Q&A…The Answers

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

Leftcoast:  I’ve seen you comment in the past that when you were managing money you were a master hedger and still beat the S&P 500. I find so many times hedging techniques are expensive and while they may create a low volatility portfolio, they usually do little more than ruin your chances of outperforming.

I was wondering if you could provide some resources that helped you learn that particular area of your craft.

CR:  I had a good run (and will probably get back into asset management again), but I was managing a small amount of money and implementing some pretty unusual strategies (which made my job substantially easier than someone running hundreds of millions or billions).  My approach has really changed over the last 10 years away from a really active stock picking approach to a more multi-strategy active/passive macro approach.  I found the stock picking to be overly onerous and not scalable to a huge asset base.  Plus, the environment changed.  I evolved.  I’m a lot smarter now and I utilize my time investing in a much more efficient manner.

I view the markets like a river.  If you can find the direction of the river just about anyone can look like a great swimmer.  You don’t need to find the pockets of faster moving water (individual stocks) though you do need to avoid the rocks (manage risks).

I “hedge” primarily through portfolio design and what Ray Dalio would refer to as “alpha generator” (my active management approaches).  I think successful portfolio construction is mostly about understanding how different assets and strategies fit together to achieve one overall goal.  A simple example is the equity/bond relationship.  To me, equities are a key component in portfolio construction.  After all, they represent the key asset related to our productive output.

To a corporation, its outstanding debt issuance (our fixed income holdings) are often its lowest cost access to capital.  To the holder of these assets (the corporation’s liabilities) we’re holding an asset that is safer (it pays a fixed income, matures at par and has a higher standing in the liquidation process), but largely in-line with the same endgame – helping the corporation achieve profits.  Just like the corporation, you don’t want all your eggs in one basket.  That’s exposes you to risks.  So, you design your business in such a manner that reduces those risks, but leverages your potential strengths.

To the corporation, debt issuance is a means of achieving this.  To the fixed income holder in a portfolio, you’re able to diversify exposure to the equity structure through the holding of a slightly safer asset.  The fixed income component is essentially a hedge.  But its gains are not achieved by offsetting the equity component.  Its gains are complimentary and achieved in a differing structure.

I really need to write something more detailed about all of this because that only scratches the surface on what I believe proper portfolio design should look like….I’ll get around to it one of these days.

Britonomist:  What are your views on bank regulation? Do you support higher capital requirements? What about regulations designed to separate investment banking from retail banking?

CR: Banks are extended an extraordinary privilege in our society.  Monetary Realism refers to bank money as “inside money” because it is created inside the private sector.  This is the dominant form of money in our economy.  Outside money (cash, notes and bank reserves) all serve to facilitate or support inside money.  So banks are the key issuers of money.  In other words, our money supply is privatized to an oligopoly of entities competing for demand for loans.  Ultimately, money is a social construct.  The govt has essentially outsourced the money supply to these banks in order to try to achieve a capitalist market based money system.  But these entities cannot and will not regulate themselves.  That’s where the govt comes in.  I think, in return for this privilege, banks should be strictly regulated.  Banks compete for profits.  They are driven by private purpose, not public purpose.  So there’s an inherent conflict in these banks being able to issue our social construct.  In order to avoid having the banks corrupt the system, we must place safeguards in the system to ensure they cannot take excessive risks.  Because, in the process of profit seeking it’s natural for banks to reach out on the risk spectrum at times.  We should not allow this to reach extremes that it has in recent years.  This will result in inevitable instability.

Stephen:  Do you buy in to the notion that over the long-term, the price of gold is correlated to global money supply levels as measured by M2? Please see chart in link below and let me know what you think. If you do believe that there is some correlation, I think this topic would make for a great article and interesting debate.


CR:  My research concludes that the key driver of gold prices is negative real interest rates.  Here’s a good paper on this.  http://www.nber.org/papers/w1680.pdf

Armo:  Are free-floating currencies a modern-day thing? In this post (http://pragcap.com/all-fiat-money-systems-fail-right-wrong) you talk about how fixed exchange rate currencies & gold standards have always failed.  How long have free-floating currencies been around for?

CR:  Good question.  The modern system of truly free floating currency regimes has been in place since 1971 when the USA broke the USD’s relationship with gold.

JM:  If the goverment runs a deficit in a given year, and part of that money spent is ‘created out of thin air’ as opposed to being (a) ‘borrowed’ in the form of bond sales to non-Fed entities or (b) raised via tax revenue, what is the most effective way to remove that excess money from the system to avoid future inflation?

CR:  Money in our monetary system is borrowed into existence.  When a loan is created a new deposit is created.  This creates money.  When a loan is paid back the money is destroyed.   In the aggregate though, loans must always expand as the economy expands.  There is no other way.  So there’s really no such thing as destroying money in the aggregate.  The money supply will always expand assuming the economy is healthy, people are taking out more loans to buys goods and services, purchase homes, make investments in their businesses, etc.  That’s just a simple reality.  We need to stop worrying so much about the expanding money supply and start worrying about the productive output that results from this money creation.  A bad private equity firm goes bankrupt when it issues loans to bad companies.  A society goes bankrupt when it creates more money for increasingly useless output.

Freemarketeer: What sort of things did you do to trade earnings back in your past life?

CR:  I had one goal – beat the analysts at guessing the estimates.  I got pretty good at it.  I’d say my win rate was somewhere in the 70-75% range.  More importantly, I knew how every stock traded (I probably traded 250 each earnings season).  I knew that XYZ needed to beat and raise or it would always gap down (knowing how specific stocks trade thinly or not was crucial in risk management).  That meant you needed to hit the bids the second the report missed and the bids showed up.  The most satisfying trade was always being the first guy out the door because you knew the right response, you got the news instantly and you digested faster than just about anyone.  And then you hit some poor guy or gal with a position they’d regret taking.  I knew ABC’s management played the analysts for fools every quarter and would beat, raise and guide the year lower (and that the stock would respond favorably).  There were so many little nuances.  The trading was fun – it was a lot like playing poker.  Especially at 3AM in a thinly trade name when you can literally see a handful of other players in the market and the spreads are nice and fat.  But it was a lot of work.  A lot of conference calls.  A lot of balance sheet and income statement analysis.  The analysis (and the waking up at 3AM PST) was awful.  I don’t recommend it as a strategy for anyone unless you have a team of analysts doing it.

Joyce:  Kyle Bass is once again predicting the demise of the Yen. Even with a basic understanding of MMR the fact that the Yen continues to go on its merry way tends to baffle me. Has anyone published an essay that clearly explains what keeps the Yen from crashing with such awful debt, demographics and now a trade deficit as well.

CR:  It’s MR.  MONETARY REALISM.    :-)  The Yen is strong for several reasons.  Its a carry trade currency which bolsters demand.  Japan is enormously productive making it a very safe currency.  And inflation remains low.  What other currency can you find that trades against the Yen that has those attributes?  Not many.  Hence, its buoyancy.

Tim:  Any chance you would consider running a Black Friday shopping special for your annual Orcam Research notes currently offered at $499/year?

Thank you for the consideration!

CR:  Sorry, but I don’t think I am planning to run any specials on the research at present.  I priced the Orcam Research at $42 per month.  So I think the $499 sounds high, but it’s not as back breaking as it might sound to some people.  I hate to be a stickler on the price, but that’s already REALLY low for this kind of research.  We’re offering institutional style insights for really reasonable prices.  I wanted the research to be accessible to small investors.  Most of this kind of research costs thousands or tens of thousands a year.  Orcam is at the very low end of the spectrum.  Some of my colleagues literally can’t believe I am charging so little….

Also, if you’d bought it a few weeks or months ago you’d know that we’ve been tactically cautious through the entirety of the -8% equity declines and nailed the fiscal cliff reaction following the election.  The early subscribers paid for their research several times over with that one insight.

Gary UK:  US Govt gold holdings fell from 22,000 tonnes to 8,000 tonnes in the 50s and 60s, due to foreign governments exchanging their dollars for gold.

During this same period the US had no trade deficit.

Can you explain how the two are related, and why the US Govt felt it needed to waste money storing those remaining 8,000 tonnes?

CR:  The US govt holds gold for the same reason most other people do – as insurance against a worst case scenario in fiat.

Ely:  What is your stance on social security? What’s the best balance to allowing people to invest for retirement on their own without letting it become so large that it over-financializes the U.S. What’s a good solution to balancing out demand leakages associated with IRAs/401ks? Thanks

CR:  Sorry, I saw this in the question section and forgot to answer.  First of all, I want to be very clear that MR takes no position on political issues.  It’s a pure description of the monetary system.  You can pretty much come to any conclusion you wanted using the understanding of the system that MR teaches.

My personal position is that a nation should provide extensive healthcare for those who cannot take care of themselves (like the elderly).  But I am not an expert on the efficiency of the program.  That’s just not my area of expertise.  Sorry.

Secondary markets are not necessarily “demand leakages”.  If I hold $1MM in assets in a brokerage account (let’s say all cash just for simplicity) it’s not like I can’t go out and get approved for a black American Express and spend til the cows come home.   Again, this is about understanding inside money.  A bank just wants to know you are creditworthy enough to ensure their payments will be received on time.  They don’t really care if it’s held in secondary markets.  And in fact, large holdings of assets on a secondary market are often the best form of collateral for getting a loan.  Just ask a bank who performs repos with the Fed!!!  :-)

Ted:  Any thoughts to how low the S&P can go? At what point would you find it attractive? It’s beginning to look like a good buying opportunity as fear over the fiscal cliff is weighing on the markets…

CR: If I provide specific market insights here the Orcam lawyers start sending me emails.  I am regulated at Orcam for a reason.  The only place I provide specific markets insights is through Orcam Investment Research.    Sorry, but I have to be careful about what I say in public now that I am regulated.  Blame the government.  :-)

Cowpoke:  How are comment’s monitored? How do you regulate what comments get posted, is there an approval process?

CR:  Comments aren’t really moderated for the most part.  I have a filter for certain (bad) words, but that’s about it.  There are some default settings that hold comments with multiple links and spammy looking style.  Other than that, you guys are generally pretty awesome about moderating the comments yourselves and respecting the freedom to comment here.  I think we’ve developed one of the more educational and insightful comments sections around.  So thanks.

Garibian:  I get your distinction between between investing on the primary and secondary market and the fine line between investing and speculating. So when I buy or sell a stock on the secondary market where does the money really come from? Is it really a zero sum game and am I just taking money out of Bferro or V11 ‘s pocket?):

CR:  Secondary markets are exchanges.  The NYSE is called the NY Stock EXCHANGE because people exchange securities there.  So, if you buy $100 of GE from someone else then you exchange your cash for their shares of GE.  You get the stock, they get the cash.  That’s all that happens.  The cash came from the seller.  In this sense, the stock market is a zero sum game.  What you buy comes from someone else’s cash account.  But the idea of zero sum is somewhat misleading because the US economy is not a zero sum game.  We can all become collectively wealthier at the same time through better living standards and a better quality of output.

dijssel:  Hi Cullen, If the Dems and Reps can reach some deal about the fiscal cliff, do you foresee a face ripping rally like the one you predicted at the end of last year. Btw, that time you were right on target. Or do you think that worries about the profit cliff will dominate the general sentiment. Love your work!

CR:  I’m going to have to apologize again, but I can’t just throw out investment recommendations here at Pragcap.  This site has tens of thousands of readers every day and the lawyers don’t like it when I use this platform to discuss specific market investments.  I created Orcam so I could help more retail investors directly.  I love the big picture stuff here and the educating, but the regulators view specific market commentary in a different light so I have to be careful about my commentary here.  Sorry.

whatsgoinon:  This was a comedic jab at Japanese Bonds by zerohedge recently.


I understand MR and your previous bond vigilantes blog post and understand that a country that issues its own currency can always make the holder of the bonds whole in nominal terms for the face value of the bond.

That said, if these government bonds are “risk free” in nominal temrs then are these bonds assets exempt from a Minsky moment type scenario?

CR: I wouldn’t say Japan is immune from a currency crisis.  But I have a very hard time seeing how Japan is going to experience a currency crisis given their state of affairs.  After all, Japan isn’t some corrupt South American nation with low output.  They’re a super power with huge output, a very strong currency, a sovereign govt and very stable financial markets.  I am not convinced by the Kyle Bass prediction that Japan is in for a collapse.  I think he’s misinterpreted the dynamics there and has dug a huge hold in a bad bet.  He’s doubling down with his recent commentary.  It’s not a bet I would make personally.

WGO:  I noticed from the Koo’s recent presentation that US interest rates bottomed and began to rise after the pearl harbor attack in 40s.


I suspect the reason for rates starting to rise then was the inflationary concerns from war deficit spending. I was going to ask how well the Fed could control rates if there was a war but I did notice that rates rose slightly after the gulf war and after 9/11 but continued their continued decline thereafter. And if rates rose because of inflation and war related employment growth that might be a acceptable outcome.

That said, how concerned are you that the brilliant elected officials in Washington will choose to start a war to spur the economy because that is the only are they can agree to deficit spend?

CR:   I certainly hope this is not in the cards.  Blowing things up is such a waste of time and money.  Especially if it’s in the name of things that aren’t really a threat to the USA.  But I don’t pretend to be able to predict the madness of politicians…..

WGO:  Last question. I often read the gold bug blogosphere (and now by some mainstream pndits) how we all need to be worried about how gold is moving from the west (US) to east (china). That is

– China balance sheet is improving because gold does not have a counter party liability like treasuries have
– This is evidence of wealth transfer from US to China. That is, China’s purchase of gold and diversifying from Treasuries is in some way the market’s way of reinstituting the gold window that Nixon closed by settling the large US trade deficit in gold.

Can you please destroy this myth and let me know why I should not worry?

Also why are these emerging central bankers acquiring gold?
And why doesn’t the US government dump its useless gold reserves. Does holding the largest amount of gold reserves serve any purpose for the US?

CR:  The USA is transferring wealth to China.  In our trade with China, we send them pieces of paper.  In exchange we get pieces of plastic.  China also gets jobs, investment, skills, etc.  This offshoring of jobs and talent is real lost wealth for the USA.  We get cheap goods and services in exchange.  It’s hard to say who’s winning this trade, but it’s clear that China’s closing the gap in terms of competitiveness.  So, in relative terms, China is winning.   But this transfer of wealth doesn’t necessarily impose some risk on the USA that makes us at risk of being “owned” by China or having them collapse our bond market.

See this post.  http://pragcap.com/is-china-boycotting-us-dollars

Rich:  You often hear the story of how George Soros “broke the Bank of England”…but, since the UK is a sovereign currency issuer as well, how is such a thing possible ? Can you explain how you perceive this event ?

CR:  I don’t think Britain was technically sovereign.  They were on the ERM back then which meant the Bank of England was forced to defend the currency in what was essentially a peg to the d-mark.  I might be wrong, but if I recall correctly the Bank of England was constrained by external forces.

Cowpoke:  From your previous experience, Do you know if Large Firms on Wall Street have dedicated departments that solely focus on lobbying (influencing)K street (political)? I know they do as all companies, maybe I should rephrase it in a more simple term. What percentage (company resources) would you say a typical wall street investment firm spends on lobby group.

CR:  According to this site, FIRE industry is one of the largest lobbying industries.  http://www.opensecrets.org/lobby/top.php?indexType=c

troll1:  Cullen: Wondere of wonders, I have a thought/question.  I understamd how you feel about the “inflationistas”, but suppose I frame the issue in a different manner. With the FED’s easy money scenario and the resultant low interest rates, is it possible that we’re having inflation occurring that is masked? Has anyone compared inflation rates to FED interest rates over the years? What would be the ratios? It could produce an illuminating chart. Thanks for being there.

CR:  Again, I am going to go back to understanding inside money.  In a world where there is so little demand for credit I find it very hard to see inflation raging out of control.  Further, inflation’s best indicator, wages, remains extremely low  How can people bid up the prices of everything when their wages aren’t expanding at a rate that would allow it?  I still see the risk of high inflation as being very low at present.

Cowpoke:  OH, One more question..Since it’s open line and all… As far as Women go do you prefer Blondes, Brunettes OR Redheads (believe it or not there is a financial correlation)?  Thanks.

CR:  I don’t discriminate.   :-)

micro2macro:  Cullen, Can you possibly debate on radio or TV Kyle Bass on what Japan’s position is? You could issue a public challenge!  It appears that Kyle is getting upset that his Japan play is not working out for him.

CR:  I think Kyle Bass has bigger fish to fry than me.

Bruce in NOLA:  Hello Cullen et. al., I have been seeing that MR and several of the ideas that have been espoused on Pragmatic Capitalism becoming more mainstream. This is interesting as there is now lots of talk about the balance sheet recession (see http://www.businessinsider.com/balance-sheet-recovery-2012-11) and how it’s ending will save the economy for 2013. What is your take on it?

PS Thanks for giving us such a clear picture of the “reality of the economy! It really has reduced my fears over the past 3 years!!

CR:  Yes, the BSR and many other insights regularly discussed here are becoming increasingly mainstream.  It’s nice to see.  But as American politicians discuss austerity it’s clear that it’s not have a wider impact.  Unfortunately, due to its relative newness, Monetary Realism has no caught on in many circles so we’ve still got a lot of work to do.  Education is still the most powerful tool we have.

Brian_Ripley:  From JKH http://monetaryrealism.com/recommended-readings/S = I + (S – I)JKH: “Private sector saving = investment, plus the change in private sector net financial assets.”AND (S – I) = (G – T) + (X – M)Cullen, why does (G – T) + (X – M) = the change in private sector net financial assets?What is it about the net Federal spending (G – T) (spending less taxes) plus the net Import Export balance (the Capital Account) (X – M) that is a “change” ?S = I + (a change from what to what to what ?)Thanks, BR

CR:  Saving is a flow.  I think it’s sometimes easier to understand our thinking on S=I+(S-I) as a stock of assets and liabilities.  For instance, in the USA, the total net worth of the private sector is $63T.  Of this, about $15T is government net financial assets.  The rest is private sector assets like common stocks, real estate, etc.  The flows of spending in the economy help the private sector to generate these stocks (govt deficit spending results in a stock of net financial assets).  But the private sector is not built on a stock of government net financial assets.  It is built on a stock of private sector assets.

The primary purpose of S=I+(S-I) is about understanding that the private sector generates most of its net worth via the I component.  That is, it is via investment that we build the majority of our financial assets.  MMT argues that the economy is built around the government stock of financial assets through govt spending.  Like all things in MMT, the argument is government centric.  This is a misrepresentation of the way our balance sheets are built.  They are not built around govt NFA, but around private sector financial assets that derive from Investment.

So, when MMT defines net saving as S-I they are essentially marginalizing the most important part of the entire Saving equation by subtracting I from S.  This is not an accurate portrayal of the way our monetary system exists.  The economy is built on a base of primarily private sector assets that develop via Investment.   Hence, the clarification of S=I+(S-I).


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • http://www.chpc.biz Brian_Ripley

    Bingo…. thanks Cullen, I get it now… S=I+(S-I)

  • Greg

    Hey Cullen

    In your answer to Mr Ripley on the S=I+(S-I) question You said;

    “in the USA, the total net worth of the private sector is $63T. Of this, about $15T is government net financial assets. The rest is private sector assets like common stocks, real estate, etc. ”

    Isnt a crucial difference in these two things, the 15T of govt bonds and the 48T of other private sector assets, that the 15T of govt assets IS totally liquid. It is in essence a *15 trillion dollar bill* while the other assets are simply a *48 trillion dollar price tag*.

    There is an expectation that these private sector assets at some point will be able to become a *dollar bill * at some point (they will be sold and then the cash spent) but right now its just a price tag. Additionally, the price tag is dependent on the vast majority of those things not being sold. If too many of those private sector assets are sold at once the price of all will plummet. So when everyone who holds a share of ATT stock at 100$ treats it on their balance sheet as if they are holding a *100$ bill* that can pose a problem, can it not? If the solvency of your balance sheet depends on these assets holding their price and the price falls 25% you are insolvent. Maybe even a drop of 10% if you are pushing your balance sheet to the edge of leverage.

    This gets to Mikes article about MoE and MoA

    My only comment to the rest of your answer, and your comments on MMT, is that I dont think Mosler does not understand what you are saying nor does he not appreciate the private sectors part of savings, I think he focuses on the 15T side because unlike the private sector side it will always be 15 T. The private sector side could be 24 T tomorrow depending on the state of the market balances.

    Isnt it fair to also point out that much of what the govt spends actually should be classified as *I* ? Does not much of G end up as a real physical thing produced by a private sector firm and often time it helps that firm expand its operations (which is what *investment* is)

    Not trying to be argumentative Cullen just wanting a little more depth.


    The primary purpose of S=I+(S-I) is about understanding that the private sector generates most of its net worth via the I component. That is, it is via investment that we build the majority of our financial assets. MMT argues that the economy is built around the government stock of financial assets through govt spending. Like all things in MMT, the argument is government centric. This is a misrepresentation of the way our balance sheets are built. They are not built around govt NFA, but around private sector financial assets that derive from Investment.

    So, when MMT defines net saving as S-I they are essentially marginalizing the most important part of the entire Saving equation by subtracting I from S. This is not an accurate portrayal of the way our monetary system exists. The economy is built on a base of primarily private sector assets that develop via Investment. Hence, the clarification of S=I+(S-I).

  • Greg

    Oops, didnt mean to include the last two paragraphs of Cullens prior comment

  • http://www.orcamgroup.com Cullen Roche

    US govt bonds are securities. They’re “money like” instruments. But not a cash equivalent. It’s highly liquid, but no more so than a stock traded at the NYSE. MMT tries to reclassify govt bonds (which are securities, by definition) to be cash equivalent. Here’s just one more example of MMT changing definitions to match their view. You can’t do that. It misleads people. It would be like MR changing the definition of inside money to include all common stock issued by corporations. No, securities are are financial instruments that represent book-entry claims on entity’s assets. US govt bonds are securities that represent a claim on the govt’s cash flows. Just like a corporation issuing debt or common stock. You can’t just reclassify these things because it fits a theory better.

    But I would point out a few key differentiating factors in US govt bonds. First, they are truly risk free in that there is no default risk. Second, their additions are net financial assets for the private sector. This is particularly helpful during a time like right now when inside money has wrecked balance sheets and issuance of bonds can contribute to rebuilding balance sheets. Lastly, I most certainly wouldn’t say that deficit spending is inherently bad. So yes, some of the flow from govt spending can most certainly add to that private stock of financial assets. We’ve seen this in recent years where corporate profits have boomed due to the deficit. But these are unusual times. Historically, this is not the norm. So it’s important to keep some balance here and not fall for recency bias and believe that govt is the solution to everything.

    I don’t think Mosler agrees with me on this stuff. He sees private share issuance as a “demand leakage”. He doesn’t seem to understand that money doesn’t get trapped in secondary markets. It moves through secondary markets. Besides, even if the money did get trapped in secondary markets it wouldn’t matter much. If I walked into a bank and showed them my brokerage statement they’d approve me for a loan with relative ease. We live in a world of inside money. The bank just wants to make sure you are creditworthy. And they know a portfolio of stocks = creditworthy (they’re money like instruments traded on highly liquid exchanges). I also know Mosler disagrees with me about a number of other things because we’ve talked about them. I didn’t start MR just for shits and giggles. :-)

    In the end, I think MMT builds a govt centric view. I start with the pvt sector and build out. They’re dramatically different views of the world….

  • Geoff

    You must have an impressive brokerage statement :)

    Personally, I’d rather borrow from my broker (i.e. go on margin) than from the bank. Yes, the interest rate might be higher but it’s less hassle than dealing with the bank. I can withdraw funds from my broker account at the click of a button.

  • Johnny Evers

    How can you say that treasuries aren’t a cash equivalent when you also say that the U.S. can’t run out of money?
    If the U.S. can’t run out of money, then there is no doubt they will redeem the bonds (either by rolling them over, or printing the money). Because we know they will do that, we can use them as cash and not ask for them to be redeemed.
    So realistically, a treasury acts as cash and can be redeemed as cash.

  • http://www.orcamgroup.com Cullen Roche

    My point is, I could walk into a bank and show them a brokerage account and they’d approve me for a credit card. Which I could then go out and spend on to my hearts content. Many brokerage accounts are even attached to credit cards these days. So it’s not like money in a secondary market is trapped crying to be released from the stranglehold of the market. Money moves through secondary markets. It’s not a demand leakage sucking the life out of the economy.

  • Geoff

    Understood. Agreed.

  • http://www.orcamgroup.com Cullen Roche

    If US govt bonds were cash equivalents the US govt wouldn’t issue them. They’d spend them into existence. They don’t do that. They harness the banks to obtain inside money, issue securities in exchange and then deposit inside money in pvt bank accounts. The bonds represent a claim on future revenues. They’re money like instruments. You can’t just call them cash equivalents because you want to. Companies and govt’s issue securities because they don’t have the cash. Or in the case of the US govt, they have chosen not to print it up. The money supply in the USA (and most of the rest of the world) is privatized by design.

  • Bond Vigilante

    The strenght of the yen is due to two/three factors:
    1. The yen is (with the USD) the main carry trade currency.
    2. Japanese companies invoice in USD, not in Yen. Japanese companies have a stash of cash (USD) and when they need the cash they sell the USD and buy yen. Hence the rising Yen/USD in times of stress (e.g. the second half of 2008).
    3. Japan had until recently a Current Account Surplus and that’s a force pushing the yen higher.

  • Johnny Evers

    I suppose the federal government doesn’t just spend money into existence because issueing bonds to obtain money puts a check on how much they can spend, or, perhaps in a more conspiratorial view, allowing the dealers to turn theoretical inside money into a financial asset accepted everywhere is a good deal for the primary dealers.
    The reason we should insist on T-bonds being the same as cash is that your very own statements of fact lead us to that conclusion. Uncle Sam can print money to redeem those bonds. The market knows that, so it accepts bonds as cash.
    You are trying to have it both ways. You scoff at people who worry about debt repayment by insisting that the debt doesn’t have to be repaid but don’t want to make the logical, *realistic* step of stating that the government is creating money at the point it deficet spends. T-bonds are monetization. Not saying it’s bad, it just is.

  • http://www.orcamgroup.com Cullen Roche

    The market does not accept bonds simply because the govt can print money. The private sector accepts govt bonds because they are backed by $16T in production that can be taxed. Having a printing press doesn’t make a country “solvent”. Having production that can be taxed makes them solvent. Bonds are just a claim on this revenue stream.

  • Geoff

    I believe Mr. Mosler would say that the difference between US dollars and t-bonds is like the difference between a checking and a savings account (i.e. not much). Not sure if MR would agree, though.

  • Johnny Evers

    AGain, that’s having it both ways.
    Here you are saying that treasuries are like traditional bonds, backed by future earnings.
    Yet when someone worries that a $12 trillion economy might struggle with $16 trillion and rising debt, you bring out the argument that the U.S. is sovereign in its own currency and ridicule the worries of bond vigilantes.
    Similarily, you are pretty strong in your opinion that Greece’s problem is that it can’t borrow Euros, even though Greece is a terrible credit risk. Your argument that the European community fund Greece is either an argument for printing (since the bond market doesn’t believe Greece can pay back its debts) or an argument to put Greece on the dole (and have other European countries make the interest payments.

  • Gary_UK

    ‘Gary UK: US Govt gold holdings fell from 22,000 tonnes to 8,000 tonnes in the 50s and 60s, due to foreign governments exchanging their dollars for gold.

    During this same period the US had no trade deficit.

    Can you explain how the two are related, and why the US Govt felt it needed to waste money storing those remaining 8,000 tonnes?’

    CR: The US govt holds gold for the same reason most other people do – as insurance against a worst case scenario in fiat.

    Cullen, you didn’t answer the first part of my question. How the US trade deficit was related to the slide in their gold holdings from 22,000 tons to only a piddling 8,000 tons.

    You want to give it a shot? As for your answer to the 2nd part of my question, I appreciate you did the best you could, but you were wrong!

  • http://www.orcamgroup.com Cullen Roche

    Right, but a savings account holds securities. If you sweep your checking account into a savings account the bank buys securities that are a claim on some revenue stream that generates income for you. You can’t just ignore that point. A portfolio of common stocks is technically a reallocation of your savings. That doesn’t make common stocks cash. Cash moves through secondary markets. Not into them.

  • Geoff

    Right. It appears to depend (as it often does!) on whether you look at it from a govt centric point of view or not :)

    Off topic but do you really wanna short my man Justin Bieber? Granted, he’s at the top, and thus has nowhere to go but down, but be careful. As he said last night, he’s proven his haters wrong so far.

    And he’s got a long-term plan, man.

  • Colin, S.Toe

    To some extent, this could be seen as a semantic distinction – one of the problems with these being that they reduce what may be better viewed as a continuum into an ‘either-or’.

    Gold bugs believe that intrinsic value must inhere in ‘true money’, while most of the rest us would put more trust in ‘the full faith and credit’ of the US government. But with inflation (and possibly deflation), even cash dollars are not of constant value. And Cullen has spoken of relative ‘moneyness’.

    I think we could agree that Treasuries are closer to ‘cash’ than just about any other security. I believe MR still recognizes them as a constituent of ‘Net Financial Assets’, while private sector securities would not qualify as such.

  • Johnny Evers

    I think it’s more than semantics.
    If a T-bond is cash, then it’s backed by the full faith and security of the U.S. government, no different than the dollar bill in your wallet. The only constraint is inflation. We can issue as many of them as we want, provided we don’t spark inflation.
    That’s what I’m getting from MR.
    But if it’s a bond, then the constraint is the ability and agreement of future taxpayers to use their tax revenues to pay back the bond holders. That’s how most people see it. That’s what freaks them out. They see $16 trillion and they panic. That’s how I saw it until I began following this blog.
    I’m just puzzled as to why Cullen will sometimes say that the debt is backed by our ability to pay it back, which is the bond vigilante argument that he ridicules.
    Why not be upfront about what we’re doing — creating money at the point of deficit spending.

  • http://www.orcamgroup.com Cullen Roche

    “I’m just puzzled as to why Cullen will sometimes say that the debt is backed by our ability to pay it back, which is the bond vigilante argument that he ridicules.”

    JE, that’s not what I say. You’re leaving out the context. Bond buyers accept bonds because they know there is no inability to pay. Why is there no inability to pay? Because the US govt can tax $16T of output at will. If the US govt couldn’t tax this output no one would accept their money. It wouldn’t matter how many printing presses they had. A govt that cannot tax output might as well not exist. The power of the US govt to “always pay” is ultimately derived from its ability to tax. Not from its ability to print.

  • Greg

    “In the end, I think MMT builds a govt centric view. I start with the pvt sector and build out. They’re dramatically different views of the world….”

    I get that, and I appreciate the different views of our system.

    Regarding govt bonds though, isnt it true that my 100,000$ govt bond will always get me back my principle? It is always worht 100,000$. Which you cannot say about a 100,000$ worth of stock.
    Yes they both are classified as securities but one is simply priced while the other will always give me back what I initially paid for it. And doesnt this have an effect on the stability of balance sheets?

    If person A has a million of govt bonds as an asset while person B has a million$ worth of GE stock as an asset will they not be treated differently by banks or insurance cos or anyone else that is looking to leverage your balance sheet? Additionally, wont financial institutions that hold govt bonds vs those that might hold a stock of the same value (today) have different levels of solvency when examined?

  • Johnny Evers

    Cullen, you’re always saying that the U.S., or Japan, ‘can’t run out of money.’ Or that the constrain is inflation.
    Now here, above, you’re saying the U.S. can borrow money so long as the bond buyers believe tax revenues will be sufficient to pay them back. In other words, it is a solvency constraint.
    Really that’s the same thing Bond Vigilante and others are saying. The difference is that some believe that $16 trillion in debt (growing at 10 percent per year) and $16 trillion output (growing at 2.5 percent per year) will inevitably lead to the U.S. ‘running out of money.’

  • http://www.orcamgroup.com Cullen Roche

    US govt bonds aren’t “always worth $100,000″. Long bonds trade with great variability in price on a daily basis (off 0.5% just today for instance). Ask someone who lived through the 70s if they think bonds are cash. They’ll call you crazy. Of course, if held to maturity, you get your principle back. But the same is true of 95% of investment grade corporate bonds since 1920. I wouldn’t call those securities cash.

  • http://www.orcamgroup.com Cullen Roche

    You’re missing the distinction. Even in a hyperinflation, the US govt wouldn’t “run out of money”. The Fed would credit the govt’s bank account directly without the bond buyers. But it wouldn’t matter. Once the govt loses the ability to procure funds from the pvt sector the gig is up. This is how almost all hyperinflations end – with a collapse in the tax system. The govt can’t procure funds from the private sector so the currency collapse when the govt continues to spend in excess of productive capacity. That’s not a solvency constraint. It’s an inflation constraint. The bond vigilante people don’t understand what’s going to cause yields to rise. And no, as I’ve keep telling you, there’s nothing magical about the debt:gdp ratio that says inflation will rise and spark bond vigilantes.

  • JJTV

    Other countries had surpluses and exchanged their dollar surpluses for gold and/or treasuries. When the countries needed dollars, like after WWII to rebuild, they exchanged their gold for dollars.

    The Fed stores gold for foreign governments, however, it does charge foreign governments when the gold is shipped or moved somewhere else.

    It appears the Fed stores gold as a favor to other nations and it also has a high quality vault. Mostly ceremonial purposes from what I can tell. All the reserve banks have tours of their vaults.

  • Johnny Evers

    The tax system is already under strain. We can’t raise enough in taxes to fund present spending, let alone pay down past debt.
    If the ability to borrow is based on our ability to pay back debt, we’ve already lost that battle.
    We will soon have a situation in which Uncle Sam is going to need to borrow $5 trillion a year from a $20 trillion economy, just to stay in business. You think the private sector can do that? That’s the solvency constraint.
    We’re Greece, except we have the power to pull inside money from the primary dealers and because the Fed can buy that debt on the secondary market. That’s printing. Own it.

  • http://www.avondaleam.com/ Scott Krisiloff

    Where does inside money stop and where do secondary market assets begin?

    Deposits are “financial instruments that represent book-entry claims on entity’s assets” too, so why does MR treat them differently than longer duration assets?

  • Frederick

    Deposits don’t represent claims on underlying assets. Deposits are just deposits. I think you’re confusing savings deposits or time deposits (CDs) with just regular old deposits. These products involve the purchase of money market assets or low duration assets in order to create a yield.

  • jt26

    re:Orcam. $500 is very reasonable, I think that it will save me that already by not having to do an economics degree; even the textbooks for a couple courses would have already covered it! Thanks for thinking of the little guys. Cullen, I just signed up. Hope you have a “Ask Cullen” and “Q&A” on the other side too. It’ll be fun to continue that interactivity and where you can speak more freely.

  • http://Avondaleam.com Scott Krisiloff

    What would have happened to depositors at WaMu without deposit insurance and why?

    Deposits have value because the loans that are held against them have value. If those assets lose their value so do the deposits–that’s why bank runs happen.

  • Frederick

    The deposits don’t lose value. They just get moved to a bank that didn’t make bad loans and the bad bank then has to find other sources for liability funding. Banks go bust when they can’t find sources to fund their liabilities. For instance, losing access to the Fed window would be a end of most banks in 2008.

  • Cowpoke

    I’m surprised no comments on Treasury Secretary Geithner: Lift Debt Limit to Infinity


  • http://Avondaleam.com Scott Krisiloff

    If depositors felt confident that their deposits would not lose value at a failing bank why would they flee?

    When IndyMac failed, $266m worth of uninsured deposits were lost.

  • http://Avondaleam.com Scott Krisiloff

    If you agree that the full faith and credit of a government security is as good as the government’s taxing authority, then there theoretically must be a point at which the government can’t “always pay.”

    There are certainly limits to the amount that a Government can tax GDP without affecting the GDP itself (a government cannot enslave its citizens and expect them to produce at potential output) so saying that the tax base is $16T is a bit disingenuous. Personal income ex-transfer payments from government is only $9.4T and that’s before taking into account the amount of money that must be spent on basic necessities. Annualized personal savings is only ~$400B. That’s the amount that could be taxed theoretically without impacting output.

    There is a much larger pool that the government doesn’t currently tax in an obvious way: consumer net worth. There’s $60T of net worth that the government could theoretically take control of if it needed to pay off its debts all at once. Interestingly 85% of that net worth is held by the top 20% wealthiest households, which means you would have to charge a household with 500k in savings ~150k if you wanted to spread the burden equally on a percentage basis at 30% of net worth.

    The US government might not be at a point where it can’t pay its public debt, but when $50T in PV social liabilities are factored in (medicare and social security), we inch closer to that line. Of course, all that means is that those programs will have to be altered.

    Japan, on the other hand, with a declining population and growing public debt may truly be beyond the point at which in can’t pay its debt back based on its taxation authority. The aggregate debt load of the government is ~1,000T Yen, while Japanese households in the aggregate own 1,500T Yen of assets.

    (55% of those assets are held as bank deposits, compared to only 14.5% in the US, but that’s another discussion :) )

  • http://Avondaleam.com Scott Krisiloff

    The Fed is still technically independent of the Federal government. Under Bernanke it’s clear that he would print and buy new issues directly if private markets froze up, but under a different ideological leader it’s not a guarantee that the Fed would print to support the debt issuance of the Federal Government at any price.

    In Europe the ECB has consistently intimated that it would do everything necessary to prevent a liquidity crisis for governments, but the market doesn’t seem to believe that it will 100%. Market psychology is not always rational and you cannot guarantee that the same psychology could not take hold in the US or Japan, especially in a leadership change.

  • Johnny Evers

    He’s making the point that federal debt is money — it doesn’t have to be paid back.
    One wonders, optimistically, if federal debt is ever ‘spent’ into the economy in a constructive way that it could trigger enormous growth.

  • Cowpoke

    I think when the FED spends on things that aid the private sector in being more effcient and productive it’s a good thing. When they spend on things that make us less productive that’s a bad thing.

    But then again to one man pork is another man’s bacon.

  • Johnny Evers

    I’m also thinking about when and how the government bonds are spent into the economy.
    Presumably in the coming decades retirees will begin to cash their retirement accounts, begin drawing their state and private pensions and cash insurance policies. Some reports suggest that is beginning to happen in Japan.
    Who buys those bonds? Will there be a market for people cashing bonds at the same time trillions in new bonds are being issued.
    It’s reported that the Silent Generation holds most of assets in the U.S. — they were great savers, but they can’t take it with them. Either they will spend it, or pass it on to their boomer children, who will certainly spend it.