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.