Q&A – The Answers

Thanks for another Q&A session.  You guys asked some really important questions.  The most important one of which was:

“Who put the bomp in the bomp bah bomp bah bomp?”

I think it’s more important to know who put the ram in the ramma lamma ding dong, but that’s just my personal opinion.  Anyhow, the answer is obviously the man who made a woman fall in love with Barry Mann.

Now that the important stuff is out of the way, we can move on to other less serious matters.

WGO:  Have you ever shorted treasuries (and not as a bond vigilante but as a trade)?

CR:  I wouldn’t call them bond vigilantes.  They’re more like bond vultures because they basically just front-run the Fed and scavenge off the communications and outlook from the Fed.   They don’t attack the US economy and push the US govt around.  And yes, I have been very short US Govt bonds.  The most aggressively short I have probably ever been was back in 2009 when I said it was going to be the “trade of the year.

WGO:  Are you surprised that equities have rallied while gold and commodities have sold off with QE3/QE4 announcements? Also why don’t you poke fun at the many gold bugs who promised the dollar would roll over and gold would surely rally after QEn?

CR:  I thought I was too hard on the gold bugs and hyperinflationists?  Maybe not.  Anyhow, I don’t view commodities as an investment class and I think it’s unfortunate that Wall Street has jumped on the recent rally in some commodities to sell this asset class as though it’s an essential piece of a portfolio.  The long-term real returns from commodities is horrible.  Gold is a bit different because it has a currency component, but it’s still also a commodity.  I build portfolios using an understanding of what I refer to as a “hierarchy of assets” and understanding how economic growth and certain environments contribute to asset class returns.  Gold is not high in the hierarchy because its currency component embeds a put in the price that is largely faith based.  This means there is no way gold can serve as sufficient protection against permanent loss.  That, in my opinion, means it’s reckless to build a portfolio that has a very heavy weighting in gold.

WGO: What do you see as the biggest risk for the markets going forward?

CR:  The biggest risk is still Europe.  I don’t think the Euro crisis is resolved.  Civilian unrest could cause a serious disruption in the global economy.

WGO:  Who is the most annoying poster on your site (note I try really hard but I’m not sure I’ve convinced you just yet)?

CR:   Honestly, readers are really well behaved here.  I had to ban a few MMT people because they were unbearable (literally the only group of people who have driven me to insults on the site), but that was really unusual.  There are a few hyperinflationists who roam the comments on occasion, but on the whole they’re very civil.  I think most readers know I don’t like to ban people and I don’t like to engage in childish banter so there seems to be a certain level of understanding here that isn’t present everywhere on the internet.  After all, I am just another guy trying to find answers to big big puzzles.  I’m not here to fight and argue with people even if some commentary gets contentious.  I like to say, we’re challenging other people’s ideas, not attacking other people…..That’s how I approach it and I think most of the readers here do as well.  I appreciate it enormously…..It’s a nice change of pace from many comment sections on the web.

Geoff:  How did the USA become the greatest hockey nation in the world? Congrats on the big win today.

CR:  Seems to have started in the late 80’s when I started playing hockey.  It was smooth sailing ever since then.

Undergrad:  In an economy with a large amount of private sector debt, like Japan or the US, is there a relationship between falling asset prices and collateral values that creates a shortage of dollars, thus putting deflationary pressures on an economy?

CR:  This is, in large part, what the balance sheet recession is all about.  Asset prices fall while debt levels remain the same causing defaults.  This can be catastrophic in an economy as you can see in Japan.  Luckily, I say the USA is “Japan on fast forward” and didn’t suffer the twin bubbles in real estate and stocks.

Tom asked about corruption and abuse in the financial space and why he shouldn’t be enraged by it.  

CR:  I think you should be enraged by this.  The US monetary system is designed so banks “rule the monetary roost”.  The US govt outsources the creation of money to these private entities in a market based system that is in keeping with capitalism.  Banks compete to issue loans.  But the private profit seeking nature of banking combined with money creation generates a bit of a conflict where banks can be incentivized to take excessive risk in order to create more profit.  Banks are the lifeblood of our monetary system since they’re the payment system in essence.  If the banks seize up the system seizes up and the govt has to ride into the rescue through taxpayer bailouts.  I think this extraordinary money creating process requires extraordinary oversight since the banks issue our money which is OUR social construct.  Simple rules can be implemented to help banks better manage risks since they’ve proven they can’t manage risks on their own.

Will said I need to debunk another sites’ content.  That’s for a full post though.  

Cowpoke:  Now that ya mentioned it, Where can I find the best fish taco in San Diego?

CR:  There is a little place in Pacific Beach called “The Pacific Beach Fish Shop”.  If you go there ask for a fried albacore taco, a lobster taco and a TKO Taco.  You’ll put on a few pounds, but that’s necessary this time of year anyhow.

William:  I want to know why there are always really hot women on those “Google banned this video” ads I see on your site from time to time, and if you have actually seen the banned videos in question.

CR:  I have never watched a video of a scantily clad woman on the internet in my entire life so I have no idea what you’re talking about.

Scott K:  I want to know how is that as soon as I moved from MD to upstate NY the Redskins acquired RG3 and they are now a team to root for? Waah.

CR:  Give them some time.  The Redskins will screw all of this good stuff up somehow.

MG:  Are you a California liberal who wants gun control?

CR:   I’m a pretty centrist guy who tends to vote socially liberal and fiscally conservative.  I grew up shooting guns in West Virginia and back home in VA/DC so I am not an anti-gun person.  I am also no gun expert, but I do wonder why anyone would ever need some of these automatic weapons that hold 30-100 round mags.  I just don’t understand that.  The only thing you can do with a gun like that is wreak havoc on things. But I also know that banning certain semi-automatic weapons isn’t going to end the gun murders in America.  Anyone who understands guns knows that you can unload 30 rounds in a couple of Glocks in less than a minute.  I think there are a lot of problems with the gun culture in the USA.  And I am not well versed in all of those areas to decide what the right fix to the problem is.  But clearly, there is a problem.

Cowpoke asked a question about the Iraqi stock exchange that was either a joke or something I am definitely ignorant about.  

Curious88:  Are you familiar with any period in U.S. or other country economic history that is similar in terms of economic and market performance to what we are living through today? If so, what are the investing lessons that we can learn from that period?

CR:  I think Japan and the Great Depression are the only two similar periods, but even those aren’t the same.  As I like to say, the markets and economy are complex dynamical systems.  The future never rhymes perfectly with the past because each occurrence is its own unique event.  I think the biggest lesson from this recent economic environment is understanding how important it is to learn how the monetary system really works.  The people who have misunderstood the big picture have made huge calculated errors based on misunderstandings.

Michael:  Does MR hold that the base case for the national deficit is about equal to the balance of trade deficit? Seems to me the projected deficits are a little weak once that is factored out. Good luck with the romance novels,is there no limit to your talents?

CR:  MR doesn’t really say what the deficit should be.  Rather, we just describe the relationship between the different sectors of the economy.  The key to understanding the sectoral balances and the relationship to the foreign sector is understanding that, with a weak private sector investment, a govt deficit that’s smaller than the current account deficit will almost certainly lead to economic contraction.   That’s just an understanding.  It’s not really an MR opinion as much as it’s a matter of accounting.

WTR:  If gold is a commodity then the dollar is a commodity………..correct?

CR:  Depends on your definition of “commodity”. http://www.merriam-webster.com/dictionary/commodity

Ray:  Do you think the Japanese central bank will be successful setting a target inflation rate of 2%, there seems strong polticial will now to seriously reflate? Also the recent Fed minutes indicate the possibility that they may stop bond purchases in 2013 i.e. growing number of disenters, do you think this would be quite negative for bond prices and eventually for equities?

CR:  They won’t be successful by implementing more and more QE.  Personally, I think Japan’s long battle with their own balance sheet recession is coming to an end so I think they might begin seeing higher inflation in the coming years.  But not because of what the BOJ did….And the Fed will remain accommodative well into 2014.  I don’t think we have to worry about them stepping on the brakes any time soon.

WTR:  People keep on arguing with me that the government forced banks to provide mortgages to people during the period 2000 – 2008. The banks accepted this coercion because the government agreed to cover any losses the banks might incur. What is your view on this point…?

CR:  Lots of blame to go around there.  Homeowners wanted to speculate, the govt wanted us to own more homes, the banks wanted to make more profit.  The conspiracies start getting muddle when people start claiming that the banks or the govt were the only one’s to blame.  I think there were many contributing factors.

Tim:  If the U.S. Debt continues to grow at more than 1 trillion per year for at least the next 10 years with no meaningful year over year aggregate inflation, then what, if any, concerns would you have for the sustainability of the U.S. Economy?

CR:  If anything, this would be consistent with a stagnant move in living standards and a huge decline in US competitiveness.  I think there are already signs this is occurring.  But I think the USA is a much more resilient economy than most are giving it credit for.  My guess has always been that the balance sheet recession would end by 2014 so if we’re running trillion dollar deficits next year you’re going to start seeing some inflation…..

Denny:  2 questions:

1) Why would a bank prefer to swap Tbonds for reserves( hold more reserves)? Is it because they expect an increase in customers demand for cash/loans?

2) Do you own a piggy bank? I’ve always wonder what investment managers do with their pennies.

CR:  1)  Remember, monetary policy is about being part of the club.  If the banks want to be a part of the Primary Dealer club then they have to make a market for the Fed.  That’s just part of the deal.  It’s not about wanting to or not wanting to.  If the Fed tells JP Morgan to jump, Jamie Dimon says “how high?”

2)   I keep a small bowl of coins around, but I don’t hang on to coins for the most part.  I hate physical money.  I’ve banked online for 10 years.  I don’t even know where my bank is or if it exists.  To me, physical money is a thing of the past.  Something that’s dying a slow death.

WTR:  You promote the macro view, which I agree is essential today and in to the future. To me macro means global. What does it mean to you, since you seem to be US centric……………..? America is no longer independent of what happens elsewhere in the world.

CR: Yes, macro is definitely global.  In fact, half of my clients in Orcam are foreigners.  I focus primarily on the USA, but that’s only because that’s the monetary system I am most familiar with and the one that generates most of the global output.  But I don’t totally ignore foreign economies and markets.  In fact, over 25% of my personal assets are invested outside of the USA…..To me, macro is about understanding the big picture so you’d have to start with a world view and break it down piece by piece into the micro.

Scott K:  Why didn’t the Redskins put in Cousins for RD3 tonight when it was clear he was hurt?

CR:  Beats me.  The kid wanted to play, but it was pretty obvious that his knee was wrecked.  Frankly, I am not that upset that we lost and he went down.  This way there’s no chance he can do more damage to the knee this year.

JP asked about the govt spending constraint.  

CR:  It’s important to understand what govt spending is in the first place.  Most people don’t get this right.  When the govt taxes it takes from Peter to pay Paul.  When the govt spends in excessive of tax receipts it must sell bonds to finance the spending.  So, they sell a bond to Peter to pay Paul AND issue Paul a bond.  So, the deficit spending results in a redistribution of existing money AND the issuance of a net financial asset (the bond).  So, govt spending is really just a perpetual redistribution mechanism.  It’s not really money printing as most people call it (unless you want to call bonds money which is not correct).  The govt sells the bonds basically by bribing the banks to be their dealers.  So the govt doesn’t “run out of” buyers.  Auctions are literally designed not to fail.  But all this spending can cause inflation.  And the issuance of net financial assets can cause healthier private balance sheets to leverage up by borrowing from banks (who are the real money printers).  This whole process can cause inflation which is the real constraint.  Spending in excess of productive capacity could cause the economy to overheat and could cause any number of problems from asset bubbles to real declines in living standards.  So always remember that high inflation is the constraint.

 

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Cullen Roche

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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