The U.S. national debt recently crossed $34 trillion.
Without causing some serious pain, paying off this debt is nearly impossible to do.
We would have to dramatically cut spending in some VERY important areas, increase taxes, or both.
This debacle has led many to label this situation as catastrophic. As a “building that we’re stuck in that will need to collapse on us before we can leave.”
Key Takeways
- But is it really as bad as some make it out to be?
- Is $34 trillion of debt truly an issue?
- Should we really be focused on paying down (or paying off) this debt?
To help answer these questions and shed light on this complex topic, I’m joined today by Cullen Roche, monetary economic expert and CIO of Discipline Funds.
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How to Listen to Today’s Episode
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Episode Resources
- Cullen Roche
- US Debt Clock
- Let’s Stop Talking About Paying Off the National Debt
- How Will We Ever Pay Off the National Debt?
- What is the United States Worth?
- What is the National Deficit?
- No Way Out [John Mauldin]
Episode Transcript
Stop Talking About “Paying Off the National Debt”
Taylor Schulte: So as of today, US government debt sits around $34 trillion, which is crazy to say out loud. If we push aside the additional debt that we're accruing here by the minute, in your mind, just this $34 million of debt in isolation, is that a problem? Does that signal that there's this looming debt crisis and this catastrophe that's ahead?
As I saw one person put it, if I operated my family finances like this, we'd be in bankruptcy court. So this is a starting point for today's discussion. Share with us how you think about the current amount of debt in isolation and then let's explore the additional debt that's being accrued and those implications.
Cullen Roche: The 34 trillion question. Yeah, so actually the analogy to a household is actually a great place to start because I think that one of the most valuable things about learning macroeconomics and learning to think in a really big picture sense is you learn to think in an aggregated sense.
And I think that one of the things that trips a lot of people up when they talk about, especially US government debt or just government debt in general, is that they think of the government like a household. And I think it's really useful to think of the government in a very different manner. The government is actually this very large aggregated sector.
So the US government especially, it's the government that represents the largest private sector, the most productive, largest private sector economy in the world. And so the US government is very large, in large part because the private sector in the US domestic economy is very large.
But the thing that's valuable in terms of talking about this relative to a household balance sheet is that aggregate balance sheets are completely different than individual balance sheets. And so actually looking at the household balance sheet in the aggregate is really useful because when you look at the aggregate household balance sheet in the United States.
For instance, if you went to the Fed website, the St Louis Fed data website, and you type in CM debt that will pull up household aggregate household debt. And what you'll notice with that dataset is that that line pretty much always goes up.
Let me take a step backward. There are three big sectors in the domestic economy, the household sector, the corporate sector, and the government sector. And in the aggregate, none of these sectors will ever pay down their debts because these are large aggregated sectors that you can break them up into components that the components individually could theoretically pay down some debts.
So for instance, the Taylor Schulte sector can pay down its debts, but the only reason that Taylor is able to pay down his debts is primarily because somebody else took on debt. So assets and liabilities they match. And so the liabilities that somebody is able to pay down, those are potentially assets for somebody else.
And so in order for all of the liabilities to go away, functionally all or most of the assets have to go away. And that's just in the aggregate. That's an impossible thing to happen because somebody always is on the other side of the asset side of the balance sheet where somebody else is holding the liabilities.
And so from an aggregated sectoral perspective, even the household sector in aggregate never will pay down its debts because that would require for so many of the assets to essentially disappear. And the way that the economy essentially grows is that the assets and the liabilities always grow over time.
And so what you'll see with these big broad data sets, these aggregated data sets is that the corporate sector is pretty much always expanding its liabilities. The household sector is pretty much always expanding its liabilities. And the same thing is basically true of the government sector. And the thing that's I think really difficult with the government is what is the right size of the government's liabilities relative to everything else?
And there's no one size fits all answer for that. Lots of people try to, I think, quantify that in some way that you could argue that, oh, the government should be this big or this percentage of GDP or something like that. And I think every economy is just different in dynamic. And so I don't think there's any sort of one size fits all answer there.
But the kicker, especially with the USA is that I think that when you start thinking in this sort of aggregated sectoral sense, you have to then begin to wonder, well okay, well if the government doesn't pay down its debts, then what's the real risk of issuing too much debt? Because the other big component with government debt especially is that the government can literally print money.
So can an aggregated sector that can print money, can it even default? That's a whole other question. I mean, I guess there are instances where governments default in large part because they take on foreign debts or they take on debts, denominated in gold or something that they can't actually produce. But governments don't default when they have debt denominated in the currency they can print. And that should just be sort of an obvious thing that most people should be able to recognize, but I think goes largely overlooked.
But when you recognize that, I think then you can kind of pivot and begin to think of this whole conversation in a really a different sense. It's not the risk of default that is worrisome. The real risk is high inflation.
That's the thing that, and I actually to simplify all of this even further, I think it's actually useful to think of all government debt as though it's basically currency. So think of all government debt, think of the government as though rather than funding the deficit, so the amount in excess of taxation that they end up spending instead of actually selling bonds, consider the alternate reality where they just literally printed currency.
So we have this sort of, you could argue it's sort of an archaic setup where we have to fund the deficit by printing what are essentially treasury bonds. Consider this where the government just printed currency when they ran a deficit. And so in that scenario, the liabilities technically would be currency or paper dollars or whatever deposits, electronic deposits, whatever you want to call it. And those liabilities are something that the government can just literally create out of thin air.
Nobody would ever worry about default risk in that sort of a scenario. But I think because we talk about these things in terms of bonds, people I think make the analogy to a household or a corporation where they say, oh, well I know that corporations or households can run into situations where they can literally run out of the ability to fund and finance their fixed income or their bond liabilities, whereas the government literally cannot experience that sort of a situation.
And when you reposition the argument in that sort of a manner where you understand that big macro topic, it brings everything back to inflation, everything becomes an inflation risk. And that is a pretty, I think dramatically different discussion than the default discussion.
Taylor Schulte: Yeah, I've got a lot of questions there, but just going back for a moment here, 34 trillion of debt. To kind of simplify what you said, and correct me if I'm wrong here, there are two sides of the balance sheet, so just looking at debt and isolation, but the other side of the balance sheet are the assets.
So the US government has assets. A mutual friend acquaintance of ours, Mike Antonelli, wrote an article, I think it was a couple of years ago, just what's the United States net worth? And he lays out the current liabilities at that time, which somewhere around the $20 trillion, 20, $30 trillion mark, and then goes on to list the assets of the United States, and he comes up with this final US net worth of $309 trillion. So total assets minus total liabilities.
And his point was like the United States has a pretty healthy balance sheet when you factor in assets. Is there anything that you disagree with there? Is that more or less what you're explaining here with just looking at debt in isolation? Anything you want to correct before I ask my next question?
Cullen Roche: No, I'd be willing to bet you Michael stole that article from my work. I'm pretty sure I sent him a bunch of my old articles on that topic a few years ago. But no, Michael's great. He does great work.
But the broader point there though is that the US government is not large and valuable because of the geniuses in Congress or anything. It doesn't have this incredible power bestowed on it because the Constitution or something or it's really valuable.
The government is valuable and issues the dominant reserve currency primarily because the US private sector is so valuable, so productive, our private sector is very large, very productive, creates arguably the highest quality products, the most valuable entities in the world. And by virtue of that, our government ends up being very valuable, issuing very safe liabilities in large part because they're able to tax all of that income that the domestic private sector makes.
And so the government is strong because our private sector is strong, and I think that's another element of this that I think some people kind of get the causality backwards with where the government's not great because the government is great, the government is great in the USA because the private sector is great, or you could argue that the private sector gives value.
They're the underlying value factor that really drives the value of things like the safe haven nature of US treasury bonds and things like that.
Taylor Schulte: So 34 trillion of debt, looking at that in isolation, reading between the lines of what you're saying to you, it's not necessarily concerned that we have this debt and this debt needs to be paid back. There are a lot of other smart people out there that have a different argument that disagree with you.
What are they getting wrong? What are these people pounding the table saying, we have 34 trillion of debt, we have to pay this debt down and there's no way for us to do it in a constructive way. What are they getting wrong in this conversation?
Cullen Roche: Well, I don't think they're necessarily getting the risk wrong. I think they understand that there's a big risk out there, and I think that risk though is something that they're probably just not focusing on the inflation risk as much as they're probably focusing on this idea that the government could default on the debt.
But yeah, I mean to their point, if you reposition all of this as an inflation debate, I think you can argue that there is this sort of element here where there is a risk of the government having to continually print more and more to finance things like unfunded liabilities and social secur and our ever-growing military and healthcare needs.
And right now the interest burden on the debt, there's certainly a valid element of this debate where you could say, well, we're reaching sort of a death spiral here, like an escape velocity with all of this where the government is going to get into this sort of perpetual money printing scenario where they end up basically creating really high inflation because they've sort of backed themselves into this corner of having to print evermore money.
But how valid is that risk? I don't know. To be honest. I think one of the lessons coming out of CO is pretty clear that if the government tells everybody to stay at home and do nothing and then they print four, five, 6 trillion in the course of two years, you get high inflation. That's the big lesson coming out of Covid.
The other interesting lesson though from the last 30, 40 years is that the government can be in perpetual deficit and you can get inflation that is actually falling over time, or at least the rate of inflation is falling over time.
So inflation is a really, really complex phenomenon. I think a lot of people, even if you reposition this as an inflation debate, I think there's a lot of people who would be inclined to just always point to the government and say the government is the entity that always creates inflation.
And I think it's a lot more complex than that. Covid was unique in that I would argue that the covid stimulus was by far the big driving factor in the inflation that we've seen over the course of the last few years.
But over the course of the last 30 years, the evidence looks a lot more complex that the government ran large deficits and despite this, the rate of inflation just perpetually fell for 30, 40 years. And so when you reposition the risk there, I think you have to then start to consider, well, okay, 34 trillion in the scope of a hundred trillion dollars asset market and the largest economy in the world where we are, the dominant reserve currency is 34 trillion of US dollars out there floating around.
Is that creating a high inflation risk? I think that if you look at the size of the deficit, I think you can certainly argue that a deficit that is one and a half to $2 trillion per year is definitely adding two inflation every year.
Is it adding to inflation in a way that is worrisome to the point where you have then start to consider, are we going to have a perpetual sort of 1970s environment or even a hyperinflation environment? And I think some of that is probably overstated.
Taylor Schulte: I want to drill into that a little bit because there are some people out there either right now listening, wrapping their heads around the debt and the comments you've made, or they've already come to this conclusion on their own that, okay, I get it.
We're never going to pay back this $34 trillion and we probably shouldn't. It makes sense for the balance sheet to expand, but then they think about the year-over-year deficit that we run and the lack of the US running a balanced budget.
So I think you shared in your writing that it can be prudent to run a small deficit every year, but if that's the case, if it's deemed prudent to run some sort of small deficit year over year, where is this line between prudent and destructive? Do we just not know where that line is and we just have to wing it here?
Cullen Roche: We really don't. One of the things that's almost worrisome about I think economists understanding of inflation in general is that, I mean, God, we just went through the biggest money printing phase in US economic history and coming out of it, economists still don't agree on what actually caused the inflation.
Was it all supply side? Was it all stimulus? Was it a complex mix? I mean, if you ask 10 economists, you'll get 10 different answers about what the contribution there was. And some of 'em will argue that the demand side had no role in any of this.
So somebody like me, I would argue that's crazy, but I mean, you can ask very, very smart people who will say that fiscal stimulus did not do this, that it was all or mostly the supply side or whatever. So I think the reality is that we don't really know the tipping point for what level of the deficit will actually cause a really scary sort of runaway type of inflation.
I think one thing we know is that for most of the last 10 to 15 years, the government has run deficits that are not too far away from the level that we're at right now, and that hasn't created, with the exception of the covid anomaly, I think you can kind of throw that one out because we all, at least I was saying at the time that the risk was that huge amount of stimulus would cause high inflation.
We've kind of normalized now though, and I think that the environment we're in now is much more consistent with a rate of inflation that's consistent with what we've seen over the last 15 years where you see sort of two to 3% inflation, which is it's sustainable. Yeah, it's a totally sustainable situation where at least you're not in this sort of death spiral where you often see economies that experience either high single-digit or double-digit inflation.
It sort of becomes a death spiral where the demand for the currency sort of spirals out of control. And I think that one thing that's especially important with the United States in the context of all this is that the United States, again is the dominant reserve currency issuer, and they're not the dominant reserve currency issuer by a small margin.
I mean, when it comes to reserve currencies, we're almost the only game in town. And so based on the IMFs data, the outstanding actual reserves held by foreign governments, 55% of it is US dollars.
The next closest is the Euro at 18%. Europe's economy is roughly the same size as the United States, but even that currency is nowhere near to being as in demand as the dollar is. And you've seen this over the course of the last few years, the dollar index has just exploded higher relative to everything else.
And so I mean, God, the next rung on that ladder is like the yen and the rebi and their three or 4% in total. So when you're talking about reserve currency status, the United States is so far head and shoulders above everybody else in terms of the foreign demand for this currency that it's not even remotely close.
It's sometimes weird for me to see people talking about the risk of the United States in the scope of all of this, because I would argue that it's sort of similar to if you were a professional short seller and you were looking at the S&P 500 and you just almost egotistically had to try to short Apple and Amazon every single week and you do it every week and you'd never learn your lesson, that these are the biggest, best companies in the world. They go down sometimes, but they don't go down very often.
And so out of all of the 500 companies though in the S&P 500, why are you picking these two? Statistically, they're just so dominant compared to everything else that from a rational perspective, it doesn't make sense to focus on those two as the short selling target that you have.
And the dollar argument often reminds me of something like that, because you might hate fiat currencies, you might hate the way that the monetary system is structured, but in terms of the neighborhood of fiat currencies, the US dollar is just by far, it's the best house in the bad neighborhood, and there's nothing else that's even really close to it.
And so out of all these currencies that people could pick that look like high risk or something where there might be a default risk or a hyperinflation risk, I would argue that there are hundreds of other currencies that are better potential culprits for all of this sort of drama that the dollar's not the one that is most at risk.
It's obviously the one that people in the USA worry about the most, but the risk of hyperinflation or some sort of catastrophic event happening with the dollar looks extremely remote to me. And I think that given the size and scope of the importance of the dollar in the global economy, if something really, really horrific is happening with the dollar, I mean, you're not going to be worried about your bank account in those scenarios.
I don't think you're worried about whether or not you've got a gun in your lockbox or not. So putting this stuff in perspective I think is important because the dollar is not the most at-risk fiat currency if you think that everything's a dirty shirt in the fiat world, it's the cleanest dirty shirt by a huge margin.
Taylor Schulte: I want to try to ask a pointed question here so people can understand your sentiment right now. Do you believe personally, do you believe that the government needs to reduce spending or slow down expansion right now?
Cullen Roche: Personally I do. I mean, I think especially with the battle that the Fed has been fighting against inflation, I mean, I would definitely argue if I were working in the Fed a year ago, if I had seen that the treasury was on course to run, what was it, almost a $2 trillion deficit last year. I would've gotten up out of my office at the Fed, marched over to treasury, and I would've been like, what are you guys doing?
We are trying to fix the inflation problem over here. We're jacking up rates, we're causing all this turmoil in the financial markets and everything, and you guys are just firing money off into the economy. It's not a problem.
So I think that there's been an issue in the last, especially the last year and a half or so where the fed's been fighting this battle, and I think thankfully they've done a pretty good job, but to a large degree, it's been offset by what the treasury's been doing because the deficit's been so large.
And so I think that especially at times where inflation is high, I think that the only responsible response to that is for the treasury to also take the same line as what the Fed is doing and try to combat that in a way where you're helping to bring down inflation rather than just continually.
I like to think of people may not call the deficit money printing treasury bond is basically just a savings account that is very similar to a dollar bill. It's a dollar bill that pays interest. And so the difference between a dollar bill and a treasury bond are very, very little.
I mean, especially if you look further down on the duration scale, the maturity scale where you look at something like a treasury bill, a three-month treasury bill is virtually indistinguishable from an actual dollar bill when you actually look at its qualities in terms of its safety of principle, especially obviously treasury bonds, long duration, treasury bonds are much more volatile, much riskier because they have so much duration risk.
But that's kind of a different discussion I think. But aggregate government debt in general is I think best thought of as just being a simple short-term liability where the government essentially is just creating currency like instruments that they can fund in perpetuity because they have the printing press.
But I think it's in the scope of today's environment, I think there are a lot of really rational arguments that argue for the deficit certainly being smaller than it is, especially with the high inflation environment. And I've been arguing that we'd be in a period of disinflation for the last sort of year and a half or so.
That means a falling rate of positive inflation, so falling from 6% to 3% to 2%. So you still have positive inflation in an environment like this, but the rate of change is slowing down. And so I think going forward that disinflation is likely to sort of continue, but there's a real risk that I end up being wrong about that and that we're in something more like a 1970s environment.
You get sort of the second big bump in inflation, and that would be largely caused by something like the deficit. If the deficit were to blow out this year to two and a half or $3 trillion, I think you could get a resurgence in inflation where you get say four to 5% inflation. And in that situation, people continue to be pretty frustrated with what's going on.
I think that's largely the sentiment that has been expressed over the course of the last few years. I think a lot of these consumer sentiment surveys come out and they're consistent with people being really frustrated. And I think that's reflected in the fact that in inflation's been high, and I think people struggle with the counterfactual of what would've happened if we hadn't had the stimulus.
And I think me personally, I think the world probably would've been a lot worse off if we hadn't done any stimulus. But even so with the stimulus, I think a lot of people feel like they've been running in place for the last three years or so.
They've seen all this money get fired off into the economy, and they see, especially things like the stock market going up a lot and the rich get richer, and I think a lot of people, especially in the middle class, feel like they've just sort of been running in place.
So even though they're better off than a counterfactual, they still don't feel that great considering everything we threw at Covid. And I think there's a justifiable risk that if you continue to run really large deficits, especially deficits that were larger than the historical average, that you could get the second bump an inflation that results in the Fed having to be a lot more aggressive and the treasury eventually having to accept the reality that hey, this is not a sustainable situation.
Taylor Schulte: Yeah. I was going to ask, what are you concerned about? I feel like you said a lot of things straight and you argue against a lot of these people that are on Twitter and everywhere else saying this, 34 trillion of debt is a giant problem.
And I think you've corrected a lot of misconceptions, and to me, sometimes when I hear you talk about it, you put me at ease a little bit. I feel better about the state of the US government and this debt situation, but I'm sure it doesn't mean Cullen doesn't have any concerns.
What are your concerns? Is it that this deficit gets larger, that if we continue at this pace it is a problem? Is that the concern?
Cullen Roche: Yeah, I think that's right. If you look at the deficit as a percentage of GDP every year, it has slowly sort of trended larger and larger. We're excluding the Covid environment.
I can send you a chart of this for show notes if you want, but the deficit really exploded from Covid and then we've kind of adjusted back to something that's more of probably a historical average from the last sort of 10 years. I think it's like four or 5% of GDP, and that's a relatively sustainable figure based on I think a lot of people coming out of the great financial crisis thought that the deficit we were running then was unsustainable.
And I sort of argued the opposite. I said the risk of low inflation was really high coming out of that environment. The risk here is that we are creating a situation where I think some people have referred to this sort of as a fiscal dominant situation where basically the debt becomes so large and the deficit by virtue of that has to keep funding this beast, and it just keeps getting larger and larger.
I mean, I think that if we had an inflation environment that was sustained and really high, I think that this thing is manageable in the sense that we can cut spending if we really choose to. I mean, there are certainly things, I mean, God, for instance, I mean obviously the Fed can control the interest rate situation with a dial, but even in terms of government spending with the Department of Defense or some of these really, really large entities that could certainly be throttled back.
These are things we can control if we choose to. It's just that so far, I don't think anybody in Congress has really made a concerted effort to try to control them in large part because the inflation problem just hasn't been out of control enough to force their hand enough.
And so I think if this persisted, I think certainly people would get fed up enough that Congress would get rolled over at some point where we would elect people that would be fiscally conservative enough to really actually start making a dent in this.
But that's definitely the big risk, I think, is that this sort of fiscal dominance environment evolves and the deficit just it continues to just grow and grow by virtue of this sort of snowball effect where we've agreed to so much non-discretionary spending that we end up just having to keep feeding this beast to the point where it causes a high inflation at some point.
Taylor Schulte: Well, it's interesting you say that. It's nice segue into my next question. John Malden, Malden economics wrote this article recently, and I shared it with you ahead of time. The title of it is "No Way Out", and in the intro he says, I think we're stuck. The building will have to collapse around us before we can leave.
So I compare and contrast that to your statement, which is a lot of this is controllable. We can control our level of spending. The Fed can easily control interest rates. Sure, this deficit might be getting out of control, but we can control these things. We can make changes where he's saying there's nothing we can do, we're stuck.
So what do you agree with? And then what do you think he gets wrong?
Cullen Roche: I really like John's work, first of all, but I think he's coming at this from the default risk perspective, first of all, rather than just an inflation risk perspective, which that's the overarching mistake that I think most people make when they think of debt in general.
Because to be clear, I think the risk of actual default, I mean aside from the knuckleheads in Congress, basically not agreeing to a debt ceiling agreement or something like that, that would be a political choice, but the idea that we literally don't have the money even though we can print it, is just really, it's just sort of ridiculous.
But when you frame it in terms of an inflation debate, I mean that becomes obviously a real risk. Maybe John's being a little bit hyperbolic in the sense that this is not an out of control house fire that we have just no control over.
I think that going back to kind of the previous point, first of all, I think you can make an argument that the house is not on fire. The house is potentially fragile. I mean, again, going back to the best house in a bad neighborhood analogy, I mean, if the US house is on fire, everyone else's house is already smoldering.
And I don't know why more people aren't talking about that. I would argue that, for instance, the situation in Europe, I mean if there's a currency problem with a major reserve currency, I mean, God, I would argue that the dysfunction in Europe is infinitely more problematic than anything that's going on in the United States with the dollar.
So the dollar to me just doesn't seem like it's not the right target for all of this angst and hyperbole. So I think Malden is probably not focused on the right risk and then probably overstating the degree to which the risk actually exists.
Because when you actually reposition this as the inflation debate, you really get into a debate of, okay, well, first of all, how risky is the deficit relative to causing inflation? And then more importantly, you get into what are the real causalities of a very, very high inflation?
My research on hyperinflation basically shows that the causes of a very high hyperinflation, which is technically like a 50% rate of change in inflation. So you're talking about a rate of inflation that is catastrophic. Covid was not a hyperinflation. People were very uncomfortable during Covid, but hyperinflation is a totally different animal.
It's a situation where when you walk into a store and you pick up a loaf of bread, by the time you get to the cash register, the price of that thing has changed literally. And so we're talking about a really, really catastrophic, frightening environment. This thing, high inflation will ruin your year. Hyperinflation ruins an entire person's life.
So it's just a very different animal. And based on the research that I've done, the causes of hyperinflation tend to be things like losing a war, really traumatic regime changes at the government level, highly corrupt authoritarian governments, and the most likely one in the USA would be a collapse in production.
So when you get into these debates about high inflation, well, the war regime change and corrupt authoritarian regime arguments don't really exist. The collapse in production I guess is always a risk in any economy, but I mean, how realistic is that one?
Even in the United States, I'd argue that if anything, the United States economy looks infinitely more robust than most foreign economy. So I don't know. I don't see the argument for hyperbole in all of this. I see a rational argument where someone could say the deficit is going to be 3 trillion this year, and that's going to contribute to 5% inflation, which is going to make everybody worse off in real terms.
And the fed's going to have to be hyper-restrictive, which could cause a recession, which will be uncomfortable. But is it a doomsday scenario? A lot of people sort of position this. No.
Taylor Schulte: Yeah, I like how you frame that. One thing I'm really curious to hear more about is your thoughts on the bond market. So at first in Marvin's article he wrote, I think we have a few years left, but there are already mutterings of stress in the US bond markets. What does he mean by that?
Cullen Roche: There is a lot of talk about the way that, for instance, long bonds can be very, very volatile at times. And I think people see the way that treasury bonds can be very volatile and they immediately assume, oh, this is some unusual stress in the bond market.
The US government bond market especially is undergoing some sort of really unusual stress. And to me it's mostly an interest rate function. I mean, when the Fed does what they did in the last year, you get big, big volatility in bonds because I mean, the math of bonds, not to get too wonky here, but a 30-year treasury bond has a duration of about 20.
I mean, so what that means basically is that a 1% change in interest rates is going to cause a 20% change in the principle value of the bond. And so when you go from zero to 5% on the overnight rate, you get a huge, huge change in the long-duration bonds.
That's just a basic duration function. So a lot of the volatility there and even periods where you see sort of overnight drying of demand in some situations that people, a lot of really perma bearish people love to highlight environments like that where there's an acute lack of demand for government bonds or something that happens in markets that happens in the most liquid markets in the world, it happens in apple stocks sometimes.
I mean, sometimes there's just not a lot of demand for stuff. But going back to the basic point of thinking of everything like it's a dollar bill, if we funded everything with just three-month treasury bills, for instance, the volatility in those things, it would be unnoticeable over a three-month period because they all mature at par, obviously.
And so you see a lot of volatility in US government bonds in large part because we have this sort of staggered maturity structure that the government issues and that is visible in the price of the bonds. I don't think a lot of the volatility that you see is that surprising in large part because it's just a mathematical duration function.
Taylor Schulte: So personally, you have no concern investing in US treasury bonds given the current state deficit and current state of the US government debt.
Cullen Roche: Well, I think people need to be very specific about the way they think of bonds. And so to me, it's interesting. I actually think of very long-duration treasury bonds as a, they're really mostly a deflation hedge.
I don't like thinking of bonds at all as an inflation hedge. If you don't say a, let's just say an aggregate bond index or even the average duration of US government bonds, which is something like six years or so, if you own a six-year government bond, you don't buy that thing because you want inflation protection.
You buy that thing because you know that over the course of a six-year period, the likelihood of you getting your money back is very, very high. So to me, bonds are very specifically principal stabilizers in a portfolio. And I think you have to know that if you're buying 30-year treasury bonds, you're not buying a principal stabilizer.
I mean, obviously if you hold it for 30 years, it'll look like a principal stabilizer, but that's a long, long period of time for anybody to hold any asset. So to me, I think treasury bonds, long treasury bonds serve very specific purpose where I never like to hold a lot of long treasury bonds because to me, they're almost more like insurance in a portfolio.
They're a deflation insurance. So they have this very unique sort of specific role in a portfolio that is very different from something like if you want liquidity and principal stabilization, you really probably should not be buying anything more than a five-year treasury bond, to be frank.
So when I help people structure portfolios, for instance, and I'm focusing on liquidity needs, I mean, gosh, we're really not even talking about anything more than a one to two-year note at the very most probably.
So if you can afford to take a little bit more risk, and if you were someone that say had a little less liquidity needs than somebody who was living paycheck to paycheck or something like that, and you can afford to take a little bit more risk, you want to lock in these current high rates or something.
I would be very comfortable buying something like a five to 10-year note at this point. When you start getting into especially the true treasury bond market, the 30-year, the long duration T-L-T-E-T-F type of durations you're talking about a very, very different animal.
That thing will whipsaw you like crazy, and it'll keep you up at night in the same way that the stock market does because the stock market frankly, is also, I like to think of the stock market as a super long duration instrument. If you're able to be very patient with the stock market, that thing will treat you well.
If you're not, that thing will keep you up at night and cause you all sorts of angst. Same thing is true with long duration treasury bonds.
Taylor Schulte: So kind of bring us home here, and this question came from a client actually who passed along this Malden article, and let's assume that John's correct that there is no way out that catastrophe is ahead due to this debt crisis and that it collides with a social crisis and it's just an absolute disaster.
What would be, if someone believes that and they want to prepare their portfolio for that sort of situation, what's the best defense? What asset classes would benefit in that scenario? How might someone invest their money differently with that sort of outlook?
Cullen Roche: So going back again to the big risk here, I think what would be going on in that environment is I think you would have very, very high inflation if the bond market is collapsing and you're seeing a real trauma in interest rates.
I think what's going on, the underlying real problem is a very, very high inflation. So you need inflation hedges, I think, in that environment. So you would need got, Bitcoin probably does amazingly in that environment. Gold does really well in that environment. Real assets do well.
So if you own a home, and frankly, I mean if you own a home in that environment and you have hyperinflation in the dollar, you probably want your home not only to be mortgaged, to get as much money as you can from any bank in the world, mortgage that thing up the wazoo. And then fill that house with as many guns as you can and barricade the doors because really what's going on in that environment where if the dollar is collapsing.
The entire global financial system is collapsing because as I said before, this is the best house in a bad neighborhood. And if that house is burning, every other house is already burned and people are probably looking to find the owner of that house and take him out.
So yeah, things are really, really, really, really bad in that environment, and you're probably not going to care what the value of your Schwab account is at that point. You're going to care whether or not somebody can break into your front door or not.
Taylor Schulte: Well, I really appreciate your time and your thoughts. Cullen, I've read a lot of your work on this topic. I've used a lot here on the show and referenced it. Where can people find more of your work? Where can they follow along, read your newsletter, read your articles, share a little bit more about where people can find you?
Cullen Roche: Yeah, so I'm the CIO of discipline funds and I write discipline alerts, which is our corporate blog. I guess mostly investment focused, but also some more personal stuff. And I like to focus on life more broadly because money is not really the goal of all of this, really. Money is just a means to an end, and I like to try to focus on not just the big picture of all this, but also the life aspects of how money is important to all of us. So you can find me there.
Taylor Schulte: Are you saying that two kids has changed your approach, Cullen?
Cullen Roche: My kids completely transformed the way I think about everything and literally everything in my whole life.
Taylor Schulte: Yeah. Well, awesome. We'll link to everything in the show notes, including some of the pieces that you wrote that kind of inspired this conversation today. But again, thank you very much for your time and look forward to having you back on the show again soon.
Cullen Roche: Thank you, Taylor.
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