The Perils of Stop and Go

Doug Nolan


China’s Aggregate Financing (approximately system Credit growth less government borrowings) jumped 2.860 billion yuan, or $427 billion – during the 31 days of March ($13.8bn/day or $5.0 TN annualized). This was 55% above estimates and a full 80% ahead of March 2018. A big March placed Q1 growth of Aggregate Financing at $1.224 TN – surely the strongest three-month Credit expansion in history. First quarter growth in Aggregate Financing was 40% above that from Q1 2018.

Over the past year, Aggregate Financing expanded $3.224 TN, the strongest y-o-y growth since December 2017. According to Bloomberg, the 10.7% growth rate (to $31.11 TN) for Aggregate Financing was the strongest since August 2018. The PBOC announced that Total Financial Institution (banks, brokers and insurance companies) assets ended 2018 at $43.8 TN.

March New (Financial Institution) Loans increased $254 billion, 35% above estimates. Growth for the month was 52% larger than the amount of loans extended in March 2018. For the first quarter, New Loans expanded a record $867 billion, about 20% ahead of Q1 2018, with six-month growth running 23% above the comparable year ago level. New Loans expanded 13.7% over the past year, the strongest y-o-y growth since June 2016. New Loans grew 28.2% over two years and 90% over five years.

China’s consumer lending boom runs unabated. Consumer Loans expanded $133 billion during March, a 55% increase compared to March 2018 lending. This put six-month growth in Consumer Loans at $521 billion. Consumer Loans expanded 17.6% over the past year, 41% in two years, 76% in three years and 139% in five years.

China’s M2 Money Supply expanded at an 8.6% pace during March, compared to estimates of 8.2% and up from February’s 8.0%. It was the strongest pace of M2 growth since February 2018’s 8.8%.

South China Morning Post headline: “China Issues Record New Loans in the First Quarter of 2019 as Beijing Battles Slowing Economy Amid Trade War.” Faltering markets and slowing growth put China at a competitive disadvantage in last year’s U.S. trade negotiations. With the Shanghai Composite up 28% in early-2019 and economic growth seemingly stabilized, Chinese officials are in a stronger position to hammer out a deal. But at what cost to financial and economic stability?

Beijing has become the poster child for Stop and Go stimulus measures. China employed massive stimulus measures a decade ago to counteract the effects of the global crisis. Officials have employed various measures over the years to restrain Credit and speculative excess, while attempting to suppress inflating apartment and real estate Bubbles. Timid tightening measures were unsuccessful - and the Bubble rages on. When China’s currency and markets faltered in late-2015/early-2016, Beijing backed away from tightening measures and were again compelled to aggressively engage the accelerator.

Credit boomed, “shadow banking” turned manic, China’s apartment Bubble gathered further momentum and the economy overheated. Aggregate Financing expanded $3.35 TN during 2017, followed by a then record month ($460bn) in January 2018. Beijing then finally moved decisively to rein in “shadow banking” and slow Credit growth more generally. Credit growth slowed somewhat during 2018, as the clampdown on “shadow” lending hit small and medium-sized businesses. Bank lending accelerated later in the year, notable for ongoing rapid growth in Consumer lending (largely financing apartment purchases). And, as noted above, Credit growth surged by record amounts during 2019’s first quarter.

China now has the largest banking system in the world and by far the greatest Credit expansion. The Fed’s dovish U-turn – along with a more dovish global central bank community - get Credit for resuscitating global markets. Don’t, however, underestimate the impact of booming Chinese Credit on global financial markets. The emerging markets recovery, in particular, is an upshot of the Chinese Credit surge. Booming Credit is viewed as ensuring another year of at least 6.0% Chinese GDP expansion, growth that reverberates through EM and the global economy more generally.

So, has Beijing made the decision to embrace Credit and financial excess in the name of sustaining Chinese growth and global influence? No more Stop, only Go? Will they now look the other way from record lending, highly speculative markets and reenergized housing Bubbles? Has the priority shifted to a global financial and economic arms race against its increasingly antagonistic U.S. rival?

Chinese officials surely recognize many of the risks associated with financial excess and asset Bubbles. I would not bet on the conclusion of Stop and Go. And don’t be surprised if Beijing begins the process of letting up on the accelerator, with perhaps more dramatic restraining efforts commencing after a trade deal is consummated. Has the PBOC already initiated the process?

April 12 – Bloomberg (Livia Yap): “The People’s Bank of China refrained from injecting cash into the financial system for a 17th consecutive day, the longest stretch this year. China’s overnight repurchase rate is on track for the biggest weekly advance in more than five years amid tight liquidity conditions.”

It’s worth noting that the Shanghai Composite declined 1.8% this week, with the CSI 500 down 2.7%. The growth stock ChiNext index sank 4.6%. Hong Kong’s Hang Seng Financials index fell 1.8%.

Despite this week’s pullback, Chinese equities markets are off to a roaring start to 2019. The view is that Beijing won’t risk the domestic and geopolitical consequences associated with a tightening of conditions. Globally, ebullient markets see a loose backdrop fueled by the combination of a resurgent Chinese Credit boom and dovish global central bankers. Rates and yields will remain low for as far as the eye can see, with a recovery of economic growth surely coming later in the year. In short, myriad risks associated with protracted Bubbles have trapped Beijing and global central bankers alike.

The resurgent global Bubble has me pondering Bubble Analysis. I often refer to the late-cycle “Terminal Phase” of excess, and how much damage that can be wrought by rapid growth of increasingly risky Credit. Dangerous asset Bubbles, resource misallocation, economic imbalanced, structural maladjustment, inequitable wealth redistribution, etc. In China and globally, we’re deep into uncharted territory.

I had the good fortune to subscribe to the German economist Dr. Kurt Richebacher’s newsletter for years - and the honor of assisting with “The Richebacher Letter” between 1996 and 2001. It was a tremendous learning opportunity.

My analytical framework has drawn heavily from Dr. Richebacher’s analysis. This week, I thought about a particular comment he made about the “middle class” suffering disproportionately from inflation and Bubbles: The wealthy find various means of safeguarding their wealth from inflationary effects. The poor really don’t have much protect.

They don’t gain much from the boom, and later have little wealth to lose during the bust. It is the vast middle class, however, that is left greatly exposed. They – society’s bedrock - tend to accumulate relatively high debt levels during the boom, believing their wealth is rising and the future is bright. They perceive benefits from home and market inflation, with rising net worth encouraging overconsumption and overborrowing. Meanwhile, inflation works insidiously on real incomes.

April 10 – Financial Times (Valentina Romei): “The middle classes in developed nations are under pressure from stagnant income growth, rising lifestyle costs and unstable jobs, and this risks fuelling political instability, a new report by the OECD has warned. The club of 36 rich nations said middle-income workers had seen their standard of living stagnate over the past decade, while higher-income households had continued to accumulate income and wealth. The costs of housing and education were rising faster than inflation and middle-income jobs faced an increasing threat from automation, the OECD said. The squeezing of middle incomes was fertile ground for political instability as it pushed voters towards anti-establishment and protectionist policies, according to Gabriela Ramos, OECD chief of staff.”

If Dr. Richebacher were alive today (he passed in 2007 at almost 90), he would draw a direct link between rising populism and central bank inflationism. Born in 1918, he lived through the horror of hyperinflation and its consequences. While he was appalled by the direction of economic analysis and policymaking, we would tell me that he didn’t expect the world to experience another Great Depression. He had believed that global leaders learned from the Weimar hyperinflation, the Great Depression and WWII. His view changed after he saw the extent that policymakers were willing to go to reflate the system after the “tech” Bubble collapse.

April 9 – Wall Street Journal (Heather Gillers): “Maine’s public pension fund earned double-digit returns in six of the past nine years. Yet the Maine Public Employees Retirement System is still $2.9 billion short of what it needs to afford all future benefits to all retirees. ‘If the market is doing better, where’s the money?’ said one of these retirees… The same pressures Maine faces are plaguing public retirement systems around the country. The pressures are coming from a slate of problems, and the longest bull market in U.S. history has failed to solve many of them. There is a simple reason why pensions are in such rough shape: The amount owed to retirees is accelerating faster than assets on hand to pay those future obligations. Liabilities of major U.S. public pensions are up 64% since 2007 while assets are up 30%...”

It was fundamental to Dr. Richebacher’s analysis that Bubbles destroy wealth. He spared no wrath when it came to central bankers believing wealth would be created through the aggressive expansion of “money” and Credit.

It should be frightening these days to see pension fund assets fall only further behind liabilities, despite a historic bull market and record stock values-to-GDP. When the Bubble bursts and Wealth Illusion dissipates, the true scope of economic wealth destruction will come into focus.

Don’t expect the likes of Lyft, Uber, Pinterest – and scores of loss-making companies - to bail out our nation’s underfunded pension system. Positive earnings (and cash-flow) doesn’t matter much in today’s marketplace. It will matter tremendously in a post-Bubble landscape where real economic wealth will determine the benefits available to tens of millions of retirees.

At near record stock and bond prices, pensions appear much better funded than they are in reality. With stocks back near all-time highs, Total (equities and debt) Securities market value is approaching $100 TN, or 460% of GDP. This ratio was at 379% during cycle peak Q3 2007 and 359% for cycle peak Q1 2000.

This is an important reminder of a fundamental aspect of Bubble Analysis: Bubbles inflate underlying “fundamentals.” Bullish analysts argue that the market is not overvalued (“only” 16.6 times price-to-forward earnings) based on next year’s expected corporate profits. Yet forward earnings guidance is notorious over-optimistic, while actual earnings are inflated by myriad Bubble-related factors (i.e. huge deficit spending; artificially low borrowing costs; share buybacks and financial engineering; revenues inflated by elevated Household Net Worth and loose borrowing conditions, etc.).

Such a precarious time in history. So much crazy talk has drowned out the reasonable. Deficits don’t matter, so why not a trillion or two for infrastructure? Our federal government posted a $691 billion deficit through the first six months of the fiscal year – running 15% above the year ago level. Yet no amount of supply will ever impact Treasury prices – period. A Federal Reserve governor nominee taking a shot at “growth phobiacs” within the Fed’s ‘temple of secrecy’, while saying growth can easily reach 3 to 4% (5% might be a “stretch”). Larry Kudlow saying the Fed might not raise rates again during his lifetime.

Little wonder highly speculative global markets have become obsessed with the plausible. Why can’t China’s boom continue for years - even decades - to come? Beijing has everything under control. Europe has structural issues, but that only ensures policy rates will remain negative indefinitely. Bund and JGB yields will be stuck near zero forever. The ECB and BOJ have everything under control. Bank of Japan assets can expand endlessly. Countries that can print their own currencies can’t go broke. And it’s only a matter of time until all central banks are purchasing stocks and corporate Credit.

Why can’t U.S. growth accelerate to 4%? High inflation is not and will not in the future be an issue. Disinflation is a permanent issue that the Fed and global central banks are now coming to recognize. With the Fed ready to cut rates and support equities, there’s no reason the decade-long bull market has to end. Old rules for how economies, markets and finance function – the cyclical nature of so many things – no longer apply.

It’s easy these days to forget about December. Let’s simply disregard the powerful confirmation of the global Bubble thesis. Bubbles are sustained only by ever increasing amounts of Credit. A mild slowdown in the Chinese Credit expansion saw markets falter, confidence wane and a Bubble Economy succumb to self-reinforcing downside momentum. And when synchronized global market Bubbles began to deflate, it suddenly mattered tremendously that global QE liquidity injections were no longer running at $200 billion a month.

As we are witnessing again in early-2019, when “risk on” is inciting leveraged speculation markets create their own self-reinforcing liquidity. It is when “risk off” de-risking/deleveraging takes hold that illiquidity quickly reemerges as a serious issue. And I would argue that it is the inescapable predicament of speculative Bubbles that they create ever-increasing vulnerability to downside reversals, illiquidity, dislocation and panic.

Beijing came to the markets’ and economy’s defense, once again. China’s problems – certainly including a historic speculative mania in apartments - are in the process of growing only more acute. China total 2019 Credit growth approaching $4.0 TN is clearly plausible.

The Fed came to the markets’ defense, once again. This ensures only greater speculative excess and more acute market and economic vulnerability – that markets view as ensuring lower rates and a resumption of QE. Moreover, the moves by China, the Fed and the global central bank community only exacerbate what has become a highly synchronized global speculative market Bubble.

Lurking fragility is not that difficult to discern, at least not in the eyes of safe haven debt markets. And sinking sovereign yields – as they did in 2007 – sure work to distract risk markets from troubling fundamental developments. Stop and Go turns rather perilous late in the cycle. Speculative Dynamics intensify – “risk on” and “risk off.” Beijing and the Fed (and global central banks) were compelled to avert downturns before they gathered momentum. But that only ensured highly energized “blow off” speculative dynamics and more problematic Bubbles.

The next serious bout of “risk off” will be problematic. Another dovish U-turn will not suffice. A significant de-risking/deleveraging event in highly synchronized global markets will only be (temporarily) countered with QE. And with the markets’ current ebullient mood, there’s no room for worry: of course central bankers will oblige with more liquidity injections. They basically signaled as much.

Timing is a major issue. Especially as speculative Bubbles turn actutely unstable, any delay with central bank liquidity injections will boost the odds things get out of hand. Central bankers, surely in awe of how briskly intense speculative excess has returned, may be hesitant to immediately accommodate. Heck, the way things are going, it may not be long before they question the wisdom of their dovish U-turn. I have a difficult time believing Chairman Powell – and at least some members of the FOMC – have discarded Financial Stability concerns.

The way things are setting up – intense political pressure, the election cycle and such – they will likely be reluctant to return to rate normalization. Yet the crazier things get in the markets the more cautious they will be next time in coming to a quick rescue. The Perils of Stop and Go.

Central banks

The independence of central banks is under threat from politics

That is bad news for the world




CRITICS OF ECONOMICS like to say that its abstract theories lack real-world pay-offs. There is a glaring counter-example: the global rise of central-bank independence in the past 25 years. In the 1970s it was normal for politicians to manipulate interest rates to boost their own popularity. That led to a plague of inflation. And so rich countries and many poorer ones shifted to a system in which politicians set a broad goal—steady prices—and left independent central bankers to realise it. In a single generation billions of people around the world have grown used to low and stable inflation and to the idea that the interest rates on their bank deposits and mortgages are under control.

Today this success is threatened by a confluence of populism, nationalism and economic forces that are making monetary policy political again. President Donald Trump has demanded that interest rates should be slashed, speculated about firing the boss of the Federal Reserve and said he will nominate Stephen Moore and Herman Cain, two unqualified cronies, to its board. Brexiteers rubbish the competence and motives of the Bank of England, while in Turkey President Recep Tayyip Erdogan has been in a tug-of-war with the central bank. India’s government has replaced a capable central-bank chief with a pliant insider who has cut rates ahead of an election. And as we report this week, many top jobs at the European Central Bank (ECB), including the presidency, are up for grabs, and some could become part of a wider political struggle over who runs Europe’s institutions. There is a genuine need for reflection on central banks’ objectives and tools. But dangerous forces are afoot that could have alarming consequences for economic stability 
The problem of politicisation last became acute in the 1970s. After the post-war Bretton Woods currency system collapsed, central banks failed to tame racing inflation because politicians, who pulled the strings, were reluctant to bear the short-term cost of higher unemployment. Two decades of runaway prices and crises led to a new orthodoxy that central banks should be given operational autonomy to pursue an inflation target. In the euro zone, Japan and Britain central banks became legally independent in the 1990s. In America the White House refrained from even publicly discussing Fed policy. This consensus survived the crash of 2007-08 and is one reason why global inflation has been only 4% a year on average over the past two decades.


The fraying of central banks’ independence has several causes. One is populism. Leaders like Mr Trump combine the politician’s desire for low interest rates with a reckless urge to undermine institutions. Another is the scope of central banks’ activities, which expanded after the financial crisis. Most now hold huge portfolios of government bonds while, at the same time policing the financial industry. And the record of central banks is far from perfect. Because they have probably been too hawkish (despite their unconventional policies) the recovery from the crisis has been slow, undermining voters’ faith in the technocrats whose loyalty is supposedly to the public interest. All this makes it easier to view them as political. Meanwhile, the memory of the crises that led to independence has faded.


Pressure is manifesting itself in different ways in different places. Mr Trump has launched an attack on the Fed. Although his legal authority to sack Jerome Powell, its chairman and a Trump appointee, is not clear, if he wins re-election in 2020 he will be able to nominate a new Fed chairman and two more governors. In Europe a flurry of job changes threatens to lower the calibre of decision-making at the ECB and feed underlying disagreements. By the end of the year, three members of the six-strong executive board and eight of the 19 national governors, who also vote on rates, will have left. The most notable of these is Mario Draghi, its head. His departure in October will happen almost concurrently with elections and a change in leadership at the European Commission and Council, a once-in-40-years overlap. Behind the political game of revolving chairs is a battle between countries to control policy. Northern Europeans have been suspicious of the ECB’s bond-buying, seeing it as cover for subsidising southern Europe. Rather than win by force of argument, they are seeking an edge by getting their own people into the top jobs. That will store up problems.

Perhaps global inflation will rise again from its grave, in which case weaker central banks may struggle to kill it off. More likely is an economic downturn. The world economy has decelerated this year—on April 9th the IMF downgraded its forecasts. Central banks may find themselves needing to pep up their economies.

This is what makes today’s politicisation so dangerous. Technocrats face a difficult challenge.

The rich world has hardly any room to cut interest rates before hitting zero, so central banks will once again have to turn to unconventional stimulus, such as bond-buying. The Fed and other central banks may also need to co-operate globally, as in the wake of the crisis. The ECB will have to convince markets that it will do whatever it takes to contain another financial panic on Europe’s periphery. The presence of political appointees, who are either ill-qualified or northern European hawks, would make all these tasks harder. It is not just that their votes count, but also that they would poison the public debate about what central banks should and should not do to deal with recessions.

The talking cure

It is right that the objectives and tools of monetary policy are subject to democratic scrutiny and that central bankers are accountable to legislatures. The Fed is reviewing its target in order to be prepared for a downturn. Other central banks should follow suit. In the long run, this secures their legitimacy and hence their independence. Yet in today’s political environment it is naive to think that politicians really want a considered debate. Instead, the more central banks are in the limelight, the more they will find their month-to-month decision-making subject to external pressure, or find themselves at the whim of boards packed with hacks. It is just that sort of politicisation that the theorists behind independent central banks wanted to avoid. Look back 40 years and you will get a flavour of what could go wrong.


Gold & Basel 3: A Revolution That Once Again No One Noticed

by Tyler Durden

Real revolutions are taking place not on squares, but in the quiet of offices, and that’s why nobody noticed the world revolution that took place on March 29th 2019. Only a small wave passed across the periphery of the information field, and the momentum faded away because the situation was described in terms unclear to the masses.


No “Freedom, equality, brotherhood”, “Motherland or death”, or “Power to Councils, peace to the people, bread to the hungry, factories to the worker, and land to the farmers” – none of these masterpieces of world populism were used. And that’s why what happened was understood in Russia by only a few people. And they made such comments that the masses either did not fully listen to them or did not read up to the end. Or they did listen to the end, but didn’t understand anything.

But they should’ve, because the world changed so cardinally that it is indeed time for Nathan Rothschild, having crumpled a hat in his hand, to climb onto an armoured Rolls-Royce [a joke referencing what Lenin did – ed], and to shout from on top of it to all the Universe: “Comrades! The world revolution, the need for which revolutionaries spoke about for a long time, came true!” [paraphrasing what Lenin said – ed] And he would be completely right. It’s just that the results of the revolution will be implemented slowly, and that’s why they are imperceptible for the population. But the effects, nevertheless, will be soon seen by absolutely everyone, up to the last cook who even doesn’t seek to learn to govern the state son.




This revolution is called “Basel III”, and it was made by the Bank for International Settlements (BIS). Its essence is in the following: BIS runs the IMF, and this, in turn, runs the central banks of all countries. The body of such control is called BCBS – the Basel Committee on Banking Supervision. It isn’t just some worthless US State Department or Congress of American senators. It’s not a stupid Pentagon, a little Department of the Treasury, which runs around like the CIA’s servant on standby, or a house of collective farmers with the name “White House”.

This isn’t even the banks of the US Federal Reserve, which govern all of this “wealth”. This is a Government of all of them combined. That real world Government that people in the world try not to speak about aloud.

BCBS is the Politburo of the world, whose Secretary General, according to rumours, is comrade Baruch, and the underground structure of the Central Committee is even more secret.

It has many euphemisms, the most adequate of which is “Zurich gnomes”. This is what Swiss bankers are called. Not even owners of commercial banks, but namely those ordinary-looking men sitting in the Swiss city of Basel who Hitler – who tried to attach the whole world to the Third Reich, and who preserved neutrality with Switzerland during all the war – didn’t dare to attack. And, as is known, in Switzerland, besides Swiss rifleman, in reality there isn’t even an army. So who was the frenzied Fuhrer afraid of?
 
Nevertheless, the “recommendations” that were made by BCBS on March 29th 2019 were immediately, at the snap of the fingers, accepted for execution by all the central banks of the world. And our Russian Central Bank is not an exception. There is even the statement of the press service of the Central Bank of the Russian Federation posted on the official website of the Central Bank. It is called “Concerning the terms of implementation of Basel III”. The planned world revolution was in 2017 (magic of dates and digits or just a coincidence [a reference to 1917 – ed]?), but it has started only now.
 
Its essence is simple.
 
In the world the system of exclusive dollar domination established in 1944 in Bretton Woods and reformed in 1976 in Jamaica, where gold's equivalency to money was cancelled. The dollar became world money and gold became an ordinary exchange good, like metal or sugar traded in London on commodity exchanges. However, this was determined there by only three firms of the “Pool of London” that belong to an even smaller number of owners, but, nevertheless, it’s not gold, but oil that became the dollar filler.
 
We have lived in such a world ever since. Gold was considered as a reserve of the third category for all banks, from central to commercial ones, where the reserves were, first of all, in dollars and bonds of the US. The norms of Basel III demand an increase, first of all, in monetary reserves. This impeded the volumes of monetary resources of banks that could be used to carry out expansion, but it was a compulsory measure for saving the stability of a world banking system that showed to be insufficient in a crisis.
 
In Russia pseudo-patriots were very much indignant at this, demanding to reject Basel III, which they called a sign of “a lack of sovereignty”. In reality, this is a quite normal demand to observe international standards of bank security, which were becoming more rigid, but since we [Russians – ed] were not printing dollars, so of course it had an impact on us. And since the alternative is an exit from world financial communications into full isolation, so our authorities, of course, did not want to accept such nonsense that was even designated by pseudo-patriots as a “lack of sovereignty”. To call sovereignty – freedom, to put your head in the noose is, let’s agree, a strange interpretation of the term.
 
The Basel III decision meant that gold as a reserve of the third category was earlier estimated at 50% of its value on the balance sheets of world banks. At the same time, all owners of world money traded in gold not physically, but on paper, without the movement of real metal, the volume of which in the world wasn’t enough for real transactions. This was done in order to push down the price of gold, to keep it as low as possible. First of all, for the benefit of the dollar. After all, the dollar is tied to oil, which had to cost no less than the price of one gram of gold per barrel.
 
And now it was decided to place gold not in the third, but “just” in the first category. And it means that now it is possible to evaluate it not at 50, but at 100% of its value. This leads to the revaluation of the balance sheet total. And concerning Russia, it means that now we can quietly, on all legal grounds, pour nearly 3 trillion rubles into the economy. If to be precise, it is 2.95 trillion rubles or $45 billion at the exchange rate in addition to the current balance sheet total.

The Central Bank of the Russian Federation can pour this money into our economy on all legal grounds. How it will happen in reality isn’t yet known. Haste here without calculating all the consequences is very dangerous. Although this emission is considered as noninflationary, actually everything is much more complicated.
 
During the next few months nothing will change in the world. The U-turn will be very slow. In the US the gold reserves officially total 8133.5 tons, but there is such a thing as a financial multiplier: for every gold dollar, the banks print 20-30 digital paper ones. I.e., the US can only officially receive $170 billion in addition, but taking into account the multiplier – $4.5 trillion. This explains why the Federal Reserve System holds back on increasing interests rates and so far maintains the course towards lowering the balance sheet total – they are cautious of a surge in hyperinflation.
 
But all the largest states and holders of gold will now revalue their gold and foreign exchange reserves: Germany, Italy, France, Russia, China, and Switzerland – countries where the gold reserves exceed 1,000 tons. Notice that there is no mumpish Britain in this list. Its reserves are less than 1000 tons. Experts suspect that it is perhaps not a coincidence that the dates of Brexit and the date of Basel III coincide. The increased financial power of the leaders of Europe – Germany and France – is capable of completely concluding the dismantlement of Britain on the European continent. It was necessary to get out as soon as possible.
 
Thus, it seems that it is possible to congratulate us – the dollar era lasting from 1944 to 2019 has ended. Now gold is restored in its rights and is not an exchange metal, but world money on an equal basis with the dollar, euro, and British pound. Now gold will start to rise in price, and its price will rise from $1200-1400 per troy ounce up to $1800-2000 by this autumn. Now it is clear why Russia and China during all these years so persistently decanted its export income into the growth of gold reserves. There is now such a situation where nobody in the world will sell gold.
 
Injections of extra money will suffice for the world economy for 5-6 months. In the US this money can be used to pay off the astronomical debt. Perhaps this wasn’t Zurich’s last motive for making such a decision. But after all, the most important thing is an attempt to slip out from under the Tower of Pisa that is the falling dollar.
 
Since the dollar and oil are connected, the growth of the price of gold will directly affect the growth of the price of oil. Now a barrel costs as much as 1.627 grams of gold. A price growth will cause the world economy – where 85% of the money dollar supply turns into stock surrogates like shares, bonds, and treasuries – to cave in. The stock exchange will not be able to bundle together such an additional mass of money any more.
 
It will be good for oil industry workers – even, perhaps, best of all, but not for long. The economical crash because of expensive oil will become a crash for all oil industry workers too. It is precisely this that is the main reason why our rights for additional emissions can remain unused in full volume, although a gift in such a form will not be completely ignored. The May 'Decrees of Putin' in the current context are being understood completely differently. Russia runs away from the oil-based economic model in all ways. Including by political reforms and changing the elites.
 
However, why is the decision of Basel a revolution?
 
Because from the autumn the financial flood in the world economy will begin. It will entail the acceleration of Russia and China’s isolation from the dollar system and the crash of the economies that completely depend on the dollar – the vassal countries of the US. It will be worst of all for them. And this means that the reasons for increased distancing between the EU and the US will increase in number manyfold.
 
A redrawing of the map of global unions awaits the world.




And the redrawing of these unions will be carried out not least by military methods. Or with their partial use, but in one way or another, reasoning involving force in the world will increase almost to the level of guaranteed war. “Almost” is our hope for rescue, because the US loses all main instruments of influence on this world. Except force.

But it’s not for this purpose that the “Zurich gnomes” created this world, so that the US is so simply turned into radioactive ashes. The US will be drenched with cold water like a broken down nuclear reactor, while the world has entered the zone of the most global transformations over the past few centuries. The revolution that so many waited for, were afraid of, and spoke so much about has started. Buckle up and don’t smoke, the captain and crew wish you a pleasant flight.


Global debt — when is the day of reckoning?

Central banks and companies still have ways of kicking the can down the road

Laurence Fletcher




How worried should we be about debt? The answer is not straightforward.

First, the bear case. In short, debt is just too big for comfort. Global debt has swelled 50 per cent in the decade since the credit crisis, according to Standard & Poor’s, the rating agency. Government debt in the eurozone is higher than before the financial crisis, as are, in some cases, household debt-to-income ratios.

Meanwhile, private equity firms’ debt-to-earnings ratios are approaching pre-crisis levels, suggesting they are again comfortable with taking on more debt on the companies they buy. So-called covenant-lite deals with low investor protections are the norm.

If this all goes wrong, it could be ugly, with broad ramifications for investors and economies.

For instance, a downturn could trigger downgrades on the huge number of bonds that just scrape into the investment-grade ratings, leading to a wave of forced selling by funds that cannot hold debt below triple-B.

So-called “financialisation” — whereby companies take on more, cheap debt to boost equity market returns — could also mean less resilience when things start to sour. Andrew McCaffery of Aberdeen Standard Investments, points to a potential “rapid negative feedback loop into economic activity”.

A side effect of higher debt levels could be that investors and economies start to feel the effects of a sell-off or a slowdown more quickly than they might otherwise have done.

But, bulls point out, immediate triggers for a day of reckoning are lacking. US housing debt is down since the crisis. US economic growth remains robust. And, if there is stress, it is not showing up yet: corporate defaults in both developed and emerging markets remain rare.

Fraser Lundie, co-head of credit at Hermes Investment Management, said corporate borrowers (even those with low ratings) still had wriggle room to avoid repayment problems. They can use levers such as dividend cuts to help bondholders, shifting some of the strain on to equity holders instead. Indeed, Mr Lundie said he had used market jitters over triple-B bonds as a buying opportunity.

Sadly for debt bears waiting for their moment of glory, borrowers are likely to be able to keep paying back high levels of debt for some time because, quite simply, it is cheap. Central banks and companies still have ways of kicking the can down the road.

A sweep higher in inflation or a dive in global growth would, of course, throw the bullish case off course. Until then, some market watchers are keeping the faith. “I’m very worried [about debt] if you have a long time horizon. I’m not at all worried if you have a short time horizon,” said David Lafferty, chief market strategist at Natixis.


ETFs 

Fund Investors Believe That Cheap is Better. But That’s Not Always the Case

By Crystal Kim 

Fund Investors Believe That Cheap is Better. But That’s Not Always the Case
Photograph by Ken Cedeno/Bloomberg News 



It took some three decades and a financial crisis, but the evangelicals of index investing finally got their message across—low fees lead to better performance.

The past decade has seen unprecedented amounts of money going into index funds. And not just any index funds, but the very cheapest: More than 97% of flows into the $4 trillion exchange-traded fund industry last year went to ETFs that charge 0.2% or less, Bloomberg data shows.

Except some new research indicates that cheaper isn’t always better. That new message is coming from an unusual corner—noted Vanguard expert Dan Wiener, editor of the Independent Adviser for Vanguard Investors and chairman of financial advisory firm Adviser Investments.

“Vanguard’s late founder, Jack Bogle, had it wrong when he said that investors always ‘get what they don’t pay for.’ Sometimes they don’t,” he tells Barron’s. Of course, Bogle wasn’t referencing ETFs, but the performance of Vanguard’s mutual fund share classes versus their ETFs is illuminating, Wiener contends.

Vanguard’s funds require a bit of an explanation. The $5.3 trillion money manager has a unique exception, enabling it to launch an ETF as a share class of an existing mutual fund, so both have the exact same holdings and strategy. Other firms must introduce a whole new fund with an ever-so-slight difference in holdings. This makes performance comparisons difficult—whether you’re weighing an ETF against a similar, but not quite exact, mutual fund, or against another ETF with a similar, but not quite identical, index as its basis. The exception is the handful of BlackRock(ticker: BLK), Vanguard, State Street Global Advisors ,and soon JPMorgan Chase(JPM) ETFs that track big indexes, such as the S&P 500 or the Barclays Aggregate Bond Index.

“It is exceedingly rare to be able to compare ETFs, apples-to-apples. You can’t hold all else equal, which underscores the fee obsession,” says Ben Johnson, director of global ETF research at Morningstar.

Because of the quirk, however, the performance of the portfolios in Vanguard’s ETFs and mutual funds can be compared directly. The firm’s Institutional Plus share class, which has a buy-in of $100 million, has the lowest fee. Admiral shares used to be the next cheapest, but Vanguard’s latest annual report shows that the ETF prices below Admiral shares—though we’re talking about a difference of maybe 0.01%. The firm also lets Admiral share class investors exchange their holdings for an equivalent ETF.

One might think that the share classes advertised as having lower fees would produce better results if both had the same holdings. But that’s not always the case.

Consider the Vanguard Total Stock Market Index fund. In the 10 years through 2018, the Admiral shares (VTSAX) returned 13.25% annually; the ETF (VTI), 13.26%. The ultracheap Institutional shares (VSMPX) did even better, rising 13.31%. That’s to be expected. However, the ETF also returned more than the previously pricier Admiral shares net asset value over certain periods in those 10 years. All the differences were only a matter of basis points—each equal to 0.01%, or just a dollar for every $10,000 invested—but they still might puzzle some investors.

Wiener, who shared with Barron’s how a real portfolio of Vanguard funds performed in his Roth IRA, noted that his return on the ETF shares differed from Vanguard’s stated return on market price—that at which you can buy or sell ETFs, which, in turn, differs from the NAV. Vanguard calculates the market price by taking the midpoint of the bid-ask spread for the trading cost of the ETF.

Why? Well, trading ETF shares involves more variables than buying and selling mutual fund shares. As a result, no ETF trade is done exactly at NAV and depending on when and how it’s executed, an investor could pay more or less than the next person.

A buy-and-hold investor like Wiener, who purchased the ETF at launch in 2008, never doing anything subsequently except reinvesting dividends, might find his real return differing by a few basis points from that reported on Vanguard’s website, because of the trading cost variable. In contrast, open-end mutual funds always change hands at NAV. Thus, gripes: “When you go to sell, how do you know you’ll get as much for your shares as someone who sells at NAV in an open-end mutual fund?”

Rich Powers, the head of ETF product management at Vanguard, says that the price differences “could be a function of penny rounding, which might present as such that one product has outperformed. “It’s a theoretical possibility.”

While the difference in performance is only a few basis points, Wiener says: “Isn’t the whole conversation around fees about basis points?” Indeed, as most investors know, a few basis points more can add nicely to the value of an investment held for many years.

Bonds Are Saying Something - We Should Be Listening: Part II

by: Eric Basmajian
 
Summary

- Despite the equity market rally, long-term interest rates continue to move lower.

- Long-term interest rates move lower when growth and inflation decline.

- The equity market was pessimistic in December and optimistic in January yet conditions have not changed.

- Bonds are speaking - we should listen to what they are saying.

- A comprehensive analysis of Treasury rates.

      

Bonds Are Saying Something - We Should Be Listening: Part II

A little over one month ago, I penned a research note titled, "Bonds Are Saying Something - We Should Be Listening," in which I gave a comprehensive analysis of interest rates and discussed the opposing messages in the stock market and the bond market.
 
While some readers took this analysis to mean that I am bearish on the stock market or short the stock market, this is not the case as I am actually long equities on a net basis.
 
This research note was simply an analysis of the Treasury market but many equity bulls or strictly stock investors always conflate research on any asset class to mean something for their equity position.
 
This analysis will be a follow-up to the original research note and again, will be about what the Treasury market is telling us and not what this means for the stock market.
 
As a macroeconomic analyst, the Treasury market provides the most comprehensive and accurate information about the forward outlook on Fed policy, growth and inflation.
 
While the equity market suffers from the rapidly changing sentiment, narratives and emotion that is typical in stocks, the bond market is different. Short-term bonds can whip around with the stock market which changes expectations of monetary policy from the Federal Reserve. Long-term bonds, specifically 20-30 year Treasury bonds, which are most sensitive to growth and inflation conditions, do not respond to wild emotional swings as the stock market does, and typically do not overreact in either direction.
 
In the last research note, I did a comprehensive study on the rapid rise in interest rates that occurred in September and October, what caused it and why it was a buying opportunity in long-term bonds. In the middle of October, I wrote a note suggesting that the rise in interest rates was a buying opportunity while there was panic in the bond market and 30-year rates are over 30 basis points lower since that note. You can find that note by clicking here.

As I wrote in the last note, the primary factors behind the analysis of the long-term Treasury bonds, and thus ETFs like (TLT), are growth expectations, inflation expectations, and credit risk. I have covered these factors at length in previous notes, and this can be empirically proven in the data. In this note, those factors will be used as assumptions.
 
 
Interest Rates Will Always Follow Nominal GDP Growth Trends:
Growth and inflation Source: BEA, FRED, BLS, EPB Macro Research
 
 
Let's take an updated look at the Treasury curve and understand what the bond market is saying relative to the lows at the end of December.
 
The equity market has rallied strongly off the Christmas Eve low and it is appropriate to take a look at how the bond market has done over that time period, referring back to the low level at the turn of the new year as a goal post of expectations.
 
At the turn of the year, fears of a recession and a global slowdown were at their highest so comparing the action in the Treasury market to the turn of the year is a relevant measure.
 
Making Sense Of The Action In The Bond Market
 
The Treasury market is full of information across various time durations but in this note, we will stick to the long-term rate.
 
Since November, the 30-year Treasury rate has fallen from a high level of 3.46% to a low closing level of 2.92% on January 3rd. From the low 2.90% range, the 30-year Treasury rate has increased as high as 3.13% and sits at 3.03% as of this writing.
 
 
30-Year Treasury Rate:
Source: Bloomberg
 
 
Several factors have contributed to this decline in long-term interest rates. First, the removal of monetary tightening expectations allowed the entire yield curve to have a parallel shift lower.
 
In October, the market was expecting the Fed to tighten policy around three more times. As that expectation vanished, the market lowered the 5-year rate and the 2-year rate by roughly 70 basis points, the amount of the previously expected monetary tightening.
 
The 30-year Treasury rate shifted lower as a result but could not fall the equivalent 70 basis points.
 
When thinking about Treasury rates, you must consider both the nominal rate on the Treasury bond as well as the shape of the yield curve.
 
If the 30-year Treasury rate fell an equal amount as the short-term rates, that would have put the 30-year rate at roughly 2.75%. This would have put the 30-year rate just 35 basis points above the Federal Funds rate, a spread that is uncommon without credible recession risk.
 
While growth is slowing, there is not an overwhelming risk of recession in the data yet so the 30-year Treasury rate cannot fall that low.
 
The best measure of recession risk is the 30-year Treasury rate minus the 3-month Treasury rate. This measure takes the longest-dated Treasury bond, the least influenced by the Federal Reserve, and the 3-month rate which is mostly controlled by Fed policy. The difference between these two rates is critically important to monitor for long-term recession risk. This spread will not tell you anything about the next week or the next month but as far as a long-term credible recession risk, there is no better spread.
 
When looking at this spread below, we can see that at the point the market was most fearful about slowing growth and recession risk, the 30-3 month spread was 51 basis points.
 
 
30-Year Rate Minus 3-Month Rate:
Source: Bloomberg
 
 
Interestingly, with over 50 basis points between the two rates, the market was never hyper-concerned with a recession but the risk of a recession was rising. As long-term followers of my research know, I speak most often in rate of change terms.
 
At 51 basis points, a recession was not likely but the market was, at that point, most fearful about a recession relative to this economic cycle. As the equity market bounced, that spread bounced too, but earlier this week, moved back to 54 basis points, just three basis points above the closing low.
 
If the spread moves back to 51 basis points or lower, it would be fair to say that a recession is still not yet a probable outcome in the next 12 months but that the market is equally as fearful about a recession as it was back in December and January.
 
The fact that this spread is nearly at the same level as it was at the turn of the year is suggestive that the long-term growth fundamentals have not changed much since the December low, despite the equity market reaction.
 
As I wrote in the last research note, the yield curve does not have to invert for there to be a recession but a recession is almost certain if the 30-year rate falls below the 3-month rate. The better way to measure these spreads is in rate of change terms. Is recession risk rising or falling? Is this spread compressing or widening?
 
 
Long-Term History Of The Yield Curve:
Source: Hoisington Management, Federal Reserve, Lacy Hunt
 
 
All recessions throughout history have been preceded by a material flattening of the yield curve but not necessarily a fully inverted yield curve. Thus, we must focus simply on the rate of change in the yield curve; steeper or flatter.
 
The Drivers Of Long-Term Interest Rates
 
Over the long-term, there are three main drivers of long-term interest rates; growth, inflation and credit risk. Given that credit risk is virtually zero in all major developed nations, this boils down to growth and inflation. We can argue about credit risk in another research note but I would submit those countries that have a public and private debt to GDP ratio 200 points higher than the US will experience credit risk first.
 
That aside, in the short-term, well, short-term for me but the medium term for most other investors, Fed policy can push the yield curve higher or lower in a parallel fashion if growth/inflation expectations remain unchanged.
 
So, growth, inflation, and Fed policy.
 
As one more aside, this is worth considering. Since 2015, China has not been a net buyer of US Treasury bonds. In that time, there have also been nine rate hikes, QT, a tax cut, "the greatest economy ever", and an improvement in the "trade discussions." The 30-year Treasury rate is exactly flat over that time period. These are not the drivers of long-term interest rates.
 
The key elements to consider are monetary tightening expectations for a parallel shift higher or lower for the whole yield curve and growth/inflation expectations for the shape of the yield curve.
 
Now that the Fed is essentially out of the market, with the market forecasting zero interest rate hikes, growth expectations play a larger role.
 
Let's spell it out.
 
This is what I wrote in the last note in February:
Right now, the Fed is priced for zero action in 2019 so unless that changes, the 2-year yield should trade in a range until expectations change one way or the other, rate hikes back into the market or a rate cut coming. If rate hikes are back in the market, the 2-year yield will shift higher and growth expectations being equal, 30-year rates would raise an equal amount as to maintain the shape of the curve. 
If the market starts to forecast rate cuts on the horizon, with growth expectations being equal, the 30-year yield will fall below 3.0% again as to maintain the shape of the yield curve.
The market has shifted to expecting one rate cut over the next two years and thus, the 30-year rate has now been oscillating around the 3.0% level, falling to 2.98% earlier this week.
 
Growth/inflation expectations will change the shape of the yield curve while Fed policy can impact the entire yield curve, up or down, in a parallel fashion.
 
Should you invest in long-term bonds? Well, that depends on your expectations of Fed policy and growth/inflation.
 
To have a proper view on long-term rates, you need to consider if the Fed will change policy, up or down, and have an analysis on the trending direction of growth and inflation.
 
As I did in the last research note, here is a template with the possible outcomes.
 
 
Interest Rate Scenario Analysis:
Source: EPB Macro Research
 
 
If you think that growth expectations are going to come down over the next several months, as I believe based on the leading indicators, and monetary tightening expectations will be moving anywhere but up, the pressure on the 30-year yield will be lower and in the short-term, we will see 2.9% again on the 30-year, indicating upside for TLT.
 
To clarify, this analysis is shorter term in nature than the secular call on interest rates which suggests growth and inflation will continue to trend lower and make a new secular low. For more on that analysis, click here.
 
If you think the Fed will raise rates again, this will put upward pressure on the entire curve. If you think growth/inflation will trend higher, this will steepen the yield curve and put additional upward pressure on 30-year yields.
 
There are hundreds of factors that can push interest rates up or down on a daily, weekly, or even monthly basis. There are idiosyncratic risks that are impossible to model from a quantitative perspective and I will, therefore, leave the short-term game for those who are inclined to trade the chop.
For longer-term investors, these are the factors to be aware of as it pertains to the trending direction of 30-year rates.

Stuff We Can’t Afford, Part 1: Paying People To Live On Flood Plains


Everyone has been there: Times are good for a while and it starts to seem reasonable to buy – or agree to – things you want but don’t need. Later on, when money gets a little tighter, you start prioritizing and realize you really didn’t need the leased Mercedes or the McMansion with all those empty rooms.

With luck you figure this out before being crushed by the weight of your bad decisions. But for a lot of people the return to financial sanity comes too late.

That, alas, is the near-certain fate of most major countries these days. Between cradle-to-grave entitlement systems, global military empires, inflated public sector pensions and myriad lesser but still in the aggregate ruinous commitments, the fiat currency era will go out in a blaze of regret, broken promises, and political chaos.

A good example of something that in retrospect will seem off-the-charts crazy is the US government’s Federal Flood Insurance program, which – wait for it – pays people to live in places where their homes get flooded every few years. From yesterday’s New York Times:

‘I Don’t Want to Stay Here’: Half a Million Live in Flood Zones, and the Government Is Paying 
When a deadly rainstorm unloaded on Houston in 2016, Sharobin White’s apartment complex flooded in up to six feet of water. She sent her toddler and 6-year-old to safety on an air mattress, but her family lost nearly everything, including their car.
 
When Hurricane Harvey hit the next year, it happened all over again: Families rushed to evacuate, and Ms. White’s car, a used Chevrolet she bought after the last flood, was destroyed.
 
“It’s not safe,” said Ms. White, now 29. “Everybody gets to panicking when it rains. You can’t live like that.”
 
But Ms. White and many of her neighbors cannot afford to leave. They are among hundreds of thousands of Americans — from New York to Miami to Phoenix — who live in government-subsidized housing that is at serious risk of flooding, a danger that is becoming increasingly urgent in the era of climate change.
 
Nowhere is that tension more acute than in Houston, where residents of the nation’s fourth-largest city have been pounded by severe storms in recent years — and where HUD is facing a lawsuit brought by Ms. White and a dozen of her neighbors. The residents say they are trapped in a dangerous area because their housing vouchers can be used only at that apartment complex, which sits in a particularly flood-prone area next to a bayou.
 
The complex, Arbor Court Apartments, which is run by a private landlord that contracts with HUD, has been in a flood plain since 1985 and under HUD’s oversight since at least 1991, according to the lawsuit, filed in federal court last year.
 
After the 2016 flood, HUD renewed its contract with the owner, for about $1.6 million a year. Only a year later, Hurricane Harvey wiped out the first floor, leaving many families displaced and others complaining of major problems, including mold.
 
HUD, citing the dire shortage of rental homes for extremely low-income families, says its goal is to preserve affordable housing whenever possible. So while the agency takes flood risk into account for new and substantially rehabilitated housing, it continues to fund existing properties in flood plains.
 
450,000 households in flood zones, sponsored by the government
Nationwide, about 450,000 government-subsidized households — about 8 to 9 percent — are in flood plains, according to a 2017 report by the Furman Center at New York University.

 
Many of those, including traditional public housing, low-income housing for older people and Section 8 properties like the one in Houston, are financed by HUD. There are also properties in flood plains that receive tax credits to rent to low-income tenants, which are subsidized with other federal money allocated to states.

In a free market, mistakes like the above get fixed fairly quickly. Two big floods in as many years, and a community empties out as residents move to less stressful places. But add a benevolent social insurance program designed to help with “unpredictable” natural fluctuations, and those same residents are locked in place. They can’t sell because no one in their right mind would move to such a disaster-prone neighborhood, and with the government rebuilding their homes as needed it makes no sense to cut their losses and flee. So they stay put and taxpayers foot the bill.

Or more accurately holders of the currency foot the bill as rising government debt leads to rising inflation and, eventually, massive devaluation.

The Optimization Trap

You have some money. Do you pay down the mortgage, or do you invest in the stock market?

You can use math to make this decision, but math is not much help, because there is uncertainty.

• The stock market allegedly returns 8 percent, but sometimes a lot less.

• Your house will hopefully appreciate, but by how much? Nobody knows.

• And what are interest rates going to do?

• It also mostly depends on where you live in the country.

• There are tax implications to residential mortgages.

• At issue also is your risk tolerance—

• Your optimism about the economy—

• And your fear of the downside.

There is a third consideration. How much do you keep in cash? How much liquidity do you need?

Most personal finance people like to say this is an easy decision. But it’s not an easy decision.

There is a lot of nuance.

The answer is likely to be a balance of the three possibilities, based on qualitative factors such as your opinion on the direction of stocks, interest rates, and real estate. And if your opinion is right, you will probably be right by accident.

There are no easy answers. There is no silver bullet. The point is to avoid getting too wound up about it. There are consequences to being really wrong, but there are no consequences to being a little bit wrong.

We are faced with hundreds of economic decisions like these throughout our lifetime. Some people are pretty good at making them. Some people are pretty bad at making them.

This is where education comes in. If you’ve been taught a little bit of personal finance, at least you can make these decisions from the right framework. Of course, some people will still make bad decisions, and we are powerless to stop them.

My point here—don’t spend too much time thinking about optimization. Spend any time on the personal finance blogs and this is where people get bogged down.

Stick to principles.

Principle 1: Avoid Debt

Debt is dangerous, and debt retards growth. Debt can also take you to zero, and make you bankrupt.

It can screw up your life. Sometimes it is necessary, but you must have a healthy respect for it.

We talk about debt all the time.

You really shouldn’t go into debt unless you have a plan on how to pay it off—a good plan. Still paying off your student loans in your late 40s is not a good plan.

If you are going to borrow a substantial amount of money, you should have a plan on how to pay it off in 3-5 years. Maybe 10 years in the case of a mortgage.

You should also recognize that the more free cash flow is going to debt, the less free cash flow is going to equity. Most people never experience what it is like when the debt is gone and all the free cash flow is going to equity, and your net worth goes up fast.

There are a lot of people out there with a negative net worth. Including people who have a pretty good standard of living.

By the way, the median net worth in the US for people under 35 is around $11,000. The mean net worth for that age group is around $76,000.

One of the funnier things about the Google monster is when you type someone’s name into the search box and it suggests “net worth” underneath. We like to find out how rich people are.

Interestingly, people don’t spend a lot of effort trying to make their own net worth go up. An easy way is to pay down debt.

Principle 2: Save

I get sick of these personal finance jerks telling people to stop drinking Starbucks all the time. I get it—if you spend 5 bucks a day on Starbucks, it’s over $1,000 a year, and $1,000 a year compounded at 8 percent adds up to something.

Starbucks is still in business, so clearly not that many people pay attention to this. FWIW, I stop at Dunkin’ Donuts every morning and get an iced coffee. Even in the dead of winter. It costs me $2.86.

I have a different philosophy on this stuff. All the other personal finance people will tell you to stop drinking Starbucks coffee, because they believe it is the accumulation of small decisions that gets you to save.

I disagree. I think it is one or two big decisions that make a difference. Skipping the coffee doesn’t do any good if you then buy a Lexus SUV.

“Penny wise and pound foolish” is a really old and corny saying, but I see a lot of people get stuck on this.

If you get a $400,000 house instead of a $300,000 house, quitting Starbucks for a lifetime wouldn’t make up the difference.

You have to get the big decisions right: going to college, buying a car, buying a house. If you get those wrong, it’s going to be difficult to recover.

Principle 3: Manage Risk

I wrote a piece on the Bloomberg opinion page recently on the merits of the 35/65 portfolio. I suggest you read it before you go any further.

I spend pretty much all of my waking hours thinking about risk. My entire life has been a study in risk: as a deck watch officer, a law enforcement officer, a trader, and then a guy who thinks about risk all the time, whatever you call that. I know how much risk I can handle. I probably know how much risk you can handle better than you do.

I also understand that different people have different risk tolerances. Some poker players are weak-tight (they play fewer hands, cautiously). Some will go all-in on every hand. Is there a one-size-fits-all solution for risk? Actually, for the most part, there is.

We can measure this empirically. We spend an inordinate amount of time thinking about returns and not a lot of brainpower thinking about what those returns cost in terms of volatility. Another thing to teach in the personal finance classes.

I talked about this a bit in The 10th Man 5 call I sent out to you guys earlier this week.

TLDR: People have too many stocks and not enough bonds.

And people are looking in the wrong places for the right balance. There aren’t many things I’m bullish on right now, but what I am bullish on is not being talked about all that much.

Geek Squad


I am doing my best at being a personal finance guru, but the collar is a little tight. I am allergic to spreadsheets—I suspect most people are. If you are working on some personal finance problem, and you can’t do the math in your head, then it probably isn’t worth doing.

You have to get three big things right. If you don’t succeed at this, it won’t be because you didn’t carry the 1.

These principles I laid out: avoiding debt, saving, and managing risk, are all character issues—who you are as a person.

That’s why personal finance is a mission of mine.

Yes, some people get themselves in financial trouble because they are unsophisticated and uninformed. So the goal here is to make people sophisticated and informed. But that’s just part of the solution.

It’s not simply about tips and tricks. It’s about being a better person—the best version of ourselves.

Jared Dillian
Editor, The 10th Man