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Q&A Answers – Interest Rates, Greece and other Unfun Stuff

Unfun is synonymous with “very important” in finance. Anyhow, here are some of the answers to the weekend Q&A. I hope it’s helpful.

Samantha asked:

Why couldn’t interest rates just be left at 0% forever? Would that be a bad idea or do you think it’s something that could be done to remove the Fed from tinkering with the markets so much?

Well, we could do that, but why would we want to? We know that monetary policy is somewhat effective at slowing an overheating economy. It’s not a coincidence that inverted yield curves lead to recessions. This makes sense operationally since an inverted yield curve is consistent with choking off the banking system. Interest rate cuts aren’t always stimulative because the Fed can’t force demand for loans to increase, but the Fed can choke off the banking system and essentially cause a supply side contraction in the economy by raising rates very high.

So, lifting rates is usually a much stronger policy measure than cutting rates.  But we wouldn’t want to keep rates at 0% permanently because we could confront an economic environment in which it might actually make sense for interest rates to be higher than 0%. In fact, I think the Fed could raise rates a bit here and not hurt the economy. Actually, I think a small increase in rates might actually be a boost to the economy as it would increase the deficit and interest income across the economy. In my view, it doesn’t make much sense to keep rates at 0% forever.

John Asked:

1.) How much (or when) do you think monetary policy impacts the economy? i.e. if you had to assign weights to fiscal policy and monetary policy what would they be?

2.) What would your wish list for monetary and fiscal policy be for the long term health of the US economy?

Good question. I am not against the use of monetary policy at all. I just think that fiscal policy can be much more directly and efficiently targeted at economic problems. So, my preference is always to use fiscal and then clean up with monetary policy.  I wouldn’t place a weight on one or the other because they’re effective in different ways in different environments, but as a general rule I think that I tend to prefer fiscal first and monetary policy second.  But it really depends on the environment. For instance, in 2008 the Fed had to respond with discretion and it had to respond quickly. So, it made sense to implement monetary policy first and clean up with fiscal. But that was a banking crisis which is pretty unusual. Your garden variety recession will likely see rate cuts (which don’t help that much) and fiscal policy as automatic stabilizers kick in. I’d prefer the govt to be a bit more proactive with fiscal at times in much the same way the Fed is with interest rate policy.  But that’s politically difficult of course.

Part 2 – This one depends. The US economy will change quite a bit over the coming 30 years so it’s impossible to say there’s a one size fits all policy that we should implement. But I would love to see some form of what I’ve called Elastic Deficit Targeting. This would be a rule based policy for fiscal policy that would target a specific size budget deficit over the course of the business cycle.  I recently discussed something similar in my interest rate post. I think the deficit could be used in a much more strategic and efficient manner than it presently is.

Anon asked: 

Do you think Greece should leave the Eurozone?

Back in 2010 I said that Greece should default and defect. That was based on my thinking that Greece would be forced to suffer a depressionary type austerity that could be avoided in the short-term. Had they left in 2010 they would have still undergone a substantial economic contraction, but it likely wouldn’t have lasted 5 years. But the situation has changed now. They’ve already gone through the depression. They’ve gone through massive internal rebalancing already.

Of course, the Euro still doesn’t look like it’s going to be completed, but I really don’t think Greece will be that much better off without the Euro at this point. This is a country that has ALWAYS had economic problems and the Euro potentially helps to solve a lot of those problems by creating price stability where it hasn’t existed. But they have to be clear at this point. If they’re going to stick with this Europe must move towards the formation of a Treasury and Euro Bonds. And if the rest of Europe can’t agree to that then they should abandon it because the alternative is reliving this nightmare once every few decades and that’s just morally and economically unacceptable.  Germany needs to realize that there will ALWAYS be a “Greece” in the Eurozone just like there are strong states and weak states in the USA. But they’re all better off if there is an internal rebalancing mechanism other than depression.

Dennis asked me to compare Puerto Rico to Greece. Rather than plagiarize Paul Krugman I’ll just point you to his link on this topic. He does a pretty good job comparing and contrasting.  Short story – PR isn’t Greece.  

Marcus asked:

Cullen, do you think the Fed should raise rates?

I think the Fed could raise rates a bit here and stimulate interest income in the economy without hurting the broader economy and the banking system. I discussed the rationale for this in a couple of recent posts (here and here).

Mike G asked:

I’ve been reading your work on the GFAP and find it quite interesting. Do you plan to write regular or semi-regular updates on it?


I update the GFAP every few quarters because the portfolio changes as the markets change, but I don’t think it’s a great portfolio so I don’t generally post it here. I don’t want to give people the impression that I endorse that portfolio as some people seem to think from my writing on it.

John asked:

Hey Cullen, What’s your thoughts on variable annuities?

Annuities are a very specific type of financial product. In general, I don’t like them, but that totally depends on your specific situation. They tend to be very expensive and the guarantees you desire can usually be constructed in a well constructed portfolio for much lower fees. But that’s all very general. They can be okay for certain people. And Vanguard even sells lower fee annuities so they’re not all bad….But you have to be very careful buying them. These are mostly high fee products with specific guarantees that you pay a hefty fee for.  Talk to a few advisors before buying anything like that. In fact, before buying any type of insurance product it’s usually best to get a bunch of different opinions from people who don’t ONLY sell insurance….

Bobby says:

Current equity valuations are clearly a function of Central Bank asset purchases. Millenials are being asked to buy-in to real estate (sub 5% yield), equities (20x earnings), and fixed income at zero rates. I don’t see how this ends well for them. Seems like small upside and huge downside tail risk. This global financial experiment is just that. An experiment to avert/delay the worst financial crisis since the Great Depression. I don’t care what historical averages look like. It seems like this is an extremely dangerous situation to which historical wisdom does not apply. Please help me understand what I am missing here.


Hi Bobby. You just explained what makes this one of the most difficult investing environments in a long time. I think you’re right to be skeptical of historical data and the “stocks for the long run” crowd. But that doesn’t mean we can’t be smart about how we go about portfolio construction. I advocate low fee, tax efficient dynamic asset allocation. It can be done, but it’s not going to be easy going forward for anyone. The math of the bond and stock markets just doesn’t look that great (long bonds won’t generate more than 3-4% and stocks are highly valued and consistent with low return environments).  My general goals – keep it low fee, keep it tax efficient and keep it diversified. You’re going to have to pull every drop of return out of this market in the coming 20 years.  It won’t be nearly as easy as the previous 20 years.

Ecor asked:

“the US Treasury can always rely on the Federal Reserve to supply the funds necessary to fund its spending.”
Need help understanding the “mechanics’ of this. Is the US Treasury allowed to overdraft it’s account?

The Fed is the banker to the US Treasury. If the Treasury needs funding it can always harness its Central Bank to buy its bonds. Of course, there are some political hoops to jump through. The Fed can’t buy directly from the Treasury and the Treasury can’t run an overdraft. But, I have a nearly impossible time believing that the Fed would stand around and watch as the US Treasury defaulted thanks to political wrangling like we’ve seen during the debt ceiling debates. And that’s really the only way the US Treasury wouldn’t be able to borrow – is if Congress said it couldn’t. Which would be crazy.

Of course, you have to keep things in context. The fact that the Treasury has its own bank does not mean that the Treasury always has “credit”.  Some people like the MMT people like to claim that the govt doesn’t tax or sell bonds to finance its spending. That’s just silly though. It’s like saying that someone with credit can always borrow. But income and output is what gives any entity credit. And any entity can run out of output and income (even governments). And when you run out of income and credit you’ve run out of LEGITIMATE money even if you can sell it to your own bank.  But that’s like the husband who writes IOUs to his wife and can’t find anyone else to accept them. What good are they really?  Not very.  You can say you didn’t “run out of money”, but who cares?  Sovereigns don’t default the same way households or corporations do. But that doesn’t mean it’s less dangerous or that a sovereign doesn’t need an income source or a source of credit.  I talk about this in more detail here.

Gary says:

Hello Cullen.
I’m guessing you think the dollar world is fine and dandy?
Do you see the global recession that is looming or not?
I expect equities to lose c. 50% in the next few years, and gold to hit c.$3,000.
Then the long term bubble in government bonds bursts, and the path to yen, sterling and dollar collapse will be a one-way street.
What do you see ahead in the medium to long term?

I’m on record saying that US economy is muddling through. No recession on the horizon. No dollar crisis in sight. Could the stock market crash? I guess, but it usually crashes inside of recessions so I am not betting on that at present. I also said bonds were “frothy” at the start of 2015, but not a bubble which has turned out pretty spot on. And I like commodities a lot more than at any point in the last 5 years.  So, I’ve come more around to your views, but not nearly as extreme!

Joel says:

Is there any reason why US rates could not go negative for long periods of time, where investors know when they invest that they will end up with less money after 5-10 years?

I think it would take a Euro or 90’s Japan style economic malaise for that to occur.  I just don’t see it here. But I could be wrong.

Matt asked:

Wouldn’t the Eurodollar market be the largest creator of money out of thin air? Rarely do I see this talked or written about.

I actually don’t know the answer to this question. I would assume that the Eurodollar market is substantially larger than the dollar deposit market, but that’s just a guess. I don’t see much in a quick Google search to help here.  Sorry.

That’s all for now. I’ll get around to the rest tomorrow.  Thanks for all the great questions.