’t “fund” their loans with deposits.  Rather, they match the cheapest liabilities with their assets to maximize profits.

whatisgoingon:  Does student debt meet your criteria for a bubble?  And if you had to make a wild guess do you think the dollar is more likely to appreciate or depreciate or remain flat over the next year and next 3 years? Related to that – does a strong dollar pose a problem for the US economy?

CR:   It’s certainly a worry, but nothing of the magnitude that we saw with the housing crisis for instance. Don’t quote me on these figures, but a quick google search shows that there is about $1T in student loan debt outstanding and $14T in mortgage debt outstanding. So the student loan problem is roughly 1/14th the size of the recent housing debt crisis. Nothing to scoff at, but not the ticking time bomb that housing was in 2006….So it’s a big concern and a potentially disastrous trend if it grows larger, but it’s not going to crash the global economy like the housing bust did.

On the dollar – you have to be more specific.  Remember, currencies are always relative to another currency.  The dollar relative to what?  The Euro, the Yen, etc?  The USD basket is relative to many currencies.  Personally, I am not afraid of a broad currency decline in the USD relative to global currencies.  Unfortunately, this is such a broad index that it’s very difficult to be specific about it.

As for USD strength, it depends.  In a secular bull the USD will likely rally as it’s seen as a strong relative currency.  In a secular bear like we’ve been in the USD will likely remain a safe haven asset where it declines during periods of so-called growth and rallies when fear comes back.  This chart is good for reference:

On reserve currency status – remember, reserve currency status is largely a function of economic size (there are other factors as well, but production is the primary driver).  The primary reason why foreigners hold dollars is because they accumulate them during foreign trade.  They don’t just end up with dollars for no reason.  If the USA is going to lose reserve status then some other country or region sharing a currency has to prove to the world through production and economic prowess that their currency is superior to the USD.

reemarketeer:  I’ve read several predictions for a stronger dollar from here. Do you agree (and think the Fed allows it), and what do you think the rammifications are?

Stronger dollar should mean lower commodities, aiding consumers on input and import costs, but will hurt exports. How do you think that nets out?

CR:  See question above on stronger dollar.  The US economy is largely consumer driven so lower commodity prices would likely mean lower oil prices which means a stronger consumer.  It’s hard to envision how that wouldn’t help the US economy….

Roger Ingalls:  Probably a dumb question, but why can’t the European countries have a floating exchange rate with each other? Wouldn’t that ease the balance of trade issues that is at the core of the EZ problem?

CR:  There’s no such thing as a dumb question.  Only dumb answers (see this post).   The EMU is made up of nations sharing the same currency.  So it’s a lot like the USA and the states.  The states in the USA don’t have trade rebalancing via currency exchange rates.  So they require the fiscal aid of the federal government to alleviate periodic imbalances.  The EMU has neither a floating exchange rate nor a federal entity to spend.

Frenchy:  Could you go over the problem of Japan as of today? My knowledge of the issue is limited. I understand it’s a currency issuer and therefore not limited in its ability to spend. But given their debt/gdp ratio and you mentioning hyperinflation as a possible outcome for Japan, I wanted to hear more on all this from you.

CR:  Japan suffered a massive bubble in both real estate and equities in the 90’s.  When the asset prices collapsed they suffered a balance sheet recession very similar to the Great Depression in the USA in the 1930’s and somewhat similar to the USA’s recent crisis.  They’ve experienced a series of starts and stops in the economy largely due to policy errors, negative demographic trends, etc.  The big difference between the USA and Japan was that Japan suffered a business-led balance sheet recession while the USA suffered a consumer led BSR that was tied mostly to real estate as opposed to the double whammy Japan had with collapses in both equities and real estate at the same time.  Japan’s businesses have spent 20 years de-leveraging so while other negative trends might persist in the Japanese economy, they’re likely moving beyond the big broad negative trend that has hampered their corporations for the last 2 decades.  I certainly don’t agree with Kyle Bass’s idea that Japan is the next Greece.  As a currency issuer they aren’t going to “run out of Yen”.  So the bigger risk is hyperinflation and not a debt crisis.  But given the health of Japan’s corporations, the diversity and size of their economy and the role of the Yen as a partial reserve currency, I’d say hyperinflation is a relatively low risk in Japan.

pat:  Hi Cullen, The USA has a Fiscal Union and a Monetary Union. The EU only has a Monetary Union.  Everyone is talking about how the EU should adopt a Fiscal Union like the USA.  Does it really matter: Some states in the USA are in real bad shape, similar to the countries, (states) in the EU. Think California and others. California has a mandate to balance the budget, but there sure was a lot of talk the Fed would bail out the states in a pinch. That’s what the EU is doing with their members, ( bailing them out)So really what good would a fiscal union do?

CR:  I only see two real solutions in Europe.  You either give each country sovereignty by establishing their old currencies and giving them the chance to rebalance growth through the ability to print money and devalue their new currencies relative to their trade partners.  OR, you create a fiscal union like the USA has.  Personally, I think Europe is likely to become further integrated as time goes on so going backwards towards the old currencies makes very little sense to me.  A fiscal union in Europe would achieve the same things it has achieved in the USA.  The biggest advantage would be stability.  The USA doesn’t suffer state insolvency crises once every few decades because they have the power of the US government backing them. The Federal government is ALWAYS spending money on the states.  On average, about 20% of state budgets are aided by federal spending.  This is a huge persistent “bailout” if you want to think about it like that, but it avoids constant imbalances and creates stability.  California is never going bankrupt.  The Federal government would never allow it to happen.  Greece doesn’t have this backing.  The USA has lots of weak states or members who don’t pull their weight.  But we don’t kick them out because we’re politically unified.  Europe doesn’t have that unity.  They need to find it.

MG:  Cullen, Its sure taking a long time to get your bio up.  

CR:  A lot of big changes are happening with my business so I am kind of in a state of flux right now.  More to come.

Ted:  What do you think about Warren Buffett’s proposal to issue “import certificates” as a way to force the USA to balance its trade deficit?

CR:  Buffett’s idea is attractive.  These trade imbalances are generally a sign of big broad trends, which, if persisting, can boil over.  Any measure that helps to keep these imbalances from getting out of control is beneficial.  I discuss the MMR position on the current account balance in section 3 here.

BG:  Cullen- You have pointed to the “United State of Europe” or something similar as a possible solution to the Euro crisis. And Ray Dalio noted that the current situation isn’t too dissimilar from the US after the Revolution. I feel from the historical/cultural angle this will be near impossible. I mean for the better part of 1000 years some of the cultural groups have at a minimum disliked each other and have fought many many wars. They had a war called The Hundred Years war! I know that was France and England, but you get my point. So I don’t think the citizens of these countries will be jumping to give up some of their sovereignty, especially since its more or less to Germany. I wondered if you have any thoughts on this?

CR:  Yes, the social and historical aspects are the hardest part to overcome.  The USA had a similar problem though obviously not to the extent that Europe has.  The north and south in the USA still get at each other in many regards.  But through unity we’ve become the most powerful economy in the world.  I know the problems in Europe are far larger and have persisted much longer, but they’re not becoming less intertwined.  The global economy is becoming a smaller place as time goes on and Europeans are essentially being forced to live under one roof.  There’s just no escaping it.  So it’s best for Europe to live and let live.  Easier said than done!

Larry – Cullen, how much weight do you give to Technical Analysis in your own investing and trading? There have been many academic studies that argue that T.A. is not very effective, and it’s accuracy is not a whole lot better than 50-50. How effective do you think it is? Are there a few practitioners, like Jeff Saut and Ned David research, who do it well? In your investing, how much weight do you give to fundamental economics vs. T.A.? 

CR:  Depends on what you mean specifically.  Some forms of technical analysis, such as historical data, can be extremely helpful in understanding the probabilities of certain events and how the future rhymes with the past.  Charting, a form of TA, is little more than a visual of this data and the fundamentals driving past prices.  Charting is excellent for perspective, but is only a compliment to fundamentals in my opinion.  I don’t put much weight in “bear flags” and “inverted hammers” and stuff like that.  There’s a lot of datamining in those “indicators”.  I use TA and historical data quite a bit in my work, but that’s more an effort to understand how the past is prologue.

My investment approach uses a big top down approach.  So I start with an understanding of the monetary system, break this down to an understanding of its impact on specific markets, and filter that into a specific strategic approach.  That’s all driven much more by fundamental work than anything else, but I do certainly utilize elements of charting and TA in my work….

Quaternion:  I’ve heard many say that the rally off the March ’09 bottom has been by QE(s), but is that really true? The current P/E ratio is a fairly moderate 15, which suggests that the rally is warranted by fundamentals to a large degree. Perhaps the QE(s) provided nudges, but did they really do any more than that?

CR:  This is a common idea.  To me, the market rallied for simple reasons.  Yes, QE1 helped stabilize a crashing market.  But so did lots of other policies.  The main driver, to me, has been the 10% persistent budget deficit.  If you’ve read some of my stuff on Kalecki, then you know that deficits can have a huge impact on profits.  Once the govt stabilized the markets by essentially backstopping them via various policies, the deficit did a lot of the work driving profits.  For instance, the ECB has had QE in place at times, but many of the European markets have crashed.  Why don’t these analysts ever discuss this when claiming that QE did all the legwork?  I think they want to claim that “money printing” helped boost prices, but I don’t think they quite connect the dots.  Yes, govt spending helped.  But the govt doesn’t need the Fed to fund its spending.  That implies that without the Fed’s help the Treasury couldn’t obtain funding in its account.  That’s simply not accurate.

Ray – I have read your papers on QE, but have some further questions if the FED swaps cash for treasuries, your say this is purely an accounting swap, but it seems to me to be a form of credit creation, because the cash is a liability on the feds balance sheet, therefore the overall credit in the system has increased. My second question has most the QE transactions by the FED been purchases of treasuries off investors rather than commercial banks or are the commercial banks just the intermedtries in the transaction. Hope you can clarify.

CR:  When the Fed buys bonds they take an asset from the private sector and replace it with another (reserves).  This doesn’t increase the net financial assets of the private sector.  The Fed implements monetary policy through the Primary Dealers so they’ve buying bonds from the banks.  It’s impossible to know where these bonds come from though….Certainly, the banks are acting as intermediaries in some of these transactions.

theppel – Three questions.  1. How does printing money (government deficit) put people to work? If there is deflation and the price of goods fall it would increase peoples purchasing power and at some point create more demand. Printing more money without an increase in productivity just increases prices and people cannot afford any more than they did before. Were the Japanese really worse off with deflation? Using your analogy of keeping score; it doesn’t change the total number of baskets made just because you credit each basket with 4 points versus 2. The same is true if you only give 1 point per basket versus 2. If government can create more productivity with their spending than the private sector can with their spending perhaps it makes sense. Also given this is a balance sheet recession it seems that if the government is going to run a huge deficit it would make the most sense if the government gave the money directly to people through a check or tax cuts.

2.Do you think that labor’s decreasing share of the GDP is a contributing factor to the high unemployment rate. That is, as labor contributes a smaller percentage to each good or service produced, does labor get enough in wages to buy the goods and services they are producing or does a greater percentage go to people who own the capital and therefore create unemployment.

CR:  That’s a pretty broad question.  Personally, I think govt has one big strength – it can’t “run out of money”.  So if we could learn to harness this power of govt in a productive manner it would be an extremely powerful resource.  Instead of entrepreneurs financing new operations through onerous loans or private partnerships, we could learn to harness the govt as a funding source.  I’ve offered up my Innovation Initiative as a possible solution here.

Of course, the govt does finance a lot of things and over time has produced many great benefits to our society (national highway system, the internet, etc).  So govt is not all bad as it is often portrayed.  Can it become corrupted and abused?  Absolutely.  The lack of a profit motive often makes the govt more lax in its decision making.  So the fear of govt is understood, but we the public need to check these measures and ensure our leaders aren’t abusing their powers.  I think we can rectify these issues to some degree by streamlining spending and forcing spending to meet certain requirements that are in-line with the true goals of an autonomous currency issuer as they stand with regards to inflation, production, etc.   But before that can ever happen we have to get over the myth that the govt is “running out of money” or becoming the next Greece.  So for now, it looks like the austerians and the “govt is always bad” crew have the upper hand.

jt26 – I’ve been spending some time reading Sumner’s blog on NGDP targeting (inc. the archive). He writes well, and his urgency seems sincere, but I find many of his arguments unsubstantiated or weak. I’m just an investor, not an economist, so maybe his deep academic work substantiates all his assertions. You haven’t written on NGDP targeting in a while, have your thoughts changed?

CR:  I’ve had some moderately productive discussions with David Beckworth and Scott Sumner.  We’ve discussed ways in which I believe NGDP Targeting can “work”.  For instance, the Fed could buy municipal bonds and finance the states directly or they could peg long rates at 0% or something essentially making credit a true cash equivalent.  But the muni option is really fiscal policy so why not just use fiscal policy?   And the rate pegging idea just adds more debt to a private debt problem.  So my big problem with NGDP Targeting and monetary policy in general has been the basics of the balance sheet recession.  And monetary policy and trying to get debtors to take on more debt (when they’re trying to pay down debt) is a self defeating policy.  So no, my position on using QE and NGDP Targeting hasn’t really changed much.

Brian – Could you please explain asset pricing in an MMR/ZIRP regime? The standard model is that an asset that returns x dollars per year costs as much at the principle that would yield x dollars per year in interest (adjusted for risk). If interest rates are zero and expected to be zero forever, this suggests infinite asset prices. Clearly something’s wrong. How does MMR get around this problem?

CR:  MMR isn’t really a “regime”.  It’s just an understanding of the monetary system.  It always applies.  And MMR doesn’t say rates should be zero forever.  MMT says this.  MMR does not agree with the MMT stance that rates should be permanently zero and that monetary policy is useless at all times.  Monetary policy is a blunt instrument particularly in a balance sheet recession, but this won’t last forever.  So maybe your question is best asked at a MMT website?

Curvo – What do you think of VII and BFerro’s calls this week? Looking at comments on 5/21 VIi said we’re on crash watch and 2 days later he is “all in long”. BFerro was calling for 1800 and now says a crash by end of month. You seem to have some readers who are not only ‘flexible’ but make 180 degree variant changes within hours.

CR:  I really prefer not to opine on specific reader’s investment positions.  I just don’t know enough about their approaches to do so.  It would be inappropriate of me to say whether their ideas are good or bad based on the anonymous comments made by some on a website like this one.  Sorry.

JK – MMT says that the JG is a price/inflation anchor. You’ve said it’s more like a buoy. Can you explain what you mean by that? i.e. what is the difference between a anchor and a bouy? Also, would a Basic Income Guanrantee have the same bouy affect? Thanks.

CR:  At the risk of being attacked by MMTers – see this article.

KG21 – You (correctly i guess) say that the gvt is able to add NFAs to the economy through deficit spending.But in the case of Eurozone where both the public and the gvt sector have to borrow in order to net spend, is it correct to say that no NFAs are ever added?

CR:  The EMU govt’s are currency users due to political constraints.  They can technically print money and create NFA’s because they have their own central banks with access to the ECB.  But there are rules hampering this access.  This is a political constraint.  So it’s not so much about creating NFA’s in Europe as it is having the ability to eliminate the risk of solvency.

Colin, S.Toe – So, enough of these minor issues. What’s your take on whether Coronado Beach deserves its #1 ranking?

CR:  Coronado Beach is a pretty spectacular beach.  The Hotel Del on one side and the hills off Pt Loma on the either side make for pretty spectacular scenery.  Then again, I think San Diego is pretty much the best city in the USA so you’re talking to someone with a serious bias here!!!

Nils – So, got any good BBQ recipes?  Also, the way the monetary system in the USA works, isn’t the social security trust fund just an accounting gimmick?

CR:  I don’t do anything fancy with a BBQ aside from your standard fare (steak, chicken and corn is about the extent of my repertoire), but I can give you a mean fish taco recipe if you’d like.  But I recommend you catch your own fish for it.  :-)

On SS – the amount of “funding” Social Security has is largely a political choice.  If we want to credit SS with more funds then we have that choice.  I’ve used the analogy of the govt being a scorekeeper in the past, but I really shouldn’t use metaphors like this because they’re misleading to some degree.  The govt really does need to obtain funds to spend (the Treasury is technically a currency user while the Fed is technically the currency issuer) and through this symbiotic relationship the US govt is a currency issuer without a solvency constraint.  But we should be precise on the operational realities.  The short answer is, SS really does need to have “funds”, but the amount of that funding is largely a political choice.  So I wouldn’t say it’s just an “accounting gimmick”, but it’s a myth to say SS is “running out of money”.










Thanks everyone for another good set of questions.  I do my best to answer them all below:

Mark:  Regarding your “ALEXI TSIPRAS GETS IT….” story. Can you explain to me why Germany should want to sell products to a country (Greece) that can’t pay for them?

CR:  Well, Greece was paying for items.  They were paying for them in large part by borrowing money from German banks!  The problems didn’t begin until the Euro’s flaws were exposed and solvency became a clear problem for each country.  Remember, they’re all in this together.  Germany helped lend to feed the consumption of the periphery nations and the periphery nations all borrowed to be able to consume.  This is a classic case of “it takes two to tango”.  The people to blame here are the ones who created a currency union that was inherently flawed….

Eludog: What do you believe is more beneficial to the economy – higher interest rates to benefit savers or low interest rates to benefit refinancing and borrowing? Also, has their been a case historically of a country returning to normal rates after they are near 0?

CR:  It depends really.  Monetary policy is generally not as weak as it is in the current environment.  That’s because monetary policy works in large part by changing the demand for credit by making it more or less expensive.  But a funny thing happened during the balance sheet recession – the demand for credit dropped off a cliff so the primary channel through which monetary policy works just stopped functioning.

As for historical ZIRP – I can’t think of any cases other than the current case and Japan when rates were at zero for this long and later led to a rebounding economy.  Balance sheet recessions are very unusual so we’re in uncharted territory.  There is still debate over how Japan should have dealt with their BSR…..I guess you could say we’re “flying blind”….

PN:  Do you own a boat or do you use charters when you go ocean fishing (figured you deserved a softball)?

CR:  I bought a boat specifically for fishing.  Actually, a reader named “Boatman” helped me find it so many thanks to him for his advice.  Now I’ll give you the best financial advice of your life regarding “big boy toys”.  Boat owners joke that BOAT stands for Bring Over Another Thousand.  And they’re not really joking.  So, my advice is to become good friends with boat owners.  But never be the boat owner.

Colin:  What are your thoughts on this company (Exxon), and the position it will occupy in the US and global economy in the next decade or two?

CR:  I really don’t solicit advice on single stocks.  Plus my expertise is not really in particular industries or stocks.  I’ve always found that single stock picking requires a very specialized expertise in that industry/name or a unique strategy revolving around individual names (not buy and hold).  So I can’t really tell you much if anything useful about XOM, but my gut tells me it’s a great company, but where’s the growth outside of riding the hope for peak oil?   The goal of investing isn’t to find the company that has already become XOM.  The goal is to find the companies who are going to eat into XOM’s market share and become the next XOM.  The reason why XOM doesn’t outperform an index like the Energy sector as a whole is because it’s become THE energy sector.  Why buy XOM when you can take lower risk in the index?  That’s my short take on it….

Whatsgoingon asked a series of questions.  I’ll break them down one by one:

1. I hear the media talk about the fact that the size of the Fed’s balance sheet is growing is a bad thing. Do we need to worry about the size Fed’s balance sheet?

CR:  The size of the Fed’s balance sheet is not a worry.  All they’re doing is swapping assets with the private sector.  It’s best to think of the Fed’s balance sheet as a black hole.  They don’t need to sell the assets to change policy in the future and there is no risk of these assets leading to insolvency.  The Fed won’t “run out of money”.  It’s just not possible.  And when they need to raise rates they’ll raise the interest on reserves which now serves as a de facto Fed Funds Rate.

b. If some assets on the Fed’s balance sheet are not recouped fully due to default (MBS) does the Fed (and not the US government) become technically insolvent? And assuming the MBS were defaulted on, who bares that cost (I assume it would show up as simply the debasement of the currency as approved by Congress).

CR:  There really is no such thing as the Fed becoming insolvent.  As a crucial part of the US government it’s silly to think of the issuer of US Dollars becoming insolvent in that currency.

C.  What bubble do you think the current low rates are fueling?

CR:  Low rates could be fueling debt bubbles, but I don’t really see it.  The US consumer just can’t take on huge amounts of debt as they did during the housing boom.  The incomes just aren’t there to service a debt boom.

D.  Should I be concerned about the Shadow banking systems and why?

CR:  Sure.  Does anyone really know what’s going on at these big banks?  I mean, the JPM trade on Friday proves that Jamie Dimon doesn’t even know what’s going on at his bank.  So who else would know?  These big banks have proven time and time again that they can’t manage risk.  But we fail to implement measures that stop them from doing whatever they want.  It’s crazy.  But we seem to think banks can manage risk without any controls in place….sigh.

E.  What do you or MMR/MMT say about the long term weakeness of dollar?

CR:  I don’t represent the opinions of MMTers since I am not an MMTer so I can’t speak for them.  But my personal opinion is that the USD is always a case of relative value.  That’s just what currencies are in a floating system.  There are many variables that go into this so it’s a broad and complex topic that I can’t do justice on in this space.  Also, the USD has not really been all that weak in recent years or over the long-term.  In fact, the USD index is at the same level it was 20-30 years  ago….So, on a relative basis, the USD is just fine.  Now, if you’re referring to the myth that the USD has lost 90% of its value then I would recommend watching video #3 in this series.

F.  And a few tin foil hat questions if I may
– How can we be sure that the Fed is not secretly “printing money” and not reporting it?

CR:  It’s best to think of the Fed as part of the US government.  And the US government IS printing money.  And they’re very transparent about it by running a massive budget deficit every year.  There’s no need to be secretive about it.  They’re in your face about it to the tune of 10% of GDP.

G.  – I guess related to that how do we know Base money or other statistics are accurate?

CR:  If the data were substantially wrong we’d likely see a real-world impact for which there would be repercussions, no?   For instance, if Shadow Stats were right about inflation and the BLS was wrong we’d see it in our every day lives.  But we don’t.  And if we did there would probably be some form of civil unrest.  Government’s can’t just lie about what’s going on and hope that the citizens never notice that things are worse than they’re letting on….

H.  – Also what are the limitations on the Fed regarding buying assets such as equities etc? Do they need permission to do this?

CR:  The Fed is not currently allowed to purchase equities.  To see a full list of assets the Fed can buy please see here.

TPR:  What are your thoughts on the most recent white paper & article by Singh and Stella, “Central Bank reserve creation in the era of negative money multipliers”?

Article via vox:

Whitepaper: “Money and Collateral”

CR:  I have not read either paper.  I’ll have to get back to you on this one.

Ted:  Any thoughts on the growing desire to find a replacement for GDP as a measure of our economic well-being?

CR:  That’s a big big question.  It comes down to how one defines living standards.  You can have per capita GDP increasing and overall living standards can be declining depending on your definition.  It’s a difficult discussion because living standards come down to a definition of happiness.  And happiness is different things to different people.  Personally, I think that when one uses GDP to evaluate the health of a nation they should understand that this is a purely economic figure and does not necessarily reflect all the potential variables that go into living standards.  For instance, GDP was rising in the USA during the mid-2000’s in large part because we were buying so many damn houses.  But are we better off because of that growth today?

I don’t think that GDP needs to be replaced as a measure.  But it could be useful to create an index that more broadly reflects the living standards of a society.  The problem is measuring it.  It’s hard to measure what makes a society “happy” or prosperous.  It’s easy to quantify GDP so that’s what we’re left with.  Other measures of living standards are largely subjective so I am not sure there’s a reliable alternative.

Anon Jon:  Any particular books that really changed the way you view the world or how you think about investing? Like Atlas Shrugged or Security Analysis, etc.? Thanks.

CR:  If I could pick one thing to read it would be all of Buffett’s annual letters including his partnership letters.  The education from those letters is more valuable than just about any investment book you’ll find.  The partnership letters are here and the annual BRK letters are at the Berkshire website.

Zach:  I recall you saying you think a budget deficit of 8% of GDP or so (I can’t find the link) is what is needed to prevent recession in 2013, can you explain how you arrived at that number? Could international problems and possible further devaluations increase this both through lower exports and the feedback into our private sector? And when do you see the budget deficit be reduced assuming a decrease in our trade deficit and/or a more robust private sector?

CR:  I don’t think we need a deficit of 8% to sustain growth.  I’ve been saying that a deficit of 8% would sustain growth.  I can’t give you the precise break-down of my models on this outlook, but the current budget deficit is enough to maintain modest growth.  Given the improvement in credit growth and the balance sheet recession I think we should see continued growth in 2012.  The big downside risks are a credit crisis in Europe, a sharp slow-down in China and austerity in the USA.  There’s substantial risk of the “fiscal cliff” hurting growth later this year and in 2013.  We’ll have to play it by ear though.

VII:  Can the TPC create it’s own sentiment survey. All Members who sign in or log in as a member get a code- We all answer it honestly. Can you do something like this Cullen?

CR:  I could do this.  Do readers actually think it would be useful?  I find that there are plenty of services that provide sentiment surveys that offer a much broader perspective….

George:   Can there be a orderly Greece exit?

Grexit Would Be ‘Regrettable, But Not Fatal’

Greeks May Hold $510 Billion Trump Card in Renegotiation

CR:  I don’t see how the exit can be orderly.  The problem is that it won’t likely end with Greece.  When the other peripheral nations see that Greece’s economy begins to recover they’ll do the same and bring back their own currencies.  The crisis will morph and ripple through the remaining Euro nations.  This doesn’t end with Greece.  It ends with sovereignty being established for ALL European nations.  That either comes from a US of Europe or many defaults and defections or some combo of the two.

JT26:  You usually talk about US economics and markets and foreign stock indices (e.g. Shanghai) in your macro trading. Do you pay any attention to foreign economics, even in those countries that do put out reliable data (Korea,Japan,Singapore,Oz,Canada,Europe,UK), inc. inflation, sectoral balances etc.? If not, why not? If so, are there some that are your favs like US rail traffic, inflation, sectoral balances?

CR: I don’t track foreign economics as closely as I track the US data.  The main reason is because I just don’t have the time and understanding of these economies to properly assess each economy.  So the short answer is no.

David:  First, do you agree that you sometimes overlook the impact(albeit slow moving) of ever-increasing Peak Oil and how it will constrain growth not just in America but globally?

CR:  Yes.  Oil is a market I am by no means a master of and I certainly haven’t developed a solid enough understanding of the oil market to properly assess such a massive trend.  Unfortunately, I haven’t found too many reliable sources on the topic either….Perhaps someone has some that they believe are reliable???

David:  Secondly, what’s your view on India/China and their slowdown. Europe-related or something else? In particular China has had a huge housing bubble even bigger than America’s. Are people underestimating what is happening here?

CR:  China’s suffering a bit of a double whammy.  First, they’ve been printing money like crazy over the years and using it to do some fairly irrational things (like building empty cities in the middle of nowhere).  So they’re suffering from a government driven growth boom and the inevitable bust that always follows.  Second, Europe is their largest export market so they’re naturally hurting from the weakness there.  It’s potentially a massive black swan given the growing importance of the Chinese economy and the unreliability of their data.  I’ve said China has the potential to make Enron look small.  An extreme comment, but so many things just don’t add up in China that I generally put it near the top of my list of “biggest risks”.

Bill:  Question: It is put forward by MMT specifically and Keynesians more generally that in a situation where there is a shortage of ag demand, the economy will fail to restore equilibrium between supply and demand through natural adjustments of debt, income, and prices, in the absence of govt intervention.

CR:  I am not an MMTer so I can’t speak for them.  We started MMR specifically because of our disagreements with the MMT perspective.  MMR also isn’t Keynesian per se.  We do not to take a policy driven approach to economics via MMR.  Instead, MMR is focused on describing how the system works.  I wrote a piece about this approach last week and how I take a Da Vinci style approach to understanding the economy.  To me, it’s not about solving the world’s problems.  It’s about providing the world with a better understanding of the machine (much like Da Vinci did through his work as an anatomist).  Da Vinci’s gift was to provide an understanding.  Not to be the surgeon fixing everyone.  I think the economics profession suffers from a terribly problem where everyone mixes prescription with description.  And in the end the ideological prescriptions end up influencing the description leading to a warped and biased view of the world.  MMR tries to separate the description entirely from the prescription.

Regarding your question – the fact is, many prices are “sticky and markets are never as quick to respond or as rational in their response as the true free marketeers always like to think.  One good example of this was the 1800’s when we experienced 6 depressions relying on these sorts of adjustments to play out.  I’m a big free market guy, but I know how irrational and slow the market can be to understand what’s really going on.  It’s not that the government understands any of this better than the market, but rather that there are proactive measures the government can implement to stop these trends from getting out of control.  One example I always use is a simple 20% down law regarding house purchases.  Would we have had a housing crisis if we’d had a simple rule like this in place?  Of course not.  It’s like putting breaks on a car.  It just makes sense.  Government isn’t always bad.  Just like the free market isn’t always good.

Bill:  Are the twin goals of alleviating poverty and infinite growth equally flawed?

CR:   Another big big question.  Theoretically, the govt can alleviate poverty tomorrow by giving everyone something that puts them above the poverty line.  Some of the recent disagreements on the MMT Job Guarantee were along these lines.  I know the govt CAN provide a job for everyone.  But does it benefit society to have the govt implement policy like this?  I don’t have the precise answer here, but I am certainly skeptical of the idea that govt can solve all of these big macro problems we have just because it has the powers to do so.  At the end of the day, this is a balancing act.  Just because our govt CAN achieve certain things doesn’t always mean it should.  We have to evaluate the upside and downside of policy and choose as a society whether we are willing to undergo a potential decline in growth in order to offer something for everyone.

Wantingtoretire:   You indicate that the USA does not NEED the rest of the world to save its future. Does this mean you believe that the US can survive without any external trade. To put this another way, you think the US can isolate itself from other countries and maintain a satisfactory standard of living for all Americans?

CR:  If the USA didn’t need any foreign trade I don’t think it would have any foreign trade. If I did say that the USA doesn’t need the rest of the world then I don’t think I meant precisely that.  The global economy is becoming increasingly interconnected.  We’re all more dependent on one another than we likely want to admit.  In theory, the USA could survive without the rest of the world.  But that’s not our reality.  The world’s a big place and a lot of Americans (myself included at times) need to start understanding that we’re not the only one’s in it.

Sam:   I’m curious what MMR suggests for US states (which aren’t currency issuers) looking to stimulate their economies and balance their books. Is there anything individual states or municipalities can do to help end their balance sheet recessions under the current legal framework? Public banking? Raising taxes on the wealthy? Private debt forgiveness legislation? Going into debt? Cutbacks at the state level have been really crippling the recovery, so this is a very serious issue. If MMR can provide a partial solution to this problem, that would be amazing.

CR:  Well, MMR doesn’t offer specific policy solutions.  MMR is an understanding of the economy.  But we can use our understanding of MMR to push the debate forward and put policy options on the table.

As currency users this all starts at the top.  As we’re seeing in Europe, the currency users are suffering because there is no federal government to allocate funding where needed.  So, in a balance sheet recession, the currency issuer must be the entity that steps up to spend and eliminate the solvency crisis that occurs at the user level.  The same holds true for the USA.  Yes, cutbacks in state funding have hurt the recovery, but deficits of almost 10% for the last 3 years have also helped us all de-leverage and fix our balance sheets.  Europe hasn’t had that luxury and depression has been the result in many countries.



Thanks again for all the great questions.  They seem to be getting more and more challenging which I don’t like.  Maybe next week you guys can throw me a few lobs?  Okay, just kidding.  I’ll do my best to answer each one below:

IM:  What do you think of the idea of non debt based money and the central bank conducting monetary policy directly with the people instead of through a handful of financial institutions?

CR:  This is an interesting subject and one I unfortunately don’t have a great answer for.  Ideally, banks would serve public purpose and function purely as the grease in the engine of capitalism.  The reality is that they are private profit seeking entities that don’t align their interests with public purpose and so often conflict with it.  Banks are very necessary parts of this system and are a core piece of the payments system and the economy in general.  We could theoretically nationalize the banking system (a system some MMTers support and one I have said is the most logical MMT construct – see here for MMR comments on this), but then lending would be highly politicized and disconnected from the profit seeking motive that often keeps it under some constraint.  Personally, I am in favor of better regulations, not a nationalized banking system.  But neither are in the immediate future so get used to the current construct and the likelihood of more volatility in the credit cycle in future decades.

Replica:  Is it possible that a private bank that is neither capital constrained nor reserve constrained creates credit money and uses that to buy a bond? The loan creates a deposit in the banking system, but no new reserves would be created right away. Or does the bond sale always involve a reserve drain somehow?

CR:  Bond auctions settle with current reserves or reserves supplied by the Fed.  You might review this article for more on this process.

Eurocrat:  You often write about how loans create deposits, with the deposit being created “out of thin air”. Does this also apply to bond purchases? For example, if a Spanish bank buys a Spanish government bond, does it create money to do so (i.e. does the bond create a deposit)? And if so, what is the limit to this?

CR:  When I refer to how loans create deposits I am referring to private credit creation.  As a currency user, the Spanish government is like a state in the USA so when it sells bonds to then spend they are just borrowing from other private sector investors.  The process of loans creating deposits refers to the creation of private credit and the fact that banks don’t lend their reserves.  Rather, banks lend first and find reserves later.

Ryan:  What would Greece, Spain, Italy, etc. look like if they exited the Euro? Is there more economic damage through continued austerity or by exiting the Euro?

CR:  We know what would happen to some degree if they exited.  Their new currencies would crater and they’d become substantially more competitive with their neighbors.  This would also likely trigger a massive banking crisis as mass defections would cause defaults which would ripple through the banking system.  It wouldn’t be all that dissimilar to what happened in Iceland.  It would be a crushing blow to the economy in the immediate term, but would certainly be the start of a long-term healing process as it would restore autonomous currency issuing states.  I see the likelihood of this as very low though.  These nations benefit from the Euro and the more rational way to become sovereign in their own currency is for Europe to unite and finalize the currency union through greater political unity and some form of central treasury.  Unfortunately though, there is no real fix in the immediate future so the sustained depression in Europe continues…..

Exertia:  Cullen, I’ve been a follower of this blog since a couple of years now and have always valued your insight into the markets and your generally accurate market calls and predictions.

This year’s short call though, when the S&P was at about 1300 has left me (and I think most of your readers) stumped. Has this been your worst call to date? Are you still sticking with the short call? What would make you call it off?

CR:  I do not ever recommend that readers attempt to mimic my moves mentioned in the algo signals.  Not only is it just one strategy of many that I implement, but it’s rather complex and precise in its implementation.  Your comment shows how great the confusion on this can be if you don’t fully understand how I am implementing the strategy.   The algo kicked off a short signal at 1325 on 1/25, but the strategy essentially dollar cost averages into the trade over a sequence of trades.  I explained this process here.   So the trade actually resulted in a sequence of shorts at S&P 1325, 1350 and 1400 (roughly).  It then triggered a cover signal into the big move down on 4/10 (the day the market bottomed) resulting in an absolute return of ~3% (it doesn’t trade the S&P), but a relative loss of  ~3% since the S&P outperformed the strategy over this period.  This shows the power of position sizing.  I shorted into a 7% move and managed to generate an absolute return on the trade.   If you haven’t read this piece on position sizing I would highly recommend it.   The search results on the site also have some good stuff on money management and position sizing.  Highly recommended.

DAC:  I have been an avid supporter for a few years now and try to explain my basic understanding of MMR to others, esp financial/investment people. No one seems to disagree with the logic for a currency issuer but their gut feel is that the markets would punish any government which converted to MMR. How would you see the transition working? Also as every currency needs to be competitive in this world of global trade and capital movement, aren’t their FX constraints in operating MMR? If a government did the right thing, focusing on keeping the economy growing rather than feeling debt constrained, there could be an ill-informed market backlash for some time causing chaos for businesses and jobs?

CR:  The true constraint for an autonomous currency issuer is inflation.  This is a powerful insight since it eliminates the fear of default (which is totally misguided and results in flawed conclusions regarding policy).  I think this understanding would result in a more streamlined process if implemented correctly.  Obviously, once politicians understand that they have a bottomless money pit, they’d have to be constrained.  So the goal then is to create a process whereby we can measure the effectiveness of spending and its impact on inflation and living standards.  I would do this by running all new spending through a CBO analysis so we can understand its impact on inflation and living standards.  I think, if implemented correctly, we could actually make govt spending MORE efficient and in-line with our goals as a society.

Bear asked a series of questions on the LTRO and Europe, but the organization of the questions were a bit garbled so here’s my broad answer:

The LTRO allows the private banks to borrow from the ECB and buy sovereign debt.  This helps keep demand for bonds high and rates low.  But it’s got ponzi aspects to it in that it is potentially filling the banks with even more debt that is not risk free (because the issuer is not the currency issuer).  But since there is austerity being imposed it is only “money printing” in that it’s not resulting in the deflation that would result from the alternative scenario.

Anti asked a series of questions about my investment approach.  I explain my multi-strategy approach here.  

Brazzo:  Every time we had interest rates very low for very long a bubble was created in some asset class. MMR says inflation will not be a problem and you believe we will muddle through. Do you see any risk of a bubble and if so in what market?

CR:  I see no reason why current policy won’t eventually result in another massive market dislocation.  Between the Fed’s misunderstanding of QE, ZIRP, the obsession with our solvency and the ineffectiveness of our government’s spending approach we seem to have many of our priorities backwards.  We have been intent on propping up markets and banks when we should have been more worried about the real economy and households.  We’ve changed almost nothing about the system and what caused 2008 so I see no reason to expect a different future result.   I wouldn’t say we’re at the stage directly preceding a bubble and a collapse, but I have no doubt that we’ll get there again in many markets in the coming decades.  It’s only a matter of time given the structure of the system.

Delta:  I do want to push you further on the interest rates part of it, though. The way I see the world from 2003-2007 is this: extremely high commodity price inflation. Moderate CPI caused primarily by a surging share of Chinese imports – lower prices on imported good led by the peg and increased Chinese efficiency. That led to skewed artificially low interest rates which were a big part of a generalized asset price bubble. Consequent rise of overall debt and a vast increase in CA deficits because the incentive structure was falsely encouraging the choice of consumption over savings. That to me is where a lot of the imbalances came from. I’d love to have you poke holes into that argument.

CR:  I think this subject is far too complex to pin on any single cause (like low interest rates).   For instance, the trade imbalances and crisis in Europe are due to the flawed currency system.   So that’s a unique case study all on its own.  Current accounts are certainly worrisome and I’ve explained why in this piece (see section 3).  I don’t think it’s any secret that govt policy in many countries has promoted consumption over production.  So I don’t even disagree with your comment really, but I do think this matter is far too complex to blame on any single cause.  Sorry for the vague comment, but this is a VERY broad subject…..

whatsgoinon:  What tail risks do you fear/see in the economic landscape and if you are allowed to say how do you hedge yourself for them?

CR:  I’ve long been predicting that the USA would NOT enter a recession in 2012.   And my work on the balance sheet recession leads me to believe that we are Japan on fast forward and that the US economy is healing much faster than many presume.  So we’re climbing out of this hole, but the great risk is that just as we’re getting out of the hole the government will kick into austerity mode and kick us right back in the hole.  So the big risk in 2013/14 is that the government ratchets back spending big time and turns healing into pain.  This is not only the big risk to the broader economy, but also to corporate profits.  So it’s all eyes on government spending in my opinion….

Johnny Evers:  What are your thoughts on Ray Dalio’s template of the ‘Economic Machine’?

CR:  I answered this same question last week.  Here’s the answer:  CR: Dalio’s a genius and I often cite him here. We both often describe the monetary system as a machine. This is a really useful way to think of the monetary system because, it is, after all, a system. And this system has many moving parts that all come together to achieve some particular outcome. If you don’t understand how all the pieces of the system work then you can’t be expected to understand how it will operate in certain environments. I think Dalio does a better job than just about anyone doing this, but in my humble opinion, he does misinterpret the way an autonomous currency issuer functions in this system. We’ve heard him discuss the problem of the national debt and a potential insolvency in the USA so it’s clear he’s not approaching the view of the machine in the same manner that I am. This is not surprising given the fact that MMR is a far from a mainstream perspective…..

Armo Trader:  Would you fuse the Fed & Treasury together given how closely they work with each other? This would mean getting rid of any private part of the Fed, and just having appointed officials working in the “Fed” part of the Department of the Treasury.

CR:  I wrote about this briefly on Friday.  Personally, I don’t think we NEED to fuse Fed and Treasury.  We just need to better understand that they’re two pockets in the same pair of pants and that the conspiracy theories about the Fed being this evil blood sucking entity are largely bunk.  Then we can get over the hysteria about the Fed colluding with banks and better understand how our monetary system actually operates.  After all, we can’t expect to optimize the machine’s output if we believe in this myths about Fed independence and how they’re just colluding with the banks to wreck all of our lives….

WOJ:  Speaking either for yourself or MMR (or both), how would you define austerity? Are there specific measures involved or is it simply a policy goal?

CR:  To me, austerity is an insufficient budget deficit.  That depends on specifics in each nation, but in the USA for instance, austerity might involve a budget deficit that is not in excess of the current account deficit.  That would result in a net drag on the country.  We’re not imposing austerity in the USA though.

Perpetual Neophyte:  2008 seemed to primarily be a banking liquidity crisis. TARP took care of making sure there was liquidity for the banking system and re-capitalized them.

2010 and 2011 seemed to primarily be an EMU state sovereign liquidity crisis. LTRO took care of making sure there was liquidity for the EMU banking system which they have used to re-capitalize themselves with the LTRO/sovereign carry trade. This indirectly provided liquidity to the EMU state sovereign bond system.

If EMU bank capitalization is reduced by falling sovereign bond prices, and bank lending is capital constrained, does this increase the likelihood of another major round of EMU state sovereign yield increases? Or, would another round of LTRO continue to “yank the leash” on EMU state sovereign yields?

CR:  There are a few important points here.  First, I don’t think the USA had a banking crisis.  We had a household debt crisis.  The banking crisis was a symptom of this.  One of the more prescient things I ever wrote here were these comments from 2008:

“We have a major capital problem at the U.S. banking level.  What Ben Bernanke and Hank Paulson are essentially proposing is an asset swap.  The Fed will take on the toxic assets of the banks and they will receive reserves in exchange.  This is important because it will alleviate the strains in the credit markets.  That’s a good first step, however, it is not a solution to the problem at the household level and THAT is where the real economic weakness is.  By introducing this asset swap idea Ben Bernanke is simply altering bank balance sheets.  He is not fixing the economy.

So, the government has a partially correct solution. Not the BEST solution, but it gets to the core of the credit issues. They will essentially trade the bad paper for good paper and it will alleviate many of the pressures on the banks. As I have written here many times the banks are the lifeblood of the system.  I like to think of the banks as the oil in the engine.  If you run out oil the system begins to break down and eventually the engine stops running.  You can’t have a healthy functioning economy if the banks aren’t lending.  Unfortunately, because this won’t fix any problems at the household level it won’t induce any borrowing.  So, it’s a clever way to resolve the banking crisis, however, it doesn’t fix the root of the problem which is at the household level.  So, again I ask – is this a “bailout”?   You bet your ass it is.   Unfortunately, it’s not a bailout of the entire system.  It’s just a bailout of the banking system.  And their problems are merely a symptom of much bigger problems at the household level.”

So why are we still muddling through?  Because we fixed the banking crisis and not the household debt crisis.  I believe our leaders failed to properly diagnose the disease and therefore failed to find the cure.  Europe seems to be experiencing a similar crisis.  Many policy makers seem to be mistaking this as a banking crisis so policy is fixed around making sure the banks don’t fail or that the sovereigns don’t default and then cause a banking crisis.  This is shortsighted though.  Europe has a currency crisis which is causing the debt crisis.  So why is Europe muddling through or even in depression in some regions?  Because they’re fixated on avoiding a spreading debt crisis, but continually fail to fix the currency crisis.

Corey:  If fed’s injection of money into the system boosts the stock market, and if the fed does not remove this money, then why should the stock market ever fall?

CR:  I explain QE in some detail here.  Technically, QE doesn’t inject money into the economy.  It swaps bonds for reserves.  So the private sector’s net financial assets are not increased.  The “money printing” is all coming through deficit spending.  And there’s no “debt monetization” going on because it’s impossible for the Fed to ever “fund” the US government (which has a bottomless hole of money that it can create at will).  So you can see why I don’t particularly agree with your phrasing here.

The more important point to understand here is that corporate profits have been largely driven by deficit spending in recent years (more than usual due to the balance sheet recession) so the real risk for the equity market is a large decline in deficit spending leading to a decline in corporate profits and a stock market that corrects as a result.  But this is a separate issue from QE which largely works through psychological channels and does very little to impact the real economy.

JT26:  What do you think is the most overlooked/underrated credit/stock market indicator. (I’ll leave it open-ended, so you can decide what an important indicator means!) Feel free to give us a bonus if you think there is an overrated candidate as well!

CR:  I would say that the most misunderstood or underrated indicator is not exactly an indicator, but rather an understanding of the sector balances and the ways that one sector is directly impacted by the others.  This leads to vast misunderstandings of the broad economy, markets and the monetary system.

Frenchy:  What is your outlook for oil this year and its impact on the fragile recovery in the US? Seasonally we’re approaching the high season and everyone is ditching Iranian oil (major cut backs by 20 to 30% in Asia).

CR:  I wish I knew where the price of oil was going!  I’d be a much wealthier man.  I’m not much of an oil analyst so unfortunately I don’t have a good answer here.

Robert Rice:  Because clearly all these questions are way too easy ;-) I wanted to ask: have you figured out a cure for cancer yet?????? And btw, in 100 years, I need to know who’s going to be President.

CR:  I have not yet discovered the cure for cancer.  But I’ll start making progress as soon as my IQ jumps 50 points and I magically transform into a doctor.  It should happen any moment now….And I don’t have a Presidential prediction for 100 years from now, but I will make a prediction for 2024:  Joe Kennedy III.  I met him a few years ago at a wedding in Boston and talked to him for several hours.  Sharp as a tack, straight as an arrow and a rising start in politics.   The name doesn’t hurt either….

Ray:  Can you explain the impact that QE has had on the USD and also is there any sensible approach to forecasting movements in currencies?

CR:  I don’t see how QE could have substantially impacted the USD since its impact on the real economy is limited.  The US Dollar Index is actually flat since QE1 was initiated so that seems to confirm this thinking.  As for forecasting currencies – they’re largely based on understanding the relative values involved so good currency forecasting essentially comes down to being able to forecast relative economic strength.  Not an easy thing to do and not a game I dabble in often….

Tom Reilly:  Cullen, Do you really believe the Federal Reserve is transparent?? I have already pointed out how one can not tie the published schedule of purchases of MBS to the weekly changes on the balance sheet and as I have also pointed out everytime there is a large increase or decrease in MBS on the balance sheet (and thus an increase or decrease in high powered monetary base juice)the stock market acts accordingly.

CR:  I think our government is incredibly transparent.  Americans often talk about the lack of transparency of government data, but they seem to overlook how transparent the US govt is when compared to other countries.  The amount of regular data releases and transparency through various govt agencies is really staggering.  It’s certainly not perfect, but I think the govt is much more transparent than in other countries where verifiable govt data is often impossible to obtain.

MGK:   Here’s a question I’d love to see Romney answer, but I’d appreciate to read how you respond: If dividend income were taxed as ordinary income, how exactly is this going to change your investment strategy and what impact will that have on the economy and jobs?

CR:  I agree with the Buffett quote below that investors won’t stop investing just because tax rates change:

BUFFETT:  I have yet– and I’ve worked with capital gains rates of 39.9 percent and 36 percent and 25 percent, I have yet to hear one person say to me, “If I call you in the middle of the night Charlie and I say Charlie I’ve got this hot investment idea.”  Your reaction is not to say “No matter what the tax rate, forget it, I’m going back to sleep because the capital gains rates are too high.”  No, what you’re going to do is you’re going to say, “Tell me the name, quick, Warren, before you change your mind.”  And you know, I have never had one person decline to invest with me.

ROSE:  Yes.

BUFFETT:  And I was running money 40, 50 years ago when rates were much higher and I never had one person to show the slightest reluctance to take an investment idea and run with it”

Dividends are an important source of income for investors and the low tax rate on dividends is a positive incentive for corporations to give profits back to their owners.  One could argue that this is increasingly important given the corporate savings glut.  A tax increase on dividends could potentially exacerbate this and have a negative impact on the economy.  I haven’t done a great deal of work on this area, but my initial reaction is that there’s no need to raise the dividend tax.

Syd:  What do you think would be optimal fiscal policy for the next 1-2 years? Extend the Bush and payroll tax cuts? Extend unemployment benefits? Keep running deficits similar to recent levels? Alter spending levels for existing programs? New spending programs? New tax cuts? Deficit reduction?

CR:  Realistically we’re likely to get tax cuts at best so yes, an extension of the Bush tax cuts and payroll tax cuts are the best we’re likely to do.  A budget deficit of 7-8% of GDP is probably sufficient to sustain growth in 2013 so this might actually do the trick.  In a perfect world I’d revamp the whole system and probably get in there and cut a ton of spending while adding several other policies and initiatives.  I can’t do the details of this justice in this limited space though so it will have to wait for another time….


Thanks again for another set of good questions. I’ll do my best to answer them all….

Delta Financial: Here’s mine. Do negative real rates matter?
If so, does the commodity based paradigm of generating capital from savings and allowing the market to determine rates based on the mix of money supply and money demand not make considerably more sense than this dodgy paradigm of a board of governors figuring the world out on behalf of the rest of us?

CR: The primary channel through which monetary policy works is credit channels. So setting rates low when growth is low will theoretically spark borrowing, investment, reduce saving/increase spending, etc. The answer is really – it depends. Negative real rates have not had a massive impact on the economy in the last few years, but as regulars well know that’s largely due to the balance sheet recession in which monetary policy has had a muted impact due to a lack of demand for credit.

The second part of your question is more one of policy. Should the government set rates? Personally, I think policy of this sort can be beneficial. Letting the market dictate the terms, is in my opinion, a lot like sending a car down a steep road without brakes or a gas pedal. Public policy can and does allow us to step on the brakes and the gas when needed (though granted, too much and too little at times).

Gray Matter: What does the concept of modern monetary theory mean for us today in practical terms? Is it possible to tie the “funny money” status of sovereign currencies, bonds, etc to Argentina’s alleged seizure of YPF which has REPSOL screaming bloody murder for $10B?

CR: First, I don’t speak for MMT since I am not an MMTer. I helped start MMR specifically because of our many disagreements. Anyhow, the fact that the USA is an autonomous issuer of a fiat currency has little to do with being a coercive or authoritarian figure in that society. If we want a very large and involved government then we can vote for that. If we want a very small government then that too is consistent with this form of currency issuer. But there’s nothing in this idea that requires the currency issuer to be authoritarian. In fact, the existence of private banks as money issuers disperses the power of money creation away from government so you could argue that the current structure of our monetary system is actually designed to avoid this sort of authoritarian approach that you seem to fear.

internationalmonetary: Should we have a separation of powers in the monetary and executive departments of the government? In other words do you believe we should separate the central bank from the government? It seems like MMT treats the monetary and executive department as one.

CR: Again, I am an MMRist, not an MMTer. The differences have become distinct (see here for details). In this regard though, both MMR and MMT treat the central bank as part of the government. In my opinion, you don’t need to believe in the ideas of MMR or MMT to understand this. You just need to look at how the Fed operates. I often call the Fed and Tsy two pockets in the same pair of pants. That’s because they are. The Fed and Tsy are in constant communication with one another and constantly need to coordinate their actions so as to maintain a smoothly functioning monetary system. The idea of the Fed operating without knowing what is going on at the government level or at Tsy is unfathomable. So while the current political arrangement has the Fed being “independent” there is really nothing independent about their actions. To me, this isn’t some special MMR or MMT insight. It just is what it is.

Jussi: These keeps me awake during nights:

1. Why the govts keep issuing long term bonds, does it make the economy more pro-cyclical or counter-cyclical? I can see arguments both ways.

2. Do we need govt debt at all, is it just disturbing the allocation of resources? What would be the best way to arrange the medium of exchange in theory?

CR: 1. Govt spending can be both pro-cyclical and counter-cyclical so I don’t think there’s really a black and white answer for you on the bond issuance question.

2. Gosh, I wish I knew what the optimal structure of the monetary system was! I’m more of a specialist in what IS and not necessarily what COULD be. The govt technically does not need to issue debt, but there are arguments for and against this. To be perfectly honest with you, I have not devoted enough time to considering the optimal monetary system so I don’t think I quite feel comfortable discussing even preliminary thoughts I’ve had on the matter….Give me 30 more years and I’ll probably spout off at some point. :-)

InvestorX: Please compare your macro view of how the economy works to that of Ray Dalio’s “machine”.

CR: Dalio’s a genius and I often cite him here. We both often describe the monetary system as a machine. This is a really useful way to think of the monetary system because, it is, after all, a system. And this system has many moving parts that all come together to achieve some particular outcome. If you don’t understand how all the pieces of the system work then you can’t be expected to understand how it will operate in certain environments. I think Dalio does a better job than just about anyone doing this, but in my humble opinion, he does misinterpret the way an autonomous currency issuer functions in this system. We’ve heard him discuss the problem of the national debt and a potential insolvency in the USA so it’s clear he’s not approaching the view of the machine in the same manner that I am. This is not surprising given the fact that MMR is a far from a mainstream perspective…..

Puzzled: I stumbled across a post in which “CP” argued back and forth with Scott Fullwiler about “S-I”

CR: This is incredibly wonkish, but no one has covered these discussions more thoroughly than JKH over at the MMR website. Rather than do his work an injustice I’ll just point you to his brilliant work on this. See here.

Q: Can you tell us how you learned to program and build your quantitative skills and algos? A CFA here that is just trying to improve through the self-taught route. I don’t want the secret sauce of the mulit-strat, just the path for knowledge.

CR: I would by no means call myself a programmer. But I built a rather basic automated trading system using simple Excel spreadsheets through the Interactive Brokers platform. This allowed me to apply my data to an automated approach. IB’s system is really dynamic and the automation just takes the human element out of it, however, any trading system you have should be able to be overridden by human interaction. Unfortunately, in order to describe how I built this I’d have to show you point by point, but I figured it all out by googling and watching youtube videos so you can probably find more info online. IB has a superb automated trading platform if you are willing to take the time to connect the dots. It was a real pain, but if don’t have the discipline to control the system on your own then sometimes it’s best to execute through the robots….My approach is not high frequency or terribly active though so it’s not as involved as most trading algos are. In fact, a HFT or math guy might not even call my approach a true algo. But I approach a lot of this through a simple idea – “keep it simple stupid”….

In Accounting: I’d love to hear your thoughts on the HSBC risk-on risk-off piece.

If you believe the above, how have you adapted your multi-strategy approach to maintain diversification?

CR: My approach is multi-strategy because I believe diversifying across strategies is the optimal form of diversification. The problem is finding the good strategies. So I actually think my approach is diversified even though it’s not the traditional form of diversification that most investors think of when they think of diversification. Unfortunately, I don’t disclose much about exactly how I approach all of this because the strategies I use are essentially the culmination of my life’s work, but I did provide a broad overview here.

hfm: It seems when market goes against your algo signal, you try to average in. So you do not cut loss?

CR: I never pick tops and bottoms. So I always average into every position I establish. It’s not “doubling down” in the traditional sense because I have a pre-established position size set at the max amount. So, if one strategy has a 30% max allocation in the overall portfolio of strategies, I might establish 10% of a position for XYZ strategy at $10, 10% more at $9 and 10% more at $8. The position then has a $9 cost basis with a full 30% allocation. From there it’s all about following the strategy as pre-established. You sell or cover when your strategy tells you to. Not when you get “squeezed” or get scared out of the position. Each strategy has sets of rules that are not to be violated. I have overridden my algo output just twice in the last 5 years. Once in late 2008 and once last year during the Euro scare. Last year’s override proved to be a big mistake since it called the market bottom nearly to the day. Stick to your discipline….That’s the lesson.

jford: What are your sell rules?

CR: I have a lot of different rules depending on the strategy. How about this? I’ll compile my favorite rules for an upcoming article….

Tom Reilly: Cullen, How does a person know in advance if the FED is going to increase the monetary base for the coming two weeks, month? Do they pre list their operations somewhere that helps someone know in advance an increase or decrease is coming for the coming two weeks.

CR: The Fed is pretty transparent about the size of their balance sheet. You just need to follow the operations as described by the NY Fed. Here’s a schedule, for instance of remaining $600B in operation twist.

Ville: You seem to be quite a liberal fellow. What are your thoughts about legalizing drugs. Obviously it would be a massive income transfer from organized crime organizations to state.

CR: I’m actually pretty centrist. I tend to be more fiscally conservative and socially liberal. On this particular issue I tend to fall into the camp that says drugs don’t kill people, people kill people. Alcohol, for instance, is a terrible drug. But it’s a drug I use fairly often. In moderation of course. Any drug that is abused can kill you. Whether it’s Tylenol, alcohol or LSD. That said, I personally have no problem with the government enforcing laws against certain drugs that are proven to be very dangerous, but I can’t tell you where exactly I draw the line on that. I am not a doctor and don’t know enough about each type of drug to decide where that line can or should be drawn…..

VB: With all of the trouble in Europe, why has the euro held up so strong against the Dollar? Do you think this will continue?

CR: Currency valuation is all about relative values. The Euro has held up because, even with the troubles in Europe, it is a very strong economic region. Much stronger than many alternatives. So a lot of this question depends on what you mean by the Euro being “held up”. Held up against what? The USD? The Yen? The Hungarian Forint? The Euro area as a whole is the largest economic region in the world. This is why I keep saying that if they could get their act together and politically unite (a tall task I know!) they have the potential to become a really powerful and unique currency union.

troll: You constantly state that banks don’t lend reserves.
Does this mean that the cash (i.e. reserve notes) that I take out of an ATM are not considered reserves – or is it considered reserves until I withdraw it – or is it considered reserves after I withdraw it? OR does this mean that reserve notes have nothing to do with reserves?

CR: Reserves are essentially required cash held on “reserve” at regional Fed banks. In the USA the reserve requirement is 10% so banks must keep 10% on “reserve” at all times. If a bank has a deposit then it must keep 10% of that on “reserve” at the Fed.

eludog: Do you believe the stock and commodity markets are manipulated?

CR: This depends on what you mean by “manipulated”? Does the government alter prices of things denominated in its currency? YES. They’re in the business of manipulating prices. The Fed is ALWAYS manipulating the Fed Funds Rate higher than it otherwise would be. If the Fed didn’t manipulate interest rates excess reserves in the banking system would result in a permanent 0% overnight rate. So the Fed has to always manipulate rates UP in order to control monetary policy. The Federal government is further manipulating prices by constantly running budget deficits. Now, as the currency issuer, this manipulation is necessary to some degree though not always efficient or productive. But yes, any autonomous issuer of a fiat currency is essentially always in the business of manipulating its currency and therefore manipulating the price of all things denominated in that currency….Then again, the banks as money issuers are also in the business of influencing the price of money and market prices. So it all depends on what you mean by “manipulating”. I can manipulate prices, but I am a small fish in a big pond. Goldman Sachs and the Federal government, on the other hand, are big fish in a big pond….So I guess you could say that we are all kind of in the business of manipulating prices to where we want them to be. And the bigger the fish the bigger the wave….

Ben: Cullen, What are your thoughts on Reuters’ recent interview with Buba’s Weidmann?

CR: Weidman is towing the party line in Germany. The fact is, Spain is part of an unworkable currency system. The current system is like the USA where the states receive no federal aid (the US Federal govt accounts for about 20% of all state spending currently). Like Europe, there’s no currency rebalancing among states in the USA, but they don’t need it since trade imbalances are offset by fiscal aid. This doesn’t exist in Europe. Instead, the countries are being told they must fix their problems on their own. But they can’t rebalance trade through currency devaluation and they can’t take on more debt because, as currency users, there is a limit to amount their debt accumulation. So it’s full US of Europe or bust. Germany’s gonna have to write the check or take it on the chin when Spain decides to leave to bring back their own currency. There’s no other way out….

Ted: Any thoughts on the increasing student loan debt burden on younger people and the potential for this to act as a drag on the economy going forward?

CR: It’s certainly a worry, but nothing of the magnitude that we saw with the housing crisis for instance. Don’t quote me on these figures, but a quick google search shows that there is about $1T in student loan debt outstanding and $14T in mortgage debt outstanding. So the student loan problem is roughly 1/14th the size of the recent housing debt crisis. Nothing to scoff at, but not the ticking time bomb that housing was in 2006….So it’s a big concern and a potentially disastrous trend if it grows larger, but it’s not going to crash the global economy like the housing bust did.

Paul: In Europe, the ECB can write check, but choses not to, partially due to a perception that peripheral institutions are inefficient and extractive. Therefore, the bond vigilantes are in charge.

In the US, “there are no bond vigilantes”, but we could chose to change that. Do you think this is a likely scenario (i.e., sufficiently likely to be worth considering or even hedging against)? Are there any “canaries in the coal mine” that you monitor regarding this scenario?

CR: To me, it’s all about maintaining faith in debt payments. So, if the USA starts to decide not to pay interest on US Treasuries then bond markets will panic and yields will rise. That’s basically what we keep seeing in Europe. When the ECB says they’re not going to backstop the sovereigns the yields spike. It would be like California nearing default and the US government allowing the 8th largest economy in the world to default. That would be madness. The Federal government would write California a check just like they do every single year (just like they do for all 50 states). It’s not in the interest of our union to allow massive economies within the union to begin defaulting. After all, the states are part of the government. But Europe doesn’t have this unity. There is no political unity and no monetary unity in this regard. So you have Germany saying they don’t want to write the check. Okay, then kick the others out of your monetary union rather than holding them hostage in an unworkable currency system…..The USA made a commitment to sustain our monetary union through being a UNITED STATES OF AMERICA. Europe wants the benefits of a currency union without the political baggage that comes along with it. But that’s not how it works.

James: Cullen, I currently work in internet advertising but am considering a switch to a career in finance. I am enthralled by the daily discussion (mostly via twitter) on the nature of money, the world economy and markets, but am not so sure I want to dedicate my full attention to the task of modelling future market values to determine whether current market prices are high/low. Could you provide thoughts on how you decided on a career in finance?

CR: Career advice is tough because we’re each different. I have always been fascinated by markets, money and the social aspects of it all. To me, it’s like one big puzzle and as a natural puzzle solver I feel incomplete not having finished the puzzle (which probably means I’ll always feel incomplete). I was never drawn to finance for the money and I think that’s the pitfall that most people fall into. They chase something not understanding what money is. But they assume that if they can accumulate enough money then their life will be great. But this confuses money and wealth. Real wealth is not having piles of money. Real wealth is being healthy, having great friends, finding love, finding peace, finding wisdom or whatever it is that you might define under the broad realm of things that make you “happy”. Money might help you in some of these aspects, but it won’t fulfill them. So my advice to you would be to find something that really interests you. But no matter what you line of work you go into understand that your monetary rewards might not directly correlate to your actual wealth as a human being. If you go into finance you should go into the industry with the intent that you want to provide a worthwhile service to others. Not that you just want to make a boatload of money for yourself thinking that this will solve all of life’s problems. If you you do something that interests you and you go into it with the right intentions then it’s hard to say you’re doing the wrong thing….It might sound cliche, but I really believe it’s true.

Rich: since the Chinese fix the Renminbi to the dollar (they’ve expanded the trading range…still not a full float, though)…and since the Fed is a currency issuer, doesn’t that mean the Fed is also an implicit issuer of Renminbi also…(only indirectly, of course) ???

In other words, are the Chinese by fixing their currency also compromising their currency autonomy…?

CR: Yes, pegging one’s currency is a way of compromising monetary sovereignty. The risk is that you become dependent entirely on the ability to obtain that currency in order to fix the peg. We’ve seen this historically and how badly it can end. Examples like Argentina and Russia come to mind.

hangemhi: +1 and I’d add other currency pairs especially USD vs. Yen and AUS. Also curious for your thoughts on Gold.

Where can I find up to date stats on deficit spending and private sector debt (expansion or contraction)? Combined this would be NFA’s, correct? Or do you not consider private debt NFA’s?

When these two are combined I would think growth or contraction would lead to overall economic growth or contraction (obviously depending on where the money is going to, but for now I’m just looking for the numbers). And then, if you have thoughts on how quickly growth (or contraction) in NFA’s show up in GDP, jobs, etc.

(and I still don’t see a subscribe button for comments that you had a month or two ago)

CR: The best place for this data is the Fed’s Flow of Funds and the NIPA tables. That’s where I compile it all.

Private debt is not NFA’s. Private debt always nets to zero. It has an asset and a liability.

I’ll look into the subscribe button. I haven’t had much time to work on the website’s layout lately….

Colin: Individual Euro countries are not currency issuers, but some entity (the ECB?) must issue Euros. How does this process occur (eg differ from the US federal government ‘spending USD’s into existence’)?

CR: I would recommend reading this post/series at Concerted Action for a comprehensive overview of the Euro system.

Exertia: Just like most of us hit for our daily fix, what are some of your daily websites / iPad apps?

Also, what have been some of the books / authors / thinkers / doers who have influenced you the most?

CR: I read a lot of bank research. The blogs I follow are the standard big blogs that most of us probably read. I don’t have any great secrets here. You can find my list of most influential market practitioners and analysts here. One of these days I’ll compile a comprehensive list of book/authors/thinkers/doers who I have been highly influenced by.

Paul: Can you comment on the practical viability of a US state using its taxation power to become a de facto currency issuer? For example, could my home state of CA pay for services using coupons good for extinguishing CA tax liability eliminating the solvency constraint? Where do you see this falling down in practice (or not … it’d be great to stop the tired “tax increase vs. spending cuts” debate around here)?

CR: States are currency users. They can create money in the form of debt, but cannot create net new financial assets like the federal govt can.

Joe: As I recall you’re not a fan of Shiller’s 10 year PE Ratio. I like it, because it’s a simple way for an unsophisticated investor (such as myself) to know where the market stands in terms of valuation.

1) In short, why do you dislike Shiller’s 10 year PE Ratio?

2) The 10 year PE Ratio currently stands at 22.98 (*), which is somewhat high. Is it possible the ratio is unfairly skewed due to abnormally low profits following the very unusual recession we had recently? Or are the abnormally low profits balanced out by abnormally high profits?

CR: I really don’t find a lot of value in PE ratios. They’re essentially a guess based on the market’s perception of current price divided by either a rear view mirror figure or a future guess by analysts. The result is something that adds little value. The CS PE just stretches the ratio out over a longer time horizon which adds some perspective, but is virtually useless for a market timer and void for a buy and holder who doesn’t care about market value to begin with. So I just don’t know how to embed these kinds of indicators into an actionable strategy….Maybe someone else has a better answer here….

jt26: What’s your current thinking on NGDP targeting?

CR: I see things differently here than the Market Monetarists do. They think the Fed can influence the market just by promising to implement QE. But I don’t see the mechanism by which this changes fundamentals. My preferred approach for NGDP Targeting would be for the Fed to set the price of bonds or to actually buy back assets that in what would essentially result in a form of fiscal policy. David Beckworth recently wrote about an interesting proposal on using the platinum coin idea first proposed by my MMR colleague Carlos Mucha.

Jonathan: What are your favorite technical indicators or combination of, for entry and exits in equities and for currency/commodities?(if applicable).

CR: I don’t really use technical indicators in any sort of specific manner for buy/sell strategies. I vaguely follow things like moving averages, % bullish, breadth, etc, but these indicators don’t decide my outlook necessarily. I generally use technical analysis as a complement to fundamental analysis and to gauge the big picture of underlying market trends. On its own I have never found that TA can be used to sustain high risk adjusted returns, but that’s just me.

WGO: When the Fed buys foreign debt are they “printing money”?

CR: The Fed supplies dollars to foreign governments through swap lines. Unless I’ve missed something, the Fed has not been buying foreign denominated debt….

Lance: Do you really believe that:

A) Your proprietary stuff is so good that:

B) So many people would use it to line their pockets that:

C) The number of followers would thus reduce your “edge” (assuming of course that you actually have one that is sustainable) by any really measurable (i.e. meaningful) degree?

The man behind the curtain retains his aura as long as he never steps in front of the curtain, yes? :)

Me? I just don’t believe in anyone’s “track record” unless I can audit the same.

CR: The results of my macro approach here at Pragcap speak for themself. Regulars who have followed my macro calls and real-time trading calls have seen my results as they’ve played out. Some of these have been broad macro calls and others have been specific market calls (like my March 2009 buy call or my pre-flash crash short call). I am certainly not arrogant enough to claim that I am never wrong (I am wrong a lot), but I understand how the machine works and I’ve generated audited returns as follows since I began keeping an audited track record:

2006: 41.99%

2007: 26.01%

2008: 18.07%

2009: 6.5%

2010: 3.17%

2011: 6.96%

Avg: 16.3%

Since I am not running my partnership this year I can disclose this info. As you can see, I’ve beat the market in many years and underperformed the market in many years. But I’ve generated steady high risk adjusted returns throughout a pretty tough cycle using a multi-strategy approach. Do I have some holy grail? No. But do I understand how the machine works, know how to manage risk and understand how to generate decent absolute returns? I think so. I’m not some man behind a curtain though. I don’t have a crystal ball. I am just another guy who’s done pretty good running a small investment partnership who happens to have amassed a decent understanding of the monetary system and the investment world and how it’s all interconnected. But I’ve got nothing to hide here so I am not some man behind a curtain. If you think my comprehensive understanding of the system is inferior then that’s fine. I don’t ask anyone to pay for the content here.

John: Banks dont lend reserves? Who told you this? They lend reserves in various ways, otherwise what would the point of having reserves be?

CR: Banks don’t lend reserves. The money multiplier is a myth. See here. Banks use reserves for settlement of payments and to meet reserve requirements.

Sam: How do garden variety open market operations work in a world where banks aren’t reserve-constrained? What is the MMR/MMT conception of open market operations and why they affect interest rates in ways that QE doesn’t appear to?

CR: OMO’s always work through the central bank exchanging assets with the private sector. MMR and MMT know that monetary policy is always about price and not quantity. So the reason why the Fed can set the overnight rate is because they set the specific price and not quantity. QE is implemented differently. They are setting quantity and not naming price. If they wanted to they could set the price of long bonds. This is why I’ve said QE doesn’t really work. Because it doesn’t actually set the price….