Q&A…THE ANSWERS

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

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

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

BenB – Can you explain why QE isn’t money printing?

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

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

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

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

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

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

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

Alessandro – Would you kindly explain how Germany benefited from the Euro in the last decade?

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

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

jt26 – Hi TPC, this is a followup on last week’s Q&A discussion on CB/gov money vs. bank/private money.  First, just to make sure I got the MMR starting assumptions correct, and without getting into a debate on the broad definition of money, let’s just talk about USDs and specifically electronic USDs (not paper currency).
(1) USD = (private+Fed) bank money
(2) government spending is financed by (creating) bank money, but the operational details is a closely-coordinated “public-private partnership” (banks+Fed). The end result is a government bond and a deposit. Although, to be honest I was confused by your comment “…Fed as the currency issuer. We also believe the government needs to procure funds from the private sector in what is essentially a coordinated activity with the banking system”.
(3) the Fed is also a bank so it is, at least, on equal footing with private banks, but not necessarily in a vastly more powerful position (your words are the Fed doesn’t “sit at the top of the hierarchy”)

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

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

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

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

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

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

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

dis737 – Cullen, What are you looking to see to call the end of the economic drain of the deleveraging cycle on the economy? Are you looking for a level at which nominal consumer debt levels stop falling, a certain debt to income ratio, debt servicing costs vs. income . . . . And how should we think about the Fed. gov. stepping in to keep consumer leverage higher than it probably should be with uneconomic lending thanks to HUD, Fannie/Freddie and Student loans?

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

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

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

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

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

whatisgoingon – 1. Care to comment on another unvetted comment often used in main stream media/pundits – “There is too much debt in the industrialized world”. The inference is to public debt (US) – so what is your position on this statement?

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

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

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

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

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

perpetual neophyte – Pick any of the softballs below:

How do you incorporate physical fitness in to your lifestyle?

How much sleep would you say you average?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

exertia - Cullen, your thoughts on this Bloomberg article: Ex-Soros Adviser Fujimaki Says Japan May Default by 2017
http://www.bloomberg.com/news/2012-06-15/ex-soros-adviser-fujimaki-says-japan-to-probably-default-by-2017.html

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

Happy Swede – Have been struggeling with this one for a while..

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

How do you feel about this?

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

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

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

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

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

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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