Can the PP perform well when two of its asset classes are falling

[stone]

OK moda, you get demand for your "loanable funds"; we have TRILLIONS of USD in bank reserves. Loans create deposits. Loans only require bank reserves to deal with frictions at settlement if some banks have more net lending than others. Anyway any such frictions would increase the interest rate offered for bank deposits rather than the treasury rate.
If I'm missing something please correct me.

Even if Ron Paul is a follower of the Austrian school he nevertheless will inherit the monetary system we have. How are his beliefs going to manifest as high treasury interest rates?

[moda0306]

stone,

First, Ron Paul could nominate an Austrian to the fed, raising short-term rates like Volcker did.

Second, I know MMT doesn't believe in the loanable funds model, but what makes real rates go up if not 1) the market demanding loans, or 2) the fed setting very lucrative short-term rates?

What do you think moves rates in the current system.

[stone]

Moda, raising rates is traditionally just the Fed selling lots of short term treasuries to artificially raise rates. They have now more recently given themselves the power to offer interest on actual bank reserves parked with them.
So if Ron Paul was to want to raise rates, then he would have to entirely reverse QE and sell trillions of dollars of short term treasuries to mop up the bank reserves or have to wantonly pay high rates on the bank reserves parked at the Fed. Choosing to pay out all of that interest would cost a tremendous amount of money given the size of the debt there now is. The interest payments would be paid out to people who largely were just holders of big portfolios and would have nothing better to do with it than buy more treasuries or park more reserves at the Fed. It would create a massive budget deficit. It would be moronic IMO but I guess many things that happen are.

[moda0306]

stone,

I agree with everything you just said... but some people think that the government actually "borrowed their money" and that they should get a handy return for it doing so... therefore, they see the fed's keeping rates low as artificially low, not the opposite as artificially high.

I literally think there are Austrian's out there that are so nervous about a fiscal crisis that they'd literally try to cause one to prevent it from ever happening... they'd direct the fed to "raise rates," worsening our fiscal situation and sending money rushing into ST treasuries paying risk-free real return (something never obtainable during the gold standard).  I agree it would be a disaster... but it's a disaster that certain people think puts the purchasing power back in the hands of the people that earned it.

Not all, mind you... but some are like the people that thought 9/11 was good for this country because it showed us how much at-risk we are from Islamic terrorism.

[craigr]

I'd question the comfort factor for someone who started a PP in the early 1980's and saw PP growth not even keep pace with STT's for the next two decades, and who may have been drawing an income (retired). Providing you however have a realistic expectation of the PP being just an inflation pacing investment then fine. There are other safer alternatives to achieve that objective. For instance Harry suggested 100% T-Bills as a second choice option after the PP.

....And if you simply start your analysis in 1982 the PermPort beats the ST bonds. And if you started it a couple years later it handily beats it.....

So you'd agree that entry time point can make a big difference i.e. timing matters. As does timing rebalancing - such as rebalancing when WEIGHT% < 15 OR WEIGHT% >35

Timing matters, but market timing doesn't fix it.

The issue is not that in hindsight that some mix of correctly timed buys would produce superior results. I don't dispute that. But what I do dispute is that these things can be known ahead of time.

It is interesting because running this forum and blog I get people writing me all the time about timing the assets. Asset X is too much, Asset Y is a better buy, I'm going to wait on Asset Z.

I just tell them to buy all at once and be done with it. And that has proven to be the best advice over and over again. Not just because they will worry less about their money, but they will take their emotions out of the decision going forward. Again it's one thing to say an investor found some kind of timing mechanism that works on historic data. But it's another thing entirely for them to actually follow it. What I've seen over and over again is that even if I thought their strategy were sound, they just don't have the follow-through.

I had people writing me back in 2008 saying they didn't want bonds because they were too expensive. By end of 2008 they went up +30%! So they got way more expensive.

Then in end of 2008 I told people to rebalance into stocks because they were decade low prices. But someone would write and point out all these technical analysis graphs showing, conclusively, that the Dow was going to 3,000 or whatever so they weren't going to buy.

By end of 2009 stocks posted almost +30% gains.

Then in 2010 someone would write and not want to buy LT bonds. They said they got killed in 2009 with -20% losses and that 2010 would be just as bad because "interest rates have nowhere to go but up."

Well they were wrong. Bonds were +9% for the year.

Then in 2011 someone would say that bonds, again, were going to lose money and they wanted to sit in ST cash because some guru had gone short on their maturity.

In 2011 LT bonds posted +30% gains.

So I understand the desire to time these things, but aside from the technical aspect of knowing if the strategy will even work, the bigger problem on top of it is that humans just aren't good at controlling their emotions. They seek out data to confirm their biases. I have found repeatedly that this behavior not only makes them lose more money than someone that just bought in, but probably keeps them exposed to other market risks.

Here is a clip of Harry Browne discussing the same exact problem. De Ja Vu all over again:

https://web.archive.org/web/20160324133 ... DoBest.mp3

[D1984]

First, before we get too far away from it, that's a great post above.  Very thoughtful and detailed.  Thanks for taking the time to organize your thoughts in that way.

MediumTex, 1979 was a year when gold rose 136%. If you expect gold to rise that much again then be my guest (that would put it at around $3,900...far above its previous 1980-81 high in inflation-adjusted terms) but I wouldn't expect that again in any environment short of hyperinflation or economic chaos...or perhaps short of some corporation, person, or central bank trying to corner gold the way Hunt did with silver (for that matter consider how much of gold's rise in 1979 was sympathetic with the rise of silver and the attempted silver corner and how much was due to inflation, negative real rates, oil shocks, the hostage crisis, etc).

If I had walked up to you in 2000 and told you that the price of gold (then $250 per ounce) would be nearing $2,000 an ounce a little over a decade later, and most of the gains in the price of gold would have occurred against a backdrop of tame or non-existent inflation, what would you have said to me?

If I further told you that in the same year that gold prices neared the $2,000 mark in 2011 that the yield on long term treasuries would dip below 3%, what would you have said to me?

Do these things sound like they would have made any sense at all back in 2000?  They wouldn't have made any sense to me.  Back in 2000, people who talked about gold were considered a little goofy, and even back then the conventional wisdom was that interest rates had gone just about as low as they could possibly go.

But look what actually happened.

In non-inflationary prosperity, do you honestly think that the asset class (equities) that is supposed to be the "star" under that set of economic conditions will honestly give that kind of gains in one year so that we could enjoy 42% gains when bonds and gold are both falling?

It doesn't really matter what equities do.  What matters is what the overall portfolio does.  During periods of amazing prosperity such as 1982-2000, the PP did fine.

I don't know what to say to some of these theoretical objections other than when the situation has actually arisen in practice the PP has taken it all in stride.

It's also important to understand how what actually happens in the future is probably too wacky to try to even ballpark right now.  If you had told people in the late 1970s that inflation was about to disappear for a generation and gold would be a terrible asset to own for the next 20 years, they would have said you were crazy.  If you had asked someone in 1990 after the fall of the Soviet Union whether the U.S. would spend over half of the next 20 years fighting two wars in two different countries simultaneously, they might have said "Two wars? Over ten years?  Like two Vietnams? At the same time?"

Weird stuff happens.  This aspect of the protection offered by the PP should not be underestimated.  As I wrote on the BH board a while back, it's sort of amusing how someone like Nassim Taleb writes a book with the central insight of "lightning strikes in unexpected places at unexpected times", while Harry Browne would say "Well, yes, of course lightning strikes in that way.  It's lightning.  What I would like to talk to you about is a cost effective lightning rod that anyone can use...."

MediumTex, gold was (on a Dow-gold, or per-capita GDP to-gold, or gold to an hour of labor at the median wage ratio) very cheap in 2000. If you had told me that (about gold being nearly $2000 an ounce while Treasuries were under) back in 2000 I probably wouldn't have believed you but if I had then I would have assumed (wrongly it turns out...although I bet most people would have assumed something similar) it would be against a backdrop of soaring inflation while the Fed deliberately suppressed LT and ST rates.

Gold is priced nowhere near that cheaply now. LTTs could go even lower in yield but on the historical basis of the 30-year yield vs the S&P 500's dividend LTTs are rather pricey. Stocks aren't really bubble-territory expensive but that aren't at single-digit PE10's like they were in 1982 or 1949 either. Cash is just cash (probably won't fall or rise very drastically over one year) but if held as a 1-5 year ladder won't have the boost of falling rates that helped it beat inflation by more than historical norms from 1981 to the present. None of the asset classes look particularly "cheap" and ready to take off the way gold did in 2001-2011.

Even if one asset of the "volatile" asset classes (stocks, bonds, gold) DID produce almost sevenfold returns like gold has over the past 11 years (since I can't predict the future any more than anyone else here I'll accept for the sake of argument that one of them will) that won't be enough to carry the portfolio alone IMO. Remember that gold had the help of LT bonds as rates fell from 6.60% in 2000 to less than 3% today (which happened along with falling ST rates as well and provided a slight boost to anyone who held 1-3 year or 1-5 year t-bills instead of cash.....inflation ran about 2.58% for '00 to '11 while STTs provided a CAGR of 4.1%; knowing what we both know about how yields fell during this time you can't deny that at least some of the greater than 1.5% gains over inflation were the result of said falling yields and not all due to coupon payments; in a rising rate environment the falling yield effect would work just as well...in the other direction). You basically had two volatile assets doing well (gold and LT bonds) while one volatile asset (stocks) managed to lose money after inflation for roughly a dozen years running. Two falling volatile assets plus one volatile asset doing very well plus cash barely beating inflation by 1% (or less, which could happen again like it did from 1950-1967) does not equal 4-5% returns or probably even 3.5% returns....2% or 1.5% would be more likely.

You are absolutely right that the PP did well in the non-inflationary prosperity of 1982-2000 but it had the wind of falling interest rates at its back. I'm not dismissing the argument that rates may fall further but unless you seriously believe that negative 30-year rates are possible (maybe if they outlaw physical cash but not until then) then there is a limit to how far rates can fall and how much this can assist the PP. Even if LT rates fall to around 1.5% and DON'T rise (say maybe they just gyrate around 1.45 to 1.7% for a number of years) for years that won't contribute the 2% real or so that LTTs historically provided (and the fact that yields didn't rise or fall much would also reduce opportunities for volatility capture).

As far as "It doesn't really matter what equities do...what matters is what the overall portfolio does"...well, what equities do affects the overall portfolio. If we have huge losses in equities (or gold, or bonds) that AREN'T offset by the other asset classes rising then the PP as a whole will suffer. Look at the Japanese PP from 1991-1999; over this period LT bonds did amazingly well overall but that one volatile asset class rising (while cash went to zero or near zero rates and so didn't help much) while the other two volatile assets of stocks and gold declined was barely enough to tread water in real inflation/deflation adjusted terms, much less provide any actual gains.

The Japanese DID have a "secret weapon" in the form of something that was like our savings bond (rates fall and you still are locked in getting good above-inflation/deflation yields; rates rise and you can cash it out for no loss) but even better and I'm surprised no one has (AFAIK) mentioned it yet. This could have given 6% returns on their cash until 2001 instead of 0% returns. For a Japanese PP investor who did not take advantage of this secret weapon, though, the 90s was grim.

Oh, and while we're on the subject of Japan, the "conventional wisdom" may have been that rates in 2000 in the US were as low as they could go but anyone who in 2000 had studied Japan for the past decade and understood the IS-LM model and liquidity traps (I'm think of Krugman and those who followed his work) knew that rates could go a LOT lower. For that matter, wouldn't anyone who had bought a house in the late 40s or early 50s with a 4% or less mortgage know that rates could still fall lower than they were in 2000 (since that person should remember how low rates were when they bought their first house)?

I am willing to accept that you (and craigr) might be right and the PP could continue to provide decent gains in an environment of strongly rising rates...but I just can't see how such can happen (unless it is by a sharp rise in rates that hurts everything besides cash/STTs and then rates fall again back to 2011 or even 2003 lows and everything rises again after being "re-set" by the rate rise and PP's get to take advantage of this because they rebalanced out of cash into the losing assets). I would like to see someone post a hypothetical chart for the next ten to twelve years showing how with rates that gradually rise (say maybe to the near 7% of 1969 or the 6.6% of 2000, not even considering the 18% of 1981) over those years, gold losing it's usual 6% real, and LTTs doing what they do best (fall) when interest rates rise (especially when starting from such a low point...for bonds, convexity is like leverage...great on the upside but a bear when rates rise from intergenerational lows) and stocks doing what they did (or less than what they did) on average in the 1950-67 or 1982-99 bull market. I'm not saying it's impossible, but I'm not seeing how it's possible either. The PP might "not take it all in stride" but rather take it in the shorts.

[craigr]

I would like to see someone post a hypothetical chart for the next ten to twelve years showing how with rates that gradually rise (say maybe to the near 7% of 1969 or the 6.6% of 2000, not even considering the 18% of 1981) over those years, gold losing it's usual 6% real, and LTTs doing what they do best (fall) when interest rates rise (especially when starting from such a low point...for bonds, convexity is like leverage...great on the upside but a bear when rates rise from intergenerational lows) and stocks doing what they did (or less than what they did) on average in the 1950-67 or 1982-99 bull market. I'm not saying it's impossible, but I'm not seeing how it's possible either. The PP might "not take it all in stride" but rather take it in the shorts.

Such a chart would have so many unprovable assumptions that it wouldn't really tell you anything. I've seen people post out 30 year market projections. The idea is just impossible. The number of variables and permutations to make such assumptions is impossible to fathom. I've not seen anyone model the markets reliably for even a week. So the idea of taking it out years is just not realistic. It's like the academics that talk about "expected" returns and then discuss why someone should own a lot of stocks. Well their expectations were completely wrong the last 10 years and definitely in Japan they've been wrong for almost a generation!

[D1984]

As regards the 40% 1-5 year ladder and 10% EDV instead of 25/25 STTs and coupon-bearing LTTs idea: I tried a backtest of that (well, sort of...I used 37.5% STTs and 12.5% zeros) from 1952-67 (the years I was concerned about the PP underperforming); it added about 17-18 basis points overall (to the whole PP for 52-67). Not bad and a good idea if you want to "tilt" your Treasuries in the PP instead of a pure barbell but it doesn't come close to turning a 2% overall real return for the whole PP into the 4-5% real returns that it has delivered from 1972-2011.

Since 1928, the PP has returned 3.5% real CAGR.  Willing the real return be higher when gold came off the peg within the last 40 years and LT bonds reverted back to the long-term historical average over the past 30 years is probably a one off occurence.

the PP but how else can cash be made as volatile on the upside (rising rates) as LTTs are when rates fall? If you (or anyone else) have another idea that can make cash gain 15-20% a year in a rising rate environment like LTTs can when rates fall I'd love to hear it.

Instead of outsized/leveraged risky cash gains in a rising rate environment on a base of 25% cash, use reallocation to increase the cash base while earning normal safe gains concurrently with less loss drag from the relatively smaller other three assets.  There will be a sweet spot where the $ gain of both scenarios match.  Quick $100K example: 25K @ 15% = $3750 - $15K (20% loss drag) == 62.5K @ 6% = $3750 - $7.5K (20% loss drag).  Okay that doesn't exactly balance out because of the drag, but it should give the general idea.

ribbons in real terms. If we do have non-inflationary prosperity at some point in the near future then stocks should do very well (maybe 16-20% a year) but which asset is going to be the one that from current low rates gives 6-8% real yields (like stocks did in the late 1970s) to help stocks compensate for falling LTTs and falling gold? Inquiring minds want to know.

Unlike the 1970's, stocks are not undervalued currently, so it would be foolish to expect near returns like that going forward unless we first have a gold bubble and bond bear that precipitates another Volcker-style deflationary event.  The Fed cannot raise short term rates without provoking unproductive inflation because it is at such a low nominal rate on such a huge monetary base.  Any move in short term rates upwards will skyrocket the velocity of money as everyone plays hot potato.  It doesn't seem like we're anywhere near that scenario yet, but it is a huge concern to have three bubblelike assets concurrently with cash to pick up the loss drag if they all pop simultaneously.  It's all a question of timing.  I, for one, don't believe the PP has been yet battle tested under such a scenario.  1981 would have been disastrous if stocks were also overvalued rather than despised.

My personal solution, also despised, is to rely on tactical allocation and reduce exposure during regimes where things are, indeed, in a bubble.  But, it has costs of tracking error to the regular PP.  No one can say whether it will be superior or worse because there simply is not enough history available to backtest it.  But, I can sleep better at night not worrying about a 50% real drawdown in a 1981-style triple bubble event or 20-years of real underperformance.

MG

MG, I don't doubt that the PP could very easily return less than 4-5% real over the next 10, 20, or 30 years. I was actually agreeing with you and warning anyone who had come to "expect" 4-5% real gains that just because we saw them from 1972-2011 doesn't mean that they are going to happen again. After all, if the PP's real CAGR is 3.5% over the very long term and we've had say 4.7% over the last 40 years then doesn't the law of averages mean that we eventually have to have sub-3.5% returns to make up for it? The PP is good but holding one doesn't make n investor immune to the basic laws of mathematics.

I am not sure what you are talking about by "increasing the cash base." If you are talking about simply holding more cash and less of the volatile assets I already tried that and it actually made real returns worse for 1950-67 (and probably would do so for any period when cash or STTs barely beat or merely paced inflation-and that's before even thinking about taxes-while rates simultaneously rose and gold fell). If you mean writing vanilla swaps on a larger notional base (say regular fixed-for-floating on a $60K base instead of a turbo swap on a $25K base) then that might work. You also mentioned 6% yields on the $62.5K....I assure you if cash returned 6% nominal consistently when inflation was 2 or 3% then I wouldn't even be thinking about swaps; the issue is that it historically very rarely has except for certain periods in the 80s and 90s. Cash/STTs typically return inflation plus maybe 1% (from 1950-67 they returned almost exactly that).

Finally, you are right that the PP has never been "battle-tested" when all three volatile assets fall hard at once; the closest I can think of would be Japan in 1990 or the US when the Fed tightened the money supply and FDR cut deficit spending and raised taxes  in 1937 (the gold price was fixed then but if you use platinum, silver, or commodities in lieu of it then the PP still loses money). Suffice it to say that in both cases the situation was not exactly wonderful for the PP.

[MediumTex]

D1984,

Another great post above.  Thanks.

What if your post had been written at the end of 2008?  Weren't all of the same conditions present at the end of 2011 present at the end of 2008 with respect to the PP's assets (i.e., LT bonds yields under 3%, gold looking expensive, stocks sideways for 10+ years)?

See what the PP did in 2009, 2010, and 2011?  Does that answer your question about how the PP can do well when you start off with LT bond yields under 3%, expensive gold and a sideways stock market?

[moda0306]

I'd add that having the world's reserve currency and largest economy makes the PP work considerably better for us than it did for Japan.

Gold cared a lot more about the disinflationary prosperity that the US was seeing during the 1990's than it did about the economic woes of Japan during that same period.  If the world would have been suffering like Japan, you can bet gold would have reacted more favorably, despite gold not being the world's best deflation hedge.

[D1984]

MediumTex, the end of 2008 was a little different. The PE10 on equities was about 15 then. It's almost 21 now. Another measure (if you don't like the PE10) of how "cheap" or "expensive" stocks are is total market capitalization vs size of the US economy (i.e. total US GDP). On January 1st 2009 this ratio (even with our recession-scarred economy)was MUCH lower than it is now. The economy may have caught a cold but the market had caught pneumonia....total market cap had shrunk much more than the economy had. Stocks have returned about 14.4% a year since then and are no longer as cheap as a result.

Gold has averaged almost 22% for the three years from  2009 to 2011. Maybe it will continue this or maybe it won't but if gold was expensive then it is really expensive now.

LT bonds have just moved up and down based on yields so you are correct that the LT bonds are at about where they were in January 2009.  They are the only volatile PP asset that hasn't (by itself) enjoyed on average historically oversize returns from 2009 to the present (note that I said "on average".....34% per year like 2011 was very historically oversize).

So basically all we need is for stocks (in the face of a possible recession here and Europe still not getting itself in order) to continue providing a real return of 10-11% vs 6% historically and gold to continue to grow at 22% a year even though it's almost twice as expensive (on January 18th 2011) as it was in late 2008/early 2009 in order to help offset the losses when LTTs fall and to provide rebalancing ammo to get back into them via our rebalance bands before they rise.

Yep...that works just right. Makes perfect sense. Umm....ever hear of Stein's Law?

Sorry if I seemed a little snarky or sarcastic in the sentence above but at some point fundamentals do have to come into play (what was that about the market being a popularity contest in the short run and a weighing machine in the long one?).

Let's just say that for the sake of argument, though, that gold and stocks actually continue to provide outsized returns like the ones above for the next three or four years and bonds continue to gyrate from 3% to maybe 4.5% and back. What happens then? The spring has just been wound even tighter for when the assets finally DO fall (and what if they fall together...stocks will be left to take up the slack almost by themselves if bonds rise in yield and gold crashes; if stocks fall again and gold falls with them-an unusual combination not seen much outside Japan's deflation but it could happen-then bonds will have to take up the slack and yields will have to fall to Japanese levels for them to offset TWO falling assets...and even in Japan that didn't work too well; if bonds and stocks crash together-who knows why...maybe due to stagflation or rising rates or another cost push inflation inducing external supply shock-then gold will have to rise from its already high levels to rescue the PP; it did so during the 70s but from an inflation adjusted $230 an ounce rising 23% or more a year for five or ten years is easier than from $1640 an ounce). The PP assets aren't bad together but even they have to revert to the median at some point.

I get the feeling that you believe that it is highly unlikely for two volatile PP assets together to fall appreciably for any length of time but that if they do the other volatile asset will more than offset them. I don't. I'm not saying that such a sequence of returns is impossible but until we've seen the PP successfully navigate

A. a period of disinflationary or non-inflationary prosperity where rates rose over a decade or more,

and

B. two assets falling hard together for a number of years-say seven or eight-when NOT cushioned by another asset that was coming off a controlled price,

I'm not betting everything on the PP

[craigr]

I'm not betting everything on the PP

So what is your strategy to deal with the possibilities you think are coming?

[MediumTex]

D1984,

All good points.

Is there another investment allocation that you think might weather the conditions you are concerned about better than the PP?

As far as 2012 goes, here are my predictions (I should put them in the predictions thread, but I'll put them here for now):

Cash - 0%
Stocks - 7%
Gold - 17%
LT Bonds - (3%)

(Note that I am only predicting that gold will end 2012 a little higher than its 2011 highs.)

This should provide a return of 5.25% or so for the year (without including dividends).  The PP has rarely provided three consecutive years of double digit returns, so I would expect a single digit year at some point.

[D1984]

I'm not betting everything on the PP

So what is your strategy to deal with the possibilities you think are coming?

Craig (and MT, since the following will as well answer your question about investment allocation, I don't think they are coming....I don't necessarily think they're not coming either. Anything could happen. My concern is that IF any of the two conditions that this thread was about....either non-inflationary prosperity with rising rates like the 50s and 60s instead of falling rates like the 80s and 90s, or two or more of the PP's volatile assets reaching bubble territory and then crashing down hard together (this was actually MachineGhost's point of concern with the PP at first and not mine but he gave me something else to worry about...thanks MG  ) do come to pass, the PP will be ill-equipped to handle them without a hefty dose of upside volatility in its 25% cash portion.

Unless there is some way for an investor with maybe a few hundred grand or two to cheaply do fixed-for-floating swaps I will probably just continue to do what I do now. I am in about 40% PP (most of my cash is in bank accounts and not Treasuries, though) and another 40% in an SCV FTM (once I have more than $100K or so in the latter I may switch to DFA funds through Assetbuilder-it's the cheapest non-annuity DFA source I know of for anyone with less than about $250K) with a twist; said twist is to somewhat minimize tracking error vs the TSM or S&P 500; I'll be glad to share more about it-if you want but given that it can involve actively managed funds, leveraged 2X funds, and maybe even what some would call sector bets it's probably heresy to both Swedroe-type Bogleheads and to PP'ers. You will be happy to hear (and MachineGhost won't  ) that it at least doesn't involve market timing.

MT,

If the PP does provide another year of double-digit returns will you start getting a little worried about some of the prices/values the assets are reaching? Wasn't the only sequence of three double-digit years in a row followed by 1981 and the 14-15% real inflation adjusted loss?

[MediumTex]

MT,

If the PP does provide another year of double-digit returns will you start getting a little worried about some of the prices/values the assets are reaching? Wasn't the only sequence of three double-digit years in a row followed by 1981 and the 14-15% real inflation adjusted loss?

Probably not.

I'll just take what it gives.

It's given me enough the last few years that I can give a little back if I need to.

[stone]

D1984, if we now get sustained above inflation interest rates it will be a real eye opener for me. Are you envisioning a change in the legal framework of the federal reserve in order to make it operationally possible for them to create those interest rates? AFAIK the Fed has to pay for the interest it pays banks for parking reserves at the fed using the interest that the Fed earns from the treasuries it holds. Those treasuries are current day treasuries that the Fed bought during QE. They simply don't have much cash flow with which to pay out interest on reserves. So they are left with the alternative of selling their stock of treasuries to try and reverse QE and hoover back all of those bank reserves that they spewed out during QE. If they are trying successfully to raise rates, that will mean that the Fed will see a fall in the value of the treasuries they hold and hope to sell to get back the bank reserves. Basically any which way it doesn't add up. The Fed is set on a ratchet. The only way would be for congress to decide to "bail out the Fed" by selling treasuries expressly in order to raise funds to pay to the Fed to cover the Fed's losses as it sells its treasuries. Even then with the high rates being paid on the massive government debt, the problem would be on going because the interest payments would be spewing out more and more bank reserves.

The only way to make it realistic would be to tax significantly more than the government spent including the amount the government spent on interest payments. That tax would also have to be directed at those who held money or held assets that they would sell to get money to pay the tax.

So basically you are envisioning that Ron Paul or someone like that appoints a Fed chairman who wants to set high rates. Ron Paul then bails out the Fed and soaks the rich

I suppose the other way would be for Ron Paul to make the USA join the Euro .

It seems to me more plausible to imagine that the glut of bank reserves we have will compete the expected long term returns of ALL assets down to zero whilst increasing the volatility of all asset prices. Then the PP might still do fine but all of the returns will be the rebalancing bonus as prices dart hither and thither like a rabbit in head lights.

[stone]

I guess the PP assets often see gains not from "economic conditions" really changing but rather from changes in expectations of what "economic conditions" might do shortly. Might the turbo swap idea not be able to tap into such irrational shifts in temperament? Because the turbo swops aren't something liquidly trading would they only gain if rates really rose rather than if the market simply got the fear that they would?

Might borrowing in South African Rand in order to buy the cash part of the (corrupted) PP be a route to "volatile cash". South African Rand would do very badly if gold hit a bear market and relative to the USD would do very badly if USD rates rise. Perhaps Australian dollar or some other gold producing country might diversify that but South African currency is the most gold effected one isn't it?

[stone]

I really think this whole thing revolves around the fact that all of the monetary base out there has to be held by someone all of the time. The only way it can be got rid of is by taxation or by selling treasuries (that themselves spew out more monetary base as interest). When Volker did his rate hike there was MASSIVELY less monetary base for him to deal with. To get things back to like they were for Volker there would have to be trillions of USD in taxation directed at the 0.1%.

The other dynamic in play is that the finance industry uses volatility capture to gather money using their money much as we do with the PP. As fast as they do that, the government compensates by replacing whatever gets gathered with deficit spending so as to avoid a depression without resorting to taxing the rich. Basically the headwind against a Volker rate rise seems a full on hurricane.

[Lone Wolf]

I really think this whole thing revolves around the fact that all of the monetary base out there has to be held by someone all of the time. The only way it can be got rid of is by taxation or by selling treasuries (that themselves spew out more monetary base as interest).

Taxation doesn't shrink the monetary base.  The government (happily) spends the money that it collects in taxes and it continues to circulate in the economy.

[stone]

Taxation doesn't shrink the monetary base.  The government (happily) spends the money that it collects in taxes and it continues to circulate in the economy.

Net taxation over and above government spending does shrink the monetary base. The Clinton surpluses were an example of that. I realise how exceptional that is and that is why I was saying we need to face up to the amount of monetary base there is before leaping to ideas that "rates must go up".

[moda0306]

Spending is often decided completely independent of tax receipts... and almost completely independent of the spending bill to begin with!!

Think of all the programs that spend based on a calculation that may change:

Social Security
Medicare
Medicaid
Unemployment

Outside of military, that's the vast majority of what our gov't spends money on.  It's not pre-decided what we spend on these programs... in fact, the last two are almost pre-designed to be counter-cyclical... aka, paying out when very little taxes are being collected.

[Lone Wolf]

Net taxation over and above government spending does shrink the monetary base. The Clinton surpluses were an example of that.

The monetary base is driven by the Federal Reserve.  Otherwise you'd find evidence that the "Clinton surplus" effected the monetary base on this chart.

Note that the "surplus" was only a decrease in debt held by the public, not total debt (which still increased.)  We haven't experienced a true "surplus" in many, many decades.

I certainly do agree that taxation is a major drag on the real economy, of course.

[moda0306]

LW,

If the monetary base is driven by the fed, because (like we've discussed), you're assuming that the treasury has to issue debt to spend, then by logical extension, if the fed will ensure all bond auctions are successful as part of their mandate of a stable monetary system, then really they are just a tool of the treasury.

This leaves all the power to the treasury to spend as much as it wants, because the fed HAS to make sure the auctions are successful.

And since it's the treasury, not the fed, that can actually fundamentally change the balance sheets and cash-flows of Americans, then it's much more useful to look at what the treasury does to determine whether people are sitting on too much net fiat purchasing power in their balance sheets, and the fed as the "janitor" that makes sure they don't leave too much of a mess in their wake.

[stone]

LW, the Fed can create monetary base by buying assets. The Fed can mop up monetary base by selling assets that they were holding. The treasury can mop up monetary base by selling treasuries. The treasury can mop up monetary base by taxation. I guess you're right,  when the Clinton surpluses occured, the treasury offset the excess taxation by selling fewer treasuries and so reducing the debt in the form of treasuries rather than reducing the monetary base.

All of this still leaves us with the conundrum of how COULD a Volker style rate hike be operationally enacted even if for whatever reason they wanted to? Wouldn't it entail both massive surplus taxation over and above spending AND issuing of treasuries?

[clacy]

I can count on one hand how many politicians that I would trust to not spend every single cent they collect, plus borrow an additional $.40 on the dollar to boot.