Why the Fed’s Policy Approach Bothers Financial Types Like Me

I spend much of my days trying to coach clients and teach them how to understand the role that their portfolio plays in their lives.  I try to teach them important lessons about money, economics and finance that go largely untaught in school and most of Wall Street doesn’t really want you to understand.  For instance, I try to teach people that their portfolio is not really an “investment portfolio”, but rather a savings portfolio.  I try to teach them that they should treat this savings portfolio more prudently than many people do (like, say, by piling 100% into stocks which exposes their savings to a rollercoaster ride).  I try to teach people that they don’t need to outperform the S&P 500 and in fact shouldn’t even try.  I try to teach people how different asset classes play differing roles in a savings portfolio but can be designed to complement one another in a way that helps you achieve the true goal that a saving portfolio should achieve – generating positive risk adjusted returns while protecting you from the risk of purchasing power loss and the risk of permanent loss.

I think there are lots of financial types out there who try to teach similarly prudent approaches.  Not all, but many.  So when  I see the Fed explicitly trying to steer people into risky assets I get rather annoyed.  They’re encouraging the exact type of mentality and actions that can be so dangerous and destabilizing.

This market focused approach to central banking gets so many things backwards in my opinion.  Not only are secondary markets (like stock markets) mere reflections of their underlying assets, but the keen focus on these assets can have a highly destabilizing impact on the economy.  People should not focus on how high they can bid up their stock portfolios.  They should focus on maximizing their primary source of income and then utilize their savings portfolio in a manner that prudently protects what is nothing more than a residual from their biggest investment in life (the job that generates your primary source of income).  The Fed doesn’t care about that so much.  And neither do many economists who promote this idea that the Fed should be “Committing to being Irresponsible”.  

In essence, the Fed is working against the prudent types.  It’s working against those of us who are trying to teach people basic and important principles about money and markets that can help one substantially reduce risk in a savings portfolio and generate substantially greater stability and predictability with regards to one’s future.

The thing is, we’re all riding through life experiencing various bumps along the way.  I wish Jeremy Siegel’s concept of “Stocks for the Long-Run” applied to most of us.  But it doesn’t because none of us can actually afford to just sock away cash in stocks and let it ride for 50 years.  A little thing called life happens along the way.  You go to school.  You have kids.  You buy a house.  You retire.  You break your hip.  These things don’t adhere to this “stock for the long-run” mentality.  They require careful planning and prudence based on the understanding that your savings portfolio must actually BE THERE when life happens.

But the Fed wants you to jump in a Ferrari and race to the finish line at top speed.  It doesn’t think you’ll crash the car because it thinks the car is “efficient”.  But most of us shouldn’t be in a Ferrari.  We shouldn’t jam our families in a little tiny Ferrari with no real safety features whipping around town at top speed.  Most of us should be in a Honda Accord driving the speed limit with our kids buckled up securely and driving in a manner that gets us from point A to point B without incurring the unpredictable crashes that often occur when driving 100 MPH in a Ferrari.

But the Fed doesn’t want you to take the prudent approach.  They want you to be irrational and imprudent.   They want you to chase stock prices higher and allocate out of safe assets into the higher risk assets while incurring all the risks that come along with owning these assets.  Personally, I think that’s a reckless message and has the potential to cause more instability over the course of the business cycle than stability.  And that’s why many financial types like myself hate what the Fed is doing.


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

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. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • Frederick

    Nice perspective. I wish more people would take the time to understand your view of the world. We’d probably all be a lot better off.

  • Effem

    In a similar spirit, negative real interest rates feel very wrong to me. The notion that money saved in treasury bills (or comparable short duration assets) should ensure a lower standard of living over time feels counter to what we want to be teaching people. I’m not saying real rates should be high, but they should not be negative either (i’m fine with zero – i.e., approximately equal to inflation).

  • http://pragcap Michael Schofield

    Yep. I’m committed to trading because that’s what they’re giving me to work with. Probably not good for most or the country as a whole.

  • Aaron

    Which is just another reason why I’m a fan of a diversified trend following/momentum/tactical asset allocation/all weather approach ala Faber, Butler/Philbrick, Antonacci, Dalio and others. Buying and holding equities is too risky for a lot of people. But if that’s what the Fed is forcing you into, then we need to go there but have a defined EXIT. The ride up will still be more volatile than bonds, but we don’t all have to participate in the ride down.

    I wish we could all park ourselves in a bond fund or CD during retirement, but that’s not the cards we’ve been dealt.

  • dctodd27

    Cullen –

    Good article but you nailed it with that last paragraph.

    How do you respond to people who say “We don’t know when this party is going to end but you have to be invested, especially if you’re managing other people’s money”…?????

  • Nils

    As long as you are a good trader, you don’t really need the Fed. These days everybody is a market genius. I’m usually spending a lot more time on my trading – I enjoy the challenge, but these days you can just go long, put in a trailing stop and wait to get stopped out eventually.

    Most people get screwed by the stock market.

  • Nils

    Nothing disagreeable there. You can always afford to lose other people’s money.

  • SS

    What else should they be doing though? They can’t really sit around and do nothing can they?

  • LRM

    But those guys you list have quite high MER’s to help themselves to our funds if you could meet the requirements to join the club.

    I guess as long as they get to use the funds and we get to keep the risk they will continue to do well given that when they get together they can measure their own success by how high their commission take is!!
    Cullen advocates for low mer’s

  • Gubbmint cheese

    What an absolutely wonderful post. Thank you SO much Cullen.. Cheers!

  • David

    Great perspective, Cullen. I think this article could serve as a great segway into a recap of what you believe the Fed should be doing.

  • Joe 401k

    Two of the most valuable lessons I’ve learned on this site are to treat my 401k like a savings account and to ignore the S&P benchmark. The third lesson I’ve learned is that the greatest fear on Wall Street isn’t losing money, but rather not making money.

    People are listening, Cullen. Thanks for the advice.

  • http://pragcap Michael Schofield

    I like the quick money made on momentum breakouts, nice profit and a high cash position is my comfort zone.

  • Aaron

    Their strategies are fairly easily done by yourself. There’s no reason to pay a management fee.

  • Nils

    Why not?

  • Nils

    Yup. I tend to play options mostly, defined risk on the trade, and always a large cash position (>80%).

  • Wh10

    This was a fantastic post. Hopefully gets spread around the blogosphere.

  • Anon

    well, yes – yes they can. Commence rant…

    That’s the problem in my eyes – in the last decade we’ve been trained to think that central banks (and governments) have the answers – that they can control business cycles and make everyone better off.

    Remember that 20 years ago the Fed didn’t even make it know what their target fed funds rate was! Now every little hiccup in the stock market or economy everyone (especially Wall St) looks directly at the Fed and asks “how are you going to fix this and ensure everything keeps on a “proper” upwards trajectory?”

    Bernanke doesn’t want to be remembered as the guy who sat around and did nothing – and that’s why he will try stuff. But look at Japan, look at the USA – look at the destabilising and unpredictable mess they have created. Bad news is good – more stimulus!!

    So yes, they can just sit around and do nothing – that would be the best thing they can do…

  • Dan

    I agree with the sentiment here, but I don’t get how the Fed is encouraging this wrong kind of investment. You write:

    So when I see the Fed explicitly trying to steer people into risky assets I get rather annoyed. They’re encouraging the exact type of mentality and actions that can be so dangerous and destabilizing.

    This market focused approach to central banking gets so many things backwards in my opinion.

    So how is the Fed explicitly try to steer people into risky assets? I’m not in risky assets and haven’t perhaps been paying much attention to them. But if I were, how are they trying to steer me?

  • thepigman

    Best thing you’ve ever written, Cullen. Much appreciated.

  • Nils

    For a small account depending on the number of transactions there are quite some fees involved though. And most retail brokerages only allow you to trade equities and maybe Treasuries.

    My broker charges $14.95 + $5 a bond for bond market transactions (never tried that).

  • http://pragcap Michael Schofield

    Cool, Nils. I can’t get to 80%, too many plays on smaller companies. I’m loaded up on options in gold, aussie, yen and FXI though. Happy hunting!

  • LVG

    the Fed has made it undesirable to hold cash and short duration paper. This forces investors to try to get rid of their cash holdings for other vehicles that will generate a return. So they’re left with a few choices, many of which are implicitly risky when compared to something like the low risk t-bonds they’re pulling out of the potential pool of asset choices.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    I can see an argument that the central banks and governments have been arrogant or shortsighted or just plain wrong regarding their strategy and ability to stabilize the markets… and perhaps the public has put unwarranted faith in them… with their limited understanding and “tools.” However, I’ll never understand putting unwarranted faith in “the market” either. To me the market is similar to any other force of nature… it’s complicated, powerful, and hard to predict… although it can be harnessed for a useful purpose in some cases, …and it can also cause tremendous damage (I think Kenya’s down to it’s last 100 or so rhinos… apparently their horns are about as valuable per oz as gold). The idea of just letting the market do its thing seems akin to me to just turning off the lights at the National Weather Service, and the Army Corp of Engineers… throwing up our Luddite hands and saying… “we’ll never know what it’s going to do! Mother nature knows best.. Better NOT to try to limit damage from the river overflowing it’s banks… it’s all useless, lets just go home and hope for the best!” That seems to be betting an awful lot on what to me is an unproven hypothesis: that the unfettered market always knows best.

    Do we need to do more “basic scientific research” before we send in the “economic engineers” (and we are thus stuck with the equivalent of economic witch doctors… throwing maidens down volcanoes in a desperate attempt to improve crop yields?). Perhaps! But to “do nothing” seems as wrong as “doing nothing” about Mother Nature. Mankind, indeed all living things, have always striven to do their best to predict, control, or at least stabilize their environments to make them more hospitable for themselves. To me it appears that our economy is part of that environment. I can see the answer being (for now) that we need to take a step back and do that basic research, but the bigger goal should be, IMO, to ultimately make a better environment. I’m willing to accept that the answer may indeed be laissez faire!… but I just don’t see the evidence for that yet.

  • Dan

    OK. Thanks. That’s not really “explicit” as CR indicated, but I see the point now.

  • Johnny Evers

    The Fed’s approach is good for prudent investors. When the market falls, there will be plenty of bargain stocks.
    I am not sure I agree with the thesis — that the Fed is trying to drive stock prices higher — especially in that MR doesn’t subcribe to the widely held theory that QE is printing new money.
    I might take the Fed at its word — it wants to drive interest rates down to revive the housing market and encourage lending.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    I don’t think MR has a problem with the idea that the Fed is “printing new money” if what is meant by this is that the Fed is creating reserves ex-nihilo to purchase assets. So it’s more “typing new reserves” into a spreadsheet ;)

  • Andrea Malagoli

    This is a great perspective. We often focus too much on the technicalities of monetary policy, while the real damage is happening on the ethical side of things. The Fed’s policy has been rewarding those who behaved most irresponsibly at the expenses of the prudent ones (anyone who has saved something). One of the most irritating facts is that now you have those same big institutional players who got saved from financial trouble using cheap financing to buy properties and rent them out to the common people who cannot take advantage of those same easy conditions. The list goes on.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    I agree in part… but I don’t necessarily think it’s right to make a moral judgement about creditors vs borrowers. Both can be bad or good. There was a guy on David Glasner’s site a while back … making the usual austerian rant about how the PIIGS had it coming to them… that they should suffer austerity and high interest rates… and deflation. He was calling any attempt to increase inflation “theft.” And Glasner had what I thought was a great comeback to that:

    “And would you mind explaining why transferring wealth from creditors by price inflation (actually by inflation greater than expected) is theft, but transferring it from debtors by price deflation (actually by inflation less than expected) is not theft?”


  • http://www.highgreely.com jldasch

    Since we know the economy is far from equilibrium the largest risk, by a huge margin, is the overall level of the economy. It is easily possible for a developed economy to get to 40 or 50% unemployment. So one can argue, probably correctly, that the Fed is worried about the largest risk. In fact, if you think through your argument and it’s emphasis on income production through work, and simply apply that to the Fed you have a potential explanation for their thinking. So is an economy with massive unemployment a higher risk for both the primary income stream of your clients (jobs) and assets (stocks, non-zero risk bonds, houses, …)? Your view may be that this is less a risk to your clients than the the current Fed policy, but to argue the Fed is not favoring a prudent approach because it doesn’t match your chosen view is just not showing balanced critical thinking skills. The Fed is taking an approach it feels is prudent for the economy overall, and this could be a far better approach for your clients. We will never know because we can’t do the experiment. My own view is that more and sustained direct (actual direct employment not increased transfer payments) fiscal efforts would be far better for the economy than the current Fed approach, but the Fed doesn’t have this option and is in fact fighting fiscal contraction.

  • Anonymous1

    @Cullen, As a regular visitor of the site I’ve read a fair amount of your economic writings, but this week’s posts in particular have impressed me with your conscience and human decency.

  • Endest

    Nice thought but in the end what other choice does the Fed have? They have a mandate to try to keep employment stable, deflation is a real threat, and the federal gov has completely abandoned even the most minimal effort to induce demand in the economy via fiscal policy!

    We are losing any entire generation of productive workers. Young people who will never catch up on missed careers. Middle aged workers forced into retirement of poverty. Massive pain and suffering and everywhere I turn you have a wealthy class complaining endlessly that some god given right to a 4% real return has been “stolen” by the Fed.

    So I ask what other option do they have?

  • Anon

    I see your point Tom. I absolutely agree that central banks (and governments) can do “things” to help in certain circumstances (I’m certainly not an “abolish the FED” advocate). In particular I beleive central banks provide a critical role in times of crisis to ensure ample liquidity.

    I simply think that right now, actions being taken by certain central banks around the world are unwarranted and potentially more damaging than helpful. I’d rather see them “do nothing” than do what they are doing…

  • http://www.highgreely.com jldasch

    I’m not sure how one can assign ethics in this situation without reflecting an underlying bias. Were those who bought houses with sub-prime loans they couldn’t understand or afford unethical, or those who offered these people credit unethical, or both? Were people who bought houses with no-doc or low-doc loans they couldn’t afford assuming they could flip the house unethical, or those who offered them these loans unethical, or both. Were people who stopped paying on loans they could afford when a house went underwater and eventually walked away ethical?

    How is the Fed’s policy rewarding those who behaved most irresponsibly? It hasn’t benefitted those who defaulted on loans very much, but to many people not paying your debts is highly unethical.

    BAC (which bought Country Wide) is at 1/5th of it’s pre-crisis level. How is BAC benefitting?

    Many of the properties that are bought and rented are financed with cash. The idea that big institutional players are buying properties with cheap financing and high debt to asset price ratios is a bizarre misunderstanding of the facts. Common people who are prudent can easily buy houses today at low interest rates, probably with a lower equity ratio (20%) than a big institution can finance the same purchase.

    Many economists argue that the high home ownership rate reached pre-crisis was not healthy. It’s now about 65%, a level higher than 1982 to 1995 and any time before 1976. Perhaps the strongest economy in Europe, Germany, has an ownership rate of 42%, while Spain has an ownership rate of 85%. Is it better to be a common person in Germany or Spain today?

    The list goes on and on.

    It’s unfortunate that people don’t think critically from both sides of an issue but let their irrational biases to dominate. Lot’s of these questions don’t have esy or simple answers, or answers at all. So to take positions like those above on ethics is simply not possible for a rational person.

  • http://orcamgroup.com Cullen Roche

    2 market crashes in 15 year and nominal GDP that is almost half of the average before the activist Fed era and you’re accusing me of lacking “critical thinking skills”? Pardon me, but have you actually been awake for the last 15 years or do you think the Fed and the market focused approach to policy has had zero impact on the abnormally low growth and highly volatile economy? I don’t think it’s fair to blame the Fed for all of these woes, but I certainly believe it’s contributed. Bubble after bubble and weak nominal GDP because they encourage a misallocation of resources….I could pull up relevant data if you’d like, but trust me, there’s no lack of critical thinking here.

    You constantly accuse me of things you don’t seem to have fully thought through or simply don’t understand. I don’t know why you keep doing that….

  • Anonymous

    They have a mandate


  • http://www.highgreely.com jldasch

    I think that is a good summary. The Fed has a legal mandate to support employment and to control inflation. If you don’t like what the Fed is doing, change the legal mandate.

    Lower employment levels, low inflation, or even deflation are pretty much in evidence all around the world today, certainly in the 1st and 2nd world countries. I think the reasons for this are pretty simple. But one simple example I think makes this quite easy to understand. The factory workers who recently died in Bangladesh were living and producing near the equilibrium sustenance level (as low as $38/month in income). That’s two orders of magnitude (100x) lower than the median household income in the US. But people like that make a lot of our clothes (and other goods in other countries).

    Cullen seems worried about the Fed having an impact on bond levels that amounts to maybe a 3.5 or 4 % (1.04 x) change is PV. This is immaterial compared with the 100x factor in production costs on clothes (ok, that’s an exaggeration, because garment workers in the US might be 1/2 or less of median income)

    Eventually we will have to come to grips with the facts. Developed countries could exist at the sustenance level with less than 10% of people working, although the political reality is that this would likely be so unstable that either fiscal policy would intervene or the countries would disintegrate.

    But to argue that the Fed’s limited efforts are destabilizing when they are mostly immaterial at the global macro level is to be unable to separate the forest from the trees.

  • http://orcamgroup.com Cullen Roche

    A doctor has a legal mandate to “do no harm”. When he runs out of things that work he doesn’t start encouraging his patients to do things that might harm themselves just because they’ve run out of other viable options. When a good doctor has no good options they generally just tell the patient the truth. “We have exhausted all viable options”. The Fed has exhausted all viable options and has still undergone “experiments” that they do not understand. I think it’s an irrational policy approach.

  • http://www.asiachart.com Gregory Barton

    Bit of a straw man argument. One could concoct a 100% equity portfolio that fits the metaphor of a Honda Accord, or, if the goal is merely to get an index return, buy an index fund. The S&P500 is still below its 60 year mean. An investment in the index now would likely yield the characteristic 8% return over the long run.

    The reference to Siegel is also a straw man. One doesn’t need to wait 50 years to get a decent return provided one doesn’t buy high.

    Volatility tolerance is a personal preference. I wouldn’t lay down guidelines as to what any individual should tolerate or not tolerate. You might do more service to your clients by emphasizing personal fiscal prudence, living within their means and keeping good personal accounts.

  • http://orcamgroup.com Cullen Roche

    You’re using the flawed idea that an all stock portfolio can diversify risk away. That’s part of the myth the Jeremy Seigels of the world have concocted and sold to the world….

  • Nico G

    great post – i spent the last 15 years shorting when things go too “Ferrari”, and buying whenever the consequential panic hits and little folks end up puking too low, too late

    i wish there were more guys like you doing the warning, and more guys like me doing the contrarian job which is proving extremely difficult to stick to these days..

  • Indignado

    Nice one Cullen. You wrote a piece a little while back trying to explore why some people hate good economic news. The perspective you give here helps to explain people´s frustration in trying to sift through the “fundamentals” and find real value in a CB dictated world of unrealistic expectations and risk being created by unorthodox monetary policy. I don´t think people hate good economic news, they hate being manipulated into allocating their hard earned savings into a casino..

  • http://brown-blog-5.blogspot.com/ Tom Brown

    [queue carnival music in the background] … Nonsense my good man!… Now step right up! Don’t be shy… there’s a sucker born every minute, er.. I mean there’s a winner every time!! ;)

  • Richard Warfield

    I have a couple of problems with this article.

    First, Cullen, you argue that for most Americans their investment/savings portfolio pales in financial importance compared to their job. But then you seem to be criticizing the Fed for focusing on employment, rather than worrying whether investors are taking too much risk.

    Second — and this is a more fundamental critique — the macroeconomy cannot be in equilibrium if too many investors are seeking safe assets (indeed, that is pretty much what a liquidity trap is). The Fed MUST encourage a certain amount of risk taking to keep the economy reasonably near full employment. There is a certain fallacy of composition in your argument — the Fed’s actions may push some investors into taking risks you think imprudent, but in aggregate, the push is necessary.

  • Nils

    I can’t find many good shorts in this market, so the up to 20% I do have have at stake are correlated to the overall market a lot.

  • Alberto

    I was unfair in the past with you. I apologize, this is a very honest post, I appreciate it a lot and I will continue to read your blog and keep on posting some rants sometimes.

  • Richard Warfield

    Doctors can refrain from intervention, but “do nothing” is not a coherent position for a fiat-money central bank. The Fed can vary its policies, but it has to choose *some* monetary policy.

  • Nils

    Short at the top and long at the bottom is a skill not many possess.

  • LRM

    The option the Fed has is to flat out look congress in the eye and say NO. They have the knowledge and if there is no history with a policy then don’t do it.
    That is a choice. Do no harm

  • Nils

    Pushing savings into the stock market instead of investment in actual ventures isn’t going to spur employment. When I buy your share of GOOG, it’s you who gets the 900 bucks, it’s not like Google is buying $900 worth of equipment. I don’t buy the theory that the added liquidity will lead to more new companies getting off the ground. There hasn’t been a wave of IPOs or bond issues, on the contrary. Companies are actually removing shares from the market because they don’t need the money. Almost all trading is in existing shares.

    Let’s say you got $250k to allocate. Would you start a new company, with all the risks, rules and regulations, the government, employees, HMOs, competition always on your back?
    Or would you choose the stock market, which appears safe and never seems to go down, with a bearded man with unlimited money (who isn’t Santa, though many wish him to the north pole) saying he’ll have your back?

    I know what I choose. I’m gonna ride the bull.

    You need to encourage the right kind of risk taking.

  • InvestorX

    Actually OPM is THE reason the Fed’s pmanipulation is working so well. Combined with Keynes’ beauty parade – e.g. people with OPM frontrunning other perople with OPM.

  • Ville

    Possible to get 50% unemployment rate? Are you serious?

  • InvestorX


    1) you are mistaking measures applicable to the physical world for applicable and desirable in the markets
    2) you are mistaking the markets for the real economy
    3) interventions in the markets can be two types: a) regulation (rules of the game, safety etc.) – fine with me if not too much red tape creating too much friction (currently is probably too much wrong type of regulation / too little right type); b) direct intervention / manipulation (central planning) / cronyism – this one is not desirable, that is what a capitalistic market is there for.

  • InvestorX

    The Fed mentioned explicitly though that its aim is “asset prices higher than they would otherwise be”

  • InvestorX

    BAC (which bought Country Wide) is at 1/5th of it’s pre-crisis level. How is BAC benefitting?

    BAC would have been wiped out completely. Its boss in jail instead of getting a bonus for losing billions. Etc.

  • InvestorX


  • InvestorX


  • InvestorX

    Since when is it the Fed’s job to “encourage a certain amount of risk taking”? What is the appropriate level of risk taking? What is the appropriate level of risk taking after a credit bubble burst? Do we cure too much debt with even more debt? Etc.

    As Nils says, Fed is encouraging not entrepreneurial risk taking, but speculative risk taking in EXCHANGE markets, thus completely avoiding entrepreneural risk taking or misallocating resources to bubbles like housing.

    In the end, are you a capitalist or a socialist in demand of central planning?

  • Advisor

    You hit the nail on the head Cullen. Real nice post.

  • Aaron

    You can use no-load mutual funds or ETFs. With Vanguard you can trade their ETFs for free. VTI for US stocks, VEU for Int’l stocks, VWO for Emerging Markets, VGK for Europe, VGIT for medium-term Govt bonds, VNQ for Real Estate, and VGSH for treasury bills. If you want commodities in there, DBC and GLD will take care of that but you’ll pay $7 a trade. That’s quite a bit of diversification and enough to run a tactical strategy that avoids recessions and bear markets.

  • LRM

    Butler/Philbrick are using momentum strategies I think and they can be very heavy weighting in one asset class.
    It requires a lot of computer power to monitor and make switches .
    I don’t see it as being easy to duplicate and that is why they get a big MER

  • Nils

    This is where the distinction between “Allocating Savings” and “Investing” is so important. Money moving into stocks is not investment!

  • fin

    when talk about money, people have very short memory…

  • Rich


    How did you gain such knowledge and wisdom at such a young age?

    Excellent piece. My wife and I who are now retired are examples of your investment approach. We worked as a team. I concentrated on my career so as to maximize my income over the years. We saved like crazy, often posponing immediate gratification. My wife, who is quite astute but very conservative financially, managed all the investments. Through the process you outlined over a 40 year period starting in 1978, we went from almost zero to total financial independence allowing us to pursue almost anything we want. Maximizing income, saving agressivley and very conservative investment where the key elements. Of course I think we hit upward trend over the 40 years, but we endured many financial crises such as runaway inflation in the late 70’s and early 80’s, 1987 crash, etc.

    Enjoy your blog. Keep up the good work.

  • Notagain

    Cullen excellent article .
    i see it the same way .

  • http://brown-blog-5.blogspot.com/ Tom Brown

    I think the MMers argument is that as the price of all financial assets rise (and the real return decreases), then the risk adjusted rate of return of investing in that new business starts to look better, and thus that’s where the smart money eventually does go. I guess you might call that a marginal shift from saving to investment (and consumption? not sure about that).

    I don’t think they’d claim that’s necessarily the case for the small investor with $250k though.

    Also… I might not be getting their argument quite right… but that’s how I understand it.

  • chase

    The misallocation of resources prevailed long before the advent of central banking…in low and high interest rate environments. I think the fed gets more credit or blame than it deserves. The fed manages the fed funds rate and QE may marginally put downward pressure on long-term rates while removing interest income from the non-government sectors (possibly a wash). Banks set the interest rates to market participants. The internet bust didn’t have grave repercussions as the housing bust did…lack of capital regulation (on both debtor and creditor) more accurately speaks towards a crisis cause.

    Law of large numbers, elevated private debt levels with low accumulated savings, and aging demographics should lower nominal GDP, all things being equal. Therefore, lower nominal GDP is a direct effect of lower government deficits.

  • Steve W

    Well said. I get the feeling the Fed has been somewhat desperate for a while. Of course, the Fed can’t control Congress and fiscal policy, so it’s using all the tools at its disposal.

    I agree that too much faith is placed with the Fed and the federal government regarding the economy. After all, the Fed didn’t see the huge risk in the residential real estate bubble. I don’t think they even recognized it as a bubble, even though it was obvious to many at the time. I knew it was a bubble — but I don’t claim to have understood the magnitude of the risks to the global economy, the amount of sub-prime mortgages hidden in pools rate AAA, how high the house-of-cards built by CDOs and credit default swaps became, etc. Bernanke was quoted as saying that Freddie and Fannie would survive just two months before they were seized by Uncle Sam.

    I’ve been a financial advisor for a while now, and I remember investors (well, at least that what they called themselves) — clients of mine, saying — from 1999 right up until the stock market tanked in early 2000 — “it’s different this time”. I remember when the Nasdaq marched up to 5,000. I told my boss that it seemed like traders, “investors”, etc. pushed it up through 5,000 for no good, fundamental reason — they did it just to prove they could.

    When the residential real estate frenzy was becoming obvious, I was hearing many of the same things from clients: “it’s different this time”, as they took money out of their brokerage accounts to buy another house or condo unit. Another gem: “you can never go wrong with real estate”.

    If we give the Fed the benefit of the doubt about QE and say that its initial idea was to help residential real estate and encourage borrowing and consumer spending, thus stimulating the economy and improving the unemployment rate, then I still can’t help that think the Fed is just as desparate now, if not more, than it was a couple of years ago. Real estate has improved bit, but the deleveraging continues to a great extent. The employment picture is no better (IMO) because of so many underemployed people and because of the very bad labor participation stats. Cullen continues to update us on stats like rail freight, manufacturing capacity utilization, etc. that point to a “muddle through”
    , sluggish economy.

    I’m sure the Fed knows its actions have pushed people into “risk assets”, even if that wasn’t the focus of their QE plan. As a financial advisor that works with many retired people, I can say that this is a very difficult time for many of them. Imagine retiring with say, $600,000- $700,000 in “savings” — an investment portfolio, thinking that you could keep a significant portion is high quality fixed income, yielding 4-6%, dependng on the issuer, maturity, etc. Heck, even money market accounts were yielding 4% or more not that many years ago. Today, with money markets earning 50 bps (if you’re lucky), and CDs, investment grade corporate bonds and insured muni bonds all at historic (or nearly so) low rates — those people must either spend more principal than they’d like, reduce their spending (so muc for that cruise this year and no tuition help for the grandaughter either), or move more savings in to things like high yield bond funds, leveraged CEFs, and dividend paying equities — or often some combination of all three.

    Financial advisors would be wise to take Cullen’s points in this post seriously, as well as examine their own biases and assumptions when putting together “financial plans” for their clients — as well as themselves. Remember when so many people assumed their equity mutual funds would “average” 10-12% over time?

    I wonder if the Fed thinks that people who have 401(k) accounts will actually start spending more because their account value looks so much better (maybe) than it did in March of 2009. We’ll never know, but I sure hope not.

    The Dow and the S&P 500 have been hitting new highs recently. Valuations are not crazy high, which brings some comfort. The “regular” folks — savers, just don’t get it, they’re scratching their heads, because they understand (even if mostly from personal anecdotes) that the state of our economy doesn’t justify such a strong stock market.

    We live in interesting times….

  • http://brown-blog-5.blogspot.com/ Tom Brown

    What do you think about NGDP level targeting (NGDPLT)? That’s what the MMers and some MM sympathizers like. (I define MM sympathizers as folks that don’t necessarily buy the whole MM line, but still like the NGDPLT idea).

    Personally, I don’t know if I like the idea or not either… but part of me wishes that some central bank somewhere would try it. I’m sure it would be a learning experience!

  • http://brown-blog-5.blogspot.com/ Tom Brown

    For example: I think true MMers say that bubbles don’t exist due to the EMH, but that idea is not required to be an advocate of NGDPLT.

  • krb

    I agree with InvestorX’s comments. The problem Tom with “doing something” is that they are human, “only” human, and prone to the same selfishness, greed, fear, etc that the rest of us are……and it inevitably makes their “something” unbalanced and unfair. They are picking the winners and losers, and not allowing the winners and losers be decided by individuals through their own decision making and behavior. All the financial and political action taken the last several years, in my view, has diverted attention from the MOST serious problem that now needs addressing…….we have completely turned upside down the incentives and outcomes for being “right” and “wrong”, “prudent” and “reckless”. The fed has done little more than rescue failure and recklessness, and made the frugal pay for it……..why this simple fact doesn’t get more attention and outrage is beyond me……..actually that’s not quite true, I DO know why…..the people getting the help are the ones who can control and drive the debate.

    Having to “do something” will only be a wise viewpoint if the people making those choices can be trusted to have the really big picture in mind, and have everyone’s interests in mind……and the next time that happens will be the first time it has ever happened. krb

  • http://brown-blog-5.blogspot.com/ Tom Brown

    “The misallocation of resources prevailed long before the advent of central banking”

    Now come on! Those tulip bulbs were worth every guilder!


    I wonder if there’s a way to actually measure the intelligence … or at least the “efficiency” of a market. I suppose someone has tried to put together an experiment like that somewhere? It would be funny if we could relate it somehow to an individual’s intelligence. Perhaps let the “market” somehow navigate a maze or something… see if it comes it at “rat” or “Guinea pig” … ha!

  • krb

    By the way…..great article Cullen.

  • chase

    hmm…I think it was the rehypothecation of tulips in the tri-party market during a margin hike that caused its bubble to burst! ha

    In physics…efficiency eventually leads to waste…there’s no such thing as having enough energy to maintain maximum efficiency. And reflexivity shows that markets can generate their own outcomes. Who cares about the fed?

    I do find it rather ironic that those with grave reservations of fed policy largely believe in the markets to derive efficient outcomes all on their own, yet the many hedge fund managers who despise the fed, actually do believe markets are inefficient (how else could you justify being a hedge fund manager?!).

    It seems to be a fed basher…or to have a strong emotional pull about the fed one way or the other…you should at least wrongly believe in the efficiency of the markets…to efficiently misallocate capital all on their own…

  • http://brown-blog-5.blogspot.com/ Tom Brown

    InvestorX and krb, I think I mentioned that I’m willing to consider that “laissez faire” might be the best course of “action.” I’m just saying lets have a little humility and do our best to use the scientific method (IMO, mankind’s greatest achievement) to find out. My internal “this sounds like religion” detector goes off sometimes when I hear strong free market advocates make their case. In spite of that, could they be right? Sure! Let’s find a way to find out.

    InvestorX, on your point 3… that “central planner” phrase makes me recoil a bit. Whenever I hear that I think it’s a subtle way to try to link central bankers to Stalinism… which seems like an stretch. But maybe that’s just me!! I agree that “cronyism” is bad… but are “mixed economies” *necessarily* bad? Is one man’s “mixed economy” another man’s “cronyism?” How would you describe the German economy? The Swedish economy? The Japanese, or the Chinese? How can we measure the degree of being “mixed” or “centrally planned” in each of these cases, and how do we measure which produces the “best” outcome?

    krb, regarding your argument that we’ll never find people that can be trusted. Maybe true… but do you use that criterion in other areas of life? Do you go to an expert for surgery? To fly your plane? To design and build the bridges you drive over? I don’t have a problem conceptually that some other “only humans” might actually be deserving of my trust as experts. Is that the case now regarding central bankers? Debatable, I’ll admit… but I don’t have a problem with the concept.

    Finally, I do find something appealing about the libertarian small government free market ideal. It’s simple and clean and elegant… but is it actually true? That’s the question.

  • krb

    Reasonable reply. My problem with it is how loosely you can appear to be tossing around the term “expert”…..throwing together professions that no one would reasonably say are similar. Is there any debate over what is the singular desired outcome for a bridge designer, a surgeon, etc.? When they are successful, there are not “winners” and “losers”…….everyone wins, there will be unanimity among the entire population on what constitutes “the right policy” or “the right action”.

    Using “expert” to describe a central banker’s role is no different than saying there are “expert” congressmen, “expert” presidents, “expert” lobbyists……let me know when you find someone who agrees that there is such a thing.

  • Steve W

    Tom, I’m flattered that you’d ask me such a question. (Perhaps you meant to ask Cullen or somebody else?) I’m not as far along as you on this whole monetary system/economics learning adventure as you are,so I have no opinion about NGDP level targeting today.

  • InvestorX

    I am totally for some socialistic redistribution of incomes via progressive taxes, unemployment insurance etc. But not about central steering of entrepreneurs (or disincentivizing them by pushing them towards paper speculation).

  • http://brown-blog-5.blogspot.com/ Tom Brown

    I wouldn’t have guessed that (about the 1st part of your comment). Good to know!

    So, I’d guess you’d have a problem with the MMer idea of NGDP level targeting by the Fed? What’s your opinion of that?

  • http://www.highgreely.com jldasch

    Excellent points, one of which I also made. Cullen correctly argues that income from a job is for most people their greatest “asset” and the Fed is trying to generate more employment (using mostly poor tools). So the Fed is focussing on what Cullen considers the most important factor for his clients and then he argues against the Fed.

    I was also going to make your second point but I’ve made it in different ways before. The 30+ year decrease yields for zero and low risk financial assets must result in large part from an increase in demand for these instruments relative to supply. It is certainly possible that the Fed sees nudging people who can afford the risk moving into riskier instruments is worthwhile if it improves employment for “ordinary” people.

  • http://orcamgroup.com Cullen Roche

    “Focusing on employment” doesn’t mean they’re actually increasing employment.

    I never said anything about equilibrium.

    The second point is a more nuanced one. I think the Fed is trying to increase the portfolio rebalancing effect which drives a disaggregation of credit. It does little for real investment, but entices others to speculate in markets. BIG difference.

  • http://orcamgroup.com Cullen Roche

    They’re only “excellent” if you misunderstand much of what I’ve written over the years.

    How much employment has QE created? More importantly, are there better policy options available? A man with a hammer doesn’t need to swing it recklessly just because he has a “mandate”. This idea that the Fed just HAS TO TRY SOMETHING is absurd. The Fed doesn’t HAVE to be doing QE.

  • http://www.highgreely.com jldasch

    Did you think that through? I mean using rational thought? When you use the technique of analogy you need to have things which are similar in substantial areas of structure. Here you have almost none.

    Medicine is full of millions of experiments over centuries. Lot’s of approaches have been abandoned or superseded and we don’t go back to them, but medicine is constantly trying new approaches. But we’ve done lot’s of things, even in routine ways, that in retrospect were harmful. Remember Thalidomide, frontal lobotomies, etc. And it’s not uncommon in medicine (especially among surgeons) to undertake procedures where a moderately low probability hoped for outcome is balanced against the risk of dying immediately or having an outcome that is potentially worse than the current situation if the response is not good. Take for example a herniated disk surgery. A neurosurgeon will tell you it has a probability of relieving pain, but for some people the pain worse, or more commonly pain in one area (e.g. leg) is relieved but back pain is far worse, or scar tissue builds up and makes the pain worse than before the surgery. Here we know the outcome can be good or bad and it’s a common surgery. Contrary to what you incorrectly said, it is not uncommon in medicine to try things where the outcome is unknown, and could be negative, but the expectation, based upon rational consideration of the various factors involved is that the outcome will be positive.

    With the Fed, we don’t have any data to support that it will have a bad outcome, but we do have some current data showing positive effects, perhaps especially in housing. And the Fed certainly has models to support both it’s current policy and the removal of that policy. The models may not be accurate, but they do very much represent rational thinking!

    So, a rational person would look at the situation and consider the potential outcomes of undertaking an untested policy based upon critical thinking and analysis and with full knowledge that the models are incomplete and base their decision upon that. Given that this is the clear rational path, to consider this irrational is only possible for someone who is not thinking rationally about this.

    A rational person would acknowledge that there are many unknown potential outcomes that may or may not even be very dependent on Fed policy. They would consider, as the Fed does, what they consider the range of potential outcomes is based upon conceptual and mathematical models of the various anticipated trajectories using their biases for the underlying dynamics in the system. They are free to take a strong position if, and only if, they have considered a range of these trajectories, or they may (probably more rationally) decide that taking a strong position is unwarranted.

  • http://orcamgroup.com Cullen Roche

    A rational person would look at the speculative housing boom which was based on the type of thinking you’re advocating and remember that it nearly caused a depression in this country. You say there’s no evidence that the Fed hasn’t helped contribute and even promote asset bubbles. That’s only true if you’re not familiar with the evidence and slept through the last 15 years. Google Greenspan Put or Bernanke Put if you need a starting point….That just scratches the surface.

    I don’t know why you insist on constantly building strawmen arguments around every single post I write, but it’s getting a little old. If you’re not that familiar with someone’s work then you shouldn’t criticize them. I am not trying to be rude, but I don’t know what you’re trying to achieve by criticizing every single post with baseless accusations.

  • Nils

    calling $250k small, big shot ;)

  • bahar

    “Mankind, indeed all living things, have always striven to do their best to predict, control, or at least stabilize their environments to make them more hospitable for themselves”

    Only mankind tries to change environment to make it more hospitable. Other living things adapt themselves to the changing environment. The former strategy is beneficial in the short term. The latter in the longer term.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Well birds build nests, right? Beavers build dams, etc. And in a broader scope, if you consider that the living things that currently exist have been successful in copying their DNA, then you can view the bodies of all living things as merely survival machines, honed through the trial and error of evolution to make a more hospitable environment for the reproduction of their DNA. DNA w/o the favorable environment inside its survival machines doesn’t stand a chance of being reproduced.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    …except by some smock clad scientists in some labs!

  • http://www.asiachart.com Gregory Barton

    Two fallacies: another straw man combined with ad hominem. I would not suggest that risk could be ‘diversified away’. Taking action that has consequences in the future, such as investing, necessarily involves risk. The goal of investing is not to ‘diversify risk away’, it is to optimize risk; that is, take the lowest risk in order to achieve one’s financial goals. You have not demonstrated that an all stock portfolio cannot achieve this end.