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Q&A – Ask me Anything

Here we go again.  It’s the opportunity of a lifetime.  You can ask me anything.  Whether it’s how to kiss a girl properly, how to dance the tango, play the violin or any of the other things that I write about on a daily basis here.   Actually, I don’t know how to do any of the aforementioned things, but feel free to ask me some other stuff if you want to.

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    Assume a middle income nation with a diverse set of imports and exports. Its central bank lacks inflation credibility. A new political party comes in power and vows to place the country on a commodity standard. If the only option is a commodity standard, what commodity do you suggest ?

    Is the cost of electric power a good nominal anchor?

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    Pete Bondurant

    Do you anticipate a “conundrum replay” in 2015 where Fed would increase ST rates but LT rates wouldn’t move ?
    What would be the effect of asset purchase program launched by ECB for EZ economy (knowing that asset purchase can be implemented in so many different ways…sorry)?

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    What is your take on the yield curve? Do you think overseas investors are flocking to long treasuries or is there something else going on?

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    More generally, what’s your take on the bond price action (10y). Why do you think prices are rising just as economic activity picks up (supposedly) and Fed stops buying?

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    What are your thoughts on Gazprom, and the petrodollar? Do you think that increasing the amount of trade of oil without American dollars could have serious consequences on the value of the dollar? If so, what kind of time frame do you see this happening in?

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    Aditya Vummethala

    I posted a question yesterday on your twitter handle.
    does the stock market returns have an effect on the course the economy takes? what I meant was for the positive economic sentiment will give a bullish run for the markets (please keep the qe conversation out for a moment) so converselydoes a good market run will result in a better economic performance!!

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    You spend a lot of time exploring behavioural issues – the biggest (negative) impact a private investor has on his own wealth is his/her decision making process itself. What’s the one thing (product, service, book, educational series, regulation… whatever!) you think would help in trying to “fix” this problem for the average investor? Thanks!

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    Why are two year yields rising while 10 year are falling? And do you think the 2 year bond and not the 10 year bond is telling the truth about the US economic health.

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    Financial Advisor Myth/Truth: Are dividend stocks “better” then growth/non-dividend stocks because they pay dividends and continue reward investors by minimizing the downside during minor market corrections (provided the company can continue pay the dividend). And your risk adjusted return is superior because the investor is always receiving a dividend that will compound in value over time whereas a growth stock is more speculative.

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    Care to commet on Yellen’s 2014 Investment Disclosure and Portfolio. I noticed she made some small changes like moving from slightly higher yielding investment grade bond funds to a more stable income fund. And you will be happy to know she doesn’t appear to own commodities (or gold) but she added a small inflation position by moving her money market into a real return fund.

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    Cullen Roche

    Oh, there is some juice there. Too busy today, but I’ll write a post on that next week. Janet looks like she could use a good financial advisor. 🙂

    Thanks for passing it along!

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    70 year old investor, retired, $1.5 million portfolio (taxable). Generally speaking (realizing you don’t have enough information) — would you recommend individual bonds or the fixed-income part of his/her portfolio or bond index funds, bond ETFs? Related question: do you like any actively managed bond mutual funds? (I don’t need to know which ones, I just wonder if you think certain parts of the bond market — like high yield, or floating rate bank loan, or international bonds — lending themselves to active managers better than the index approach.)

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    You didn’t ask me but I hope you don’t mind if I take a stab at part of your question. Given that high yield bonds require an extensive amount of credit analysis to separate the wheat from the chaff, I think they lend themselves well to active managers. Passive HY bond funds and ETF’s must buy every piece of crap bond issue that comes along. You don’t want that!

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    Thanks Geoff. That’s what I think. Same goes for floating rate bank loan funds.

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    Cullen – since “monetary sovereignty” is so important, I admit my ignorance and would like to know which “emerging markets” have their own currency, which do not, and which might be in-between in some respects. I know China has it own currency.
    Thanks much.

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    The Fed & BofE have recently acquired about a third of outstanding government debt. In view of this, how can the level of the debt ever be scary?

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    Noah Smith is always saying that no one knows what causes the business cycle, and in particular recessions. How would you respond to this?

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    What’s your thoughts on the drought/water issue in California?
    Why does the state waste financial resources on high speed trains instead of desalination plants?

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    There is also chatter that Scotland might join the Euro, which would be even more stupid! But as Cullen says, you need a decent productive base to back a currency. I’m not sure sheep will do it. 🙂

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    Just a quick comment today. Thanks for bringing back the comments section with a sensible solution, Cullen. I learn a ton from you and many of the participants in these discussions.

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    I graduate next May. What kind of entry level job should I be applying for if I want to work in finance/economic theory?

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    Cullen Roche

    Thanks Jim. Disqus seems to be working nicely. The comment count is down, but the quality of comments has improved and it’s a much more manageable system for me. I think it’s working well.

    And yes, as soon as I turned off the comments I realized I had removed one of the most valuable pieces of the site – the interaction. Given that part of my mission is to help educate, I wouldn’t be adhering to that without the comments so I am glad this system is working well.

    Enjoy the holiday weekend! Don’t spend time reading these comments!

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    Are stock buybacks deflationary? Assuming they’re not financed by loans, that is, but purchased with cash from operations.

    It seems to me like they have the same effect as paying off a loan, and something “money-like” is destroyed in the process.

    And if so, how much of an impact would this have in the big scheme of things?

    Thanks! ( And I already had a discus account, so I love this solution!)

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    I can actually answer this. A monetary tightening shows up as either a less steep yield curve or an inverted yield curve. Why? When the economy enters a recession, banks and firms will have difficulty making payments to one another, which means the price of liquidity (the short term interest rate) goes higher. The long end rate generally fluctuates with the NGDP growth rate expectations. Why? Because the NGDP growth rate is the average gain from holding real economic assets. If there’s a huge gap between the NGDP growth rate and the long end rate on bonds, you’ll have individual market participants long one and short the other until it converges. Basically, I’m saying that NGDP growth expectations-long end rates can be thought of as a risk spread.

    If you’ve got a monetary tightening (equivalently, liquidity tightening), you’ll naturally have falling growth expectations as people will have more difficulty making payments. If you’ve got expanding liquidity, you’ll have the long end rates go up (and the yield curve steepen).

    We have to stop thinking in an IS/LM-like manner and think in terms of finance, human behavior, balance sheets, and arbitrage. These are complex systems that’re highly sensitive to all sorts of things, including the initial conditions. To think equilibrium models like IS/LM can tell us what’s actually going on is absurd. I’m not saying you think IS/LM is a good model, because I’m not. All I’m saying is that just because the Fed buys long end bonds, it’s absurd to think long end bond prices are gonna go up. That’s actually a very IS/LM-esqe way of thinking too.

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    Vincent Cate

    Paul Krugman is always saying nobody has a model for how a country that prints its own currency can get into trouble when debt and deficit get too high. I have a model but can’t seem to get his attention when I comment on his site. He seems to respond to your site. Any chance I could write one article for your site addressed to Krugman?

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    Vincent Cate

    Of course I would have the disclaimer that “the views expressed here are those of the author and not those of the web site owner” or whatever you want. 🙂

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    This doesn’t really explain the short end of the yield curve. That is, observing the bond pricing the 2 year and 10 year bonds tend to be highly correlated and move in the same direction [though one or the bonds yield of one of the terms may rise/fall more then the other but usually in the same direction more]. You can observe that the 2 and 10 yields infrequently move in opposite directions even during previous QE but they have been doing so most of this year.

    Last year, both the 2 and 10 were rising during QE as well as for the majority of time since 1970s as the two yield terms tend to move in the same direction. But this year the 2 is still rising indicating a healthy business cycle while the 10 is falling indicating weakness. And during other instances of geo political and global growth risks the 2 and 10 yields both fell. They are not doing so now. I think global yield arbitrage (sell low yield Yen/German bonds and buying higher yielding US long bonds) and pension funds demand who because of rule changes are now allowed to own more treasuries (and are matching long term liabilities by buying more long bonds is what is behind the 10 year bond yield drop). Rather then, the 10 year and yield curve giving warnings of slow down.

    I suppose the yield curve can be saying that things for the business cycle for at least the next 2 years look good but over the next 10 years the economy maybe face a downtick in growth. This divergence in movement of the direction in 2 and 10 yields as I noted above is atypical behaviour as they tend to track directions together. However from the slight flattening of the yield curve is saying exactly that.

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    First off, past trends don’t matter. Why? The last time the world was in a similar situation was in the 1930’s, but that was also a different monetary regime. Past correlations and trends tell us nothing about the future and are only indicative of the future if we’re in a similar situation as in the past. In all of those data sets you’re using, they’re not indicative (at all).

    In 2008, what we really witnessed was a shift in the monetary system. The Fed went from targeting the money market rate of interest to the monetary base. However, it’s not changes in the monetary base as much as it is changes in the monetary base/NGDP. With the Fed tapering, you’ll eventually see the monetary base stay flat while (hopefully) NGDP keeps growing. That implies a declining monetary base/NGDP ratio which implies that we’ll eventually be seeing higher short term interest rates. This is why, I think, the 2 year is starting to go higher: it’s the market pricing all this stuff in.

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    I haven’t seen anything to say NDGP or monetary base (I’m not sure which one you are referring to) does or does not impacts yields or at least as reliably as short rates do. That is, many have shown that the low end of rates as set by the fed fund rates tends to push or pull the longer bond yield in its direction. That is the ultimate source of the correlation with all treasury bond yields.

    And of course correlations can breakdown along the yield curve which they have now and that is what I’m trying to better understand. And I’m not sure why you are talking about 1930 or what have but even for the last 10 or 30 years the correlation has been quite good. And we have had plenty of recent recessions and recoveries without anything as uncorrelated between the long and short bonds. That is why I personally continue to have difficultly rationalizing the base/NDGP explanation though perhaps it is “correct”.


    At any rate, I see the mainstream media is latching onto my big idea about the diverging correlation. Ok I’m probably not the first person to notice this but at least there are some interesting speculation of what is the source of this. I don’t really like the FT answer though perhaps arbitrage of 10 yield bonds in ECB and US explains it but that doesn’t explain why the 5 yield is not tracking the 10 which has occurred previously in other years when yields have been abritraged.

    Econbrowswer blogged a good review of this question today and speculates a few possiblities which seem plausible.

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    The stars must be in alignment! This is the first time I have visited your site and I came here specifically to see if I could post the same question to you, that I posted on munkneedotcom after reading paraphrased excerpts from an article* by you entitled This Commonly Referenced USD Purchasing Power Chart is Useless.:


    A question for Mr. Cullen Roche about the two charts shown above, how does either one or both apply to everyone that is in the “Poor Group”, people that are either retired and/or unemployed?

    My gut tells me that for the “Poor Group”, things have gotten worse not better, since the buying power of the US$ has not kept up with what Social Security’s Cost of Living Adjustment (COLA) provides.

    Thank You in advance for any insight(s) you might feel like providing.

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    I don’t know why the comparisons to the 70’s (or to any other dataset) have to mean anything. My point is that we really shouldn’t be using these past behaviors as having the ability to tell us anything about the future movement as the situations are completely different. In other words, risk lies in the future, not in the past.

    What you’re saying about the yield curve explaining expectations of the next 2 years vs the next 10 actually does make a lot of sense BTW, but how do we know it’s “atypical”? It’s atypical based on the limited datasets we’ve got available to us because the last time the world was in a similar situation from a global macro standpoint was the 30’s, which was a completely different monetary system.

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