22 October 2022

Stig has invited back Investment expert Cullen Roche to talk about how the world of investing has changed over the past decades and why you need to think as a macro investor first and foremost. 

Subscribe through iTunes
Subscribe through Castbox
Subscribe through Spotify
Subscribe through Youtube


Subscribe through iTunes
Subscribe through Castbox
Subscribe through Spotify
Subscribe through Youtube


  • Why and how do we need to understand the macro environment when we invest.
  • Why we should think of the economy as we think of the human body.
  • Why the traditional buy-and-hold equity strategy is flawed.
  • Why a house we live in is typically not a good investment.
  • How has the stock market performed after inflation and taxes?
  • Why investors are not globally diversified when they invest in the S&P500.
  • Why bonds bear markets are different from bear markets in stocks.
  • Why diversification is about hating some of your portfolio all of the time.
  • How money creation will change with a digital currency by central banks.
  • What is yield curve control, and how is it exercised?
  • What is the third mandate of the FED?


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

[00:00:00] Stig Brodersen: For today’s episode. I invited Cullen Roche back to talk to us about macro investing. Those of us who are raised as value investors have a strong bias not to consider macro. I’m guilty as charged. In this episode, Cullen compares individuals stock picking to finding the new Michael Phelps swimming in the river, which can of course be extremely profitable, but he also argues that we should focus on the current of the river instead, because that is how macro masters think.

[00:00:23] Stig Brodersen: I love to challenge my beliefs in investing and life, and I think you’ll find this episode particularly interesting. Cullen started his career really all above his letters and have taken that mindset into macro investing. All right, let’s hop to it.

[00:00:40] Intro: You are listening to the Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

[00:01:01] Stig Brodersen: Welcome to the Investors Podcast. I’m your host Stig Brodersen. And Cullen, it’s always a privilege to welcome you back on our show.

[00:01:08] Cullen Roche: Hey, Stig. It’s always great to be here.

[00:01:11] Stig Brodersen: So Cullen, the main topic of today is your book, Pragmatic Capitalism, and in your book you have a series of principles intended to piece the puzzle together of the global financial system.

[00:01:22] Stig Brodersen: So it’s no small feet we’re going to talk about here. It’s all about how to help us as investors, so let’s just jump right into it. Our show is founded on the principles of Warren Buffet, and it would also suggest that if you build anything around the principles of Buffet, you are in turn party building on the regional work of Benjamin Graham.

[00:01:41] Stig Brodersen: Benjamin Graham is the author of the Intelligent Investor and security analysis that he wrote together with David Dodd and to the Public. He’s perhaps most famous for being Buffett’s employer, friend, professor, mentor. You have this wonderful quote from Graham in your book before his death in 1956, and the quote goes like this.

[00:02:01] Stig Brodersen: In general, no. I am no longer an advocate of elaborate techniques of a security analysis to find superior value opportunities. This was a rewarding activity, say 40 years ago when our textbook Graham and Dodd was first published. The situation has changed a great deal since end quote, and the textbook he refers to Graham and Dodd would mean that security analysis that the book he’s referring to, Now, I don’t want to elude it to Graham being a macro investor.

[00:02:27] Stig Brodersen: That’s not the reason why I brought up this quote. He’ll probably be offended if I did so, but I wanted to use it as a segue to, into the opening question about the changing world we face as investors. Because you argue that you understand the rapidly changing global economy. You must understand the macroeconomic environment.

[00:02:44] Stig Brodersen: So let’s build the foundation for this conversation. Why do we need to understand the macroeconomic environment?

[00:02:50] Cullen Roche: Yeah, so it’s interesting. I mean, my evolution as an investor, I would say it certainly started with Graham and Dodd and value investing in Warren Buffet. Really. I mean, reading Buffet’s annual letters, in my opinion is probably one of the most valuable things you could do and go back and find, I’ve actually archived these on my website, Pragmatic Capital.

Read More
[00:03:14] Cullen Roche: Go back and read the archived ones of his, the previous ones before Berkshire Hathaway. So he has, a lot of people don’t know this, but he wrote an annual letter for Buffet LP for, I don’t know, 10 or 15 years. And some of those letters are way more interesting than the actual ones that we read from the, that are on like the listed Berkshire website.

[00:03:35] Cullen Roche: But you can find all these online. There’s so much knowledge and understanding inside of all of these letters, and that’s part of why, you know his annual shareholder meeting is so popular is because you get these nuggets of wisdom that, you can find one paragraph and these things that is just mind blowingly intelligent and will sort of build on or transform the way you view the world.

[00:03:57] Cullen Roche: But I think that, one of the things that is really interesting about looking through Buffet’s career. And the transition of value investing into, different factors and more macro based, I think perspectives like, I would argue that the typical passive investor these days is really a macro investing approach.

[00:04:17] Cullen Roche: You’re just taking sort of an approach where you buy, lots of stuff rather than trying to pick the, the needle in the haystack. And I think a big part of why that evolution has occurred is because the world is just very different than it was in the days of Buffet. Not only just in terms of the way information is processed and transferred so much more quickly and efficiently in the markets, but the world has become a much smaller place these days where, you know, back in the days where Buffet was picking stocks, I think you could argue that the economy, and especially economies like the United States, they were much more localized.

[00:04:51] Cullen Roche: You could look at a candy store in Omaha and see. How valuable it was relative to all the other stores in Omaha. Whereas today, if you see a store in Omaha that makes candy, well, you have to identify whether that store can compete with stores in New York and Hong Kong and London. And so the world has become this very small place, in large part because of technology and just innovations that have made intercontinental trade and international trade just a huge thing where the world is now so interconnected that macro has become much more important.

[00:05:31] Cullen Roche: And I think that the main place where we see this is in government policy has become much more involved in everything. In part because of all of the same trends, so for instance, there are rumors today, And over the weekend that Deutsche Bank and Credit Suites are starting to have some financial problems.

[00:05:49] Cullen Roche: And I don’t know if there’s any real truth to these, the rumors there, but the reality is that the Federal Reserve could end up having to be involved in this because the banks in Europe are now very interconnected with the banks in the United States. And that could create an international payment processing problem where the policy makers in the United States through almost no choice of their own have to become involved.

[00:06:12] Cullen Roche: And all of this stuff is just the result of the interconnectedness of the global macro economy now where global trade and technology have made us much more interconnected. I certainly don’t want to give the impression that people should not do individual security analysis or anything like that, but I think that in today’s world, I think.

[00:06:34] Cullen Roche: I like to think of stock picking as sort of, someone who, if you’re trying to pick the best swimmer who is swimming with the tide, well you could certainly try to find like the Michael Phelps who is swimming in the river. That’s your, your goal. But to me it’s equally important to understand the dynamics of the river.

[00:06:51] Cullen Roche: The river is really the thing that is determining to a larger degree how fast all of these people will actually be swimming in the water. And so you have to understand both. But I think as a foundational starting point, I think it’s incredibly useful to understand the macrodynamic so that you can at least get a big picture, a top down view before then you start to then try to understand, what are the best individual securities in certain markets.

[00:07:18] Stig Brodersen: Yeah, and I love Cullen, how well you present this and how you thinking in metaphors that might make it a bit more approachable for us as investors to understand this because it is very complex. At least it is to me. One of the things you said, and just to continue on this train of thought, is that we can think of the economy as one of the world’s most sophisticated machines, the human body.

[00:07:39] Stig Brodersen: What do you mean by that?

[00:07:41] Cullen Roche: Well, in a lot of ways, Ray Dalio had this great video. It was like 30 minutes and it was basically, I can’t remember what the title of it, I think it was How the Economic Machine Works in, in 30 Minutes and he went through the really the way that the economic machine is a lot like any sort of machine that we might build and the global economy really.

[00:08:05] Cullen Roche: Like a very interconnected system to a large degree. And there are things that when you, there are certain inputs that you can input into that system that will then output certain results. Like I try to focus on, when I explain things like how, for instance, quantitative easing works, I like to explain it like this, a systematic process where when the Federal Reserve is doing something specific, well there is a flow through effect through balance sheets.

[00:08:30] Cullen Roche: And when you understand the balance sheets and the flows through that system, you can then understand, kind of going back to the, the same sort of metaphor that we used earlier with the rivers. When the fed pumps water into the river, for some reason that flows through to lakes and it impacts not just the flow through the river, but it impacts the quantity of water that ends up in the lakes.

[00:08:53] Cullen Roche: And you can think of balance sheets as being the same sort of thing where income statements reflect the rivers and balance sheets are reflected by the lakes. And to understand how the, all of this is gonna impact the balance sheets in the long run, you need to understand how the flows work. And so the human body is very similar in the sense that when we put certain things inside of our body that has a certain impact, that flows through everything, it impacts all of the different organs and comes to rest to some degree in certain places.

[00:09:22] Cullen Roche: And can result in whether or not muscle development occurs or whether cardiac arrest occurs or whatever it might be. But there are these very. Flow through events that impact the system in a very machine-like manner. And the, really tricky thing though with investing and the economy in general is that you have the problem of, well, there are brains involved in all of this.

[00:09:48] Cullen Roche: And so the brain has an impact on everything. There’s emotions that impact all of this. And the emotions impact all of this in a very, really unintelligible way. You, it’s very hard to decipher how people will respond. To certain things. So like you could have a really sound understanding of the flow effects of something like quantitative easing.

[00:10:09] Cullen Roche: But if somebody responds to that policy in an emotional way, that maybe results in, say, them going out and buying like a bunch of high yield bonds, even though let’s say are, let’s argue that there is no practical reason for junk bonds or high yield bonds to have any different value after quantitative easing, let’s just say investors perceive that flow from the Fed to have impacted something.

[00:10:32] Cullen Roche: Well, you could have what is essentially an irrational effect that is just purely psychological. And I think this is one of the things that makes not just investing so hard but it makes economics really hard because you have this social effect to it. Economics is not really a hard science.

[00:10:52] Cullen Roche: It’s not biological in the same sense that, you can look at things, you can perform tests in chemistry and biology that you can’t really perform in investing because you can get these irrational responses. And I think, like the last two or three years are just a great study in this where you can argue that in a lot of ways there was no reason for a lot of the things to be going on that were happening in the last couple of years, but you had this strange psychological effect where there were frankly just a lot of people who were sitting around at home because of covid with not a whole lot to do.

[00:11:27] Cullen Roche: And they did a lot of crazy stuff. They bought a lot of, these sort of scammy crypto coins or they, they, they ran up game stop in amc. And so that’s the ec. The interesting thing is that I like to build these understandings from sort of a first principal’s perspective, where you can understand the economic machine and the financial system as a sort of machine.

[00:11:50] Cullen Roche: But then there’s this second order effect where you also, you almost have to also be a psychologist and learn, some of the like conmen and traver techniques where you’re starting to think in, in sort of a second level thinking process, where you almost have to, you can’t just get the economics right, You also have to get the response mechanism, right, where it’s like playing chess to some degree.

[00:12:12] Cullen Roche: You could be playing against a horrible chess player, but if you’re not interpreting their future moves well you could find yourself in a pretty rocky situation. So you’ve gotta be able to think, a few moves ahead to interpret well how is all this stuff gonna work? And that’s what makes investing, know, such a tricky thing.

[00:12:30] Stig Brodersen: To understand macro. We also have to understand the macro concept of investing. Countries that invest well prosper. However, when we as retail investors think about investing, we usually think of stocks and bonds. Now, from a macro perspective, it’s not the right way to think about the differences between investment and savings.

[00:12:52] Stig Brodersen: Could you please paint some color around this?

[00:12:55] Cullen Roche: Yeah, so I always loved the, when I first came across from a macro economic, I mean my background is really in like college, and a lot of my work coming outta college was really involved in just studying macro macroeconomics and so very high level stuff.

[00:13:14] Cullen Roche: Macro econ to some degree is this sort of pseudoscience. And it’s interesting when you compare it to the financial world, there is, in the financial side of everything, there is a lot of jargon. There is a lot of terminology that is just sort of used, I think more as a sales pitch that anything else. And, but this is also true in macro economics.

[00:13:37] Cullen Roche: For instance, the word money in macro doesn’t really have very specific meanings. In fact, to certain schools of economics, it has a different meaning. I mean, like an Austrian economist would argue that gold is money. Whereas a new Kasey economist would argue that gold is absolutely not money. That money is defined by, let’s say like the M2money supply or something like that.

[00:14:00] Cullen Roche: And. And then you can get into varying debates there where it’s like, well, Macroeconomists actually have different definitions of money where it’s actually like it’s could be MZ or M1 or M2 or M3. And you start getting into this situation where it’s like, Well, oh wait, what the heck is money in the first place?

[00:14:17] Cullen Roche: We don’t even have a clear definition of this thing. And it’s kind of an essential part of the whole puzzle here. And it was really interesting when I first started deep diving into like the, this precise definition of the word investing. It is a explicit contradiction with the way that financial people typically use the word, because in macro econ, the word investing means to spend for future production.

[00:14:42] Cullen Roche: And that’s usually done by corporations. So when a corporation goes out and builds a factory, for instance, they are spending some of their money for future production. They are hoping to generate an asset that generates a return on investment in the future. And it’s interesting from the perspective of a, your average retail investor, when we do what we call investing, well, what we’re actually doing is we’re technically just reallocating our savings.

[00:15:12] Cullen Roche: We are not building factories or in a lot of cases, what you do on a secondary market when you’re buying stocks and bonds has almost no impact on the actual corporate operations. And so you are really, from a technical economics perspective, you’re reallocating your savings when you do that and what the firm does when they spend for investment.

[00:15:35] Cullen Roche: Well, That can impact the value of the savings, meaning that when a firm invests well in itself, you know when Apple builds all of these great innovations over time, well, that actually accrues to the value of savings because those investments have a return on investment that people find more valuable.

[00:15:57] Cullen Roche: It has real tangible economic value, and that’s reflected in secondary markets as a revaluation of savings because Apple’s stock price will change, but your actual actions of buying and selling the stocks. For the most part, really it does. I wouldn’t say it has no impact, but to a large degree it doesn’t have much of an impact on the actual, underlying operations of the firm.

[00:16:23] Cullen Roche: And so from a proper economic perspective, what we’re all really doing is we’re reallocating our savings. And the reason, know, some people might hear that and say, Oh, well, who cares? Like Cullen’s just being a nerd about the technicalities of the jargon. And, but to me, I actually think it’s a really useful way of framing all of this because to a large degree, what we are quite literally doing when we buy and sell stocks is.

[00:16:48] Cullen Roche: We are reallocating our savings, and this is literally we earn an income and then we choose how we’re going to reallocate that savings from that income into cash or stocks or bonds or these other instruments. And so from the retail investor’s perspective, I think a lot of people have this tendency to think of investing from an economic perspective.

[00:17:12] Cullen Roche: It’s sexy, it’s very high risk. Go out and build a factory, start a company. Man, that is a very high risk endeavor. I mean, over the course of a 10 year period, 90% of corporations will fail. And so investments spending is a very high risk, potentially high return endeavor. Whereas most of us, we shouldn’t be treating our savings like it is.

[00:17:35] Cullen Roche: Concept of investing because I think it has this connotation of being a very high risk, high reward type of endeavor, which it certainly can be that, but I think for most of us, it would be wise to step back and say, Well, I really am reallocating my savings. And that is a much more prudent and practical process where, I should hold some cash in a bank account to be able to meet my monthly liabilities.

[00:18:00] Cullen Roche: I should hold some money maybe in a high yield savings account in case I need to buy a new car in the next few years. But I’m uncertain of when I’m doing that. I should diversify my assets for retirement because I maybe don’t know when I’m gonna retire, but I know it’s gonna generally be in this sort of a time horizon.

[00:18:17] Cullen Roche: And so I think when you approach it from that, you get away from the tendency that a lot of people have to think of all of this in this very sort of sexy, get rich quick sort of mentality, which is what I think. I think that’s the mistake that a lot of people make when they approach the concept of investing.

[00:18:34] Cullen Roche: And they’re watching, these financial TV shows that sort of sell the same concept of Get Rich Quick and Hey, you’re gonna buy the next, Solana before it soars. Or you’re gonna buy the next Microsoft when it you know, is at one penny and goes to a thousand dollars. And so I think even though it’s a very technical understanding, I think it’s a useful framework to really internalize so that you can approach this from a, I think a more practical foundation.

[00:19:02] Stig Brodersen: I always like your promatic approach to investing in savings. For example, Cullen, you don’t see the traditional buy and whole equity strategy that’s been held for decades without flaw. The Financial system assumes that we accumulate assets from, say, our twenties to our sixties. And while that might be true, to some extent, life happens simultaneously.

[00:19:23] Stig Brodersen: One life cycle could be that we get married now, twenties by a house, have kids in our early and mid thirties. You might start thinking about your kids’ college payments in your forties playing for retirements a bit more seriously in your fifties, and perhaps you break a hip or something in your sixties, and perhaps your life cycle is just completely different from what I just described there.

[00:19:43] Stig Brodersen: But the point is that life happens all the time and as much as we like to plan it, life is what tends to happen whenever we’re busy planning it. And so how can we make sure to balance a portfolio and allocate our savings to have certainty that our portfolio will be there for the big events in our life?

[00:20:02] Cullen Roche: Yeah, I mean, this is. This is the problem of life. This is the problem of financial planning and finance really is time. And I think it’s been frustrating for me over the course of my career that a lot of investment analysis focuses on how to generate the best type of return and, the best risk adjusted type of return.

[00:20:26] Cullen Roche: But we don’t really talk that much about generating the best risk adjusted return across time. And time is the biggest problem we’re all confronting because we’re obviously not only limited by time across our lives, but our lives occur in, like you were saying. Different time horizons. You’re gonna retire in 30 years, or you’re gonna buy a house at some point in the next five years.

[00:20:52] Cullen Roche: Nobody can afford to buy a house anymore because of, the crazy market that we’re living in. But, you plan your life across these very specific temporal horizons, and you have monthly liabilities or weekly liabilities that you have to meet, whether it’s your credit card or your rent or your mortgage.

[00:21:10] Cullen Roche: And then, you wanna buy a car, maybe in the next two years, you wanna buy a house in the next five years, you’re gonna get married in 10 years. You’re gonna have kids after that, and the kids are gonna be graduating with these huge college tuition bills in 18 years. And then you’ve got retirement that is, way down the line.

[00:21:29] Cullen Roche: And then, like you were alluding to, you have unknown health problems. And obviously healthcare is, inordinately expensive now. And a lot of people can’t predict, well, you know what? You break a hip at 60 and it completely transforms your ability to afford all of the other things you want in life.

[00:21:46] Cullen Roche: And so you have to, I think, not just approach this from this idea of buy and hold or stocks for the long run, because a lot of people, frankly, we just can’t afford to only own stocks for the long run because we have all of these short term time horizons where hey, it makes sense actually to own buckets of cash and even buckets of like say intermediate bonds or instruments that are, more short term.

[00:22:15] Cullen Roche: And I, it’s interesting, I actually, my big focus, I would argue in the last year and this paper I published in the last month was called All Duration Investing. And it’s actually focused on trying to solve this problem where we’re not approaching the world of asset allocation from optimizing return per unit of risk in a sort of standard.

[00:22:38] Cullen Roche: Modern portfolio theory approach. We’re approaching it more from the perspective of having money when needed and having money in certain time horizons so that you have greater certainty about your asset allocation and your future ability to meet certain liabilities. And so I actually, I’ve always loved like bond ladders and the beauty of a bond ladder is that if you have a hundred thousand dollars, well, what you do if you need a bond allocation is you take, let’s say 10% of all of that allocation.

[00:23:09] Cullen Roche: And so you would take $10,000 and basically you bucket it out from one to 10 year maturities and the bond portfolio. Every year you’re gonna have bonds that are maturing and you’re just systematically rolling them over into a new set of bonds every year and you’re, you don’t care what’s going on with interest rates, really, you’re just systematically rolling this portfolio.

[00:23:31] Cullen Roche: But the beauty of it is that you always have a short term bucket in there where you know the principle inside of that thing is very certain. And so to meet cash flow needs, the beauty of that is that you’ve created this systematic process by which even though you have, much higher risk in the 10 year portion, you have much more certainty in the one year instrument.

[00:23:52] Cullen Roche: And so what I did with this paper that’s called All Duration Investing, is I actually calculated the duration of all assets. I literally calculated the duration of things like gold and commodities and wreaths, and the stock market is an 18 year type of bond like instrument inside of my model. And the.

[00:24:12] Cullen Roche: The nice thing about approaching this is all, I’m obviously doing a lot of guesswork inside of building a model like this, but the, I think the nice thing about it is that you can build a framework by which you can then apply time horizons to certain assets and compartmentalize them in a certain way.

[00:24:27] Cullen Roche: Where yes, stocks are for the long run, stocks are that 18 year instrument or whatever, but that doesn’t mean that you should just buy and hold a portfolio of stocks because the problem there then is that you don’t have short term liquidity. You find out in a year, like this year that hey, the stock market goes down 25%.

[00:24:46] Cullen Roche: You don’t have liquidity inside of that part of your portfolio. And the problem that a lot of people find themselves in years like this is that they didn’t plan for that in the future. And so before the bear market, they came in way overweight, the stock market, for instance, and then they find themselves if they need some liquidity,

[00:25:05] Cullen Roche: Well then you have to make the worst behavioral mistake you can, which is being a forced seller of stocks into a downturn because you just need the liquidity. And so for me, there is no, the biggest biases I think in investing is being too short term and being too long term. And you can get caught in this trap of, if you’re a day trader, well you’re just, you’re highly biased by the short term in a lot of ways.

[00:25:31] Cullen Roche: If you’re a only a stocks for the long run type of thinker, well, you’re biased in the long term and you’re, you haven’t prepared yourself for the reality that, yeah, we live in the long term. But really, life happens in the short term, and you have to plan your financial asset allocation in a way that it matches all of these different time horizons.

[00:25:54] Cullen Roche: So there is no. There is no one stop shop sort of answer to this. Whether it’s stocks for the long run or thinking more short term and trying to, turn a long term instrument into a short term instrument by day trading. Because by definition you can’t turn a, you can’t turn a 10 year bond into a one year bond.

[00:26:14] Cullen Roche: That 10 year bond is, it’s always gonna function like a 10 year bond.

[00:26:20] Stig Brodersen: You have this wonderful section with myth busting in your book. Myth 10 is quite controversial, though perhaps not as controversial this year as it would’ve been say 12 months ago. You claim that it’s a myth that your house is a great investment and I just wanna bring this up cause it’s always such a, it is really divisive to make a statement like that because to most people, their house is the biggest investment they’ll ever make.

[00:26:44] Stig Brodersen: So in knowing that it can make it very unpopular. I still have to ask you, Cullen, could you please elaborate on why a house that we live in is not a great investment?

[00:26:55] Cullen Roche: I know I get a ton of hate mail for mortgage brokers and real estate people. When I say that, cause real estate obviously is made, I mean, arguably more people wealthy in this country than any other asset.

[00:27:08] Cullen Roche: And what I’m being specific with there is that I’m not saying that a house can’t be an income generating type of instrument. That, or especially within a business, like I was going back to the definition of investing earlier. You could build a business where you are literally, if, for instance, if you’re a home builder, obviously homes are a great investment for you.

[00:27:29] Cullen Roche: Where you are, you’re actually doing the thing that is generating the future production and generating the return on investment that is very valuable. But, From your standard retail investor’s perspective, your home, I think on average over very long periods will not be as good of an investment as I think a lot of people tend to just assume.

[00:27:53] Cullen Roche: And I think the main function of that is that people don’t actually calculate their returns on that investment accurately, because for most of us, what we do is we go out, we buy a home, and we live in it. And a home is really just a, it’s a big block of wood that is falling apart. It’s a de deteriorating asset on valuable scarce land.

[00:28:16] Cullen Roche: But the problem is that the actual physical structure itself is an incredibly expensive asset in so many ways, whether it’s upkeep and maintenance. Taxes. And if you think of a house in terms of having an expense ratio like a mutual fund does, or a, or an atf, that house is phenomenally expensive per year because of the upkeep and the time and the taxes involved.

[00:28:43] Cullen Roche: And so when you actually back out what I call real returns in the book, which is basically that’s your after tax, after fee, after inflation return, what you find is that real estate for your average homeowner is actually not that great of an investment because they don’t actually quantify all of the real, real after, return that they incur over time.

[00:29:09] Cullen Roche: And so most people don’t think of, all the time they spent pulling weeds and hey, the water heater broke, 10 times while I lived in the house, or whatever it is, there are all of these real costs involved in owning a home that people tend not to actually quantify when they sell their home.

[00:29:28] Cullen Roche: And that tends to be the way that most people think of their return on investment in a real estate purchase, is that they say, Oh, well I bought my house for $200,000 and then, 30 years later I sold it for $600,000. And so I had made this fabulous return on investment. And you forget the fact that, well, yeah, but you paid a boatload in taxes over that period of time and you went to Home Depot a billion times to repair stuff that was falling apart.

[00:29:55] Cullen Roche: And so when you actually go in and, and then adjust for inflation during all of this, and what you find out is that real estate historically is only generated about a one, maybe 2% real return. And so, there are certainly periods where. You could time the market well, like if you bought real estate back in 2012 or let’s say like right before the covid boom, well, you did really well.

[00:30:18] Cullen Roche: But if you’re somebody who bought it in 2006, like your story could be completely different. And so it’s not that you can’t make money in real estate, it’s that I think you have to understand that on average, the likelihood of your home making you rich in an investment sense is a very different endeavor than say, starting a corporation, which that has the potential.

[00:30:46] Cullen Roche: Or even, I like to talk in the book a lot about human capital, building skills, investing in yourself in a way that has a very high return on investment. To me, those are the things that have the, are the very best investments. Whereas the, a lot of the traditional stuff we think of buying and selling on secondary markets.

[00:31:07] Cullen Roche: They tend to not be as good of an investment or not even properly termed investment the way that I think a lot of people frame them.

[00:31:16] Stig Brodersen: Yeah. And I also just wanna make the disclaimer that I don’t want to glorify stock investing by asking the previous question about how it’s perhaps not being the best investment.

[00:31:25] Stig Brodersen: Certainly there are quite a few challenges by being a stock investor. It’s like you read those textbooks. I remember reading them back in school and it was like, Yeah, the stock markets, it gives you the 8, 10, 12%, whatever kind of yearly return. I was like, Wow, that’s so much better than the bank.

[00:31:41] Stig Brodersen: But then as soon as you start investing yourself, you realize it’s a lot more volatile than that, and it’s not, you’re not grinding out one return after the other. That’s just not how it works. But Cullen, I know that you’ve been digging into the data. What does the data tell us about the profitability of being in the stock market?

[00:32:01] Cullen Roche: Yeah, it’s interesting, Buffet actually talks about this in a lot of his old letters about how you should assume that the aggregate stock market after inflation is probably only gonna do like four to 5%. Which is, I mean, amazingly that’s like half of the number that you commonly hear referred to in the financial media and cause there is this 10% number that a lot of people have in their mind of that’s what, just what the stock market does on average.

[00:32:28] Cullen Roche: And, but when you, again, when you go in and you back out all of the taxes and fees involved in this, well, you find that the stock market really is not. Really the place where you generate very high returns. And this again, is like, it’s one of the reasons why I focus so much on human capital in the book and investing in yourself.

[00:32:47] Cullen Roche: And I literally, I wrote a whole section in the book about how investing in yourself is the absolute best investment you can make. Because that’s the thing where you can actually control so much of the outcome. And that’s the, I think the big thing with the stock market is that, well, when you actually put the, that four to 5% figure into perspective, I think it’s part of why passive investing in indexing has become so popular in the last sort of 10 to 15 years.

[00:33:13] Cullen Roche: Because there are specific things about stock market asset allocation that we can directly control, and those tend to be taxes and fees. You can’t control what the market is gonna do in any given year, but you can control taxes, fees, and I focus on behavior a lot because behavior is obviously something you can control when you become disciplined about it.

[00:33:36] Cullen Roche: And so, I think it’s really important to look at those things that you can control for. And working from this perspective of human capital, building your own skills and investing in yourself. Well, those are things you can control. You have a direct control over the amount of knowledge that you build over something.

[00:33:55] Cullen Roche: I mean, you, you obviously can’t just go out and become LeBron James if you wanna become a professional basketball player, but you can find something that you are good at and you can make real investments in those skills in a way that has a return on investment for you personally. Whereas the stock market and buying, homes and things like that, there tend to be so many variables involved in that you can’t control.

[00:34:18] Cullen Roche: And I think that, when you start to put these things in the proper perspective where you realize, well, mathematically after taxes and fees and all this other stuff, well these instruments don’t do quite as well as, I think a lot of the financial media would like us to think. Then you can put these things in the proper perspective where you start to say, Well, okay, it actually makes very little sense for me to sit around in day trade stocks because after you back out all of this, all of these, sort of uncontrollable aspects of it, and actually the more active you are though, the less control you have because you’re incurring higher taxes and fees along the way.

[00:34:59] Cullen Roche: Well, it doesn’t make sense to actually spend a lot of my human capital doing some, an endeavor like that because, The much more probable high return on investment is building skills that other people will find valuable, where then I can generate a higher income. That becomes a, in a sense, you almost, when you build a lot of human capital, you build your own sort of bond.

[00:35:23] Cullen Roche: You become this high income generating type of instrument where now the return on investment that you’re generating is controlled not by a function of what other people are doing, but really by what you are doing.

[00:35:38] Stig Brodersen: So continuing talking a bit more about stock investing. I wanted to challenge the notion that we as investor are diversified from sold, being invested in the S&P 500.

[00:35:48] Stig Brodersen: It’s not something I heard you say, so I just wanna sit the record straight for that. But it’s something that I hear being throwing around a lot. I often hear that because American companies have international revenue, as would be the case with the S&P 500, it’s similar to buying international equities.

[00:36:04] Stig Brodersen: And I kind of feel I’m giving you a bias, so, and perhaps it’s too late, but I would like to continue on this threat here because I believe that it’s not true and I hope you, being the myth buster, you can give me some pushback. One example, I wanna make taxes. I read Thomas Piketty’s books, Capital Ideology and Capitalism in the 21st Century.

[00:36:22] Stig Brodersen: And a huge shout out for those books. They are absolutely wonderful. It is also an acquired taste. I just wanna make that disclaimer. If you think that 1600 pages of the world’s tax systems and how the developed are interesting, hopefully you won’t. But if you do find , if you do find interesting press, those are the books for you.

[00:36:39] Stig Brodersen: But one thing I learned in those books, which surprised me, is that the tax rate in the US was 52.8. In 1968 and in 1969. Now, I don’t believe that would happen anytime soon. I also have to say I never believed that the world’s countries would agree in the minimum corporate tax rate, even though it’s still up in the air.

[00:36:58] Stig Brodersen: I never believe that we have a war in Europe in 2022. Things happen going away from taxes. Another thing I wanted to throw in into the ring is this integration of supply chains. We see that between the us, Europe, China, and the rest of the world, and this is something that we can expect to continue if we continue to see increasing conflicts.

[00:37:17] Stig Brodersen: And again, I am very biased in how I phrase this question, but I really hope you can give me pushback on this. Are we diversified in equities if we own the S&P 500 only, or would we need to buy global equities?

[00:37:31] Cullen Roche: I always like to use an example of like, imagine you were living in London in the year 1800 and you were somebody that was kind of involved in finance and the financial world was really starting to develop in most of Northern Europe around that period and really turning into something, more like what it is today, where people were actually forming companies and then selling parts of those companies to the public.

[00:37:57] Cullen Roche: And, but if you lived in Northern Europe or London in the year 1800, well would you have ever thought of investing internationally? And who knows? Maybe you own something like shares in the Dutch East India company or something, which you could technically argue was like an international company to some degree, but you wouldn’t really have thought of ever investing outside of probably like the UK if you were in that environment and.

[00:38:25] Cullen Roche: In the long run, if you were that person, what you missed out on was literally one of the greatest economic booms in all of human history, because in the year 1800, there was this little tiny country on the other side of the ocean that was in the process of building an economic monster. And that’s what the United States eventually became, was the United States became the biggest, most productive, innovative country and economy in the world over the course of the next 200 years.

[00:38:58] Cullen Roche: And so if you had this home bias, well, you not only were invested back in what was known as the world’s reserve currency back then, but you, if you only invested in the home bias. You missed out on all of these other economic booms internationally. And so look I’m a very, I know we have a international listenership here, and I’m based in the United States, so I have a lot of biases because I’m a very patriotic American and blah, blah, blah about all that.

[00:39:27] Cullen Roche: But I still, I look at the United States and I know the history of World Reserve currencies and I know the history of world superpowers, and I know that over the course of economic. The reserve currencies come and they go the world’s superpowers. They ebb and they flow. And in 50 years, who knows where the United States is gonna be.

[00:39:48] Cullen Roche: Who knows, whether it will be Europe again, or China or India or whatever country it might be, that is the next big thing. And so from a perspective of allocating assets these days, to me it just, it seems like such a no-brainer to diversify internationally because what if you’re the person who’s only invested in the S&P 500?

[00:40:11] Cullen Roche: And sure, yes, you’re getting some international diversification because of international revenues, but you know, with the sort of change in globalization to some degree, you could argue that a lot of these international firms might be forced into becoming much more domestic types of firms. And so you could make an argument there that you’re actually losing some of your international diversification.

[00:40:30] Cullen Roche: Who knows what’s gonna happen with all these global conflicts. I mean, we could all end up. Japanese to some degree where we’re more, we all become much more, I isolationist and actually Japan’s an incredible example of home bias where if you were only invested in Japan in 1990, well you suffered through one heck of a big stock market trauma because you didn’t own a lot of international stuff.

[00:40:51] Cullen Roche: And if you had been a Japanese investor in the 1990s who owned an international stock portfolio, you performed vastly better than the person who just lived in Tokyo and only bought Japanese stocks in that period. And so to me, I think that’s the real benefit of owning, diversifying internationally is that you’ve gotta get away from home bias because you just never know what’s gonna happen.

[00:41:15] Cullen Roche: I mean, I don’t personally think that like the United States is gonna lose reserve currency status anytime soon or that. The United States corporations are gonna start to, lose lots of market share, but hey, I have no idea what’s gonna happen in the future. And I think that’s part of the, one of the big lessons from being a good investor is that you have to humble yourself to these unknowns.

[00:41:38] Cullen Roche: And you have to recognize that there is a certain arrogance in being American and only owning the S&P 500 because you are just implicitly saying, Well, I don’t need to own all those international companies because the United States is number one and, ra, ra, ra, I just, I only need to own America.

[00:41:57] Cullen Roche: And so I think international diversification has a huge benefit. And this is statistically supported too, that the, especially when you look at the booms and busts of the markets over time, we go through these big ebb and flow cycles where international stocks, for instance, they kick the pants off of US stocks in the two thousands and.

[00:42:17] Cullen Roche: Then we’ve, we’ve been through this long 15, 20 year cycle where the US has, kicked the pants off of everything international. But hey, that could be changing right now as we speak. And to some degree looks like it is starting to transform. And so to me, from a diversification perspective, I think it not only is supported by the empirical evidence, but it’s supported by the historical evidence.

[00:42:40] Stig Brodersen: Yeah, and I think you bring up multiple good points. You mentioned Japan, we had David Stein on episode 478 and you talked about whenever he entered financial career, he was looking a lot of Japan. And at the time, if you bought a global index, Japan would be 45%. And today it’s less than 5%. It’s incredible to think of.

[00:43:00] Stig Brodersen: And it would be interesting to see, I would imagine like if you were a good patriotic Japanese person in 1989, you would be thinking I should buy. Japanese equities, why wouldn’t you? And I feel the same way as you, Cullen. I have a huge bias with the US companies. I understand the country, I understand the stock market.

[00:43:18] Stig Brodersen: I have a lot of trust in the country. I can’t see that the global currency will go anytime soon. But I also think it’s important to understand, like, to your point about that gentleman, or in 1800 in the uk, it would’ve been really expensive to have a, I would imagine, to buy equities in other countries at the time, it’s not today.

[00:43:36] Stig Brodersen: You can do that with click of a mouse. It’s not like, I don’t know if you would go from four basis points, like eight basis points, which might seem like it’s twice as expensive and it is, but it’s really from nothing to a bit more than nothing in terms of costs. And so it’s just something that I really wanted to pass on to our listeners.

[00:43:54] Stig Brodersen: Having that humility you were talking about before Cullen, I think that’s so important as an investor and not just look at the past, say 10 or 15 years, too much money has been thrown on board from bias, recency bias.

[00:44:06] Cullen Roche: Totally. Yeah. And the cost aspect is a huge one that you bring up where it just it’s not expensive now to own international equities.

[00:44:15] Cullen Roche: And so, another, it’s one of those things that you can control and you can control, the level of home bias without having to pay, crazy fees that we know detract from total returns in the long run.

[00:44:27] Stig Brodersen: So Cullen, let’s talk about bonds. Historically, bear markets and bonds have been different from bear market in stocks.

[00:44:35] Stig Brodersen: What does the data tell us and does that change Again, we don’t want to have too much recency bias. Does that change if we enter a new long term cycle with rising interest rates for decades? Just like we see the opposite declining interest rates since 1981?

[00:44:52] Cullen Roche: Yeah. Well, God, this is an interesting time to be talking about bonds, obviously, cause they’re going through their worst run in arguably history bonds are they’re a different beast than the stock market because buying something like, say, US government bonds or investment grade bonds, for the most part, you really, you can mathematically quantify what your returns are going to be over specific time periods. And I think this is another thing that’s important with owning bonds is that I think that you have to understand that specific concept of time inside of the instruments where it’s very easy, for instance, in a period, like right now, to look at a five year bond and say, Well, that five year bond is down, 15% this year because interest rates have gone from zero to 3%.

[00:45:41] Cullen Roche: And I know this is hard for a lot of people to be patient with, but over the course of a five or six or seven year period, when you let that bond mature, it will mature at par and it will have just clipped the coupon at whatever you purchased it at. And so, Going back to kind of that idea of like segmenting things in certain time horizons.

[00:46:01] Cullen Roche: Well, if you were buying treasury bills right now you can buy six and 12 month treasury bills right now for 4%, which is a world that hasn’t existed for 10 to 15 years. But the kicker there is that, with a six month bill, you’re gonna get a one time coupon. And so you’ve gotta understand that, hey, this instrument isn’t gonna do anything for six months, but then you’re going to recoup your, your full four per coupon or 2% cause it’s an annualized rate, but it’s gonna mature par and, but you’ve gotta be patient enough to let the instrument do what it’s designed to do.

[00:46:38] Cullen Roche: And so that’s one of the things that makes bond investing very hard. It’s interesting coming off of Zero because the world, I wrote about this a lot back when interest rates were down at zero. That when interest rates are at zero, your interest rate risk is just, it is completely different than when interest rates are starting at four.

[00:46:57] Cullen Roche: So, because bonds are, obviously, they’re protected by the income that they generate. And so, I write about this a lot with the period of the 1970s. A lot of the people that write about that period think that bonds were a terrible investment because interest rates went up so much. But the interesting thing about bonds is that the more interest rates go up, well, the higher income you’re actually generating from the new bonds that you’re rolling into.

[00:47:22] Cullen Roche: And so in a certain weird way, when you’re buying a bond that generates 8% and inflation’s at 8%, well, from a nominal perspective, interest rates have. Basically you’ll go continue to skyrocket even more because they have to generate a negative nominal return, now they have to offset 8%. And so your five year bond that, let’s just say it has a five year duration, which is it’s interest rate sensitivity.

[00:47:51] Cullen Roche: When that thing goes up 1%, you lose 5%. If you’re earning a coupon of 5% in that bond, well, you lose basically all of your coupon in the annual year that the interest rates rise because it completely offsets your 5% rate. But if that bond, let’s say you buy it and it’s starting at 10% rate, well that bond has to lose the equivalent of two years, basically worth of principle to actually offset the interest payment.

[00:48:21] Cullen Roche: In a weird way, bonds operate a lot like stocks in the sense that when interest rates rise, the prices fall, their future returns become better. And the stock market functions tends to function in a very similar way, where when interest rate or when, sorry, when the stock market falls in value, it actually tends to become a higher return generating instrument in the future.

[00:48:45] Cullen Roche: And the bond market is very similar. And so weirdly, we’re in this environment now where, yes, if interest rates continue to soar, then you will continue to incur principle losses. But your math now is vastly improved because now you’re able to buy bonds that are yielding five, 6%. So your starting point is much better protected in this world than it was in the 0% market.

[00:49:12] Cullen Roche: So to me, there’s been a lot of commentary about, Oh, bonds are dead, bonds are useless in a portfolio. And I always tell people, well, That’s actually you. You could argue that bonds were a far worse value proposition two or three years ago, certainly. But today I actually think the math is completely transforming.

[00:49:31] Cullen Roche: I would argue that bonds are a much far superior value today than they were because interest rates have risen and the likelihood that interest rates are going to continue to rise at the rate that they’ve been rising, in my opinion, is lower, which actually makes bonds even more attractive going forward.

[00:49:49] Cullen Roche: So, but again, it depends on your personal situation. Bonds. Bonds shouldn’t be owned by everybody and not everybody has a need for these short term type of instruments that are going to provide certainty over very specific time horizons. And so your bonds are, Bonds have to be very personalized and customized to people.

[00:50:10] Cullen Roche: In the same way that, like when I was talking about the bond ladder, I think you have to build very systematic fixed income portfolios. Are applied to people’s time horizons, where bonds for me, typically are instruments that you really, you should use them inside of like a five year time horizon where you’re not exposing yourself to just crazy amounts of like interest rate risk like you would if you owned a 30 year treasury bond.

[00:50:34] Cullen Roche: That the dynamics of that instrument are just, they are completely different than owning something like a, a six month treasury bill or a five year treasury note where you can structure that thing across a very specific time horizon within your financial plan, where you actually know from a nominal perspective a lot of the mathematical outcomes that are likely there.

[00:50:55] Cullen Roche: And that, not to get on a whole other tangent, but for me, I write about this in the book very specifically. I really do not think people should think of bonds as being a real return protecting type of instrument. It’s one of the reasons I’m not a big fan of tips and inflation protecting its securities in fixed income markets in general, is because bonds, to me, they’re principle protection instruments.

[00:51:17] Cullen Roche: They are instruments that over very specific time horizons will provide a certain amount of principal stability. They are not in your portfolio to generate real returns. Your treasury bill that you can buy today at 4%, there is no chance that thing is gonna beat the rate of inflation. But that’s not the goal of the instrument.

[00:51:36] Cullen Roche: The goal of that instrument is to give you 4% nominal certainty because you know that if you just leave that money sitting in the bank, you’re gonna get 0%. And so from a value proposition perspective, a relative basis on a nominal return basis, that instrument is a no brainer to own. Assuming you have a six month time horizon for that money.

[00:51:58] Stig Brodersen: So Cullen, now that we’re talking about bonds and the role in terms of diversification, I would like to continue talking along those lines cause you have this wonderful passages in your book about diversification that I found very useful. And the quote goes like this, Diversification is about learning to hate some of your portfolio all the time.

[00:52:19] Stig Brodersen: And it really makes me smile and not in agreement. It’s wisely said and on my end, it’s wisdom born out of pain because Could you, Cullen, talk more about how you see diversification and why the imperfect portfolio you can stick with will perform better than the perfect portfolio you cannot stick with?

[00:52:38] Cullen Roche: Yeah, well I think that’s the thing. A lot of us are seeking is that portfolio that just only goes up. You wanna own all the instruments that are just only going, from the bottom left to the bottom right all the time. And I think that one of the, know, not only is that obviously just an incredibly difficult endeavor to achieve, but the, one of the purposes of diversification and generating better risk adjusted returns or smoother styles of returns over time is that you have to know that in order for diversification to.

[00:53:12] Cullen Roche: You have to have instruments that are uncorrelated. You have to have instruments that, Well, let’s say the stock market is booming. Maybe your bond portfolio isn’t doing that well, and you have to build a portfolio where you do end up kind of hating a portion of your portfolio. I mean, just looking at a stock market, a global stock market portfolio, for instance, in the long run, owning a value portfolio, for instance, in the last 10 years has been a horrible relative performer inside of a total stock market portfolio relative to growth.

[00:53:47] Cullen Roche: But now we’re seeing the tide kind of change there where value in the last year and a half, has absolutely smoked growth. And so that’s part of the beauty of diversification is that there’s a lot of people that in the last 10 years could have looked at the value port of their portfolio and said, Hey, this, the Vanguard Value Fund or whatever it is that you own.

[00:54:08] Cullen Roche: This thing hasn’t done very well and I hate it. It goes down every day and it’s driving me crazy. And the growth stuff keeps, going up and you can get into these debates about momentum, versus something more diversified and balanced. But to me, I think that in order to build a portfolio in the long run that does well on a, in a and creates a more stable type of return, you have to build in things knowing that parts of that portfolio are gonna do badly over time, but on average over longer periods of time.

[00:54:42] Cullen Roche: When you blend that value position with the growth position, you don’t get into the timing the market thing. You just kind of know that, well, there’s gonna be periods where the value stuff does badly, but growth. Does, badly at times and, but if I own all of it on average, it will all on average generate a pretty decent return.

[00:55:03] Cullen Roche: But when you blend the two pieces together, what you really do is, and this is the main goal of diversification and especially owning things that are outside of the stock market, things like cash or bonds, or whether it’s gold or commodities, whatever it might be. What you’re really doing is you’re dampening the volatility of the instruments that are really volatile, which tend to be things like the stock market.

[00:55:27] Cullen Roche: The stock market in a year, like this year where it’s down 25%. Owning bonds or gold, nothing’s really worked that well, but the investor that owns gold or commodities or even bonds in this environment, well what they’ve done is they’ve buffered the negative 25% return in the stock market.

[00:55:49] Cullen Roche: Because even though bonds are down, 11% or whatever, and I think gold is down 10%, commodities are up. What you’ve done there by building this sort of very diversified portfolio through owning uncorrelated asset classes is you have buffered the instrument in that portfolio that is really the most volatile, the one that especially, is going to cause you a lot of behavioral angst because if you only owned the stock market component there, you’re down 25% and you’re looking at your portfolio and you’re.

[00:56:21] Cullen Roche: Oh no. If I lose my job or I need to tap some cash, I’m gonna have to take a big principle hit in this instrument. Whereas if you own the diversified portfolio, you own a bunch of stuff that you know years past, you probably would’ve hated all of it. You would’ve hated the bonds. You would’ve hated the commodities.

[00:56:41] Cullen Roche: You would’ve hated the. But now you find yourself on average over longer periods of time in a portfolio that’s actually performing more stable, where you have optionality not from a, be only from a behavioral perspective, but from a cash management perspective where you can now better manage your finances because you’ve created a diversified portfolio of things that, yeah, cash has been trash for 10 years because it’s been earning 0%, but cash is, cash has been one of the absolute best things to own this year.

[00:57:12] Cullen Roche: Even though in real terms, it’s down, whatever, seven, 8% cash on a nominal basis is down zero. And so it’s been in this beautiful part of your portfolio because it’s helping you sleep better at night and it’s helping you manage your liquidity needs if you have them. So that piece that you hated suddenly becomes the piece of the portfolio that you love.

[00:57:33] Cullen Roche: And that’s just the ebb and flow of. Of life. I mean the, what is the old saying? Variety is the spice of life. And it’s, that’s the same thing is true in portfolio management, where if you own all the same stuff, that all does the same basic performance over time. Well, yeah, that might be great in the super long run.

[00:57:52] Cullen Roche: And that is the basis of the argument for stocks for the long run. But you can find yourself in these short term periods where, man, when you’re in trouble, you are gonna find yourself in big behavioral trouble. Because when all those things are correlated one to one, they’re correlated negatively in a really bad way.

[00:58:11] Stig Brodersen: Yeah. And I think to that now that you mentioned that gold is down 10% here in Europe, people are pretty excited because gold is up. And that’s of course because the euro is down 16%. So it really depends on how you measure it, but also goes to the whole diversification piece in different currencies.

[00:58:27] Stig Brodersen: But Cullen, one thing I’ll learn from following your work and a topic that we covered multiple times here on the show is how the most important form of money in the modern monetary system is issued almost entirely by the private banking system. And I, at least I remember like doing that the first time and I was shocked because at this idea that of this printing press that was running, kind of like what you’ve seen, like from back in the day before it all became digital.

[00:58:52] Stig Brodersen: But anyways, so like whenever I learned that from you, I was like, this is really interesting because in market based systems such as the US and the European Mont Union, the government in those countries do not directly control the money supply or create the most money. Will this change with the central bank control digital occurrences that we hear about?

[00:59:12] Cullen Roche: It’s an interesting concept because just to. To kind of give a really high level overview so people do understand. What we really have in most modern monetary systems is sort of a two-tier system where the banks are really the dominant money issuers. We call money that banks make credit, but really from a practical perspective, loans create deposits and deposits for all practical purposes or money.

[00:59:35] Cullen Roche: And they’re even, in most countries, they’re government backed, I mean F D I C insured here in the United States, for instance. So deposits are, in terms of their comparison to like dollar bill, they’re identical, essentially. And so what you have is this two-tier system where theoretically, a lot of people think of this from the perspective of the government, where the government runs.

[00:59:57] Cullen Roche: And the central bank specifically runs the inner bank market where this is where, this is the banking system basically for banks. And so the rest of us all use the primary banking system, which is where we exchange deposits, but. If I were to pay Stig and Stig banked at a different bank than I do, well the two banks would go to the inner bank market to settle the payment, and that’s the bank controlled by the Central bank.

[01:00:20] Cullen Roche: But, so it’s kind of this behind the scenes sort of banking system in the old theory is that if the central bank gives banks more money in the inner bank market, in the secondary market, that then they can create more money in the primary market. And that’s just not really how it works. The primary function of loan creation is demand for loans and the bank’s ability to actually, find credit worthy borrowers to issue those new deposits.

[01:00:46] Cullen Roche: So the go. The government doesn’t have no control over money, obviously. I mean, they can create financial assets that are very money like. I mean, government bonds, I always argue, are very money like. They’re not technically, like deposits, but when the government runs huge deficits, what they’re really doing is they’re giving a bond generally to a rich person, and they’re taking that money and then they’re spending it into the hands of somebody who isn’t as rich, who has a higher marginal propensity to spend.

[01:01:13] Cullen Roche: And so they’ve created an asset that is essentially like a savings account, given it to the rich person, taking the rich person’s money, and then given the money to the poor person. And in every sense of the word, I would argue that is money printing in a sense of like the sort of traditional way we think of it.

[01:01:28] Cullen Roche: Whereas when a central bank creates reserves, they’re not necessarily really printing money because the money that they’re printing isn’t really in the private sector. It’s not going to a depositor and then being spent at, Walmart or some, big box retailer or something like that. But, From the perspective of, controlling the money supply, it really is controlled primarily through the banking system.

[01:01:53] Cullen Roche: And, it would be very interesting from a theoretical perspective whether central banks started to issue digital currencies. Because in a sense, if you let the banks, the central banks run what is essentially, retail type banking systems where they’re actually making loans to the private sector, you could argue then that, well, in that instance, the central bank becomes much more like a Bank of America or any regular old bank where the government then is actually direct, directly controlling the credit issuance and the loan creation process in a way where they are actually creating deposits and creating money.

[01:02:37] Cullen Roche: So it’s highly theoretical. But I think it would, in a sense, it would start to really transform the way that the modern monetary system is structured. Because right now most of the money creation on average is controlled by private entities that basically they really compete for depositors.

[01:02:57] Cullen Roche: They compete to make loans that result in the creation of deposits. And that’s a very sort of market based function. Whereas a lot of what the government does when they create financial assets is it’s obviously much more politicized. And you could argue that it’s not nearly as market based. Not that the modern banking system is perfect by any means.

[01:03:18] Cullen Roche: It’s certainly not. You could argue that there are big problems in the way that we have these private competitive banks to some degree. But in general, yeah. Wrapping all of this into the government and having the government basically become the equivalent of like a retail bank, Yeah, that would completely transform the system, cause politically it would.

[01:03:36] Cullen Roche: It would not only change central banks from being somewhat independent, but into specifically really very politicized money issuing entities. But it would diminish the power of modern private banks significantly.

[01:03:53] Stig Brodersen: And for us investors, I think it’s important to understand that the Fed could, in theory, control the entire yield curve of government debt.

[01:04:02] Stig Brodersen: One expression or one term that’s been thrown around a lot is this yield curve control that we hear about. And perhaps you can start explaining what it is, but also why the Fed allows the marketplace to control long rates of US government bonds.

[01:04:16] Cullen Roche: Yeah, it’s an interesting question. I mean, kind of backing up, the way to think of this is that the Fed and the way that they control interest rates is a lot.

[01:04:25] Cullen Roche: Like, imagine the analogy of somebody walking a dog on a leash and the at the handle, the man holding the leash has absolute control and they determine exactly where that leash is held. Whereas the longer end is kind of like the 30 year bond and they let the dog wander from side to side. And it can kind of gyrate based on really what it’s trying to do is to a larger degree, it’s trying to predict where the man is gonna walk to some degree.

[01:04:51] Cullen Roche: So there’s this weird sort of feedback relationship where the man has a certain amount of control over where the dog is going, but doesn’t have absolute control over it through the leash. And so interest rates function very much the same way in the current system, where theoretically the man could take that leash and he could pull it all the way in and he could basically.

[01:05:13] Cullen Roche: Control exactly where the dog is by grabbing the collar basically and eliminating the leash. Right now in the system, we have the most central banks. They don’t target the price of long rates. They let long rates just sort of float. And this is part of the argument why I always say that quantitative easing isn’t as effective as a lot of people tend to think because what they’re doing is they’re controlling the quantity of bonds, they’re not controlling the price of bonds.

[01:05:42] Cullen Roche: Whereas at the short end there’s a huge difference because at the short end, they specifically control the price. They explicitly determine what the overnight price is and the Fed or any central bank is such a big, powerful money issuing entity that it is a monopolist essentially. And it can, Banks don’t try to fight the Fed on what the overnight rate is because they just quite literally cannot.

[01:06:10] Cullen Roche: Whereas the Fed lets the long end float and banks will try to front run and change long term rates because they know that the monopolist isn’t actually setting that rate. But if the Fed came out and said, for instance, the 10 year treasury bond is worth 3%, the 10 year treasury bond, would, I, it would immediately, or within days go to 3% because the marketplace would know that there’s no way they can arbitrage that out because the Fed is gonna come in and the fed’s gonna set the price and they’re gonna, they’re gonna pay interest on that instrument in a way where they’re able to very precisely control it.

[01:06:50] Cullen Roche: And so that’s essentially what yield curve control is it’s the central bank coming out in explicitly saying, this part of the yield curve is now exactly this price. And they’re able to do that because they’re the reserve monopolist in the, in that second tier interbank payment system. So, It’s very sort of controversial because like to some degree, like a lot of the theory argues that it’s actually good to get market signals from letting the long bond float because the market then is sending a signal like when the yield curve flattens, for instance, in an environment like this, like I would argue that what the long end is essentially saying is they’re saying, Well, we actually expect long term inflation to be much lower than what the Federal Reserve expects right now.

[01:07:34] Cullen Roche: And so with the 10 year yield lower than the two year today, the marketplace is basically saying we are not as worried about inflation as the Federal Reserve is over the course of the next 10 years. And that generally is consistent with a market signal that is. Hey, the Fed is maybe a little bit too tight here.

[01:07:55] Cullen Roche: They are maybe a little more worried about inflation than they should be, which is why, this is the reason why the yield curve tends to be a pretty good predictor of recessions is because that’s the market signal that it’s sending.

[01:08:08] Stig Brodersen: Speaking of the Fed, it is well known that the Fed has a dual mandate of price stability on one hand, and then full employment on the other.

[01:08:16] Stig Brodersen: But you also argue that the Fed could be, seem to have a triple mandate. What is the third mandate and how would the economy look if we didn’t have the Fed?

[01:08:25] Cullen Roche: Whew, that’s a good question. Well, we didn’t always have the Fed, the, the banking system. Before we had the Fed was basically, I like to describe the Fed as a central clearing house.

[01:08:38] Cullen Roche: They really, the big thing that they do is they just clear payments in the inner bank market. That is their, they get a lot of press for doing things like quantitative easing and changing interest rates. But their day to day function really is this inner bank clearing process and they clear trillions of dollars of payments and they, for the most part, this system works really well.

[01:08:56] Cullen Roche: It works really smoothly, and they don’t get, they don’t really get any credit for that, or there isn’t a lot of talk about it because it just generally it, I mean, the vast majority of the time it’s not a problem. And when it does become a problem like it did kind of back in like 2008, they’re actually very good at smoothing the functioning of the payment system so that it doesn’t become a big problem.

[01:09:16] Cullen Roche: And before we had central banks, before we had the fed for instance, and the reason we actually have the Fed to a large degree is because in 1906 and 1907 and many panics before that, We had private clearing houses where instead of Bank of America and Citibank clearing a payment through the inner bank market, through the central bank, they would clear the payment between themselves and they would literally meet at a clearing house and they would settle up their debts at the end of the day.

[01:09:44] Cullen Roche: And what started to happen increasingly was that you had private entities that were going in and they were looking at each other doing financial panics. And the, the city bank banker was looking at the Bank of America banker and saying, You know what? We don’t trust your balance sheet. We know you have a whole bunch of railroad loans out that are melting, and we’re gonna wait about three months before we decide to do business with you.

[01:10:05] Cullen Roche: And as the economy became this more nationalized economy, much more interconnected. That became a huge problem because then you could have, Citibank wouldn’t settle any payments with Bank of America, and then all of a sudden Cullen can’t settle a payment with Stig because we just happen to both use these two banks that won’t work together.

[01:10:25] Cullen Roche: And like, Stig and Cullen might have no problems. We economically, we might be running the most successful businesses ever, but like we can’t settle a payment between each other just because the banks are bad at their job all of a sudden. And what the Fed basically comes in and does is they operate as this third party intermediary where they come in and say, Look, okay guys, you can relax because we actually have seen Bank of America’s balance sheet and we know that it’s fine, it’s, they’re gonna make it through this, and so we’re gonna act as the third party intermediary.

[01:10:55] Cullen Roche: And that’s what they did in 2008. And it actually worked really well. You could argue that, I mean, like, I’ve been really critical of their interest rate policy in the last year. Because there are legitimate controversial things that they do, but for the most part, this central clearing process works really, I mean, beautifully to a large degree.

[01:11:14] Cullen Roche: So if we didn’t have central banks, you would probably still need some sort of third party intermediary because financial panics turn into financial depressions in large part because the financial system starts, getting mucked up. And that’s a huge problem. And actually one that central banks are very good at resolving.

[01:11:31] Cullen Roche: So, in terms of their third mandate, that really is it’s to sustain financial stability and that’s a big part of the thing that the Fed is actually really good at that people just don’t ever really talk about. And, we can, like I said, you can have lots of debates about whether, like, I think quantitative easing is a bad policy.

[01:11:51] Cullen Roche: I don’t think they should have ever done it. I think that the way that we control discretionary interest rates with like, basically. A group of people meeting and putting their fingers in the air and saying, Hey, this is where interest rates should be. I think that’s kind of a silly way I would, I think there are systematic ways where we could implement this that would, take a lot of the guesswork, a lot of the human element out of it.

[01:12:12] Cullen Roche: So there are, I think, fair criticisms of things that they do, but as a financial stability and entity in terms of just monitoring and regulating the payment system, they do a pretty darn good job and they don’t probably get enough credit for that because it’s just not something that people, I think, actually know a lot about because we just sort of take for granted the fact that the payment system pretty much always works pretty smoothly.

[01:12:39] Stig Brodersen: Cullen, as always you’re a wealth of information, it’s just always great having you on this show and learning from you. If the audience would like to learn more perhaps about your wonderful book, Pragmatic Capitalism, Your website, that’s called the same, but would you like to give any handoff to the audience about whether they can learn more about you?

[01:12:58] Cullen Roche: Yeah, so I mean, like Stig said, It’s Pragmatic Capitalism is the book. I just released a second edition. So it’s been, a while since I published the first edition, but updated it with sections on, I would argue that I’ve evolved more and more into a behavioral investor. I think that trying to control for investor behavior is actually probably one of the most important things we can try to do.

[01:13:21] Cullen Roche: So there’s updated sections with what I refer to as discipline based investing and trying to be, you know, having more discipline over your investment processes. But yeah, I write the blog that I’m probably best known for is Pragmatic Capitalism, which is pragcap.com, P R A G C A P dot com. I’ve started doing little video series where I’m trying to do a lot of the similar stuff where, this is a 250 page book that it jams.

[01:13:47] Cullen Roche: I tried to jam probably way more content into it than I ever could have. I, arguably do some topics that’ just an injustice because I could, you could write a thousand page book about certain aspects of, that I write about for 10 pages in here. But I’ve started doing these videos, Three minute money videos on YouTube.

[01:14:05] Cullen Roche: They’re just little snippets of generally little lessons. Or recently, because of all the turmoil, I’ve been talking a lot about the macro economy, but still starting from a first principal’s perspective where my goal is really to understand the system for how it works, and then you can apply these behavioral elements where you’re trying to navigate that system, but do so in hopefully a pragmatic approach.

[01:14:28] Stig Brodersen: That sounds wonderful. And Cullen, thank you once again for coming on the show to teach us about the global change in the economy and more about why we should pay attention to macroeconomics. This was the 10th time you were on. I mean, how amazing is that? I hope we can bring you on at least another 10 times.

[01:14:42] Stig Brodersen: Cullen, I know I’m putting you on the spot here, but it’s always a pleasure.

[01:14:46] Cullen Roche: I love it. I love talking to you guys. Your audience is awesome. I always get great feedback from everybody, so thanks for listening. I hope you learned a bunch. And yeah, I’ll look forward to doing it again, for sure.

[01:14:57] Stig Brodersen: All right, so let’s put it in the book sometime but hey Cullen, again, thank you so much for your time. It’s always wonderful to speak with you.

[01:15:04] Cullen Roche: Yeah, thank you Stig, and thanks for listening, everyone.

[01:15:06] Stig Brodersen: All right. As we let Cullen go, I’m excited to share an upcoming event hosted by The Investor’s Podcast. We are launching a stock pitch competition for you to compete in, and the first place winner will receive $1,000 plus a yearlong subscription to a TIP finance tool and more.

[01:15:23] Stig Brodersen: If you’re interested, please visit theinvestorspodcast.com/stock-competition. For more information, the last day to submit your stock analysis would be Sunday, November 27th and to compete, please make sure you sign up for a daily newsletter. We study markets while we announce the winners. All the enteries can be submitted to the email: newsletters@theinvestpodcast.com.

[01:15:45] Outro: Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investor’s Podcast Network and learn how to achieve financial independence. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional.

[01:16:06] Outro: This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.


Help us reach new listeners by leaving us a rating and review on Apple Podcasts! It takes less than 30 seconds, and really helps our show grow, which allows us to bring on even better guests for you all! Thank you – we really appreciate it!



P.S The Investor’s Podcast Network is excited to launch a subreddit devoted to our fans in discussing financial markets, stock picks, questions for our hosts, and much more! Join our subreddit r/TheInvestorsPodcast today!


  • Invest in high-quality, cash-flowing real estate without all of the hassle with Passive Investing.
  • Private assets represent 98% of companies in North America but are absent in most portfolios. Reconstruct your portfolio with private markets with Mackenzie Investments.
  • Build a plan that helps you strengthen your financial security with RBC Wealth Management. RBC capital markets LLC, member NYSE, FINRA, SIPC.
  • Throw out the old traditions and get progressive. Discover the complete package – smart design, lots to love under the hood with Genesis.
  • Have gold and silver shipped directly to your door for you to hold at your home. Get BullionMax’s Gold Investor Kit today – 3 ounces of the world’s most desirable gold coins, including the Gold American Eagle and Canadian Maple Leaf.
  • See the potential of your business. Find solutions that work for you, that tick bigger boxes and help you grow with Square.
  • Confidently take control of your online world without worrying about viruses, phishing attacks, ransomware, hacking attempts, and other cybercrimes with Avast One.
  • Enjoy a 400-calorie meal that contains 40g of expertly sourced, premium plant protein, all 26 essential vitamins and minerals, and a scientifically calibrated mix of carbs, good fats and fiber with Huel Black Edition. Plus, get a free t-shirt and free shaker with your first order.
  • Start printing everything your small business needs and discover the endless printabilities with VistaPrint.
  • If your business has five or more employees and managed to survive Covid you could be eligible to receive a payroll tax rebate of up to twenty-six thousand dollars per employee. Find out if your business qualifies with Innovation Refunds.
  • Get position and investment info for nearly 6,000 Asset Management Companies with Moomoo, Australia’s first A.I. powered trading platform. Sign up and fund your moomoo account before October 31 and get $10 for every $100 you deposit. All investment carries risk. AFSL 224 663. T&Cs apply.
  • Start building a portfolio of alternative farm and timberland assets with AcreTrader.
  • If you’re aware you need to improve your bitcoin security but have been putting it off, Unchained Capital‘s Concierge Onboarding is a simple way to get started—sooner rather than later. Book your onboarding today and at checkout, get $50 off with the promo code FUNDAMENTALS.
  • Support our free podcast by supporting our sponsors.

Disclosure: The Investor’s Podcast Network is an Amazon Associate. We may earn commission from qualifying purchases made through our affiliate links.




Check out our latest offer for all The Investor’s Podcast Network listeners!

WSB Promotions

We Study Markets