Q&A…THE ANSWERS…
Thanks for the great questions again this week. I’ll try to offer some brief thoughts on each, however, I won’t disclose info on proprietary indicators so those questions are left unanswered. Sorry, but there are just some things I can’t disclose. My dog needs to eat after all….So here goes:
Dunce Cap: ”Can you give some background and description on how you use/view rail traffic data including how (and how well) it works as an macro-econ. indicator?”
CR: I use rail traffic as one of MANY macro indicators. I build it into some of my models and various indicators, but it’s just one of many different indicators that we should look at. Historically, it has been a very good leading indicator and one of the few weekly indicators of economic growth that investors can use as a fairly real-time gauge of the economy. But while it’s very useful in gauging broader perspective I would never lean on it by itself.
Bernard: I read your blog every day, have followed links to past seminal articles you have written, but have not seen anything from you that acknowledges the U6 unemployment rate(taking into account those no longer looking for work after four weeks and the under-employed).
CR: I do track the U6 unemployment, but I guess I just never really found it to be much more informative than the standard unemployment rate data. For instance, the correlation between the two is extremely high. So while it’s important it just doesn’t tell us a whole lot more than the standard unemployment rate used by the mainstream.
WOJ: Spain clearly seems to pose a large forthcoming issue for the EU/ECB. Spanish banks hold untold losses in housing related assets and are now sitting on further losses from the recent LTRO-induced purchase of Spanish sovereign debt. What are the odds that Spain is forced to withdraw from public debt markets in the next 6 months and receive a bailout from the EU/IMF? If this happens, how quickly will the situation deteriorate in bond markets for Italy and in providing support for the remaining core countries facing increasing bailout burdens? Lastly, do you foresee further attempts at QE, via LTRO, or direct purchase of sovereign debt by the ECB to be the next step?
CR: I really think Europe will continue to hold the line in bailing everyone out as necessary. There’s certainly some chance that the smaller nations could defect and default, but that won’t happen unless civil unrest becomes a problem similar to the Arab Spring and forces real change from within. For now, the European establishment wants to hold Europe together. So it’s all about whether the ECB will continue to write checks until they get some sort of permanent fix in place (a central treasury of some sort).
dijssel5: You mentioned about an increase in the risk for recession due to a decline in deficit spending or a “fiscal cliff” in 2013. Don’t you think that when faced with a slowing economy, the government will extend the Bush tax cuts, payroll tax cuts, unemployment benefits?
CR: I do think the downside risks in spending cuts are likely exaggerated by the CBO’s outlook for spending in 2013. But it’s clear that the deficit is encountering increasing hurdles as we enter the second half of the year and 2013. But we’ll have to play this by ear as things progress. It’s impossible to predict the madness of politicians!
Drew: According to your account of MMT, Treasury does not sell bonds to fund government expenditures. Why then does Treasury sell bonds at all?
CR: This is a common question under MMR/MMT and probably the most confusing aspect of the current monetary construct. Now, I don’t think you have to understand MMR to understand this point, but the mainstream understanding of floating exchange systems is so poor that many myths persist. The truth is that this is just the way an autonomous currency issuer in a floating exchange rate system operates so there’s really nothing unique to MMR about this. It’s just the way it is.
An autonomous currency issuer never needs to raise funds or tax in order to “fund” its spending. An autonomous currency issuer can never “run out of money” so there’s no such thing as this currency issuer needing to take back the funds it issues to its users in the first place in order for it to have more of these funds (that it can create at will). The whole notion of the USA taxing to bring in funds is crazy. The government has a printing press. It doesn’t need our dollars in order to have more dollars. That just makes no sense at all. Instead, the government taxes to control aggregate demand and inflation (the true constraint for the currency issuer).
Now, the bond market confuses people because it’s designed as a “funding” source. But this is a relic of fixed exchange rate systems and is not really applicable to the current system. The problem is, if the government spends and reserves in the banking system remain uncontrolled, the banks will inevitably try to lend the reserves to one another in the overnight market which will drive the rate on overnight loans to zero. If the government does nothing to alter the reserves in the system then the central bank will lose control of the overnight rate. So in essence, the government must issue bonds or control the level of reserves in some way to help hit their target interest rate. So bond issuance actually helps the Fed control the overnight rate. The Fed hoovers up reserves, manipulates the overnight rate higher and helps achieve its target rate. Of course, now they’re paying interest on reserves so the Fed can control the overnight rate directly through changes in IOR, but up until 2008 the bond market served an important purpose in helping the Fed hit its overnight rate.
You can see more on this in the following video:
Ted: Your expansion/contraction model (with its 2013 recession call) seems to be in conflict with your prediction of emergence from the balance sheet recession in 2013/2014. Can you clear up your prediction of the future for us? It would be nice to know. 
So if there’s a recession in 2013/14 it won’t be due primarily to the lack of consumer credit demand or collapsing credit. Remember, a balance sheet recession is due to private debt collapse. It’s the imbalance in the balance sheets that leads to the recession. But we’re seeing real improvement in balance sheets and moving towards sustainable debt trends. This is clear as consumer credit has started to shows serious signs of improvement and loan demand is even coming back. This doesn’t mean the effects of the BSR are 100% over, but the consumer debt dynamic will not likely be the driving force behind any renewed recession. So it’s impossible to say that a new recession won’t be partially the result of this massive credit overhang and continued sluggishness, but I wouldn’t describe a new recession as part of the BSR in 2013/14.
Anon John:What’s your thoughts and opinions about all of the financial education/training out there. Whether it be CFA, MBA, MFin, etc. I know most mutual fund PMs are CFAs while most hedge fund managers are MBAs but I’d like your take.
CR: I think designations are important and worthwhile. I will never talk badly about someone who makes an investment in themselves and their education. As I like to say, an investment in yourself is always the best investment. Personally, I have not taken the time to obtain any of these professional designations because I’ve been learning by doing. That’s been my preferred course of education. But I wouldn’t take that as me downplaying designations. It’s just more of a personal choice.
Frenchy: All right let’s hope I get an answer to this one. I often read on this blog that there is slack in the amount of dollars the federal government is actually able to print (for deficit spending) before it starts creating excessive inflation. How much are we talking about in your opinion?
CR: There are many different indicators that can provide us with an idea of slack in the economy. The output gap, capacity utilization, employment, average hourly earnings, etc. Unfortunately, there are so many moving parts in this equation that it’s impossible to tell exactly when inflation is having a negative impact on society. The best we can do is use these broad macro indicators to judge broad trends and respond accordingly. There’s no holy grail unfortunately so we’re left to relying on our flawed judgments to some degree. But I think that these inflation figures are better indicators of the health of the economy than worrying about things like debt ceilings, debt:GDP ratios that so many prefer to worry about….
Jensen: Love the site, read it daily. Truly my favorite economic commentary that exists. What do you do for fun in your free time? Or maybe the question should be: Do you have free time? If so, what do you do for leisure?
CR: Thanks Jensen. This is an interesting question and probably one that not many people care about! A lot of my friends call me an old man in a young man’s body. And this old man is obsessed with the sea. I’ve taken to fishing in the last few years and spending as much time on the water as I can. I get a lot of my best work (thinking) done in 150 fifty feet of water off the coast of California. To me, there are few things better than being on the ocean with a rod in the water and a clear head to just let my mind wander for as many hours as life permits.
ArmoTrader: What’s the appropriate FFR in this environment? Should the fed raise rates to provide interest income to the private sector or should the fed stick to ZIRP until the economy recovers?
CR: I think Fed policy is appropriate at present given the continued risks to the economy and the low demand for credit, however, as we head into 2013/2014 the Fed will likely have to alter this position of permanent low rates as credit demand comes back and the BSR effect wanes. We’re moving towards an environment that will more resemble past economic environments and not this highly unusual environment. Fed policy will be forced to respond.
JT: You had a post several months ago about momentum – at the time, I asked for some clarification and you mentioned you would be posting a follow-up at some point.
CR: I use a fair amount of trend following approaches in my own approach. I wrote the Foreword for Mike Covel’s recent little book on Trend Following and swear by many components of his approach. Understanding momentum and trend following in general is enormously important in building a broad and dynamic approach. See the above link for more.
jt26: Investing myths? Often you here some variation of “watch bonds, they’re the smart money”. Do you agree? If so, which class/spreads of bonds do you like the follow and their importance: e.g. IG-Tsys? IG CDX? BB-A spreads? HY? Italy-Bunds? Tsy 2s10? MBS? CP?
CR: I’ve always found that bond traders just know the markets and the macro economy better than the equity guys. Equity guys are generally very specific whereas FI traders have generally tended to take a broader view of the world. Plus, bonds are just more complex than equities so it takes a more sophisticated trader to master the world of bonds. So yes, my experience has always been that the smarter money is in the bond markets. But that doesn’t mean the bond market as a whole is smarter than the equity market. Any market is the summation of the decisions of its irrational thinkers. And when it comes to the bond market the one thing bond traders have really mastered is keying in on the Fed. The bond market tends to align itself with the Fed because you really can’t fight the Fed if you’re a bond trader. And being on the same side of the trade as the Fed is generally a pretty wise decision….
Larry: Thanks for all you do. This is my favorite website that I read daily. My questions are: what do you think is the probability of a European banking crisis similar to the Lehman event we had in 2008? If that is not the greatest downside risk out there, then what is? What do you see as the probability of a China “hard landing” with their growth rate falling to below 7%?
CR: I do not think the Europeans will allow a repeat of Lehman. The only way that happens is if civil unrest causes a default and defection. Ie, the power gets removed from the core and to the periphery. What are the odds of this? I’d say less than 25%, but they’re certainly not zero….As long as the core is in control a Lehman style banking crisis won’t happen because it would be the German banks that implode….
SM: Have you or others read James Rickards’ _Currency Wars: The making of the next global crisis_? I’ve already sent an e-mail to Scott Fullwiler to get his views, but here are my questions about two quotes from the book:
CR: In the first part your comment you cite Rickards claiming that QE increased the money supply. This is just not true. QE is an asset swap of bonds for reserves. It does not leave the private sector with more money. The more money came from the massive deficit spending in 2009/10/11. If there’s been inflation from “money printing” it was the extra govt spending. Not QE. QE has primarily worked through markets by forcing investors to replace lost interest bearing instruments with other assets like corporate bonds and equities. So yes, QE can have an impact on prices via this channel, but I would not describe it in the same manner as Rickards describes this. See my QE primer for more here.
In the second part of the comment you ask about the Fed’s solvency. Well, how does an entity with a bottomless money pit ever run out of money? If the Fed were ever technically insolvent the US Congress would vote to make it solvent. It’s kind of like worrying that the Federal government will run out of money one day. The whole idea is misguided.
JFord: What software do you use to crunch numbers? I use Excel but find it limiting with the amount of data it can process at once without crashing. Thanks for your time, love the site.
CR: I also use Excel a lot. I use a few other programs for various things, but Excel is where the primary data dump is….
Mercator: Where do we look, or what do we follow to see and feel a recovering economy?
CR: As briefly mentioned, the best real-time indicators of the economy are probably rail data, weekly jobless claims and I use the daily treasury statements to gauge a few directional trends. But other than that you really need to wait for the monthly reports on ISM, employment, etc to see the broader trends.
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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48 Comments
Nice. Thanks!
very nice thanks a lot!
Follow-up question:
CR: “The broader trends in consumer debt and incomes are really stabilizing and becoming more sustainable”
Am I missing something or isn’t there a loong way down to the 0,6 ratio of debt/income we had in early 80′s when leverage really took off?? Or do you mean that a ratio of 0,8-0,9 is sustainable? In that case why this ratio and not 0,3 or why not 1,5??
It really depends on the interest rate outlook doesn’t it? If rates stay low for the forseeable future then the absolute debt load which is managable by households will be higher than it was in the 1980′s, when rates were comparatively high.
Agreed interest rate is definitely part of the equation, one could however argue that current rates are “abnormal” and should mean-revert (up) in which case debt loads of close to 1 should be unsustainable (I guess). Would be interesting to see the chart back to early 1900′s, my guess is debt/income plunged a whole lot more from the top before the great depression as compared to now.. If we are just 1/3 through the bs recession then there should be a whole lot of more pain the coming years right? CR?
Does it have to be 0.6 again though? Isn’t a stable level below 1 probably sustainable?
But “sustainable” sounds like flat or low growth, and with the deficit reduction demands doesn’t that combo of low/no new money growth spell trouble for years and years? Looking at that chart it was parabolic and obviously led to massive growth. Doesn’t it act like a decling stock now? Or another lost decade or two ala Japan?
It could be, my issue is that all bubbles tend to overshoot on the downside, why should a creditbubble be different?
Anyway youre probably right that it is the change in leverage and not the level that is the most important, so assuming leverage stabilizes at around 1:1 the bsr effect should slowly disappear the coming years.
A question I missed to post – maybe you save it for the next round: How does your view fit with Ray Dalio’s “economic machine”? What are your differences, comments, critique?
Best,
Cullen, Thanks. Another well done Q & A.
Good stuff.
W.r.t. the rail traffic and Mercator’s question, do you think paying for the Billion Prices data, as a real time data feed is worth it?
P.S. I’m surprised there aren’t more enterprising start-ups targeting the real-time economic data market.
BPP is very highly correlated with CPI. Do we really need daily price data? And don’t bond markets kind of offer that already???
Thanks Cullen for the responses. I am a CFA charterholder and yet I swear this site is as beneficial to my financial knowledge as the CFA is. It is amazing is the lack of understanding of how our monetary system works even in the industry that should be well aware of it.
I love to help. So thanks for the compliment.
Cullen, one quick question to settle my brain once and for all. The so called deficit ever year is equal to gov spending minus gov receipts. Based on what I think I understand about our monetary system, treasury issuance does not have anything to do with the deficit. Am I thinking about this correctly?
Thanks
I’m working out a deal to try and buy a bulk order of some of the more approachable books (like Mosler’s 7 Deadly Innocent Frauds) to hand out to colleagues and peers.
I believe Cullen has said before something to the effect of, you can disagree on the best policies, but not until you understand the current mechanisms.
Yes, that was the basis of my disagreement with MMTers. They seem to think they can sell a macro theory with politics draped all over it. But that will distract people from even learning how the system works. So MMR really hones in on operational realities and removes policy as best as possible.
Thanks CR
A most informative read … thank you!
Cullen,
I found this very interesting:
CR: I think Fed policy is appropriate at present given the continued risks to the economy and the low demand for credit, however, as we head into 2013/2014 the Fed will likely have to alter this position of permanent low rates as credit demand comes back and the BSR effect wanes. We’re moving towards an environment that will more resemble past economic environments and not this highly unusual environment. Fed policy will be forced to respond.
That sounds a lot like natural interest rate thinking!
David,
I keep saying it – one of the big differences you’ll find with MMR and MMT is that we’re not as closed off to the option of using monetary policy!
CR, I still keep trying understand how to teach enough people to learn the true working of our monetary system. Granted I have learned so much on your blog, but I don’t expect you to be the means of educating America. If enough people–even politicians, had more understanding we might have a better, healthier economy.
Yeah, it’s a sad world we live in where people don’t even understand the very basics of the operational realities. You don’t even have to understand MMR or MMT to understand much of this. But it’s very hard to get people to stop thinking in terms of the household = govt or currency user = currency issuer paradigm.
Should true interest rates be zero percent?
That is, if the Fed can issue dollars without going through the bond market, why should we pay anything to borrow money?
…
The idea that taxes are not used to fund government spending pretty much flies in the face of economic history, doesn’t it?
If rates were zero like Sheila Bair joked around about this weekend then hyperinflation would ensue. Bank money would be state money. And we’d all borrow infinitely at 0%….
Her ‘joke’ was a sly way to make a serious point. Our current policy IS zero percent money, except to certain institutions and investors.
Yeah, but it’s not really correct. Banks don’t just borrow from the Fed at zero and buy govt bonds. Ironically, it’s the FDIC’s job to make sure they don’t do that….
Isn’t China close to that? The PBOC prints money and orders its banks to lend it out in particular amounts at a specified rate. That is why they have so many empty cities, isn’t it?
If MMR is a correct way of moving forward, then the national debt will inevitably add exponentially more debt each year going forward. While this may not be inflationary on the face due to the deflation persistent in all things denominated in debt, everything now, interest rates will have to stay near zero forever. When the debt outstanding is in the $30 trillion range in about 5-10 years, any up tick in interest rates would be highly inflationary via payments on interest of $30 trillion in debt, no?
MMR seems to be nothing more than a recycled attempt at a free lunch which gets regurgitated at every fiat crisis in history, each time under a new snake oil salesman thinking he or she has discovered a way around actually working to produce.
If interest rates are pegged at zero, then the free market is gone and there must be another name for the type of government we are entering in this country, no?
Just trying to wrap my head around what seems so obvious as the inevitable recurring fiat crisis throughout history. They all have different reasons for their demise but the basis for why they do not work is always the same. The government gets corrupted and the money supply gets abused to the point of where we are now.
The velocity which ultimately destroys the currency comes from different reasons, but always comes. Are we heading off this eventual velocity by eliminating pillars of our free market economy? Will that be the end written in the history books.
I guess an explanation of how this all plays out, or unwinds in the future would best answer this dilemma for me. I am willing to assume a perfect scenario for arguments sake, but how does our free market system return without creating velocity that outpaces productivity?
I think govt int payments are in the range of 250B right now per year. So it’s not a huge amount, but it’s also not peanuts.
I am obsessed with production. It’s been the central point in the MMT vs MMR schism. See point 7 on what you produce or what you consume. http://monetaryrealism.com/how-is-modern-monetary-realism-different-than-modern-monetary-theory/
Pretty much all currencies in history have failed, including any on a gold, silver, salt, rice, grain or cattle standard. Pretty much all governments, constitutions, institutions, countries have failed at one point, except for the ones still alive today. Just because it has happened in history does not mean you don’t make the best of what you have, improve and try to persevere. We can either last a 1000 years like the Romans (or two thousand with the Byzantines), or be an afterthought in history from poor governance and war.
MMRs don’t necessarily like 0% interest rates. They don’t really like trade deficits where we consume more than we produce in addition to adding to the budget deficit. If we had followed an MMR(/MMT/neo-Keynesian while we’re at it) way of getting out of the crisis: rapid fiscal response to exit a BSR, structural investments including to reduce our trade deficit, the economy would be much better and the budget deficit would be much lower. But instead, we’re puttering along with mediocre growth, fairly high unemployment, and a trade deficit of -3.5%. Larger persistent budget deficits only tend to happen when your economy is weak, credit doesn’t grow and your trade deficit is high. It’s very possible to lower your debt-to-GDP while running fiscal deficits, you just need a healthier foreign sector and credit expansion for growth to outpace a fiscal deficit.
all Gold economies fail, so enough with this “all fiat fails” nonsense. If our government AND the population understood the monetary system, it would not be as corupted as it is today. We’ve let “free market” “monetarism” allow financial elites to abuse the system… claim that all Gov is bad, so give more money to us financial elites, while not actually shrinking the gov but instead funneling money to their cohorts in the military, big oil and Wall St. All this fear mongering over the debt/deficit, over “entitlements” (clever f’ing name), and all things that gov does, is so clever…. well, if you’re a low info voter… that we’ve allowed the system to get corrupted. Of course on lesser blogs my opinion would be bastardized into me being a socialist/communist who wants gov to do everything. Which is the clever/stupid argument. The fact is we have two sides of the economy – the private sector and the public sector and they should be in partnership where both understand the monetary system and neither can take over completely. Unfortunately we seem light years away from that despite the great strides by MMT and MMR
Yes, a currency issuer could issue all the currency it needs (like the US could do) but then it will destroy the value of e.g. the USD. And that means:
1. Higher price inflation.
2. Higher interest rates.
And that’s not good for economic growth. The same happened in the 1980s and 1990s in Europe (Italy, Greece) when there was no Euro around. Rates and inflation were higher in those countries. France switched from a “”weak currency”" policy to a “”strong currency”" policy in the late 1980s and the result was what would expect: interest rates going down and more economic growth.
And that’s why countries including the US prefer to issue T-bonds over issueing more currency (=increase the size of the balance sheet of a country’s central bank).
Yeah – and what idiots for giving me a car with a gas pedal, I mean I could just lean on that thing all day long and next thing you know I’m going 160 mph and then eventually spinning out and killing myself. OBVIOUSLY all cars with gas pedals end up doing that eventually… just like a government with a printing press who will OBVIOUSLY print so much we’ll have a hyperinflation. cut and paste for any comment “mr market” repeats ad naseum
Cullen,
Thanks for an informative website.
My question is in regards to the role of the Fed and QE. Though I understand the concept that QE is simply the Fed swapping reserves for bonds, isn’t it also true that in changing the type of holdings on its balance sheet, the Fed potentially puts its credibility at risk? Yes, the Fed can simply print money to finance the bonds, so at first glance, the bonds are default-risk free. But if market participants anticipate money printing and bid up the price of real assets in the economy, don’t they in essence create inflation? This in turn erodes the value of bonds held by the Fed and makes it appear less solvent, even if it maintains the ability to print. Wouldn’t the result potentially be a run on the dollar or a liquidation of bonds by private investors, even if the Fed continues to hold its bonds or even buy more?
This is an intersection of the MMT mechanism and market sentiment, obviously, but I’d appreciate your comments.
Thanks,
Chris in Boston
The Fed can’t lose credibility in terms of solvency. Like the govt, it can’t “run out” of money. So this talk about the Fed being insolvent is just more of the false household to govt analogy. It doesn’t hold.
The bigger risk for the Fed is the market one day realizing the Fed has no ammo left. That would seriously undermine their efforts.
The Fed has lots of ammo left. The Fed may own most of the Treasury’s long term bonds, but it only owns $1.5T in agency mortgage bonds from QE1. There is at least $5T in total agency mortgage debt plus at least another $5T in non-agency mortgage debt outstanding. So, the Fed could potentially buy $8.5T in mortgages in future QE operations. And if the Fed buys up all the mortgages in the USA, they could still buy corporate bonds, muni bonds, and of course, stocks.
Chris: According to John Hussman, that is exactly the Fed’s policy — by buying back bonds and driving down interest rates, it leaves the banks with cash earning basically zero percent, which is designed to force them to bid up equities and commodities to get return.
When Dr. J writes a letter that short…it’s probably time to reduce risk
Right. But that works as long as (almost) every asset class is going up. When (not if) every asset class is going down then no one wants to borrow money to speculate on rising asset prices. And then even the banks can’t get increase the credit (NOT money) supply.
So, the central bank is dependent on rising asset prices. And even Steve Keen agrees.
Cullen- Thank You for always being there for your readers. It’s been wonderful being a reader and TPC friend. Your top notch. Insightful Q/A.
I think a TPC Social Cocktail hour in Los Angeles would be fun.
In order to make the FED solvent (=recapitalize the US financial system) again the US will:
1. Devalue the USD against gold.
2. Make it illegal to posses gold.]
Like F.D.Roosevelt did in the early 1930s.
That is absurd. The USG does not care about gold, and it will not care unless the global financial system changes in a manner that requires the USG to settle accounts with gold. The only way this could happen is if OPEC was able to enforce a requirement that oil be paid for with gold. That would be a game changer, and then the USG would quickly move to seize control of all gold in the US, and would probably ration gasoline as well.
mr market – It must really suck to have 100% of your portfolio in gold while it stagnates and goes down. No amount of nonsense from you is going to reflate the gold bubble. Gold like oil is a scarce worldwide commodity… except we actually use oil. Good luck making gold the preferred currency with stupid rants on pragcap
Great. Thanks Cullen for sharing your thoughts, your website has been a must read to me since I first came across it in 2009.
Cullen, I do not agree that the EU is totally committed to keeping the EuroZone together. I think they are hedging their bets by using LTRO to re-nationalize Sovereign debt holdings. They are making a dissolution of the EuroZone thinkable, and if it becomes thinkable some politicians will be encouraged to push the issue in some EU State. Spain, perhaps? Ireland?
Looks to me MMT is the best argument yet to abolish all taxes!
I think the report from John Williams is rather convincing except for one (or more) fatal flaws. If everyone is going to dump US fiat dollars (60% of the world’s fiat currency is USA fiat currency), then what are you going to trade it for? Euros? Pesos? I don’t get that part. IF you dump US fiat dollars what are you going to trade them for that is better? He has the gold price significantly rising in US fiat dollars, but that is happening with all the world’s fiat currencies. But like I said, except to people on this site, he probably represents a mainstream of thinking. http://www.shadowstats.com/article/no-414-hyperinflation-special-report-2012
No one is going to dump Fiat currency for gold unless gold is required to settle payments. The only way this could happen is if gold was needed to pay for oil. Russia + OPEC could impose this if they were sop inclined.