You're listening to IP Today show, we have a good friend, Colin Roache, with us. Colin has met hundreds of millions of dollars for the past two decades, is always a wealth of information.

During the 2008 financial crash, Cullen's private investment partnership was up 15 percent for the year. He's the father of capitalism, the author of multiple investing books and the regular guest on Bloomberg and major financial news outlets. And today's show would talk about inflation. The state of the economy and whether there is a rational argument for stocks to be trading is 50 times earnings. So with that, let's go ahead and get started.

You are listening to the investor's podcast where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to the show, I'm your host protozoan today I'm here with one of our good friends and we start. Thank you so much for joining me here today, Colin. So call it let's jump right into the first question, and that question is about money supply. What you previously said here in the show is that it doesn't tell you anything that the money supply is going to grow because that's just an operational reality of the way we structure a debt based financial system.

And you also said that the amount of deposits and the amount of loans are always going to grow in the long term. So going into this, really also to preface this conversation with you, could you please elaborate more on that and how the money supply impacts the economy? So obviously, money is an extremely important component of what goes into the economy, how we measure oblation and things like that, one of the I think problems that I have with, for instance, some people might be surprised to hear this.

I used to be a pretty strict adherent of the Austrian school of economics kind of coming out of college.

I read a lot of Mises and Hayek, and I think that one of the problems I eventually ran into working in the financial industry and working specifically with a lot of bankers and people that were literally the money creators in the economy, was that the Austrian school defines inflation as an increase in the money supply. And I started to find this problematic because if you look at the money supply over the course of history, it basically always expands over any really long time horizon.

The money supply will always expand. And the reason for that is basic in that essentially when you look at what really creates money, a lot of people think that the central bank is the money creator. And really what we kind of found coming out of the financial crisis, especially with quantitative easing, was that when the Fed makes reserves, so the Fed makes reserves, which is money for banks and it's only in the banking system, the the reserve money or money as reserves doesn't get outside of the banking system.

So we kind of know like this whole concept of the money multiplier is misleading at best, and that when the Fed creates one dollar of reserves, this doesn't necessarily multiply into ten dollars of deposits or ten dollars of loans. And that's the kicker, is that loans create deposits. OK, so when a bank makes a loan, they're creating a new deposit liability for the bank. That's an asset for the borrower. Basically, the real kicker with this is that as the economy grows over time and expands, people want more money.

They need to borrow more to produce things in the banking system is just sort of the liquidity provider that they create the deposits through a loan agreement essentially that literally liquidate the economy. It creates the liquidity that makes it possible to go out and say, invest in new technologies that we think might create a return on investment or to build a new home or to purchase existing homes or there's a lot of bad uses for credit. I mean, you could argue that, for instance, a high rate credit card is that you're just buying frivolous nonsense with is a really bad use of credit, but even that is an expansion of the money supply.

And and that's just kind of a function of growing population and growing demand for goods and services over time. And so if you look at the quantity of loans and deposits over any long historical period, they're always trending up. I mean, always virtually over any really long time period. And that, in a way, is actually a good thing because it means that there's more demand in the economy. There is more output being created because people are using a lot of this.

And this is the big kicker is that a lot of the borrowing that's done is done for real investment. It's done to innovate, it's done to build homes. And a lot of this is just accounting. So when the money supply expands, they're not creating liabilities. We like to talk in the sort of binary ways where people will tend to focus on only one half of the equation, and they'll sort of mean that in a way that has a very negative connotation.

And the reality is that, yeah, debt can be really bad, but debt can also be really good because the side of a liability is an asset. When somebody takes out a new loan, there are not just liability. There isn't just the debt. There are the assets that are created in those assets are potentially good. They're potentially bad. There's no like this that when someone takes out a loan and the result of borrowing really depends on what ends up being done with the loan.

When I go to a bank, let's say I want to build a new home or something and know I go to the bank to take out a new loan, I get an asset deposit that is mine. I have a liability in the loan. The bank has an asset that is the loan and the deposit liability. So the balance sheets are just completely balanced right there. The balance sheet, they're completely balanced. But if I didn't take that money and I take those deposits and I go out and with just sheer will and hard work, I go out and I build a home and I let's say then repay the loan at the end of the terms by selling that home, the balance sheets, compress the balance sheets, go right back to where they were when I repay the loan because loans create deposit.

But repaying loans destroys deposits, so the balance sheets compress right back to where they were and from the start, but what's left over? We have a house, we have a real asset. So we are demonstrably better off after all of this because I borrowed and used the debt in a way that was productive. And that's the ultimate kicker. With inflation and money supply and all these things, it's not just about how much money is being produced, but it's more important to understand what is the money really being used for and are we are we creating more output?

Are we creating more goods and services that create demand essentially for future money that makes the whole economy viable in the long run? I guess the follow up question to that would be now that we've seen, say, from November twenty nineteen to November twenty twenty, we've seen the money supply expansion up twenty five percent. Does that mean that we have twenty five percent inflation? What is money, I like to think of money on a I call it a scale of muddiness because money to me is really a medium of exchange.

It is just the thing that is most liquid that gives you access to goods and services, essentially. But there are different things that are good for that in different environments. I mean, for instance, I mean, let's say that covid ravages the whole economy. We very well could be in an environment where gold, for instance, is literally the best form of money because it's the thing that people will accept essentially for barter as money in a modern, technologically advanced economy.

Deposits are basically the ultimate form of money because they're the thing that is most widely created and acceptable in across the entire economy.

You can use deposits for virtually anything to purchase any goods and services in a modern technology based economy. So. The problem with the way that a lot of people define money is, for instance, a lot of professional macroeconomists will define real money as the stuff that the government creates, the actual physical currency, the reserve currency, as in literally bank reserves, that the the Federal Reserve creates things like that, that they would argue are the real forms of money.

And so you have all these sort of conflicting definitions and narratives about what is not only real money, but how that will actually filter into causing inflation.

And so that's a big issue. I've seen, for instance, in recent weeks, I've seen a lot of charts about how anyone has increased by some huge amount in the last few weeks. And if you actually dig deeper into it and you look at something like M2 in the United States, M2 hasn't actually changed.

And the reason why and one increase in M2 didn't change is because what essentially happened was you had something that is included in one which is basically savings deposits, and it was converted into demand deposits, which at the M2 level there was no change because there was just a conversion. But because of the demand, deposits aren't in. And one, you had this sort of like technical increase in them, one that a lot of people would look at and say, oh, this is going to cause huge inflation.

And really it was just sort of an accounting change. You have all these sorts of competing narratives and definitions of things. And ultimately, I think when we look at covid, there is no denying that covid has increased the money supply by virtually any definition. The response to covid was colossal. We talked last time about how I'm a lot more concerned about future inflation than I was coming out of thousand. I was actually pretty much a not a deflation is coming out of twenty eight, but a disinflation is meaning that I believe that the rate of inflation was going to continue to decline, so the positive rate of inflation would continue to decline.

I am much more concerned this time that you could see real inflation just because the response has been so humongous. For instance, I mean, we're talking about the latest stimulus in the United States here, which was roughly nine hundred billion dollars. That's bigger than the entire fiscal stimulus that we enacted in 2008. And people are complaining that this was tiny, that this wasn't big enough. So putting things in perspective, and this is in addition to the Keres Act, which was two trillion dollars plus, not including all the Fed policies and things like that.

So the response here has been humongous. There has been, you know, by any technical definition, there has been you know, let's just rather than using the term money, let's just say there's been a lot of financial assets created in those financial assets. They are being held by the private sector and they're they've enriched the private sector in financial terms. My big concern with inflation going forward is not just you've created a lot of financial assets in the last year, but that we've seen a lot of real disruptions in supply chains that we're seeing filter through the real economy in a meaningful way, that in the next two to three years could you know, I'm not worried about a hyperinflation, but I think you could easily be in an environment where we're at the twenty, eighteen, twenty, nineteen levels of inflation or much higher than that, say, three, four percent inflation.

By that point where the the Fed is really backtracking, they're really on their heels jawboning about having to potentially raise rates and concerned that all these big policies worked and maybe worked a little better than they had hoped. So let's continue talking about inflation and some of your thoughts on that, because if you look at the five year swap rate in the United States and also in continental Europe, it seems like the inflation expectations have turned upwards.

How do we as investors position ourselves accordingly if we agree with you and you agree with the market that this trend of rising inflation continues?

I think that from a domestic currency perspective, you just want to be somewhat hedge against that risk because, you know, I mean, for instance, in the fixed income markets, I mean, the problem with low interest rates when you're a bond investor is that when you have low rates, the percentage increases in interest rates impact your bond investments a lot more just because the the math is so much dirtier about it. For instance, when you have an interest rate that's 10 percent and interest rates by two by one percent.

Well, you only had a 10 percent principal impact. So in terms of a one percent interest rate, when interest rates rise one percent, you've get a one hundred percent principal impact. So mathematically know you're not earning the same amount of interest, which basically means you're not earning the same amount of coupon protection from your fixed income payments as interest rates are rising. So that one percent increase in rates has a much bigger impact on your principal because over the course of the year, you're not earning that high interest rate that you would have been, for instance, when interest rates are 10 percent.

So you have less interest rate protection when interest rates are low because you're just naturally earning a lower coupon from your starting point.

So fixed income investors are sort of exposed in an unusually negative way to rising interest rates in a low interest rate environment if they're exposed to very long duration instruments. So in the fixed income markets, if inflation is your worry, you're eventually worried about interest rates increasing.

And and so you would want to be for certain, shorter on the the maturity curve. If you're a fixed income investor. I'd like to think of stocks very similarly to bonds and that I like thinking of all financial assets as having sort of a duration. And to me, stocks are just their instrument that basically has either a perpetual duration or at minimum, a very, very long duration 30, 40, 50 years. And that's part of what makes them so volatile is that they by definition, because they're such long term instruments, they are more volatile because their income stream your less predictable.

They provide the investors or the underlying financial asset owners with so much less protection from the way that they earn their income over time because corporations are just naturally long term entities, the way they earn their cash flows is very long term by nature. And so from a stock market perspective, if you're worried about rising interest rates while you're worried about the way that those cash flows are going to ultimately be repaid. And the kicker with that is that if you have rising interest rates, you have probably rising inflation.

And inflation makes managing a corporation very difficult because it disrupts supply chains. Or you could argue that inflation is evidence of a supply chain disruption. And so by definition, when you have high inflation, you just have a lot more uncertainty inside of a corporation. And so this makes the whole management and cash flow management of a corporation much more difficult to predict over time. And so the cash flow streams become less predictable. So stocks should become not only more volatile, but they should become more volatile and specific types of sectors.

And so if you're worried about domestic inflation, I think the obvious answer is that you'd want to be globally allocated. So allocating outside of the domestic economy is generally going to be one way to protect against a higher rate of inflation. The obvious one is to own real goods and services. You want to be the owner of stuff. So if you can't be the owner of a of a corporation itself, you'd want to be the owner of physical assets, whether it's real estate or even things like precious metals.

And then going looking kind of within the domestic stock markets.

You're someone that say you still want to own a piece of your domestic economy. I would argue that you're probably better off owning or at least diversifying into something like a value type of stock versus a growth stock, because the typically what we find with value stocks is that they tend to be safer businesses by nature. So, for instance, you might argue that the the typical sort of the classical sort of Warren Buffett type of value stocks, the old brick and mortar, the boring, reliable types of businesses, may be the ones that aren't quite as sexy as the the Pelton's in the Facebook books of the world that those are going to do better a.

Rising inflation. Boring businesses, they have more predictable cash flow streams, and so something like a Facebook potentially becomes a lot less attractive in a high inflation environment just because their cash flow streams are somewhat unpredictable. They're dependent on things that are are not necessarily based on the real economy, but based on sort of this Internet based economy and whether or not the demand is there for those things consistently in a high inflation environment versus are people going to continue to pay their utility bill, it becomes a little less certain that so value versus growth becomes sort of the way to diversify within the domestic economy if you're worried about inflation.

It's interesting that you would say that, Colin, because last time we talked about how growth stocks typically performed better than value stocks in the low inflation environment. Now, if we continue this train of thought growth, stocks also perform better than stocks, with interest rate being so low since the discount rate is correspondingly low. And this is also giving the assumption that you don't discount with something like the money supply or something like that, but you've got discount or something like the Treasury rate are similar to that.

And I've been really trying to wrap my head around. This can be really consider future earnings being almost equivalent to earnings today because of the low interest rate. And how should we as investors look at the valuation between value and let's just call that earnings now and then grow stocks and let's call that earnings later, giving this way of discounting back with something very close to zero?

It's always kind of confounded me that the way that I think people tend to for instance, they think of the equity risk premium as something as being at least highly impacted by the discount rate with a zero percent interest rate. A lot of people would argue that the equity risk premium, basically the premium that equities deserve to earn over bonds is vastly superior than it is when interest rates are high. And, you know, to me, I've always found that using interest rates as the kind of central component of a valuation metric can be misleading because interest rates are a function of future inflation expectations.

So, you know, I would say that I prefer to use the term the equity inflation premium, that when interest rates are low, it really means that inflation is low and that future inflation expectations are low.

So the Fed, for instance, they have interest rates at zero because they expect inflation to remain really low.

If inflation was to rear its head in the next few years, the Fed would start raising interest rates over time to try to get ahead, to try to create more demand for money by getting people to basically earn an interest rate that makes them want to hold more money, in essence, to kind of oversimplify things. So to me, this really isn't about interest rates. This is about really understanding what is the future rate of inflation going to be. And there's no iron clad rule that says that when inflation rises and let's say interest rates rise correspondingly, there's no ironclad rule that says that that equities have to earn more or less premium inside of those environments.

I mean, if you were an investor in Zimbabwe, in corporations, when their inflation was raging out of control in the Zimbabwean central bank, was raising interest rates, well, you know, no one was talking about an equity risk premium in that environment. The rate of profit is for most corporations inside of an environment like that, because your economy is just being completely ravaged by the rate of inflation that's going on. And so we kind of have this privilege of in the United States having you not just low inflation, but very stable inflation where we have a great amount of predictability.

So to me, to kind of answer your question, I think people would be better off looking at inflation rates in the future. When you make an interest rate debt of any type, you're really making an inflation bet. And if you think that inflation is going to remain low in the next five to 10 years, what you're really making a bet that the Fed is right, basically that the Fed is going to keep interest rates low and that you're not going to really see a high rate of inflation.

And if that's the situation, then, well, I mean, all the trends that have been in place basically for the last 20 years are going to continue. Value's going to continue to be terrible versus growth.

The US domestic economy probably continues to outperform foreign stocks, just especially on a domestic currency basis. And real assets do OK ish versus everything else. So if you believe in the opposite, if you believe that inflation is going to be high, then you you go out and you kind of diversify into all the things we talked about in the previous segment. But to me, interest rates kind of confused the whole narrative because the interest rate is just set based on what the future inflation expectations are going to be.

So keeping that in mind, what you just said, I have to ask one of the buildings that we follow closely here on are we started building this billionaire, Ray Dalio, and he was recently doing an ask me anything on Reddit. And we will, of course, make sure to link to that in the show notes. And so he was asked whether he thought that the current equity prices were a house of cards. He answered with bond interest rates where they are, bonds are trading at roughly 75 times earnings with the amount of money out there and cash being such a bad alternative, there is no good reason that stocks shouldn't trade a 50 times earnings and just gives the listener some context before trading around thirty three times earnings in the US right now.

So do you agree with that assessment? You're essentially arguing that this paradigm that we're in is sustainable and going to be prolonged.

So you're basically arguing that this environment of very low inflation with really poor demographic trends and rapidly changing technological changes, you're basically arguing that that is the dominant macro paradigm that we're we're not just in, but that we're going to continue to be in that paradigm. People have been saying, for instance, with the cap ratio, they've been saying, oh, valuations are too high, they've got to come down. And people have been saying that for 20 years.

But the real fact of the matter is that as long as we're in this sort of alternative universe, economists would call it an alternative equilibrium. Basically, the economy has shifted into a new equilibrium where now the current equilibrium is this low rate of inflation and this sort of stagnant growth period where certain types of firms just do really, really well inside of that type of environment.

And growth stocks obviously are the big beneficiaries of something like that because their cash flow streams, because they become so predictable to a large degree. But if we're in this new paradigm of permanent low inflation, a sort of Japan bifurcation of the entire developed world economy, there's a justification, you could argue that there's a rational argument for why valuations are the way they are in that environment. And you could argue that if we were to let's say the rate of inflation was to go lower, let's say that we become more Japanese in the next 10 or 20 years, inflation falls to zero or interest rates go negative like they are in a lot of European countries.

Yeah, you could argue that the corresponding valuations are going to be even higher because the demand for these really high flying, crazy expensive stocks become more attractive versus everything else because the rate of inflation is so low that corporate cash flows are just there. The obvious beneficiaries of all of this, they become the hot potato that everybody wants to own because there's kind of nowhere else to earn such a reliable, relatively low risk type of return. Is that the environment that is going to continue?

I mean, me personally, I think that we are in an environment where you're not likely to go back to the nineteen seventies. So I just don't think that there is the dynamics for, say, double digit high inflation. But would I be comfortable being at, let's say, the 10 year Treasury right now is at one percent. Would I be from a risk management perspective, would I be more comfortable betting on a three year Treasury bond versus a zero point five or zero percent 10 year Treasury bond in the next 10 years?

I would certainly want to be hedged against the three percent outcome because I view it as such an asymmetric bet in my mind, given the the way that the politics in the government response seems to be changing.

And to me, that's one of the big kickers here, is that we do seem to be entering this different paradigm where and this is the thing where Duilio might be wrong about this, is that from a political perspective, you're seeing a real serious sea change, especially the way that economists view inflation and fiscal policy and coming out of the financial crisis, you know, fiscal packages that the likes of what Europe has agreed to recently, austerity was the name of the game.

You had to suffer a little bit to be able to grow. And that was the way that macroeconomists, a lot of macroeconomists viewed the policy response in twenty two thousand nine. The current environment is completely different. I mean, we just spent I can't even keep track of the number three, four, five trillion dollars this year in the United States.

And hardly anyone is batting an eyelash at that. The numbers are just so big that the the way we've seen just a huge sea change in the mentality in the way that people perceive fiscal policy and government spending relative to the risk of inflation is such a huge sea change that that to me feels like a trend that is not only just starting, but is going to continue into the next ten, twenty years. We just had one of the biggest recessions ever in economic history and all we did was we slammed a ton of money at it.

And what happened? The economy just snapped right back. What do you think policymakers are going to do the next time we have a big recession? They're going to do the same exact type of thing.

So fiscal policy is going to be front and center. And, you know, the worrisome thing, the reason I say this is such a. Asymmetric bet to me is that no one knows what really causes inflation. I mean, there's sort of general theories about, oh, well, more money chases more goods.

But, you know, that theory to some degree has been debunked in that, you know, we printed a lot of money coming out of 2008. And what did we get? We got even lower rates of inflation over time. No one really knows all of the moving parts that really contribute to a high inflation. And this is just a much more confusing phenomenon than most people have made it out to be and certainly the way that economic textbooks have made it out to be.

And that's worrisome in that, let's say we had this huge explosion in fiscal policy. Well, let's let's say we do find out that to avoid the term money, more financial assets is really the the way to create more inflation in certain types of economies.

Well, we're going to find out whether or not that's true in the coming five to 10 years, potentially.

So that to me, the political sea change makes this a a really somewhat asymmetric bet that if you're betting on the permanently low inflation, you are to a certain degree, you're betting that the politics aren't going to change. And I don't know. I feel like the politics are starting to change. The sort of the MMT advocates of the world and the the Bernie Sanders of the world are going to become more vocal types in creating this, I think, sort of perception that fiscal policy doesn't have a lot of downside.

And I've been a big advocate of actually fiscal responses for the last 10 years. But there's something about the sea change here that it starts to make me a little uncomfortable and maybe I'm just too much of a risk manager. But I in terms of managing the risks, I'd want to be hedged against that risk for certain.

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Dotcom today. That's Monday Dotcom. All right, back to the show. So let's continue talking about inflation here, because inflation is seen by many as the savior of the growing public debt to GDP ratio. And many countries have in the past deliberately used this and this, meaning inflation as a tool to reset the debt situation. Do you think that using inflation to erase debt or at least minimize debt is a viable solution in Europe and in the US?

And what would be the potential negative consequences if that was the approach that was taken? The first thing I would say is that the debt to GDP ratio. I don't know if there's anything about that number that is really meaningful, you know, we use it as kind of a general barometer of of what's going on. But I don't know what this number really tells us. You know, there was a famous study back in, I can remember, 2009 or 2010.

Reinhart and Rogoff came out with a paper and then they later released, I think, the Excel spreadsheet that they used. And they had argued that something like a 90 percent debt to GDP ratio was kind of like the break, even the breaking point for government debt, basically. And a lot of people had a problem with that because there's I mean, first of all, there's a lot of evidence that that's just empirically wrong. I mean, Japan has, what, something like a two hundred and fifty or three hundred percent debt to GDP ratio, and they have crazy low inflation and have for 20 years.

So there's doesn't seem to be anything magical about this line. But the funny thing with the Reinhart Rogoff study was that it ultimately had a spreadsheet error, like a basic math error in the spreadsheet where they had come up with this number, not in just a sort of phony theoretical way, but they made a basic math mistake within it. So I don't know that there's anything about this number that is really that meaningful to begin with. And kind of, again, going back to the balance sheet accounting of it, to me, people just, I think, talk about debt in a sort of lazy way where they say, oh, well, more debt is bad.

And, well, you know, again, more debt. It doesn't just mean more liabilities. It also means more assets. And there's I'm by no means a believer in the idea that the government necessarily creates financial assets and does so efficiently. But there's nothing necessarily negative about creating more debt. And if you have an economy where the underlying private sector is just super, super productive. Well, you know, if you're creating more debt, in theory, you might have a big multiplier effect within that economy where more assets actually they liquefy the domestic economy in a way where that economy might actually become even more productive because it has an underlying inherent level of productivity already in it where you maybe you just didn't have enough liquidity to begin with.

Maybe there were tons and tons of entrepreneurs out there that had great ideas that we're going to change the world and really big, meaningful ways. And they just didn't have the liquidity to be able to enact those ideas. There's a chance that what we're seeing here with a lot of this government stimulus and the way that it hasn't been really explosively inflationary, there's some evidence that that's actually what's happening, that you're adding liquidity to the economy, which is just, you know, in a lot of ways, I think creating a little bit of a multiplier effect where you're giving liquidity to people that really just needed it.

And that the domestic economy might just benefit from having that greater amount of liquidity, but there's nothing, again, kind of trying to hammer home the point that there's nothing necessarily good or bad about debt in and of itself, and that the the other thing is that I think when people look at government finances, they'll have a tendency to think of them in sort of household terms.

And so a lot of people talk about, for instance, repaying the national debt. And this is basically just a big fallacy of composition and that the national debt will never get repaid. You literally cannot repay the national debt without, again, reducing the size of the balance sheet correspondingly on the asset side. And the kicker is, is that the government debt is a humongous portion of the private sector's financial assets in that people who have Social Security or government pensions or even just bond investors broadly who own all of these assets, these are assets that they own.

And in order to repay the government debt, you not just repay the liabilities side of the balance sheet. You'd have to shrink the asset side of the balance sheet. And, you know, at an aggregate economic level, really, financial assets, they don't get repaid and you actually don't want them to be repaid over the long term. I mean, going back to the the household sector, for instance, when I talked about that example earlier, building the home where I borrowed money to build a home, you don't want people to just be repaying all those loans.

What ends up happening over time is that especially as the population grows, you just have more and more debt. You have. But again, you not only have more liabilities, you have more assets. And over the course of any really long economic period, you're just going to see a natural growth in both the assets and the liabilities, mainly because the other component of the balance sheet is equity. So the equity component is going to grow over time.

Our networks are going to grow because ultimately the value of our assets should, in a healthy economy, expand versus the value of the liabilities, which creates net worth, which ultimately is the real and non-financial capital that makes all of the economy sustainable over very long periods of time. So to me, I think people are kind of going back to the confusion and the question marks around what causes inflation.

I think a lot of people look at government debt and they automatically say, well, more government debt is bad. And so this or that ratio will contribute to inflation. And I think the sort of scary thing about inflation is that no one knows what level of government debt causes inflation or causes the economy to start performing worse or not. And that's the problem with big ratios like a debt to GDP ratio or this idea that you want to inflate your way out of debt, because ultimately we don't know the actual relationship between government debt and inflation.

And so to specifically answer the question of whether inflation you can really grow the inflation rate to retired or to kind of erase debt over time. Well, inflation is not a good thing. I mean, in a perfect world, you would have basically a zero percent inflation rate. You'd have growing money supply over time because people would be borrowing more money and creating more things would be so innovative and so productive that our technology would put a downward pressure on the rate of inflation to the point where there was virtually zero inflation.

Our economy is not perfect like that because there really is scarcity in the economy, especially on the real side of things. And we see that anyone who's tried to buy things during covid knows how true that is. I mean, I've I've looked at the price of a two by four sort of jokingly over the course of the last few years as I've been building my house here and just watch the price explode during covid because of the scarcity of a two by four during the last year.

So these dynamics are real and you're likely to pretty much always have some positive rate of inflation just because real resources really are scarce. And so that's going to create dynamics where we've created this technology that is sort of a double edged sword in that we create money from nothing, but we can't create the corresponding goods and services from nothing. And you would never use inflation to grow your way out of debt because very high rates of inflation are a sign of huge economic problems.

I mean, when you have an economy where you go from, say, 10 percent to one hundred percent in. Your economy is essentially broken. I mean, people talk about the problems that we have in the United States where we have very low rates of inflation and low growth. But, boy, those things are a blessing compared to very high inflation because very high inflation, it will ruin everyone's life. You know, we talk about the problems that you have with low inflation, where there's inequality and things maybe aren't quite as good as they could be.

But at very, very high, inflation ruins everyone's life. It doesn't just ruin the poor people's lives or certain components of the economy. And so the whole idea that you'd want to inflate your way out of debt, it's just sort of I don't know, it seems sort of nonsensical to me. And, you know, why would you blow your whole body up to save yourself from what you view as sort of a miserable life?

It does. It doesn't make any sense to me, because once you've destroyed the domestic economy, yeah. You might be able to come out and say, oh, we reduced our our real debt levels, but we did so by blowing up the whole system. It doesn't make a lot of sense to me. So I don't think that's what policymakers are trying to do. I think policymakers are when they're enacting these policies, I think they're really trying to grow their way out of debt.

They know that inflation is going to be a byproduct of increased demand to some degree just because of the basic dynamics I was talking about earlier. But they're really trying to grow their way out of debt. Let's talk about that strategy, because another way for a country to repay its debt is to grow this economy. And as long as the economy grows at a higher rate than the normal interest rate, meaning the debt in time, debt will be repaid.

And so that really takes me to the next point about productivity. We often hear productivity mentioned in various debates and I read about the need to increase productivity. So let's first start by defining what is positivity. Well, this is one of those sort of macro economic debates that nobody really knows the answer to. So, I mean, productivity at the most basic level is just output per hour. How much stuff are we creating per unit of work, basically?

So one of the things that a lot of people find disconcerting about the last 20 to 30 years, really since the 1970s, is that the rate of productivity has declined and nobody really knows why. And I don't know how much of this is a just sort of a natural sort of basic trend that's occurring in the economy because of that. I'll give you my personal view on the whole productivity debate is that basically, sure, people have become slightly less productive in terms of the amount of real stuff we produce, but that the the way we quantify whether or not that's really impacted our lives positively or negatively is very, very subjective in a lot of people use this as sort of a measure of of our living standards over time.

And I would argue that since the 1970s, for instance, the blast, the Bureau of Labor Statistics releases a survey every 10 years. It shows the the household share of income expenditures as a percentage of total necessities in the basic. We're talking very basic necessities in the three big metrics that they use are food, housing and apparel. And if you look at the three of those, the housing component has obviously increased. But the apparel and food component as a share of household income expenditures has declined really significantly.

In total, the share of that has declined since 1970 from about fifty eight percent to about forty five percent. So the amount of money that we spend on what we deem as very basic necessities has declined substantially. And sure, even if we become less productive, our living standards haven't necessarily declined over that period of time. And a modern home is a technological miracle. From top to bottom, the insulation is magnitudes better. The things you can't even see, the drywall is better.

You know, when I was building my house here, I couldn't believe how different every single material was all along the way. I mean, I used things in our foundation construction that a poxes that had been invented in the last ten years, that these things you couldn't blow them up with dynamite. I mean, these are things that are just leaps and bounds superior to everything that existed in the nineteen seventies. And so when people talk about our living standards and productivity, you get a lot of very subjective ideas that go into this.

And and the bill, they come under attack a lot because they like he doneck adjustments and things like that. This is all very subjective. You could argue they're very somewhat sloppy necessarily so about the way they sort of subjectively attribute gains to a lot of these things.

But the world's just become really, really complex in the last 10, 20 years where I think that the idea of productivity gains and whether or not we're better off as an entire economy has become so subjective. And to a large degree, a lot of this is great that, for instance, in today's economy, people would argue that a college education and health care are now necessities. One hundred years ago, you never made that argument. Nobody went to college.

One hundred years ago, very, very few people did. Nobody had good access to good health care one hundred years ago. But objectively, we now consider those things to be necessities in a modern economy. That alone is evidence that regardless of how productive we are or how much stuff we create, our living standards have increased over this time. I'm not making excuses for things like inequality. There's definitely been a lot of winners and losers over the course of time.

But in the aggregate, I don't think you can make a really convincing argument that our living standards have declined over the last 30 or 40 years, regardless of productivity. So in the way we measure these things, because a lot of it's just so subjective.

And I think that we just have a very hard time objectively analysing these things because living standards, to a large degree, they're like beauty to some degree. I mean, back in the Roman Empire, a big overweight woman was considered beautiful. And today we look at runway models, these pencil thin women, and that's the essence of beauty in today's economy or today's society. And so there's so much. Subjectivity about the way we perceive these things, and I think living standards are very, very similar.

So let's go back to this theme of Corona, and it's on everyone's minds, assuming that we use 2019 as the benchmark and that the world will have somewhat normalized in 2022. And we can always talk about what a normalized world would look like today. But which countries and regions do you expect that would have weathered the pandemic best measured in economic growth? And how should we as investors position ourselves accordingly? Yeah, so this is kind of the the big question coming out of really since the financial crisis was the whole monetary policy versus fiscal policy response.

I think one of the things that people missed, you know, I was saying I was really vocal in April about this idea that a lot of people thought the stimulus was going to be really bad for the economy. And my argument was basically the economy was going to be really good for whether or not it was good for households, whether or not targeted really efficiently was meaningless for a stock market investor, because the basic math of corporate profits is that when the public spends more money, where does that money go to?

Well, if you assume, for instance, that the personal savings rate during a recession, it increases. OK, so if the government spending checks to households, households are saving that. But as the economy heals over time and let's just say that regardless of what the government is doing, that the economy heals naturally over time.

Let's say we get a vaccine covid slowly goes away. Well, all that spending went to households. They saved the money. What ultimately happens with it? If the savings rate declines, all else equal that money ends up going to corporations. That's where the money flows. So my ultimate argument was basically that when the government spent all that money back in April that eventually you were going to see, assuming that covid goes away and that the economy normalizes to some degree, you were going to see all this money hit corporate balance sheets.

At some point it was all going to flow down to the bottom line of corporations, because that's the basic math of the profits equation when you look at the aggregate economy. And of course, I'm assuming that the savings rate will decline. But that's pretty much if I had to bet the farm on something happening, it would be that Americans will not save money in the future, that they will spend, spend, spend, and they ultimately the personal savings rate will decline as the economy heals over time.

And that money just all flows to corporations in the end. So I think that you're measuring things from sort of a basic metric like that. You'd want to be exposed to the countries that were just throwing money at this thing because that ultimately those are the countries where corporations within those domestic economies are going to perform really well. And, you know, from a fiscal stimulus perspective, the countries that have thrown the most money at this thing or Japan, Canada, Australia and the United States, I don't know what the updated numbers are with the US after the most recent, but those are the four who have thrown the most money at this thing.

And so you could make a strong argument that if you're a stock market investor, those are the four economies where the underlying corporations are likely to perform the best over not just the covid period, but the post covid period, because as the savings rate declines, the money will ultimately flow to those corporate coffers. And so, you know, again, you're making a bet on the virus to some degree. But I don't know. There seems to be some evidence.

I was also really vocal in April that I thought life would largely return to normal or that I thought the GDP would at least recover within eighteen to twenty four months. It looks like that might be pretty much dead on whether or not life will have normalized. I mean, again, that's kind of a subjective term. I guess we've kind of been knocked into a different paradigm to some degree. I think the overall trend is kind of accelerated a lot of the trends that were already happening.

And so that's probably a whole different discussion. But if you're looking at this just from a really top down macro perspective, it's all about fiscal stimulus, looking at the central bank policies, ignore the central bank policies because the central bank policies, as much as people like to focus on them as the real money printers. You know, I always describe, for instance, quantitative easing as being an asset swap. But the kicker with quantitative easing is that if the Fed creates a bunch of reserves and swaps them with Treasury bonds, so they expand their balance sheet, they issue new reserves, which creates deposits in the banking system.

The bank swaps a Treasury bond with the household for a deposit. So the household now holds a deposit. The bank temporarily owns a Treasury bond, which sells it to the Fed. What does the Fed do with that Treasury bond? It basically buries it in the backyard. It's not in the real economy. It has no monetary impact at all on the economy except for the remunerations that the Fed ultimately ends up paying to the Treasury, which are pretty insignificant and in the long run.

But the kicker is that this is a clean asset swap. But the big component there is. Well, what if the Treasury. Expand their balance sheet by three trillion dollars like they did this year. Well, that changes the way we have to view QE because QE in a vacuum with just the the monetary policy side of it, it's just a clean asset swap. It's not money printing in any meaningful way because all you've done is you've created a reserve that's zero percent interest bearing and you've swapped it with a Treasury bond in the private sector.

That, to me, actually has the potential to be slightly disinflationary or deflationary because the household now has a lower interest bearing government asset, basically. And the government has, for all practical purposes, retired the Treasury bond from circulation. But if the Treasury is actually expanding their balance sheet, well, that's a whole different dynamic. So you have to look at all these other dynamics and looking at covid, I think that was the big thing that a lot of people missed, that when people were calling the Fed's policies money printing, they missed the fact that the real money printing was occurring from all these treasuries and that the basic math of it was that as much as you might hate the results of all of the government spending, the ultimate beneficiary of it was going to be corporate America.

And I've had big, long debates with people about why, you know, whether or not QE causes asset inflation and things like that. And I always say you've got to look at the underlying fundamentals. And is there an underlying fundamental rationale for why asset prices have increased in this case?

I would argue definitively there has been, because mark my words on this, you're going to see record corporate profits next year and probably in twenty, twenty two. And so, yeah, asset prices have gone up and you could argue that's all government policy, but you could also argue that there's an underlying rationale for why that has occurred.

And so if you're pinpointing the countries that are the kind of parts of the global economy that are likely to weather that had nothing to do with whether or not you did shutdowns or not, I think one thing we've found with covid is that nobody knows how to fight this thing from the management perspective of can we manage the shutdowns and openings in people at times were saying, oh, Sweden is doing so great and now they're doing terrible. At times people were saying, oh, look, the United States is doing so great and now they're doing terrible.

This thing seems like it's going to get you eventually. And you either ride it out until the vaccine comes and save the day or not. You can shut down your economy and tell everybody to stay home. But at the end of the day, the thing that really matters is how much fiscal policy is being pumped into the domestic economy and how much is that going to ultimately filter down to corporations in the long run. So I would like to shift gears here at the end of the interview, as everyone can tell, we love speaking with you here on the show because you do such a great job explaining and simplifying advanced macroeconomic concepts for someone.

Listen to this. Who is super interested in becoming as knowledgeable as you, but perhaps also feel it's a little overwhelming to start on this journey. Which three steps do you recommend they take to get started right away? It's funny, I am mostly self-taught on all this stuff. It's so complex, I would argue that no one knows a lot of these great big answers. You know, nobody knows what causes inflation. Nobody knows for certain whether Fed policy causes asset price inflation, things like that.

I think a lot of it requires just a super, super open mind. And one of the things that I think has been interesting over the kind of learning process that I've gone through is that I have managed. And I think part of this is the fact that I'm directly involved in managing people's money is that I have to try to be somewhat objective. I can't fall victim to political narratives and falling into a kind of tribal mentality where I align myself with a group of people that just have a generally a political narrative.

And they just through any type of environment, they have to promote that narrative. And that sort of, I think, really curious open mindedness is so useful because there's lots of good components of all different economic theories. MTIs under a lot of attack these days. And I attack at a decent amount, but there's actually a lot to like inside of me. There's a lot of good components that are really eye opening and somewhat useful. The same is true of any economic theory and I would argue any financial theory, too.

You know, you don't have to be only a value investor. You don't only have to be a growth investor. You don't only have to be a domestic technology investor. You can be open minded about all these different things and understand that there's a lot of good in a lot of different aspects of all of these things. And I think you just have to explore these things in a very open minded way. I did create a page on the awesome group website, so it's awesome.

Kamilaroi S.A.M. group Dotcom. And under the education page there's a tab called Understanding Money. And I kind of just collected a whole bunch of links in there that are things like my big paper on understanding the modern monetary system I linked to. The Duilio came out with a famous video back in 2013 called How the Economic Machine Works.

And there's a link in there to like Blackmun's video on everything you need to know about finance in 30 minutes.

And there's so much to learn. I think one of the daunting things, especially with macro econ and macro finance, that the more you learn, the more you learn how little you know. And if you're not open minded and you're really, I think, sort of politically driven into certain octa, I think you just expose yourself to the potential that you're going to end up being wrong about big, big things. And you need to be more open minded and just really curious and have this voracious appetite to try to understand other people's perspectives, because there's almost always something useful.

Even all of the people's views that you disagree with, there's usually some rationale. You might think I'm the biggest idiot in the world, but I guarantee you there's at least some little bit of rationale in the way that I'm approaching the world from my specific perspective, and that there is some rationale for the way that everybody's sort of navigating the world. And, you know, I'm not an efficient market hypothesis believer, but I do believe there's at least shades of gray in the idea of efficiency and that you're better off trying to understand why people either promote a certain theory or the things that they're teaching, because there's usually tidbits of truth in there.

So I think you just have to be really open minded and and try to really understand all of these different theories from all of these different perspectives. Well, Seth Cohen, thank you, as always, for coming here on the show. I would also like to give you the opportunity to tell the audience where they can learn more about you of capitalism and the awesome group.

Yeah, so pragmatic capitalism is my blog.

It's kind of just where I have you know, over the course of the last 10, 15 years, I've just sort of vomited all of my thoughts and knowledge or stupid ideas onto the website. That's Praag cap, dotcom, Praag cap, dotcom. I've listed a lot of different pages over time. Again, there's an education tab there, recommended reading, understanding money. I have some research papers on there. It's very top of the page. There's a new here, a welcome mat that just shows kind of the big, big, broad topics that I think are kind of the most important things to probably understand.

You can get pretty wonky and it takes time to digest and understand a lot of these very, very big macro concepts. And it takes a lot of time and effort and the ideas change over time. So you've got to keep up with the changing technologies and the changing paradigms and all this stuff. But I think having a good sort of objective, first principles based mentalities, it creates a really good foundation for being able to navigate these things, especially because it will help you, I think, avoid a lot of the politics that naturally get intertwined in a lot of these discussions where bias is exposes to big, big risks and so can create that foundation.

And I have a forum on my website. I would love to answer questions there if people have any. You can also e-mail me Cullin Roache at IRCAM group Dotcom. If you have questions and I'm always happy to help. I love so many people have been so helpful to me over the years, learning all this stuff and answering my stupid questions that I really, really love helping people learn and educate people where I can. So fantastic.

And we will definitely make sure to link to all of that in the show, notes Colleen. Once again, it's been an absolute pleasure. As always. You always have so much fun. We always learn so much from you. I really hope that we can bring you back on the show another time. All right, guys, that was all that I had for this week's episode of Westry Billionaires on Wednesdays. Remember, Preston is back with a specific episode about Bitcoin and then weekends we're doing traditional we in this episode next weekend, Traini will be back with our interview with Tim Geithner, CEO of Michael.

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