We Study Billionaires - The Investor’s Podcast Network - TIP 078 : Billionaire Moves in the Market & Negative Interest Rates (Business Podcast)

Starting point is 00:00:00 We study billionaires, and this is episode 78 of The Investors Podcast. Broadcasting from Bel Air, Maryland. This is the Investors Podcast. They'll read the books and summarize the lessons. They'll test the waters and tell you when it's cold. They'll give you actionable investing strategies. Your host, Preston Pish, and Stig Broderson. Hey, how's everybody doing out there?

Starting point is 00:00:29 This is Preston Pish, and I'm your host for The Inferterson. Investor's podcast. And as usual, I'm accompanied by my co-host, Stig Broderson, out in Denmark. And today we've got a guest, a repeat guest that's coming on the show. And his name is Colin Roche. And for anybody who missed one of the previous episodes that we had Colin on the show, it was a fantastic episode. And after you guys listened to some of Colin's comments today, I'm sure you'll see why we brought him back on for a second episode. Just so you know a little bit about Colin, he's the founder of Pragmatic Capitalism. And if you want to go to his website, it's Prague Capital. And if you want to go to his website. It's pragcap.com. He also wrote a book called Pragmatic Capitalism. And here's what makes

Starting point is 00:01:07 Colin great is he has a performance, a track record of performance that is quite different than most people. So from 2005 to 2012, Colin managed a private partnership, which generated a 17% annualized return from 2005 to 2012 with no negative years of performance. So if you're remember, that was whenever 2008, 2009 happened, and he still had a positive return during those years. So whenever we talk to a guy like Colin, he comes with, how could we say it, Stig? You know, he has been tested through probably the most dynamic and difficult market conditions a person could ever experience and came out unscathed. So on his website, pragcap.com, Colin, how many articles have you written through the years? Would you estimate her on your site?

Starting point is 00:02:00 Oh my God, like 10,000. An embarrassingly high number. This is great because all of his articles are 100% free. They're on his site. You can search through, I mean, just mountains of information. And you can see why he's so smart. They say, if you want to learn something, just start teaching it. And that's what Colin does on his site is he teaches people.

Starting point is 00:02:24 And he teaches people how to think about things. The reason we have him on the show is there's a couple different billionaires. that have been doing some moves in the market. We want to discuss some of those decisions and some of those moves that they've been making with Colin and kind of get his opinion on why they might be doing it, whether he agrees with what they're doing,

Starting point is 00:02:41 and just some general questions about the market, the current market condition. So I've got the first question here, and it relates to billionaire Jamie Diamond purchasing $26 million of JP Morgan's stock. This was probably, what, two or three weeks ago that he did this, and it just completely,

Starting point is 00:03:00 coincided with his annual pay. So if you didn't know, Jamie Diamond makes $26 million a year from J.P. Morgan as the CEO. And Diamond's a billionaire. And I just, when I look at this decision, I'm kind of like, why in the world would he be doing that? When I look at the banking sector, okay, the U.S. banking sector is much different than the banking sector over in Europe. But whenever I look at that with interest rates continuing to just get abused around the world, I look at these bank stocks. Yeah, they might have a strong balance sheet, but how are they really going to make a lot of money with interest rates so incredibly low and moving lower? I want to hear Colin's opinion on that particular topic. Yeah, gosh, I mean, I think you're probably right about that. It's funny. The U.S. banking system is becoming increasingly sort of like a utility just because the regulatory environment and the interest rate environment has become so naked. for these banks, that the days of them being able to ramp up these alternative operations and really generate huge profits, they're probably behind us.

Starting point is 00:04:13 You know, it's probably a good thing, but I think you're probably right about the stock purchase that Diamond is probably just posturing to, I mean, God, it's a, you know, drop in the bucket for him. So, you know, he's probably got a massively diversified portfolio anyway. why not dump a little bit more into J.P. Morgan anyways, in his mind. So I don't think I would read too much into the stock purchase to begin with. And I think people need to put it in context. So I think Jamie Diamond's net worth is just a little over a billion. I don't know the exact number, but I don't think it's much higher than a billion. And so if he makes a $26 million

Starting point is 00:04:50 acquisition of some common stock, that's 2% of his portfolio. So it's not a big position when you look at it from that context. I know it sounds like a lot, but it's really not that much money to his overall portfolio size. Now, just kind of a piggyback question on that, Colin. So when you think of banking in general, you know, when we look over in Europe and we look at Japan and now they're doing all this negative interest rate stuff, how are these banks going to stay profitable? And more importantly, do you see that environment kind of coming to the U.S. over the next, call it three years. Do you see the negative interest rate environment kind of coming this way and why? It doesn't seem like Janet Yellen is on the negative interest rate train, which I think is probably a good thing.

Starting point is 00:05:41 My view on negative interest rates is pretty simple. So I basically think of all of this through the operational side of the way that a bank works. And a bank basically, the way that a negative interest rate impacts them is that what's happening is the central bank is taxing their reserve account. So the way to think about the reserve account in a bank, banks, think of it like this. We use the banking system. Okay. So the households and consumers use the banking system. And the banks have their own banking system, which is the reserve system. So the Federal Reserve runs the banking system for the banks. And JP Morgan and Citigroup and all these other big banks, they run the banking system for the rest of us. So these banks have to have deposits at the Federal Reserve. And what the Fed is doing,

Starting point is 00:06:30 basically, when they implement negative interest rates, is they're taxing that reserve account. Okay. So the thinking here is that if they tax this bank account that all these banks have, that maybe these banks will go out and make more loans or they'll take a little bit more risk or something like that. And they'll do things that can maybe, you know, stimulate the economy through that channel. And I just don't think that's right. I view banking as something that is almost entirely consumer demand driven. So the demand for loans comes from the household sector primarily in the corporate sector. And if there's no demand for loans for whatever reason, banks can't force more loans on the rest of us. I mean, they can reduce credit quality

Starting point is 00:07:16 and lending standards. But that's not necessarily a good thing. I mean, that's what we saw during the financial crisis basically leading up to it. So, negative interest rates act as a tax on banks, and banks will tend to just pass that tax onto consumers in other forms in terms of fees and things like that. So I view it as basically a negative environment. So let me ask you this. When you talk about they're not being a big demand presently for private individuals or companies to take out loans, would you attribute that to the fact that there's just too much competition in all these different sectors because of low interest rates?

Starting point is 00:07:56 No, I think that the low demand for debt right now is a function of just the lack of health at the primarily at the consumer level. I mean, if you look at household borrowing, I think we're plumbing. I mean, we're still in an environment where a year over year, if you look at the Federal Reserve has a data set on all of this stuff, I think the, if you type in, CM debt on the Fred database, the economic database of the St. Louis Federal Reserve, you can see this chart that I'm looking at right now. And it shows household and nonprofit organizations, year-over-year change in borrowing. And we're at 2.5% relative to historically,

Starting point is 00:08:41 this has been at like 7 to 8%. So we are literally lower than any recessionary period. And we're seven years into a recovery here. So something really, really strange has been going on at the household sector for demand for debt. And I think that's a big cause of why the economy has been rather weak in the last seven years. And it's why I think in general, just the demand for debt has been low because household balance sheets just aren't fully repaired from the credit crisis. So, Colin, basically what you're also saying here is that now that the ECB decided to buy back 80 billion euros instead of 60 billion, that's not going to have any in fact because the customers or the households won't be credit worthy or simply don't have an

Starting point is 00:09:28 appetite for taking on debt. Right. So that's the problem with relying too much on monetary policy. So the central bank has really been, I mean, central banks around the world have been the primary policy tool that we've relied on for the last seven years. And the thing about central banking is that all a central bank is is just a much bigger version of normal banks. So the only way or the primary way that a central bank can impact the actual economy is through the banking channel.

Starting point is 00:10:02 So they basically have to try to influence the way that we borrow money or the way that we use deposits or whatever. And the problem with relying on that sort of a policy during what is essentially still a credit crisis of some sorts is that the central bank can't force people to borrow. So as a result of that, I mean, reducing interest rates, it makes credit marginally more attractive. But I mean, gosh, when a man is bankrupt and you offer him a 5% interest rate relative to a 10% interest rate, he still says, I can't afford to borrow at that rate. So there's just very little that the central banks can do around the world to stimulate the economy at this point. And I think that that's a concern is this rivalry between monetary policy and fiscal policy that you're here. hitting at. And it really comes down to there's no friction when you're talking about implementing monetary policy as far as Janet Yellen. If she wants to raise rates, lower rates, she can do it.

Starting point is 00:11:01 She's dealing with, you know, a board of how many people are on the board, like 10, 15 people that are like voting members of that board. And then they just make a decision. If you want to complement it with fiscal policy and you want to do that, well, now you're dealing with Congress. And the friction that occurs in order to implement fiscal spending, say you want to build, you know, a, you new bullet train from Vegas to L.A. in order to spend money domestically or whatever, you know, whatever fiscal thing you want to spend, induce spending domestically. The buy-in that you need and the churn and the time that it takes in order to do that is just, it just can't happen.

Starting point is 00:11:37 And so what we've had is this total polarization to the fix is monetary policy instead of fiscal policy. And I think that that's breaking things. I think it's like somebody lifting weights and they're only lifting with their right arm and not their left arm and they walk around and look ridiculous. Yeah, well, I always say this with quantitative easing that people always talk about monetizing the debt and things like that and how this could be inflationary. And I've basically since the day that QE was implemented, I've sort of been saying this policy

Starting point is 00:12:08 is not going to do that much. I mean, QE1, I think you have to make an exception for QE1 because QE1 was different because they were making a market in bad securities that it definitely bolstered bank balance sheets, for instance. I mean, they were swapping bad assets for good assets. And that, that was just such a unique environment. But once we kind of transitioned out of that environment into a more normalized economy, quantitative easing, it really just swaps good assets for good assets at this point. I mean, we're swapping treasury bonds now for basically reserve deposits. So it's a good asset for a good asset. You're actually reducing the overall interest

Starting point is 00:12:43 income to the private sector, which means that in the long run, what we're doing is we're actually reducing aggregate income to the private sector, which means that there's a chance that QE, unlike what a lot of people thought it would be, you know, either high inflation or hyperinflationary, QE is potentially deflationary because it's reducing the aggregate income to the private sector. But the kicker there is that QE and monetizing the debt always relies on a consistent deficit, basically. Congress is still running the quantity that can be monetized at any point because they're the ones that are running. I mean, if the Congress, U.S. Congress decides to start running a surplus, there's that much less debt that can be monetized every year, which means that really Congress is running that train of policy and where it actually goes along the way. So I've always sort of said that the focus, especially in a credit crisis like this, should always be on fiscal.

Starting point is 00:13:48 policy because fiscal policy is the mechanism through which you can really substantively change the composition of household balance sheets. I immediately get sucked into trying to understand the end state of where all of this is going. Because in the short term, I think all that stuff makes sense. But whenever I look at Japan particularly and also over in Europe, my personal opinion is that's a precursor of what we're going to see here. That's my opinion. But whenever I look at those two locations, let's talk Japan.

Starting point is 00:14:17 They're at a point where they're taking this liquidity and they're purchasing ETFs and common stock basically off the market. So what they're effectively doing is they're taking assets on the market, whether it's bonds, equity, either one of those, and they're nationalizing it. That's crazy. To me, this doesn't end well. It's funny. I think that some of this has to be put in some person.

Starting point is 00:14:47 Because I think that we've been really spoiled by high growth. So from the period of basically 1900 to the year, I mean, 1999, basically, we had incredibly high economic growth, basically ranging from three to four percent per year at the aggregate level. We're sort of just maturing and we're developing into more of an economy where the growth is still going to be growth, but it's just not going to be. the type of growth that we've sort of grown accustomed to over the last 100 years. So in my mind, it's not necessarily a bad thing. It's just that I think maybe we just need to get used to this world

Starting point is 00:15:29 where we're growing at one or two percent. And that's okay, in my opinion. So I got a point. And I like the discussion of the time frame that you're talking about and the uncharacteristic amount of growth that we saw. Where I would like to maybe scope the time frame that you're talking about is from 1940 to 1980 particularly. And if we look at the time of this, so the Fed gets stood up, call it 1914 or somewhere around in there, they're really kind of ensuring that the monetary baseline remains fixed at its starting value until 1940 and they've got to basically pay for World War II. So from 1940 to 1980, which you saw was a Federal Reserve that started acting in a little bit

Starting point is 00:16:15 of a different manner where they didn't want the downturn in these business cycles, is what they're commonly referred to. They never really zeroed it out. Instead, what they were doing is they were actually increasing the monetary baseline just decade after decade for 40 years straight. And when they did that, they were actually adding more monetary baseline to the system over that 40 year period without ever taking it back out. What they're actually doing is they're basically putting a loan into the system without

Starting point is 00:16:44 any assumption for risk whatsoever. Now you're not having the monetary baseline being controlled and manipulated by the Fed. Instead, what you're having is you're having the banks actually controlling that are driving those interest rates as they're coming back down the hill to where we're approaching right now zero percent. Would you agree with that idea of what I'm describing there, Colin? Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through

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Starting point is 00:21:10 That's Shopify.com slash WSB. All right. Back to the show. It's tricky. I mean, when you have, I mean, sort of by definition, when you have a central bank, what you're basically doing, I mean, if you look at what a central bank is, I mean, in the United States, all the Federal Reserve is basically a big clearing house. So if you kind of look at the historical.

Starting point is 00:21:35 the history of banking. Prior to 1913, the way that private banking basically worked was you were starting to see in the late 1800s really a national banking system. And what was happening was that all these different banks really were working more as partners over time because you would have, for instance, Stig might bank at Citig might bank at Citibank at Citi Bank and the investor podcast LLC might bank at JPMorgan. And if Stig makes a payment to the Investor Podcast LLC, well, they have to settle their bank accounts at the end of the day, basically. And so what would happen before there was a Federal Reserve, these banks would all meet up basically at the end of the day.

Starting point is 00:22:18 They would settle in some sort of private clearinghouse to settle all of their payments. And so you had these private clearing houses that were run by the banking system, basically. But what would happen is because these were private-run clearing houses, during financial payment, next, the clearinghouse would shut down basically because then J.P. Morgan would look at Citibank and say, whoa, whoa, whoa, we don't know what your balance sheet really looks like. So we're not going to accept your liabilities to clear this payment. So, you know, we're not going to, we're going to sit on this. We're going to let things settle down. And we'll see if we can settle this payment maybe next month. And then all of a sudden, you've got this huge economic disruption just because banks

Starting point is 00:22:59 don't trust each other. It's almost like the plumbing in your house just shuts off because you're bathroom doesn't like your sink or something. And so that doesn't really work because that impacts everything else in the economy. I mean, all of a sudden, you've got industries that have nothing to do with a financial panic that are being impacted because Citibank can't settle a payment with JP Morgan. All a Federal Reserve does or a central bank does is a central bank leverages the power of the government, basically, or really the aggregate private sector and comes in and says, okay, rather than have this clearinghouse be run by a private institution, what we're going to do is we're going to run this as a federal institution and we're going to ensure that during financial panics, this clearinghouse, it will never shut down. And from that perspective, central banks around the world have worked beautifully for the last 100 years because, I mean, you saw this during 2008 when all the other banks wanted to shut down their businesses and J.P. Morgan thought that,

Starting point is 00:24:02 Bear Stearns and Lehman Brothers and all these other Washington Mutual, all these other potential banks were bankrupt. The Federal Reserve came in and said, hey, guys, calm down. We're going to make a market in all this stuff. We've got your back. We're going to support the whole system. And as a result of that, I mean, you had a situation there that was scary where, I mean, General Electric couldn't pay their employees potentially one day. I think they were the ones that called the White House and said, guys, if you don't do something about this, we're not going to meet payroll next week. And the Federal Reserve basically came in and said, okay, that is not going to be a problem

Starting point is 00:24:40 because we cannot have credit worthy companies that can't settle payments just because the banking system is shut down. So from that sense, the central banks have worked really well. And by necessity, their involvement has gotten bigger just because the U.S. banking system has gotten so much bigger and so much more complex. I think a lot of people have a tendency to blame central banks for everything. And I just, I just view it a little bit differently. I view central banks as sort of, they're just an intermediary to some degree, mainly in

Starting point is 00:25:14 clearing payments. And so I don't think that, I mean, for instance, let's go back to the credit crisis. I mean, a lot of people blame low interest rates on costing the credit crisis. But I hesitate to say that they had an excessive. cause and effect there. I think that that really more had to do with just people speculating in a financial asset that ended up being, I mean, God, mortgage debt is something like 70% of all household debt in the United States.

Starting point is 00:25:45 And so, I mean, add 10% to that, which is basically what happened during the credit crisis, and you take the most important asset in the world and the most important asset on household balance sheets, and you make it potentially really unscended. stable. And so that's all that happened. That was, in my mind, that was just really a speculative bubble that people bought into. And the fact that interest rates were low or high before, I don't think it really would have mattered whether interest rates were 2% or 4%. I still think people would have been getting zero down, zero interest rate mortgages that they were getting before the credit crisis that

Starting point is 00:26:21 ended up ultimately blowing up. So I guess I hesitate to blame things so directly on central banks. I have one more comment that I'm going to throw it over to stick. So I'm glad you said it that way because I completely agree with you. I don't think that Janet Yellen's out there trying to bring evil to the world. I don't think that any one of these central bankers that have been in charge of the Fed over the last call it 80 years, we're trying to cause problems. But what I do think that's happened is that in aggregate, they've made small mistakes. And that mistake is that they manipulated the monetary baseline without actually ever bringing it back to its most fundamental level.

Starting point is 00:27:03 And this is obviously the money multiplier reserve ratio from 1940 to 1980. During that period of time, I think that if you added up all of those Fed chairmen and the decisions that they made, in an aggregate, they made a really bad decision, an aggregate. But as far as their decision on an individual basis, it probably didn't really seem like it was really all that bad. But whenever you make bad decision after bad decision and it adds up, I'm really glad that you put it that way because I totally agree with you. I don't think anybody is out there trying to wreck havoc and cause major issues. I think there's been mistakes and they've been made in an innocent manner and they just haven't been corrected. Yeah, I think that's

Starting point is 00:27:45 totally right. I mean, I would say that there's a difference between, I think, the central bank's intended purpose as a clearinghouse and what we've sort of veered into in the modern day of monetary policy where central banks these days are they're not just clearing houses they do all sorts of funny things whether it's manipulating their currency directly or things like quantitative easing and a lot of that is in my opinion it's sort of just funny academic theory and stuff i mean a lot of these economists that run these central banks, they are operating almost purely on a theoretical basis. I mean, nobody has really any idea what negative interest rates even do. A lot of it's just economic theory. I mean, before quantitative easing was implemented in any mass fashion,

Starting point is 00:28:37 nobody really knew what it did. And I mean, I've got some of the most famous economists in the world on records saying basically that QE was going to cause hyperinflation or that if all of these reserve dollars get out of the banking system, which is something that is quite literally impossible, then this would cause hyperinflation or high inflation. And so you had a lot of theoretical misunderstandings and policy being run by people who are essentially academics. I mean, Ben Bernanke is really, I mean, he's a guy who was essentially an action. academic for his whole life, all of the sudden thrust into a central bank involved in the biggest crisis ever. And he probably managed it okay. I mean, all things considered. But at the end of the day,

Starting point is 00:29:26 I think that the central bankers are a large degree, just theoretical academics who are implementing things that they don't really know if they're going to do anything. So they're almost throwing, you know, you know what at the wall and hoping that it sticks and does something. So, yeah, I think that that's, I don't think you're far off there. Well, we're coming so close, guys, to actually saying something nice about central banks. Then we'll wait back to the other side of the fence. All right, guys, so really interesting discussion about central banks and QA and so on. And I think we're up to a good speech here.

Starting point is 00:30:05 We have eight questions and we are basically done with the first one. So the second question, that's about one of the most interesting currencies out there in the Chinese Rwembe. And just a few months ago, IMF approved it as a reserve currency status. So we have seen a lot of volatility before and after. And just recently, the Chinese has pulled out capital that is pressuring the Rwembe. So, Colin, how do you see the Chinese currency in the world economy the next, say, 12 months, but also more importantly, in the decade to come? Yeah, I mean, this is a great, great question because, you know, I think I mentioned this last

Starting point is 00:30:45 time we talked that nobody really knows what's going on in China. I mean, I think there's a lot of people out there, a lot of commentators who have opinions and I mean, gosh, I've got an opinion on China and it's basically that I have no idea what's going on because I don't think you can really trust most of the data that's coming out of the Chinese government. So, but regarding the reserve currency, this is a. a this is a good topic to discuss because I think a lot of people misunderstand what it means to be a reserve currency. And the reason for that is that I think a lot of people seem to have this

Starting point is 00:31:22 idea that the USA one day just sort of said, well, now the US dollar is the most important currency in the world and it shall be bestowed upon us that we reap all the benefits of this. And that's not really. I mean, that is to some degree what happened. But the reason why we were basically able to say that in the first place was that we had become the largest and most important currency in the world by product of our global output and our global importance to the global economy. And so in that sense, reserve currency status is something that is earned, and it's earned through literally the hard work of the institutions and the firms that comprise the entire aggregate economy. So China's situation is interesting because I think people look at,

Starting point is 00:32:12 you know, like the IMF decision that you mentioned and they say, you know, can the IMF bestow reserve currency status on China? And that's just not the way that it works. China has to earn their status as a reserve currency. They have to prove to the world that they produce the goods and services in the world that deserve to be held as a reserve, basically, for the rest of the world. Do we find the Chinese currency to be really valuable enough in global trade and trustworthy enough in global trade for people to want to hold that currency as a reserve, basically? And so in that sense, reserve currency status is something that has to be earned. The Chinese can't just say, oh, we want reserve currency status, and now we're going to

Starting point is 00:32:59 have it, people have to trust what is coming out of the Chinese government. They have to trust the currency and they want, they have to want to want to hold that currency as a reserve. And we're just not in a situation where I think that the Chinese currency is becoming increasingly important, but it's still, when it comes down to it, I mean, the dollar is just something that everyone has a lot more trusted when it comes to global currencies just by function of our economy being so dynamic and really very transparent. I mean, our government and central banks are incredibly transparent relative to all others. So, Colin, let's talk more about the relationship between the U.S. dollar and the Chinese renminbi. So I think as most of the audience are familiar with, the Chinese

Starting point is 00:33:48 currency used to be pegged to the dollar, but now they're pegged to a basket of currencies. And so, for instance, they're still pegged to the dollar but only by 26%. So what do you think would be the direct trade implication of this in the medium to the long run for the U.S.? So China is basically reversing years and years of valuation in the Raminbi, where now we're going through something that's really unusual and something that is potentially frightening because, and I think this is what's caused a lot of the, the turmoil in the financial markets over the last six months is that people don't really know what's going on in China. And they're worried that now the world's second largest economy is going to go through sort of its own version of a 2008 or something.

Starting point is 00:34:38 And people don't really know how that's going to impact everything. And what the Chinese government has basically started doing is they've started devaluing the Raminbi, I think, to try to offset some of that domestic weakness. So they're trying to basically make the Chinese. currency more attractive relative to everything else in order to bring in more exports essentially and boost growth. And so you've got kind of this situation where, I mean, gosh, a lot of different governments are trying to do some version of this where they're trying to devalue their currency

Starting point is 00:35:08 relative to everything else. And in my view, it's been potentially really bad for the United States because we've seen just a huge rally in the dollar in the last year or so relative to everything else. And that's bad for, I mean, on a relative basis, it's bad for primarily U.S. corporations and basically their potential profits going forward is really the big hit. And so that, it potentially all sort of boomerings back to us in the form of this negative trade impact and negative corporate profit impact that hurts domestic companies and ends up potentially reducing domestic employment and things like that.

Starting point is 00:35:48 So the kicker is that nobody really knows exactly. exactly how bad things are in the Chinese domestic economy right now. So they're doing things that look sort of unusual and extreme. And I just, I mean, I wish I had a great answer for this, but I just don't. I don't think anyone really knows how bad things are in China. I think that, I mean, gosh, I'm not bearish really at all on the U.S. economy right now. I mean, I think there's pockets of weakness, certainly. I mean, if you look at places like Texas and the Dakotas and places that,

Starting point is 00:36:22 are really oil dependent. I mean, they're in a full-blown recession right now. But at the more aggregate level, things don't look that bad in the United States. But I just have no idea how all this stuff in China is going to boomerang back to us. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up. And customers now expect proof of security just to do business.

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Starting point is 00:39:45 investing, including objectives, risks, charges, and expenses. This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. So, Colin, it's interesting that you say your opinion on the U.S. market, not being that much of a bear. So one of the questions that we have here, so billionaire Ray Dalio, who I know you're familiar

Starting point is 00:40:11 with, just released a white paper saying that there's an asymmetrical downside risk to the U.S. market due to prices only offering about a 4% yield at their current market price. And this enormous currency pressures combined with no interest rates, really kind of providing this thrust and this momentum to potentially push the U.S. equity market and stock market lower. So you don't agree with Ray. And I'm just kind of curious, where do you see things differently than him? I would say that I actually see things, I mean, in terms of the way that the, the monetary system works.

Starting point is 00:40:49 Dahlia and I actually see things very similar because we, I think we view things basically through the, the idea that an economy, a modern monetary economy is basically just a bunch of balance sheets and income statements. I mean, that's really, if you look at it, if you look at the U.S. economy, the U.S. economy is basically made up of a whole bunch of big Excel spreadsheets.

Starting point is 00:41:12 And that's kind of all it is. And those are, to understand, and how all of that's interrelated, it's all about understanding assets and liabilities. And so Dahlio has this theory basically of a short-term debt cycle and a long-term debt cycle. And he basically says that we're at the point in the long-term debt cycle where we've sort of exhausted all potential asset and liability growth, basically. And I just don't fully agree with that notion, I guess, of a long-term debt cycle. I think that the economy basically has operated in more of a steady state and that you have at times these sort of unusual deviations that

Starting point is 00:41:58 cause either recessions or in the case of a 2008, you basically had an abnormal growth in balance sheets where you created essentially the environment for a credit crisis. And so you have potentially a lot of short-term debt cycles. But I guess I don't agree fully with his idea of a long-term debt cycle and this notion that balance sheets necessarily have to become over leveraged in the long term. I mean, you mentioned earlier that are we all sort of heading towards the situation of Japan? And I just don't, I don't think the world has to enter that sort of an environment where we all become like Japan. I think Japan's environment is sort of unique to its own, you know, just being an island nation with a basic, a depleting population at this point.

Starting point is 00:42:47 In the in the aggregate, I don't think the global economy has to look like that. I guess that's the big point where we sort of disagree is that I just don't, I don't really know how to digest the idea of a long-term debt cycle and something that occurs over the course of in his model, it's basically 75 years or something like that because we just don't have any data on anything like that. I mean, the economy in a modern state hasn't even existed for more than, I mean, 100 or 150 years, you could really say that we're really operating in just the post-war period in terms of how the modern economy really is operating. So there's just no data supporting the idea of

Starting point is 00:43:26 a long-term debt cycle, I guess. So I see it completely differently than you calling it. This is interesting because whenever I look at interest rates and you just kind of look at since, call it 1940 to where we're at right now, you can see this long-term debt cycle. I mean, it's really, in my opinion, it's very clearly defined when you look at, call it the 10-year Treasury. You can see it go up and you can see in 1981 it peaked and then it's come down ever since. If you go and you look at PE ratios on stocks from 1940 till now, during 1980 when interest rates were sky high, the multiples that people paid on equities or stocks was extremely low compared to what it's been in the last 10 years because interest rates are now low. So for me, I see it. I completely.

Starting point is 00:44:13 agree with Dallius position that, you know, and his opinion in that article is that the Fed's really missing the long term cycle and they're just looking at the short term cycle and that's going to cause their fatal mistake in the long run. I'm glad you brought up P ratios because I think that kind of dovetails really nicely with this that people sometimes, I think, look at things like the Schiller Cape ratio and they say things like, well, this is high relative to its historical norms. And I just, I don't really know how to put that in perspective because I don't think that there's any reason why why can't a PE ratio of say, I don't know what it is today,

Starting point is 00:44:51 the Schiller Cape is it something like 16 or 17, I think, something like that. And it's usually its historical average is something like 12 or 13, I think. So people say the market's vastly overvalued. And I just, to me, the concept of value is something that is, it's so dynamic. It's so subjective. And I don't see why. I mean, 50 years ago, we might have thought that to use beauty as sort of an analogy, we might have thought that this fashion trend was beautiful 50 years ago.

Starting point is 00:45:23 And today it's something totally different. And I kind of view stock valuations as being something sort of similar, that why can't the public's perception of what is valuable today just be different than it was in a different era? And in that thinking, there's no reason, in my opinion, why a P ratio of 16 today, why can't that be just the new normal or so relative to 12, the way people perceived it 50 years ago? So I just, I guess I don't always look back at these historical data sets and say, well, historically these have been mean reverting. Therefore, this has to revert back to the mean, which means that we're in a state. where we should all be either bearish on stocks or expect stocks to fall by, you know, 30, 40, 50 percent or something like that, just because people's perceptions have, are not

Starting point is 00:46:21 changing is basically what the theory would say. And I just don't, I don't know if that's right, I guess. So I kind of see it the way that you're talking. I think that there's a qualitative piece to it. But at the same time, I think that there's definitely a mathematical piece to it. So one of the things that we did whenever we built the website Buffett's Books.com is we created this discount cash flow calculator. So I wrote the math behind this thing to try to understand it myself and, you know, posted on the website. And whenever you're doing that, you play around with all the different numbers and things that you get.

Starting point is 00:46:52 If you had a fixed amount of cash flow, let's just say it's $100 from now into infinity. And you're going to discount that back and an appropriate discount rate, Warren Buffett always says to use, you know, the 10-year treasury is kind of the ruler or the benchmark for that discount rate. So let's just say we were using 10% and we are going back a couple decades and we were using 10% as that 10-year treasury yield that we'd get. So we'd be using that as our discount rate. So not adjusting the future cash flows of company X, okay, and qualitative all stays the same as interest rates change. The multiple that people are going to pay over or below that 10% is I think the key starting point. And that's where you have to look at it from

Starting point is 00:47:37 that mathematical standpoint. If the 10-year treasury is now at 2%, the premium or the discount that people are going to pay over or above that is drastically, in my opinion, drastically impacted by that change on the interest rate scale. And so whenever I look at this Ray Dalio, you know, 70, 80-year cycle, That's why I'm saying you go back to 1980s. The premium that people paid on stocks significantly lower than it is right now. And if you plotted that PE ratio from 1940 to present day today, I think you would really see a pretty strong. Now the premium, the discount would kind of change as the business cycle that's riding on this long-term wave, it would fluctuate. But in general, you would see the lowest premiums people pay for stocks definitely in the 1980s.

Starting point is 00:48:27 and I think it's completely based on those interest rates. So I guess I'm trying to sell you on this. So I like, I guess here's the thing. I guess maybe I'm the one thinking too much in extremes because I feel like what I tend to see, people will look at current P ratios and they say 2008's coming back. And I think that that's oftentimes the implication that a lot of people have, that because stocks are at a, you know, whatever, a 30 or 40% PE ratio premium to what they have

Starting point is 00:49:02 been relative to the historical norm, that people then say, oh, well, the S&P 500 has to fall back down to 1,000 or 1100 or something like that. When P.E ratios are high, we tend to have lower future returns. And when P. ratios are low, we tend to have higher future returns. And that's just sort of, I think that that's just really sound operational thinking. I mean, the way that I think of it is if you took a zero coupon bond, I mean, take a treasury bill, for instance, and you have a treasury bill that's at 2% today, if that bond, if that bill, that's literally the second after I buy it, if that bill shoots up to a 3% interest rate, what happens is basically the future value, the future return of that Treasury bill, it has to increase.

Starting point is 00:49:55 So someone who buys that bill tomorrow or literally a minute after I bought it when interest rates jumped up, they're buying something that will generate a higher future return. And if you think of the stock market in the same sense, the exact same thing happens when the stock market rises and falls in value. When the stock market rises in value, I mean, in a year, years like 1999, what's essentially happening is you're pulling future return. into the present.

Starting point is 00:50:22 And so the future returns are, they just mathematically have to be lower because the stock market cannot sustain 50% returns because corporate profits don't grow at 50%. Corporations literally, they cannot pay out those types of returns with any, you know, consistency. So that's what tends to happen when you see these huge bull markets is people excessively pull future returns into the present, which means that it just means that the future returns are going to be lower. So I guess what I'm saying is that I just think of things more in terms of, okay, P.E ratios are high, which means the future returns are going to be lower, but it doesn't

Starting point is 00:51:01 mean that the P.E ratio has to go back to 12. Does that make sense? Yeah, I think it makes a lot of sense. And press the line, we have discussed the P.E. ratio a lot of times in the podcast. And I definitely see we're coming from in terms of saying that value is like a relative thing. and it's definitely influenced by the interest rate. But I think the way that I want to say we, but I don't want to pull Preston into this. Don't you pull me into this. I guess I kind of disagree with you, Colin, in the sense that... Pull me into this.

Starting point is 00:51:34 In the sense that basically the value of any asset is the castlet produces. So it is mathematically restricted by how much cash is going to spin off. And if you look at the value of a stock, it's like, Basically, you're just discounting that cash flow. And if you look at the value of the stock market, you're thinking, how much could I make if I owned all the stock on stock market? So I definitely like the notion of thinking of a new normal. But if it's only has that increased value due to the interest rate,

Starting point is 00:52:05 it's just not sustainable the way I see it. Because whenever the interest rates will go up, whatever that will happen, you will simply see that the drop in your yield anyway. So I'm trying to really politely say that. I disagree what you said about our valuation. But I think it's really interesting because we have brilliant people like Jeremy Siegel who's saying exactly the same thing as you are. So you might be right. You might be right too.

Starting point is 00:52:28 The thing that I will say, Colin, that I do appreciate that I think a lot of people don't have is an appreciation for the qualitative piece. And they immediately say, oh, it's a PE of 25. It can't go higher. Well, and that's a bunch of bunk because you could just go back to like 1999. And you can see it can go a whole heck of a lot higher because of this qualitative, you know, dot com boom that that happened during that period. So I think I really do believe that it that you have to have a balance of both the qualitative and the quantitative in how you look at it.

Starting point is 00:53:01 And I'm glad you brought it up. There's definitely validity in what you're saying. I feel like we maybe agree more than I'm I'm leading everyone to believe. I mean, I'm, I'm certainly no Jeremy Siegel. I mean, I'm really critical. I'm really critical of experience. extremist thinking of any type. And I think that Jeremy Siegel is one of these guys that he will advocate 100% stock allocations for most people most of the time, which I just think is

Starting point is 00:53:28 totally crazy. And I guess that's sort of the thinking that I'm trying to avoid with a lot of this stuff is, you know, just because P ratios are low, it doesn't mean that you should be excessively bearish about stocks, even though I totally agree with you that I think future returns are going to be low. I mean, my, my equity model basically outputs about a four and a half percent 10 year average return on U.S. equities going forward, which is really low relative to historical norms. So I'm not this, you know, raging crazy bull that that maybe, maybe I'm coming across as, but I'm also not this doom and gloom jumping your bunker type of thinker where I say, oh, well, just because the average historical P ratio was 12, it doesn't mean that, yeah,

Starting point is 00:54:17 returns are going to be lower. But, you know, God, you're probably in the next 10 years, you're probably almost with 100% certainty going to do better in an aggregate stock market index than you will in an aggregate bond market index or certainly an aggregate cash index. So that's, I guess, kind of where I'm thinking. All right. So we're over the hour, Mark. We got through, what was it, three questions?

Starting point is 00:54:40 Stig? Yeah. And we were forcing it. Let me tell you. We were forcing three questions. Yeah. And we even wanted to put in the extra question because we were talking back and forth before the interview was like, hey, let's address this too. Because we have plenty of time like an hour into you, right? But no. We got to wrap this up. I talk too much. I'm sorry, guys. No, you're all good. That's totally not it. So here's the thing. I know anybody who listened to this conversation can have a deep appreciation for how smart Colin Roche is. So one of the things that we talked with Colin before recording this episode was syndicating his blog posts on our website.

Starting point is 00:55:18 So if you don't go to the Prague Cap website, we're also going to have his feed of the articles that he writes. And how many articles do you write a week, Colin? I usually try to publish one thing a day, basically. Awesome. Awesome. Okay. Some of the articles that he's publishing, we're going to try to syndicate that onto our

Starting point is 00:55:37 blog tab of our website. And if you don't go to our blog to see some of the different, because we're probably not going to publish every single one that he writes. But if you do want to get his feed and see what he's writing every day, you can go to pragcap.com and you can see what he's talking about and some of his articles. I know he's also on LinkedIn and I see a lot of his feed through LinkedIn. So you might want to add him there as well. If people want to know more about you, Colin, where can they go and learn more outside of the Prague cap? Well, Pragap is really the best place to start. I mean, I've got, so actually, if you go on the Pragcap website and you click on the Tools and Resources tab, I've got a tab for education, which is probably the thing that would be most useful to people. And that will link, it actually links to my corporate website where I have basically a page called Understanding Money. And that link is basically, I mean, it's hundreds of links to just sort of basic understandings. A lot of, of the things that I was sort of going through today where, you know, talking about sort of the

Starting point is 00:56:37 basics of central banking and understanding what the reserve system is and getting into kind of the operational things. I think that I tend to view things sort of almost from the perspective of like an engineer where I view the whole monetary system as basically this system that you can understand how the pieces all kind of fit together. And if you can kind of understand basically, if you think of it like a car, basically, you can look at the parts of the car and understand, okay, well, this is attached to that and this is attached to that. And if I push this nozzle, then this will do this and that will do that. And if you can kind of then just sort of understand the behavioral piece of it, which is basically the person that you put into the car and understand

Starting point is 00:57:20 kind of the almost the behavioral finance side, you can get a really sound understanding of how the financial system works and how the economy basically works. So we will definitely, highlight that link to this resource page that you have in our show notes. So if you can't remember what it is, just go to our show notes. We'll have a link to it. And I've been on this page that he's talking about, and it is beyond in depth. I actually, so I literally just published a free new white paper called Understanding Modern Portfolio Construction. And that kind of dovetails with my paper understanding the modern monetary system because it's basically the financial explanation of why we allocate assets, whereas my monetary system papers, it's a lot more wonky. It gets into central

Starting point is 00:58:05 banking and banking and things like that. And I think your listeners will probably find the modern portfolio construction paper a lot more useful and a lot more applicable. Because I just sort of go into again, some of the sort of operational aspects behind why we allocate assets, where returns come from, why certain assets generate the returns they do. And I touch on stuff like the discussion we had earlier where, you know, thinking of returns and where returns come from and, you know, putting P ratios in perspective and valuations and things like that and trying to understand how all this actually is applicable in a real world setting. Fantastic.

Starting point is 00:58:47 So, folks, that's Colin Roche. Colin, thank you so much for coming on our show and taking time out of your day to have this discussion with us. We have a blast when we talked. So thank you for coming on the show, Colin. If anybody out there wants to sign up for our newsletter where we read our different books, go to the investorspodcast.com, and then you can subscribe on our email list. Also, if you're wanting more information than something that comes out twice a month and you want to get our blog posts and you want to try to follow the show a little bit closer, go to Facebook, type in We Study Billionaires and you'll see our fan page pop up. And that's where we're going to be posting blog posts.

Starting point is 00:59:24 and you might see some of Colin's articles being popped up from our Facebook page. So go ahead and like that. And we'd love to have you as part of our audience on Facebook or on our email list. So thank you guys so much for your time. And we just want to thank Colin Roach for coming on the show. We'll see you guys next week. Thanks for listening to The Investors Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit

Starting point is 00:59:46 www. www.com. Submit your questions or request a guest appearance to the Investors Podcast by going going to www. www. asktheinvestters.com. If your question is answered during the show, you will receive a free autographed copy of the Warren Buffett Accounting Book.

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We Study Billionaires - The Investor’s Podcast Network - TIP 078 : Billionaire Moves in the Market & Negative Interest Rates (Business Podcast)

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