How asymmetric information, price discrimination and the stories we tell ourselves contribute to artificial profits and income inequality. Thanks to CNote for sponsoring today's episode.[0:20] Rents, overpayments, and income inequality are all side effects of market distortions[8:55] Value-based pricing vs pricing based solely on cost[17:13] Pricing is inextricably tied to the stories we tell about ourselves and to others[22:30] Consumers need to consider these 4 things when evaluating the cost of goods and services
How the Great Financial Crisis changed how individuals and institutions invest, and why we shouldn't invest solely focused on the next crisis. Thanks to CNote for sponsoring today's episode.[0:40] Overview of how the 2008 financial crisis continues to impact investing today[6:48] Data on current investments and the stock market[8:40] How you invest depends on your experience in the 2008 crisis[11:41] Future investing is enveloped in big questions and unknown variables[16:10] The great financial crisis impacted both individuals and institutions[19:58] Should you invest in preparation mode for the next crisis?[26:00] Invest smartly by separating speculations from investments[28:40] Consider this when investing and thinking about the future of the market
How to evaluate cash savings options at banks, credit unions and brokerage firms. Why are yields on cash savings so much higher than a few years ago. How to tell if your bank or credit union is in experiencing financial difficulties. Thank you to Blinkist for sponsoring this week's episode.
[0:10] All about banks, credit unions, and the pros and cons of cash savings
[4:47] How can banks and credit unions become financially unstable?
[14:25] The Federal Reserve is setting a new short term interest rate target
[15:55] What tools does the Federal Reserve have to keep short-term interest rates in line with its target?
[19:20] There are other options for investing your cash savings
[25:49] Is it really worth pursuing multiple investing options for your cash savings?
How fewer publicly traded companies, less stock shares outstanding and more intangible assets have led to higher earnings growth for U.S. listed companies and ultimately stronger stock market performance. Thanks to Circle Invest for sponsoring today's episode.
[0:08] Observations on the current state of the US stock market
[4:01] What if there’s something going on within the US market that suggests continued outperformance is coming?
[7:23] Why the number of publicly listed companies, particularly small companies, is shrinking
[14:52] The impact of intangible assets within small companies
[18:21] Increased amounts of buybacks are leading to a shrinking stock market
[20:38] Multiple factors are contributing to higher shareholder profits, yet lower wages for employees
[26:05] What are the investment implications of low wages due to monsopony?
What are the headwinds facing China that could slow economic growth, but still could lead to China growing faster than the U.S. Also, what is going on with Turkey and are other emerging market countries vulnerable to the same plight? Thanks to Circle Invest for sponsoring today's episode.
[1:07] Is China or the US more vulnerable to economic downturn?
[4:55] Why have emerging markets done so poorly recently?
[8:51] The concept of balance of payment is reviewed and examined in a case study of Turkey
[16:20] Emerging markets are doing better than in previous years
[20:35] The 3 reasons why China is more vulnerable than the US
[22:25] What China has to do in order for their economy to continue growing quickly
Which rebalancing strategy is best or should we even bother rebalancing? Should we just exit stocks completely, especially given how overvalued the U.S. stock market it is? And why do companies split their stocks? In this episode, we answer these and other listener questions.
Why peer-to-peer lending on platforms like Lending Club and Upstart is no place for individuals to invest given higher defaults, lower returns and competition from institutional investors.
Thanks to Circle Invest for sponsoring today's episode.
[1:04] There are a lot of issues going on with the global P2P lending market
[5:34] How the P2P lending environment has changed over the past few years
[11:24] Why advertised returns are higher than actual returns
[15:35] How are these P2P lending platforms surviving?
[21:26] How these 3 credit enhancements impact the P2P lending market
[25:51] Individual investors don’t do as well in P2P lending environments - here’s why
[30:00] Here’s the bottom line on why you should avoid P2P lending investments
Will stagflation cause the dollar to crash and be a bottomless pit when the next recession hits? That is what Peter Schiff is predicting. We look at where he is right and where he seems to be off the mark when it comes to the U.S. economy and a dollar collapse. Thanks to Haven Life and Wunder Capital for sponsoring today's episode.
[0:33] Is a dollar collapse imminent?
[3:07] Economic expansions don’t die of old age
[5:22] How tariffs and imports impact the US economy
[10:44] If the dollar has to crash, it does so relative to other currencies
[14:01] The relationship between the Federal Reserve and interest rates
[19:11] Bank deposits, savings, loans, and interest rates all contribute to the US economy today
[24:29] The relationship between money supply and inflation is essential to understand
[33:08] Why David doesn’t believe a dollar crash and economic ruin are on the horizon
How the foreign exchange market works and how George Soros made more than a $1 billion shorting the British pound in 1992. Why currency trading today is more like gambling than when Soros made his billions. Why trading closed end funds can be more profitable than currency trading. Thanks to Wunder Capital and Blooom for sponsoring todays' episode. Use code DAVID on Blooom for your first month free.
[0:35] David introduces the listener question for this episode, “Should You Trade Foreign Currencies?”
[2:24] Why David would never invest in Forex strategies
[6:56] How trading works on platforms such as Darwinex
[8:43] Investing through trading currencies is like gambling
[11:40] The George Soros story and how governments can balance the economy through interest rate control
[24:20] Betting against the exchange rate of foreign currencies isn’t reliable
[27:50] The benefits of investing in closed-end fund markets
How health insurance isn't really protection against a catastrophic illness but prepayment of routine healthcare consumption, leading to overconsumption of healthcare and over treatment by medical professionals that drive up costs. What would it take to reform the health insurance marketplace so it is more fair and functions more like life insurance or homeowners insurance. Show notes and links can be found here. Thanks to Circle Invest for sponsoring today's episode.
How a complex global trade system has reduced poverty, raised incomes, increased productivity, and lowered prices while a trade war will reverse those trends. You can find show notes and links here. Thanks to Blooom and Wunder Capital for sponsoring this episode.
President Trump recently unveiled new tariffs on trade with China, and many fear this decision could lead to a trade war. This 25% tariff on $34 billion worth of Chinese imports into the U.S. and an additional $216 billion of announced tariffs will change the trade landscape in the coming months. On this episode of Money For the Rest of Us, David explains why trade wars tend to increase the prices of goods and the poverty rate. He discusses the consequences attached to global trade tariff decisions and outlines why healthy global trade is successful in reducing poverty. To hear informed information about the complexities of tariffs and global trade, be sure to give this episode your full attention.
Why does the US run such a large trade deficit with China?
In 2017, China exported over $500 billion worth of goods to the US. In that same year, the US exported $130 billion to China, resulting in a trade deficit of $375 billion. Why is this figure so high? There are three main reasons why the US has such a large trade deficit with China:China has a lower standard of living and pays workers lower wagesTechnology and the internet has reduced the risk to US businesses when importing from ChinaAt times, the Chinese yuan is too weak relative to the US dollar
Healthy global trade reduces poverty - here’s why
Countless economists and writers have examined why healthy global trade reduces poverty. In 1981, the percentage of the world’s population living in extreme poverty was holding at 42%. Since then, the number of people living at that level of income has fallen by 1 billion. And in 2013, the most accurate data puts the world’s population living in extreme poverty was 10%. This figure has fallen so dramatically because of trade, specifically because China has significantly ramped up its manufacturing capabilities and exports, increasing household income through higher wages.
From 1820 to 1920, in Great Britain the percentage of the population in extreme poverty fell from 40% down to 10% from the 1820s to 1920s. From 1870 to 1970, Japan did the same - taking their poverty population from 80% down to nearly 0%. China is on course to reduce extreme poverty even faster. To hear more about the relationship between poverty and trade, don’t miss this episode of Money For the Rest of Us.
Global tariffs can lead to unintended consequences
Trends show that both the US and China are wealthier because of trade. However, trade wars have the power to reverse those trends and increase the level of global poverty once more. There are 2 types of unintended consequences: those that are positive and natural, and those that are negative and disruptive. Positive consequences include developing powerful and beneficial global relationships between countries producing various goods. However negative consequences could destroy a complicated global supply network that has been slowly built, year by year, into the powerhouse that it is today.
Companies and industries are adaptable when tariffs are imposed. However, there’s only so much flexibility a company can handle before having to make sacrifices. Moving production facilities, cutting wages, or increasing prices when faced with steep tariffs. These consequences should never be overlooked when considering new tariff plans and laws.
Trade wars aren’t the solution to unfair trade practices - but THIS is
Trade wars caused by broad based tariffs are not the solution to unfair trade practices. In order to remain globally competitive and productive, US companies need trade deals that recognize the strength that comes from global operations and supply chains. Trade wars are a complex subject, and this need-to-know info is best understood by listening to this podcast episode. Check it out!
[0:42] The Trump administration's recent tariffs could lead to a trade war, increasing prices and poverty
[2:24] Why does the US run such a huge trade deficit with China?
[6:47] Historical data on tariff rates across the decades
[8:38] Trade reduces poverty - here’s why!
[11:12] Measuring the wealth of a nation is important in the trade wars discussion
[15:51] Reducing trade deficits cannot be solved through trade wars
[19:08] There are 2 types of unintended consequences
[23:30] Companies will adapt to trade tariffs, no matter the circumstances
[28:24] Broad-brush trade barriers don’t work!
[33:40] So what is the solution to unfair trade practice?
Why housing bubbles can last such a long time and what to do if you really want or need to buy a house in a frothy market. More information, including show notes, can be found here.
Navigating a housing bubble is often on everyone’s minds. With changing family needs, balancing multiple incomes, and varying environmental factors, finding a great house is a struggle most families face. On this episode of Money For the Rest of Us, David responds to a listener’s question of how to navigate a housing bubble. He explains the idea of “economic gravity,” outlines factors that are influencing the global housing market, and offers solutions to the housing bubble crisis.
A housing bubble cannot break free from economic gravity
David discusses the idea of “economic gravity” on this episode. Simply, over the long-term housing prices can't be disconnected from the ability of households to service a level of mortgage debt - to successfully make those payments every month. Nobel prize-winning economist Milton Friedman explains, “When (corporate) earnings are exceptionally high, they don’t just keep booming - they can’t break loose from economic gravity.” The same concept applies to home prices. When prices are high, they can boom for an exceptionally long time. But they cannot break free from this underlying economic concept.
Factors that are driving up the global housing market
Housing bubbles are being created across the globe because of a few major factors. Low interest rates, offshore demand for domestic property, influxes in immigration, and interest only loans are all contributing factors to the housing bubble discussed in this episode of Money for the Rest of Us. David draws many parallels between the US housing market and those in Australia and Canada.
Housing markets don’t always align with growing family needs
Joe, the Money For the Rest of Us listener that submitted the question for this episode, is seeking different housing for his family as it grows and shifts. But he’s finding that unfortunately, housing markets don’t always align with growing family needs. Better school districts, larger homes, easier commutes, etc. are all factors that millions of Americans are seeking for their prospective homes. David encourages listeners to consider what type of housing their family can reasonably afford and still maintain the type of lifestyle they desire. You never want to purchase a house that you cannot comfortably afford. To hear more about the housing market in the US today, data on current housing prices across the country, and even more great information, don’t miss this episode.
3 ways you can respond to rising house prices
After considering all the data related to the housing bubble and overall market in your area, you essentially have 3 options:You can stay putYou can move to a cheaper localeYou can buy, while being patient and prudent
In order to make the most of the housing opportunities for your family, David encourages every listener to consider their personal affordability and examine their ability to handle unforeseen financial stress (loss of a job, medical emergencies, etc.) Navigating a housing bubble is challenging, but this episode of Money For the Rest of Us can help you make sense of all the angles. Be sure to listen.
[1:05] A listener poses a question about how to handle a housing bubble in his area
[6:47] Current data on the American and international housing bubbles
[10:02] Is the current housing bubble starting to break?
[10:57] What factors are driving the home prices in Australia, for example?
[12:41] Comparing the Canadian housing bubble to Australia’s
[15:45] So what should you do during a housing bubble?
[18:09] Housing markets don’t always align with growing family needs
[21:36] How to combat the factors driving up housing prices
Why fair markets require uncertainty for both the buyer and the seller, and why sellers don't need to disclose everything they know to the buyer. More information, including show notes, can be found here. Thanks to Wunder Capital for sponsoring this week's episode.
A recent listener of the Money For the Rest of Us podcast posed the question, “Are there always winners and losers when trading?” This question is the focus of this episode of the podcast. David explains an age-old thought experiment created by Cicero and how it relates to modern financial decision making. The key differences between concealing and simply not revealing information are discussed and how trading decisions can be ethical for all involved. David also explains how high-frequency trading bots exist outside the parameters of conscious decision making and how they can impact market volatility. It’s an episode full of great insights and should not be missed, so be sure to listen.
There’s a key difference between concealing and not revealing information
In Cicero’s thought experiment, there is a grain seller that has imported foreign goods during a period of domestic hardship. Is the seller required to disclose information of additional shipments coming into the market soon? Or is he able to sell his stores at a higher price, without telling the buyers what he knows? David explains that technically it would be an ethical sale since there’s not a defect in the grain he’s selling. The seller isn’t concealing critical information, he’s simply using the current market conditions to his benefit. To hear David’s full summary of this scenario, be sure to listen to this episode.
The outcome of a transaction should be unknown for all parties involved in order to be ethical
Simply put, the outcome for any transaction must be equally unknown to all parties involved in order to be considered ethical. David explains by saying, “If they (buyers and sellers) go in not knowing exactly what's going to happen, and there isn't a defect that is being concealed, then that's just how markets work.”
These schools of thought differ between normal commerce and financial markets
In normal commerce, where a buyer purchases a product from a seller at a specific price point, there is an exchange of currency and value. The buyer loses money but gains function and value from the product. The seller reaps financial benefits from the transaction. Even if the seller then drops the price, it’s ethical because there wasn’t a defect in the product at the original price point. For financial markets, there generally will be a winner and loser because the price WILL change. The key is both buyers and sellers go into the transaction with a level of uncertainty.
How could high-frequency trading bots influence market volatility?
In this episode of Money For the Rest of Us, David also explains how high-frequency trading bots can increase market volatility, or the level of risk involved in transactions. Human traders have a point of view, a position, and a set of moral ethics. Bots based on algorithms do not. That’s why when “shocks of unknown origin” crop up in the market, most bots will simply sell or back out entirely. This can result in a negative feedback loop leading to even less liquidity from high-frequency traders and multiple flash crashes. David says that “There is a risk of higher volatility because here markets have changed. Most trading in stocks is no longer an investor with a fundamental view. It's an algorithm, and we could have more downside when the next bear market comes along.”
[0:44] Discussing the idea of “winners and losers” in investing and financial markets
[4:45] Is full market disclosure recommended? Is keeping some information private immoral?
[10:35] The difference between concealing and not revealing information
[13:17] This is why laws come and go, but ethics stay
[16:04] The outcome of a transaction should be unknown for all parties involved in order to be ethical
[19:10] Why could high-frequency traders (bots) increase market volatility?
[24:33] The difference between value and knowledge in normal commerce and financial markets
Is it worth investing outside your home country given the risk? Should you hedge currency risk? What is the impact of Chinese "A" share listed companies being added to emerging market indices. More information, including show notes, can be found here.
Should you be investing internationally? What are the benefits to having foreign stocks in your portfolio? Do the currency risks outweigh potential returns? On this episode of Money For the Rest of Us David considers these questions and more. Comparing different markets, understanding expected stock return projections, the benefits of hedging international stocks, and more are covered on this insightful episode – be sure to listen!
Why would anyone WANT to pursue investing internationally?
Many investors focus solely on domestic markets. Why? Because it’s familiar! They know historical market patterns and there’s no currency risk. Why then should you consider investing internationally? There’s one main reason – because your returns could be higher! To hear why investors are branching out into foreign markets, and some considerations you need to understand before taking the leap, be sure to listen to this episode.
This is why you can’t simply compare one country’s market to the next
When comparing international markets it’s essential to remember that you have to understand their differences in terms of sectors. For example, the US market is comprised of 26% tech stocks, while the world ex-US contains only 6.5% tech. The tech sector and its percentages in varying global markets is only one example why comparisons cannot be made simply. If you adjust your research to accommodate varying sector percentages, you can start to get an idea of which markets are more expensive than others – but these numbers are never set in stone.
Should you invest in hedged international stocks?
If you choose to invest internationally, should you hedge those investments? Hedging international investments can remove the currency exchange risk. Many investors find success in partially hedging their portfolios. It can reduce the amount of volatility associated with currency rate swings. However, in some market conditions, it can actually reduce your returns. For more information on the pros and cons of hedging while investing internationally, be sure to listen to this episode of Money For the Rest of Us.
Yes, there is risk in investing internationally – but there is opportunity as well!
No matter how much research you do before investing, there will always be risks involved. Any investing market, domestic or international, carries currency, political, and human factor risks. Just because one market has dominated in the past does NOT mean it will continue to prosper. No matter in which markets you choose to invest, always remember that diversification is key, timing is everything, and risk management is essential.
[0:45] Should you even bother owning international stocks?
[3:50] The importance of questioning our underlying assumptions
[8:24] There’s only one reason why you should invest outside of the US market
[9:06] How investing internationally affects the 3 drivers of asset class performance
[11:57] This is why you can’t just simply compare countries’ markets
[14:08] Expectations for stock returns over the next decade
[19:24] The importance of currency exchanges when investing internationally
How a Chinese ban and careless recycling habits by households and businesses led to a market collapse in recyclables. More information, including show notes, can be found here.
The biggest market crash facing the United States today isn’t entirely economic in nature. It’s actually surrounding the idea of recycling and recyclable goods. Recycling is a service that most communities require and demand. But is it economical? Why has the market crashed in recent months? What are the solutions? This episode of Money For the Rest of Us will answer all that and more, so be sure to listen.
What are the current values of recyclables, given the market crash?
Most types of recyclable products have fallen steeply in price. Mixed paper prices have fallen 98% in the past year. Corrugated cardboard has fallen 48% and plastics ranked 1 to 7 have fallen 78%. Co-mingled plastics, aluminum, and steel have been holding steady or even increasing, however, the vast majority of recyclables aren’t bringing in the high returns they used to. In areas such as the Pacific Northwest, you even have to pay a company to take it off your hands. What changed? Be sure to listen to this episode to find out.
What has caused this massive market crash?
The biggest influencer in the recyclables market crash was China’s decision in January 2018 to ban imports of 24 different types of recyclable materials. Americans recycle 66 million tons of material each year, and much of this material used to be sent overseas to be sorted, cleaned, and processed. However recyclable exports to China fell 35% in the first 2 months after the ban, and future rates aren’t looking favorable. Now, all of this recyclable material has nowhere to go. To get the full story behind the China ban and how it impacts the US recycling industry, be sure to catch the full audio for this episode.
The 5 main ways we can improve our recycling habits
To solve the market crash issue, Americans need to rethink their recycling habits. The problem with “aspirational recycling,” or thinking everything can be recycled just because we want it to, is a contributing factor to this complex issue. 5 ways to combat the recyclable market crash and current mindset about recycling are featured on this episode of Money For the Rest of Us. Here they are:
Understand that recycling isn’t going away
Consider recycling rate stabilization funds
Consider banning certain materials at specific plants to reduce contamination and mixed goods
Revamp educational programs about recycling
Develop recycling markets right here in the US
What’s the real solution to the recycling market crash issue?
Even with all the great strategies discussed on this episode, simply recycling in better ways isn’t enough to solve the true issue. Everyone has to start considering the life cycles of the products we use every day. Changing the way countries around the world handle waste and preventing it from entering our waterways and contaminating our land is the real solution – basic recycling is just a temporary fix to a much larger issue.
[0:42] Why the recycling business is currently crashing and collapsing
[4:28] The current value of recyclables, given the market crash
[8:09] What has caused this crash in recycled goods?
[9:32] The problem with “aspirational recycling”
[14:38] Why we have to do better at recycling
[22:05] The true heart at the of the recyclables market crash issue
Why the mega rich don't have magical investing powers, but there are some investing attributes they possess that we can emulate. More information, including show notes, can be found here.
A new listener of Money For the Rest of Us inspired the question for this episode: how do the mega rich invest? Forbes reports that there are 585 billionaires in the US and most of them utilize a family office/professional management structure. But do they have some magical, secret way of making more money than the general population? Do they become exponentially richer by allocating their money in certain ways? These questions and more are explored on this episode, and it’s one not to be missed.
What are the major differences in how the mega-rich invest?
While the mega-rich, also known as ultra-high net worth individuals, don’t have any secret ways of making exponentially more money than the rest of us, they do invest in different ways. The biggest difference in investment strategies falls within the area of alternative investments such as venture capital, private real estate, energy investments, hedge funds, etc. Ultra-high net worth individuals invest as much as 46% of their portfolios in these areas, which is significantly more than many other investors. The mega-rich also hold more cash, combatting the illiquidity of their alternative investment strategies. These strategies are available to all investors but are more easily accessible to people with more funds at their disposal.
Don’t be fooled, mega-rich investors DO make mistakes
Even though the mega-rich invest in slightly different ways than typical investors, they are liable to make the same mistakes as everyone else. Many ultra high net worth individuals have fallen under the allure of hedge funds, but have generally been disappointed with performance. For example, a study CEM Benchmarking found hedge funds overall have been underperforming customized benchmarks with similar volatility at a rate of 1.3% annually, and they have been since 2000. Returns have also been especially disappointing in the long-short equity space.
Do mega rich investors achieve the same rate of return as typical investors?
Ultra-high net worth investors DO receive the same rate of return as other investors, however, they benefit from compounding. It’s simple math. If you’re able to put more money into a certain type of account that compounds in a beneficial way, you’ll come out on top faster than those who cannot invest as much.
Why the leveraged loan market (i.e. bank loans) is becoming more risky. What are collateralized loan obligations and how do they influence bank loans. Why I will sell my bank loans fund when the economy turns. More information, including show notes, can be found here.
Just as you need to be “bear aware” when traveling in the backcountry, you also need to be aware of the risks and benefits when investing in asset classes such as bank loans. What may seem harmless on the surface could backfire within your portfolios if not treated with the appropriate level of caution and knowledge. On this episode of Money For the Rest of Us, David examines bank loans, also known as floating rate or leverage loans, and the various risks associated with this type of asset class.
What are bank loans and why don’t they have interest rate risk?
Bank loans or leveraged loans represent loans made by banks to non-investment grade companies. They have variable interest rates because the interest paid by the borrower is tied to short-term interest rates that are connected to LIBOR – the world’s most widely-used benchmark for short-term interest rates. For bank loans, as interest rates go up, values don’t go down. Bank loans also hold seniority when it comes to bankruptcy payback.
Bank loans are getting more risky as investors move away from high yield bonds
During the week of May 13-19, 2018 the net inflow to bank loan mutual funds reached $925 million – the largest intake in 55 weeks. The past 11 weeks have also had extremely high levels of bank loan intakes. Comparably, high yield bond funds had $1.3 billion during the same week in May 2018. The increased demand for bank loans from investors and from collateralized loan obligations is pushing up prices for bank loans, lowering their yields. The increased demand is also prompting more issuance. The bank loan market now exceeds $1 trillion – double the amount in 2010.
Protections to those investing in bank loans are lessening
There are more leveraged loans in the system as companies take on more debt. However, lender protections are weakening. Many bank loans are “covenant-light loans,” meaning they don’t have as strong of legal protections for creditors. Bank loans also have more flexibility regarding definitions of default. 82% of all leverage loans were considered covenant lite as of April 2018, compared to 60% in 2015. The lax lending standards should definitely cause investors to pause and consider the risks before investing in the asset class.
Collateralized Loan Obligations
David profiles the characteristics of the largest buyer of bank loans: collateralized loan obligations, also known as CLOs.
[1:02] What are bank loans and why do you need to be “bear aware” of them?
[8:30] The price of bank loans can fall as spreads widen as investors worry about potential defaults
[10:06] What yield are you receiving over LIBOR?
[11:32] There indeed is a strong demand for loans in today’s market
[14:12] High demand for bank loans has led to more issuances, but caution is necessary
[22:38] Collateralized Loan Obligations are the largest purchaser of bank loans
[27:55] A summary of things to look at when considering an asset class
If the Federal Reserve has printed over $2 trillion dollar and given it to banks to lend, why is U.S. inflation still low? More information, including show notes, can be found here.
Many people wonder if the Federal Reserve is really printing money. Varied schools of thought exist behind the value of money, how it gets injected into a country’s economy, and how it impacts the private sector. On this episode of Money For the Rest of Us David offers insights into this complex subject, all while giving you the best information regarding the Federal Reserve, its open market operations, bank reserves, and why we aren’t experiencing hyperinflation. It’s sure to be an educational episode that you don’t want to miss.
Can the Federal Reserve create money without printing it?
The US Federal Reserve is not able to produce physical money in the form of coins or bills. That’s the responsibility of the US Treasury, their Bureau of Engraving and Printing, and the US Mint. The Federal Reserve, however, can “print money” when it purchases U.S. Treasury bonds with money it creates by adding to its member bank reserves.
Kimberly Amadeo, a writer at The Balance, explains this buying/selling of US treasuries by saying, “One of the Fed’s tools is open market operations. The Fed buys Treasuries and other securities from banks and replaces them with credit. All central banks have this unique ability to create credit out of thin air. That’s just like printing money.”
How do banks create money for individual borrowers?
Contrary to what many believe may happen, banks do not transfer money from a different account or withdraw it from a central vault for loans. Rather, David explains that banks “create money out of nothing” and withdraw it when loans are repaid. Thus, excess central bank reserves are not a necessary precondition for a bank to grant credit and therefore create money. Banks typically only have to have 10% of all accounts in reserves. If a bank lacks the reserves to cover the payments, it can be borrowed from an inter-bank market or central bank system.
Why haven’t we seen hyperinflation due to these processes?
The United States hasn’t seen an influx of hyperinflation because the private sector hasn’t been willing to borrow enough funds to strain the current capacity of the economic machine. David further explains the lack of inflation by using the two money aggregates that exist in the US: M1 and M2. M1 is composed of currencies, paper, bills, notes, traveler’s checks, and checking accounts (demand-deposits). M2 is made up of everything in M2 plus savings accounts, CDs, retail money market funds, etc. In March 2009, at the height of the recession, M1 levels were around $1.6 trillion. As of April 2018, the M1 was at $3.7 trillion – a 130% increase! Does this mean households are wealthier? Not necessarily. The majority of them simply have more liquidity, because Treasury Bonds were sold to the Federal Reserve in exchange for checking account deposits.
[1:15] Is the Federal Reserve really printing money?
[6:40] Two ways to address this question
[11:50] So how do individual banks create money for borrowers?
[21:20] Monetary aggregates in the US and how they indicate the level of wealth and liquidity
[23:50] Why hasn’t this led to hyperinflation?
How low real interest rates contribute to low returns for stocks and other risk assets. How real interest rates are determined. More information, including show notes, can be found here.
Low investment returns are never the best news for financial investors. On this episode of Money For the Rest of Us, David examines the relationships between real interest rates and investment return, who or what is driving real rates, and offers historical information on previous periods of low rates. His insights will shed light on this concerning issue, so be sure to give this episode your full attention.
The US and the world are in a period of low real interest rates and real returns
University endowments, retirement funds, and individual portfolios are currently affected by low-interest rates and low investment rates. If this continues, overall portfolio values could decrease after adjusting for inflation and spending. In the United States, we have seen an average 6.5% real return on stocks since 1900. The global average for real return rates has been hovering around 5.2%. However, these rates have been lower in the past 2 decades than they have been in the previous 80 years.
There’s a linkage between real interest rates and subsequent asset class returns
David delves into research on the relationship between real interest rates and subsequent investment returns on this episode of Money For the Rest of Us. He explains that when real rates were higher, the returns were much higher. For example, when real rates reached 9%, real returns on stocks were as high as 10.8%. Today, the real rates hover around 0% or even dip into the negative percentages. The real return for stocks at these rates have historically been just over 4%.
What drives these low real rates?
After hearing all of this information, listeners may be asking, “So who or what is driving these low real rates? And can they be manipulated to be higher to produce higher returns?” David quotes Former Federal Reserve Chairman Ben Bernanke who explains, “But what matters most for the economy is the real, or inflation-adjusted, interest rate. The real interest rate is most relevant for capital investment decisions, for example. The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed.”
Essentially, no group or institution can manipulate these rates. What DOES influence these rates is the balance between those who save and those who borrow. Currently, the world is in a period of high savings and less borrowing, resulting in lower interest rates and lower returns. The tides for these rates will change, in time.
Very long periods of time are required to balance out the good and bad luck for investment returns
Keep in mind that all of the data discussed in this episode of Money For the Rest of Us are for relatively short periods of time. A recent historical analysis shows that countries have seen periods of negative real returns for as long as 16, 54, and 55 years in the US, France, and Germany, respectively. Still, the long-term historical record shows positive real returns for stocks. It just takes patience.
[1:00] Why are investment returns so low?
[11:00] The correlating relationship between real interest rates and subsequent returns
[15:40] Who or what exactly drives real rates?
[27:17] Returns can deviate from these low interest rates
How to make better investing and life decisions. More information, including show notes, can be found here.
David asks the question, “Is investing more like poker or chess?” on this episode of Money For the Rest of Us in order to help you better understand why investing is inherently unpredictable. The book, “Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts” by Annie Duke inspired this episode. David ponders big ideas such a reflexive vs. deliberative thinking and why the differences between causation and correlation must be considered. If you’ve ever wondered about how to improve your investing decisions while combining analytical research with skilled intuition, this episode will answer many of your questions.
Investing and life are like poker – not chess!
Many investors approach financial decisions like a game of chess, where there are correct and incorrect moves. However investing, and real life, are more closely related to poker, a game of uncertainties. Duke explains in her book that a term known as “resulting” drives poker games. “Resulting” is the belief that the quality of a decision affects the quality of the outcome. However, David explains that a great decision is a result of a great decision-making process, regardless of the end outcome. Learn how to improve your decision-making process by listening to this episode.
Don’t assume causation when there’s only correlation
One of the biggest threats to a good decision making processes it the belief that there is always a direct causation linking the process and the end result. Even with the best knowledge and highest levels of skill, investing still contains an element of uncertainty. Sometimes there aren’t any connections between the decisions investors make and the end goal. For example, if you purchase a house, fix it up, and sell it 3 years later for a 50% profit, does that make you great at real estate investing? Maybe. But it could also have been a result of an overall uptick in the housing market, and any buy/sell transaction would have been profitable. David wants his listeners to know that correlation between good investing decisions and profitable outcomes do not always mean the same result will occur.
How can you improve the quality of your investing decisions?
Since investing is strongly related to the uncertainties and variables found in a game of poker, there are never surefire ways to ensure every decision will be profitable. But there are ways to increase your chances of succeeding. Duke explains that “The quality of our lives is the sum of our decision quality plus luck.” Investors can enhance their decision-making skills by considering market trends and understanding that no one knows for sure what market variables are going to do. David shares more tips for improving the quality of your investing decisions on this episode.
Deliberative thinking vs reflexive thinking and the idea of wu-wei in investing
David outlines two main patterns of thought on this episode: reflexive (fast) and deliberative (slow). Responsible investors utilize both methods on a continual basis. Always reacting to the market and going off of intuition is not a sustainable way of making investing decisions. However, utilizing only deliberative thinking could result in missed time-sensitive opportunities. That’s when the idea of wu-wei comes into play. David explains that wu-wei is “A state of perfect equanimity, flexibility, and responsiveness that is unrestrained by the conscious mind because it does not attempt to predict variables.” Essentially, it’s the idea of embracing the unknown and keeping the balance between fast and slow thinking.
[0:57] Is investing more like poker or chess?
[7:02] Investing, and life, are like poker – not chess
[12:05] Don’t assume causation when there’s only correlation
[13:38] How do we improve the quality of our investing decisions?
[18:45] 2 ways of thinking about investing: fast & slow
[23:00] The idea of wu-wei and how it relates to investing