AIPIS 238 - Asset Inflation & the Investor Class with Pragmatic Capitalist Cullen Roche

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It's my pleasure to welcome Colin Roesch to the show. He is the founder and editor in chief of Pragmatic Capitalism. He's also the founder of Monetary Realism, the founder of the Orcam group, which by the way is macro spelled backwards and he's author of Pragmatic Capitalism. What Every Investor Needs to Know About Money and Finance. And if you can't tell already, he claims to be a pragmatist, a realist like me. And you know, you know I've said that to you many times that complain about the system as much as you want, complain about the banking cartel and the Federal Reserve and the evils of the people that run the world and run the system. But the fact is, at the end of the day, the best thing you can do is align your interest with these most powerful forces that have ever existed in human history. Colin, welcome. How are you?

Hey Jason. I'm good, thanks for having me.

Good to have you on the show. Give us a sense of geography. Where are you located?

I'm in Encinitas, California, which is North County, San Diego.

Good stuff. So you're with all the tree huggers and the yoga folks.

A little bit. You know, Encinitas, my town is a weird mix of surfers and old crotchety rich people.

Yeah, yeah, but you got a lot of new age people there too. In incinence. I lived in La Jolla for a year or so. It's beautiful up there. Beautiful place. So what is Pragmatic Capitalism? What do you mean by that title?

Well, it's a website I started during the financial crisis. So I'm an investment manager by professional background. And during the financial crisis, with all of the new sort of iterations of various monetary policies and fiscal policy that was being implemented, I started writing online quite a bit about how a lot of this stuff works because a lot of what I was reading in the sort of mainstream media looked like it was erroneous, sort of based more on politics and a lot of policy ideas and economic theory rather than working from Sort of operational perspectives. And a lot of your listeners might know my work best because I wrote probably, I don't know, thousands of articles literally on quantitative easing and how it works and just going through the actual accounting and the operational mechanics. So, you know, my goal, like you said, has always been to sort of understand the world for what it is rather than what it, what we want it to be, which is so much of what we get from the mainstream media and especially politicians. And so thinking more of the world from an investor's perspective, I was just trying to basically understand it so I could make money from it, in essence. And so you have to take a very sort of objective, apolitical perspective of the world. And that is essentially what I try to do with the website. And it's weird. The website sort of grown into its own beast in a weird way. I never would have thought I would write a blog for as long as I have, in essence. But it captured a lot of attention because of the, I think, unusual way and sort of objective way that I approach a lot of things.

A lot of people that follow well, I believe the most sensible form of economics. And we have, for example, like I mentioned to you, Ron Paul speaking at our Meet the Masters of Income Property event not far from you in La Jolla, they really like the Austrian school of economics. And I do too. That seems to be. Of the various sort of belief systems out there about economics, that seems to be the most valid. But is it, is it flawed in some way?

I would essentially argue that almost all economic theories are flawed in some sense because most of them are somewhat politically motivated. So the Austrian school, I would argue, is a useful school, but one that probably tends to veer too much towards an anti government sort of perspective. So a great example of this is a lot of Austrians just despise the Federal Reserve. And when you work through what the Fed is from a very operational perspective, well, the Fed does some funny stuff like they mess around with interest rates, they mess around with quantitative easing and things like that. But at the end of the day, what the Federal Reserve really is, is it's just an interbank clearinghouse. That's literally all it does. It helps every day. You don't see this or you don't hear about it much, but the Fed just helps banks settle payments amongst each other. And having a central clearinghouse that does that, that is sort of backed by the strength of the federal government, is useful because specifically in periods like 2008, that interbank clearing system falls apart, it literally stops working. And it can be the difference between a garden style variety recession and a depression caused by literally just banks failing to do what they should do. And so.

All right, but before you go on and I, please remember what you were going to say. Wouldn't it be fair to argue, I mean, the Austrians would, that the whole reason the crisis occurred in the first place is because of this attempt to the economy, something that should be a free market system? That's what the Austrians would probably say, right?

Yeah, I would definitely say that's fair to some degree, certainly. But at the same time, pinning down the exact cause of the crisis is pretty difficult. I tend to think that the U.S. economy, at least to a large degree, as far as global economies go, is a pretty free market system in relative terms. And the housing crisis in my mind was more irrational exuberance and people sort of projecting that home prices could never fall and would perpetually go up in value. And the banking system making all of this worse by leveraging that idea on top of what all the home buyers were doing, it just kind of got out of control. Certainly low interest rates help exacerbate something like that. But you saw the fear, Fed's really inept ability to control and manage the economy and the way that the Fed responded prior to the financial crisis, they were raising interest rates. And part of the problem that the Fed was having before that was what Greenspan called his interest rate conundrum. He couldn't get long rates to go up. So in a weird way, the market was doing something different than what the Fed actually wanted the market to do. So I, I think people tend to overreach when they say that the government caused the housing crisis. The government certainly played a role, but I wouldn't pin the cause of it on the Fed or the federal government as much as I would say that the housing bubble was just sort of a garden variety bubble where people, they rationally bid up an asset value in a way that was unsustainable.

Right. But you know, the financial crisis wasn't just the housing situation itself, that it was really two parts. It was the mortgage crisis, which came from ridiculously liberal loans that were, you know, government insured. Right. And if Fannie Mae and Freddie Mac didn't exist in the first place and that secondary market wasn't there, it couldn't have happened, at least not to the degree it did. The second part of it was the Wall street crooks and, you know, they were taking the same loan and sell and pooling it and selling it in 33 different pools and so there was vapor. It was just fraud. It's amazing that no jail, that's just mind boggling to me still. But that's sort of a rabbit hole that we don't need to go down. But I just wanted to kind of throw those in there. But so what do you think is going to happen? What, like what's coming, you know, do you think, I mean, look at you're in San Diego. That's a linear cyclical market that has just been nuts. I mean what housing prices have done in all of these cyclical markets around the country. It's insane. We're way past the point of fundamentals. But you know, if there's easy money, you know, it can, it can go on for. What are your thoughts?

The real estate market is weird right now. It is very location dependent. Unlike the period prior to the financial crisis. It was just so widespread. I mean it was truly a national bubble with the exception of a few rare places like parts of Texas and whatnot. But right now you're seeing, like you said, crazy things happen in the Pacific Northwest, for instance, San Francisco, Southern California, to a slightly lesser degree, parts of the Northeast. There are very unsustainable trends occurring in a lot of these markets that like you said, will, if not correct soon. They will certainly correct at some point. You literally can't have an asset price in real estate increasing at the national rate right now is about 6%. In places like San Francisco and Seattle, it's double digits. You know, historically if you look back to using Shiller's data going Back to the 1870s, real estate typically barely generates a real return. So it's typically something in the 2 to 3, maybe 4% range. So at a national rate of about 6%, we're certainly in an environment where this is an unsustainable rate of appreciation. But it's so location.

I just got to say Shiller is wrong because he, he's viewing real estate as though people buy it with cash and just wait for appreciation. It's mind boggling that an academic like Shiller can totally frickin miss the multidimensional aspects of income. Property that can produce income, have mortgage pay down, have inflation induced debt destruction, have leverage. I mean that's just mind boggling that he says that. I read his book Irrational Exuberance and yeah, I mean he just completely ignores that.

Well, that's so much of what economic theory is. It's sort of funny. They simplify the world down to the point where the model that they're using is virtually useless in a lot of cases.

Yeah, yeah, it's crazy. Okay, go ahead, go ahead.

The broader context of everything, the macro economy looks still pretty healthy. I mean, I, I've sort of been saying all along the way with Trump and this was one of the reasons I predicted he would win back, I don't know, two years ago or so. But I said that one of the reasons for that was that his economic policies, relative to anything that the Democrats were proposing, was far more stimulative. You know, there's a lot to probably criticize in the way that he's implementing certain things. And I suspect that things like wealth inequality will increase under President Trump. But he's very economically friendly, almost to a fault. And so it's hard right now to put together a picture where the economy starts to kind of fall apart for some reason, because you haven't seen any of the. In a general sense, my theory on the way the economy generally works is that it basically trends 80% of the time and about 10% of the time you get out of whack. On the upside, a big boom happens like the real estate bubble or the NASDAQ bubble, something like that, and then it all kind of falls apart, corrects, and you get back to trend at some point. Basically.

I just keep wondering, and I'm not a stock guy, I like income property and I like businesses. That's where I like putting my money. But I just keep wondering if I shouldn't be shorting the S and P right now.

Well, that's probably, you know, if you, if you had to pick a place where there is probably a sort of unsustainable or destabilizing boom in the economy, it's certainly probably corporate America. And the way that the stock market has boomed and the only place where we've seen really excessive credit increases is in the corporate market. The corporate bond market has been issuing, you know, some of these companies are issuing crazy amounts of debt at 0% or 1% or super low interest rates, almost taking advantage of this view that for some reason people seem to think that a lot of corporate bonds are somehow similarly risky to like treasury bonds or something. I mean, the best example actually is in Europe where you see junk bonds right now are yielding about 2.3%. That is equivalent to a 10 year US treasury bond right now. There's no way in the world that high yield bonds in Europe carry the same level of interest rate risk or credit risk as something like a U.S. treasury bond. So there's some crazy Stuff happening and you know, has it gotten out of control to the point where it's all going to fall apart? I don't know. I don't know if anybody knows. But yeah, if you had to pick sort of your destabilizing point in the economy, I think that would certainly be it.

Yeah, yeah. Okay, so when you talk about pragmatic capitalism, I mean, teach us some more about that if you would. You know, in looking at the book and looking at, you know, the chapter titles in the book, you know, what Is Money? Why the New Macro Economy Matters More Than Ever. The market myths out there talk to us about some of those things. Take your pick. You know, there's a lot of interesting subheads here in your contents.

I really try to view the world through the lens of understanding sort of a macro perspective, understanding what's called a top down approach. So sort of understanding the world almost from the perspective that like an engineer would basically an engineer that was building, let's just say a plane, for instance, would try to understand the environment in which he's first building anything that might fly and then would apply the right components and take advantage of, of his engineering expertise to make sure that he built basically a micro instrument that can fly inside of that macro environment. And that's very much the way that I approach the financial system. I try to understand the system from a big top down perspective and then understand smaller things like banking and the way that the Federal Reserve operates and the U.S. treasury and corporations and, and kind of put together all these little pieces to make a coherent big picture perspective so that you can hopefully make sort of objective decisions about what potential outcomes are going to be going forward. And that's, that was really the goal of the book there was to put together. I wrote it in a little bit of a textbook format, which is probably a little too boring for most people, but from a really objective sort of operational perspective, it's just a very sound understanding of the way that the financial system works so that you can sort of understand and attack these things in a way that creates a more objective likely outcome than what we hear so much in the mainstream media and especially from economists and certainly policy economists who are so motivated by politics and sort of outside interests that I think it's a, it's hard for them to provide really objective opinions on things because I think their views are sort of inherently skewed by whatever their, their policy interests are or what their corporate interests are.

There's no question about that. And that's what blows my mind. That people who have really fallen hook, line and sinker into the religion of environmentalism. They think that like all these scientists around the world that believe one thing or another about global warming. Yes, no, maybe. You know, they think that those people aren't political. They think that those people are just these objective people that sit there in white coats and analyze things all day. And, you know, they're just inhuman robots that are so objective and logical. They're not. They're politically motivated, just like economists. Yeah, you're absolutely right.

Well, there's so much data mining involved.

In everything that data dredging is the right word. More than data mining. It's data dredging. Right.

But you can find, you know, you can torture the data to say whatever you wanted to. And that's so much of what we see in today's world with economics and finance.

You are absolutely right. You are absolutely right. So good to know. Well, well, okay. So with all that in mind, what should investors be doing?

It totally depends on really what type of risk profile anyone has. It's virtually impossible as a, as an advisor and portfolio manager to give really general, general sense to people. But from a really big macro perspective, my view is that certainly the, like I said before, the equity markets, the stock markets around the world are probably where the outsized potential risks are coming from. And if you're in the same camp that I am that believes that interest rates are basically going to be lower for longer and that the global economy is going to kind of continue to stagnate, that means that, weirdly, bonds are probably a lot more attractive right now than a lot of people think, which is probably the ultimate contrarian play in.

A world where, yeah, that's surprising.

Most people seem to hate bonds and assume that because we're in a low interest rate environment that bonds only have one way to go. But I just think that you're in a place now where if you're not really, well, diversified, if you're not sort of telling yourself that you don't know what's going to happen, or you're acting in a way that you think there is certainty in any one of these markets, you're in for a big, big, big surprise. Because I just think there's so many pockets of uncertainty right now about the way things could go that if you're not really broadly diversified across all of your assets, you're doing it wrong.

I think one area, and I'd love to know what you think. And you know, again, I'll say once again, because this is like A cult too. And people get really, really upset about this, you know, and I'd love to be wrong about it, but I think the cryptocurrency thing is like tulip bubble mania. I think a lot of people are going to lose a lot of money.

Am I wrong?

You know, I'm still trying to figure out what the heck they are. They're a weird asset class. I've basically called them a form of equity. In essence, they're.

Are they even an asset class? I mean, you know, that's what we're from.

From an accounting perspective, they don't really fit into any sort of designation. Specifically, they're basically a non financial asset because they're not really issued by anybody. There's no corresponding liability. So they're almost like a commodity in that sense. But they're obviously not a commodity because they're not a real resource. They're just sort of a digital asset. So in my mind they're almost, they're a lot like a patent basically in that they, they have some intellectual property to certain people. And what you're buying when you buy, for instance, something like a better example than Bitcoin, because Bitcoin everybody thinks is just money is something like filecoin, where what you're really buying into is when you buy something like filecoin, you're buying the coin that represents the value of the data storage to certain people. And so you're almost buying the equity of whatever the underlying service is. So people find Bitcoin valuable because Bitcoin operates as a decentralized payment system for people, almost like gold does, in essence, except that it's much easier to use than gold. So arguably it's much more valuable than gold. But yeah, like you said, the value of these things is impossible to know. That's what makes it from an investing perspective, it's almost a greater fool asset in that you need, you just need to be able to convince someone to buy at a higher price than what you bought at to make money at it. Because there's no way you could possibly know what the actual underlying asset is worth because it doesn't kick off any cash flows. There's no way to run, you know, a traditional like discounted cash flow model on it or anything.

So very, very speculative.

Yeah, very speculative. Almost like buying, buying art or something. It's just values in the eye of the beholder almost.

It's sold based on scarcity and there is no scarcity when you can just invent another one. Tomorrow there will be a new Coin, you know, it's. I mean, that's, it's like the ultimate fiat currency in a way that's pretty interesting. So what's the future look like? Is it inflationary? Dec. Deflationary? I believe you're going to say it's disinflationary. And maybe you want to tell the listeners what disinflationary means.

Yeah, so that basically means that the world will be inflationary, but it will be a world of basically falling rates of inflation. So kind of more of what we've seen in the last few years, in essence. And, you know, there's a bunch of big trends that I think are causing this. The really big ones are demographics. We're seeing the rate of population growth decline around the world. The population is getting older, and all of that, from a sort of basic economic perspective, puts downward pressure on the economy because you need more people to generate more demand for more growth going forward.

Right. But the, the population thing is pretty localized, though. I mean, that's not a. You know, it's pretty.

Well, I mean, the, the global rate of population growth is certainly on the decline, and. But it. In the developing world, world, it's even more exact.

Oh, Europe is over, Russia's over. I mean, Japan is over. Everybody listening has got to read, you know, Mark Stein's books. I mean, the guy is very intelligent guy, and he just talks about how these countries just will not exist. You can't have a country if you don't have children. Like, it's over. It's just done. It's baked.

Like, if you're looking to go long on Japan or Russia or Western Europe, you're out of your mind. I mean, there is zero possibility that those economies can thrive without people procreating. You just can't happen.

It's just a very basic economic fact that you need more people to generate more demand for more growth. And so a lot of these developed economies are. They're not unlikely to grow at all because productivity trends will still grow. But you're really trying to, you know, to overcome just a huge deflationary trend there. There's a few other big ones, though. The biggest one probably is that we've seen in the last 40 years is that the labor class has just been crushed down in terms of their ability to negotiate on wages. And you've seen sort of, you know, a reduction in the number of unions and the power of unions. And that was one of the big causes of the wage deflation of the 80s and the 90s, because the capitalist class has just become so powerful in a relative sense. I always tell people that in today's world, you shouldn't want to be the labor class going forward. You need to be the capitalist class. You want to align yourself with the ownership class because they're the ones with all the wage power going forward.

You know, Colin, I know you're not, but there's a little tinge of Marxism in this conversation.

But no, you're absolutely right. I mean, yes, and this is a big theory that I've been working on and I've talked about it a little bit. It's the concept that, you know, we can argue that technology has been a very deflationary force. And technology has made incredible strides over the past, you know, couple of decades, of course, right. It's been a huge revolution for the entire human race almost. That is true. But then the monetary and fiscal policy of virtual, virtually every country on earth has been completely irresponsible. Right? So there is a war being waged between the deflationary or disinflationary, both, you know, combined pressures of technology. Right. And the very inflationary pressures of irresponsible fiscal and monetary policy. Right. So these two forces are at war, Right. And which one will win, nobody knows, because they can print money ad infinitum. But you know, technology is on kind of a hockey stick progression now. But when you look at what I call asset inflation or the investor class, there can be no argument that there has been massive inflation in that world. So to enter the investor class nowadays is much more expensive than it has ever been. You know, I remember when I was in my 20s, it felt like every girl I was dating, you know, owned a condo when she was 24, 26 years old. Nowadays that's almost non existent. I mean, look around you and Encinitas, right? And so they're not entering the asset ownership capital class, the investor class, as much as they used to. And they're certainly not having like these nice stable corporate jobs that pay 60, 70 grand a year either, that's for sure. So when you play that out 10 years, it's like looking through a telescope. You know, you're looking at the moon and you just accidentally touch it slightly and it's off like light years. Now you can't see the moon's nowhere near it. Right. Because of the magnification effect. Right. And so you play that out 10, 20 years and I think that'll really makes society poorer because the investor class is not available to as many people. Now you could certainly argue that there's all kinds of online trading platforms and anybody can buy stock. And that's true, and that's technological, but asset prices are higher. I mean, any disagreement there, feel free to disagree with me, by the way.

Yeah, no, I. I mean, I think that a lot of that is pretty much dead on. It's. Yeah, it's easy to tell everybody to, to become the capitalist class.

Right. But to do it is harder.

Yeah, to do it is really hard. I mean, I've run my own businesses for 15 years, and I'll tell you that, you know, two of them have essentially failed. And, you know, I've. I've sort of. It's always been sort of a work in progress to build something that works, and it's really, really difficult to make it work. So, yeah, it's harder than it is to say, but it. At the same time, I still think that if you're one of these people that sort of succumbs to just working your typical 9 to 5, I think that you just have to sort of accept the reality that the likelihood is that you're going to be left behind in a world where the capitalist class just has so much more power than the labor class does. Because, I mean, think about capitalism in a sort of natural environment. If you had no government, a good capitalist, what they do is they monopolize everything. I mean, that is essentially, if you could privatize all of the means of production in an economy and you could be the capitalist that owned that. Yeah, you're the most powerful person in the world. That is the literal goal of what a good capitalist should be trying to do.

And essentially that's what happens in dictatorships and socialist and communist worlds, because there's more monopolization, even if it's not complete. But, you know, the government monopolizes things. Right. So they do it in the worst.

Way in socialist economies because. Because they don't have a free market, they're not allowing competition to basically destroy the entities that are inefficient.

Yeah, yeah. There's no creative description. Joseph Schumpeter. Creative description.

So you have a huge conflict of interest in a lot of these socialist economies. You see this in South America once every, like, five years now, it seems, or every other year almost with Brazil and Argentina and Venezuela and some of these economies that are run by, you know, crazy people who think that the government can spend money in perpetuity and that you don't need to have an underlying capitalist economy creating productivity through competition and what you end up getting there Is is a huge conflict where you have almost a dictatorship that is, you know, asserting control over private entities and also asserting control over essentially the big monetary institutions. And in a lot of these economies, they're the ones that literally create all the money. So, you know, one of the weird things about that I always talk about in the US is that a lot of people think the US Creates the money. The US Government creates all the money in the financial system. And that's not really true. It's actually the banking system that creates most of the money. And in a weird way, we have a private competitive banking system that actually makes the issuance of money fairly stable over time because the banks are so paranoid about lending. In most environments, this obviously doesn't always hold, as you saw in the housing crisis. But in most environments, the banking system is so worried about their own skin that they actually issue money in a fairly prudent manner because they're so concerned about their own bottom line that they literally can't take too much risk. So in a weird way, a competitive private banking system is far more efficient in the way that it distributes money than something like a socialist economy where the printing press is to some degree controlled by a crazy guy who just, you know, maybe wants a bigger bunch of tanks for the military or, you know, a new Ferrari on the side for his girlfriends or whatever. And so that's one of the big sticking points with the way a lot of these particularly South American economies are run in that they don't let the market system actually operate in a way that allows it to basically, you know, kill the dead wood that is in the system over time, which is so much of what makes the system vibrant and resilient over time.

Yeah, of course. Couldn't agree more. Couldn't agree more. Okay, so anything else on what's going to happen next? We got to wrap it up and then, of course, give out your website.

I think the world is. Is pretty boring going forward, to be honest.

I. Well, maybe that's a good kind of boredom.

Yeah, well, you know, it's weird. I think the. A lot of people have been complaining about the last eight or nine years, and I keep calling it sort of a golden era of low and stable growth. The world could be a lot worse than it is. And I think that what we're seeing, although we're seeing low growth, we're seeing sort of unprecedented stability in the way that we're achieving that growth. So in a weird way, you think of it in sort of an investor terminology. We're generating from an economic perspective very high risk adjusted returns in the way that the economy is growing. So yeah, for now I kind of think there's more of the same. And one of my sort of outlandish theories is that if anything, the biggest risk here is that the stock market continues to sort of go crazy the way it has and goes so crazy that the world sort of starts to look a lot like it did in the late 90s. The late 90s are a pretty good, I think, playbook for what's going on around a lot of the global economy right now. And I think you could see an environment, if we're not already in it, where the stock market has reached sort of an irrational level of exuberance that it becomes pretty destabilizing at points. I think that Trump in a weird way sort of contributes to that because Trump has sort of championed the stock market to such a degree that I think it adds to the irrational exuberance to some degree. And I think the economy is going to have a hard time following through with a lot of the talk that we've seen from the administration and not that things are going to be bad, but that you're unlikely to see a boom in the economy that supports the boom that we've seen in asset prices in a lot of these markets. And that is, that's a disconnect that can't continue.

Very interesting. It's an interesting time, there's no question about it. But for my money, just the conservative, you know, simple properties that produce income. You know, I'm, I'm boring.

I think, you know, I'm Jason, I'm even more boring than you. I'm a huge bond manager, so.

Yeah, right, right. Yeah. Yeah.

AAA rated bonds and, and high quality treasury bonds. That's kind of my go to.

So good stuff. Well, Colin, it's great talking to you. Give out your website.

It's pragmatic capitalism. It's pragcap.com p r a g c a p dot com and I usually post something there at least a few times a week. So sometimes it's more informative than others. But I usually try to post things that are sort of timely and at least interesting.

Colin Roche, thanks for joining us.

Thanks Jason.

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