Monday, November 22, 2021

Crazy Cryptos

Any discussion about economic bubble mania always use the "Tulip Mania" as an example. What is more astonishing is - the mania happened in Netherlands in the period of 1630s and we still use the example very vividly even though it happened almost 400 years ago. I am not sure why THIS mania is remembered fondly compared to thousands of other manias that followed it. But I am sure - the next 400 years, future generations would talk or ponder the crypto mania we are engulfed here in our generation as the worst part of human greed and irrational exuberance to its core.


During bull markets, prices of assets grow to new highs and gradually recede during the recession that follows it. Usually crazy things happen in few specific sectors of the economy. Unlike water, the "new money" does not balance at all the same level. It so happens - some sectors of the economy get very hot - really hot and start operating without logic. Eventually as the recession hits through - the astronomical prices come down crashing. It was the dotcom crash of 2000 that brought the tech stocks to zero and the 2007-08 housing crisis, bought the prices of US homes crashing by more than 50% across most of the US cities.


The current boom we are in is being rightly described as the "mother of all bubbles". Definitely the tech stocks are over-priced and the NASDAQ is more than 3 times what it was in year 2000. Housing prices are now at its peak - well above its 2007 highs just before the crash. It can be easily argued the US bond market is in a bubble as well.


Unlike earlier boom/bust cycles - it appears the boom is in danger zone in multiple sectors of the global economy.


But out of all these, nothing is so screwed up like the entire crypto market.


There are quite a few things that are bad in the crypto market.


An asset has to have an intrinsic value. When you take a home, people live there. It has a utility value. There is a need for housing. It is a place, people can keep themselves warm or cold from weather changes. Its where you keep your belongings safe. It has a use value. Because of its use value, it has a proportional exchange value. Home owners sell their homes for getting cash and use the proceeds to buy another asset . Assets such as home will always have value because it has the fundamental components of productivity - land, labor and capital.


Other assets like stocks - represent a piece of action in a profit making businesses. They have an intrinsic value. The business has assets and employees with skills who can make the shareholder money in the long run.


Every boom period is defined by something new. The newest girl in the block always gets a lot of attention. This bull market that is in place since the 2008 financial crisis has created huge asset price appreciation overall. The causes being the zero percent interest rate policy of the world central banks and endless quantitative easing measures the world hasn't seen. With the covid arriving early in 2020 - Every boom has been re-catapulted with more stimulus. With "free money" everywhere, investors have no choice but to buy risk assets all over the world. That would explain the exponential growth of the crypto market.


Cryptos have all increased in value during this phase of the boom. For example Bitcoin has went from few dollars into its all-time high of $68000. For anyone who made the journey they have profited exponentially.


No asset go up in price for ever. For those investors who missed the bitcoin ride regret not being able to get in to the ride when the price was really in double digits or even triple digits or few thousands. For those investor who got in and burnt themselves in volatility know the high price of losing the money on the way up. But for me - the best investor are the ones who will make the sane decisions and stay normal during crazy times. I have been watching bitcoin when it was as low three figures. When it reached $4000, I thought it was way expensive then. Today its $68000 - of course it's way expensive now. Can it go higher and higher still - Of course yet. Can it go to $100,000 - Yes, it can. Can it go to a $1M - possible but not probably. With each coin costing a million, it would seriously undermine other monetary parameters.


The cryptos are digital meaning you need to go online to view or see it. Its virtual - which is it is not fungible (felt or touched). Peter Lynch in his "Beating the Markets" says - the investments you make on businesses must be explainable with crayons. There are many things that can be explained - but not the cryptos. People who have no idea about cryptos - don't invest in them, and the people who do -> think it's very valuable. Only way out for someone who is holding his bitcoin is to sell it to someone who is willing to give more money than what the seller paid for it.


Crypto currencies by itself are transmissible tokens via the internet. It can be exchanged between the crypto valets of users. That's all it is. Their value is only exchange value. There is no use values. Meaning people will not buy it because there isn't any use to it, they will only buy under the belief that someone else will be willing to pay more for it in the future. It doesn’t solve any problems. It takes a lot of electricity to "mine" the cryptos. The cryptos are end product of the mining operation. If it's not useful by itself - what is the purpose of "mining" them.


One of the big drawbacks of the cryptos is its lack of simplicity. The medium of exchanges is not physical. It is online. With a large population of the world outside the internet, it is not sellable to any larger public.


If you have a checking account in the bank and you are able to digitally transfer funds to your friends and family 24x7 and to any part of the world - That is a reasonable mode of exchange that we know works well. It solves all problems that bitcoin tries to solve. When you are without an internet or a power supply, you will not be able to do a fund transfer in your bank account mobile app. It’s the same there too. If an bank account can facilitate exchange of currencies online - separate channel of mechanism is redundant.


Because they are not useful by itself - when the confidence is lost, the price of the cryptos will go to its minimum of zero. There is a precedent to it for us. The dotcom companies who made spectacular stock market debuts in the 1990s - eventually went to zero when reality caught up with it. The same is true for today's cryptos.


One of the big talking points of bitcoin enthusiast is its scarcity. They say there can be only 22M odd number of bitcoins ever. Even though there may not be enough bitcoins, there are enough crypto currencies, actually 13000 of them that are being traded. Even within bitcoin there is a "bitcoin cash" which operates along with bitcoin. It’s a separate crypto that operates outside the 22M limit. So the whole things is very unconvincing and we hard to explain even by the so called "crypto experts".


Centrals banks printing money has dramatically increased since the great recession of 2008. Bitcoin enthusiasts point to this obvious problem with the fractional reserve banking the world economy follows quite rightly. They advocate cryptos as financial instruments that is outside world governments. They often site it as free from government regulations and its uncontrollable independence from any entity. The individual countries stand behind their currencies. Even though we do agree with the problems world Central banks have created - crypto is not an effective alternative for it as it lacks a lot of other qualities of sound money.


Internet is a life changing invention. Most of its value derives from its experience of being mostly free. It doesn't cost much to be using the internet. Say If popular social media sites like FB are made payable site. The traffic would come down to single digits overnight. For most people, its optional meaning they would want to use it only if free. If its chargeable - they will choose to ignore or choose an alternative site, that is less sophisticated but doesn't cost any. Unlike the internet - the cryptos are not something people cannot live with.


The astronomical valuations of certain cryptos confirm the big asset bubble the world has ever seen. It is very hard to believe - it will gradually smoothen itself to a new normal. There is going to be adjustment and when it happens it will be more painful than before as the monster bubble is massive this time. 


Eventually all cryptos including bitcoin will go to zero as that is where it belongs.

Sunday, November 29, 2020

Why this world needs a Gold Standard!

Gold has been an investment for hundreds of years and at this point of time in history, its relatively under owned.  

To put it in perspective, there are some myths about our understanding of certain financial terms. 

"Money" is something that has intrinsic value. Additionally it should also be a store of value. There should be a natural demand for it. Gold is money. It is possible any commodity can be money. For example - oil can be money. It has a intrinsic value and store value. We can run automobiles after scientifically processing them. There is a natural demand for it. It is however not portable, fungible or easily exchangeable. The precious metals - mostly gold and silver have always been used as money since mankind evolved. Their availability is limited and people have a natural desire for it. 

The US constitution mandates only gold and silver as money. No where it talks about dollars. Dollar bills were mere paper bills or IOU, that represented the gold it was backed on. It was used for convenience and never by itself a money for most of American history. 

The US Dollar or the Euro or the Pound or the Indian Rupee is NOT money. They are currencies. By itself - they do not have any value. The government prints it on paper and mandates the collection of taxes and commerce on it. It controls the supply of it by controlling the flow of it - often referred as liquidity in financial terms. These paper currencies are fiat currencies and should not be called money. They are currencies. The demonetization that happened in India few years before - made most of the existing paper notes invalid. Overnight they lost its value. It was substituted with new paper notes. It is a recent example of a fiat money losing value overnight, if the government that controls it wants to do it. 

Usually there is lot of argument - if gold is an investment. Gold is not an investment. It is a store of value. let's see what this is.

Say you have a capital amount of say, Rs. 50 Lakhs to invest. You have three choices

1. Keep the currency in a safe

2. Buy physical gold with that money say 1 KG and keep it in a safe somewhere

Also note, we can buy a luxury car today, that cost Rs. 50 Lakhs.

Sometime in the future, that can be say between 2 years to 100 years, you come back to this "investment". This is what you realize

1. The currency in the safe is as is. But the currency buys lot less than it used to be. It might become completely worthless over time. 

2. When selling the gold in the safe, it gives me the exact value, as of in today's currency value that helps me to buy the the exact SAME thing I wanted - in our case the luxury car. 

It should be obvious with this example that gold never acts as investment. It just stores your purchasing power over any number of years. The other way to say is - if you are young and energetic and happen to have a job and make x amount of money over n amount of months. If you end up investing everything in gold at the current market price every month, then what you are assuring yourself is - at any point of time in the future for any given month, you can see the x amount of money and live your life with the same life style for the month. As an example - if you saved for five years of your monthly salary amount in gold now., you are guaranteeing yourself that you can use that money for "any five years" down the future and you will be able to do the exact same thing you can do it with now. 

Governments control money and as always they are not good at anything and this one is not an exception. They have convinced the world that little inflation is always good. The price of everything going higher is always a good thing. It is not. It helps those people who have heavily borrowed money. It does not help the savers who have dutifully saved. In other words - the risk taker is rewarded at the expense of the conservative saver. This has caused the economic malfunctions the world is facing now. Had there been a fixed money supply - it would guarantee stable prices. The industrial and technological inventions would cause prices of everything to go down because of increased productivity. The world the way it operates now is - completely backwards. The government along with its special interest group (who benefit from this set-up) - keep this game going for their own convenience. What is very sparkling in history - This always happen and people force governments to go back to the gold standard. This is often economic failures or revolutions that throw out dishonest governments and their quasi entities that benefit from it, who promise economic prosperity without human productivity. 

Now we look around, in the post covid-19 world, the major channel of investment -  pretty much boils down to equities. Equities are all at an all time high, primarily facilitated by easy currency policy of world central banks. Buying the US Treasury 10 year bond for a yield of 0.7% interest is well below the government statistics of 1.5% of consumer price inflation. It clearly says that any buyer of a 10-year bond, is guaranteed to lose money if he holds it to maturity. This is a bad investment and no profit-oriented buyer will buy it. Because the central banks are in the bond market buying bonds - the entire market is phony. The only option is to sell the bonds to the Central Bank for a profit. The Bank doesn't care - as it just prints currency bills to buy the bonds. There is neither an investment or productivity involved in this transaction. Bank of Japan has been following this for years and literally days goes by where not even a single government bond is bought or sold. 

Bottom line - With all Centrals Banks printing currency bills like crazy - the general inflation is only going higher. Gold is the only hedge to this rising inflation.

Whenever you are upset with the current governments and their lavish spending spree's, throwing and wasting money (currency actually) in the name of people's welfare - what you do, is you take your savings and head towards a precious metal seller and buy yourself gold and silver. That is the only way to be prudent. 

Right now - all economies of the world are socialist economies. All governments are propping up private companies that should be allowed to fail. We are all Marxist now. Capitalism cannot be good when things are good and cannot be seen as evil when things are bad. If capitalistic economies cannot stick to free-market principles during bad times, the collapse of the system has already began. In the US for example - the amount of new currencies printed in the last 3 months exceeds the amount of currencies ever printed in the history of United States. This won't have bad after effects is not believable. Even if things come back to normal - what is the plan on re-introducing capitalistic principles again? The federal budget deficit is alarmingly high. It is expected to remain high for the foreseeable years. 

If governments can print this much currencies in this short time, and it does not create any problems - then why even do taxation? We can repeat this every year and it should make a difference. 

The whole indebted western economies are more and more cornered. The only thing that people should hedge against is the future inflation. Gold and Silver offer that. 

People say, we cannot go back to the old standard. We are not going back to the old standard. We are going back to the good standard. 

Saturday, April 11, 2020

It's the economy, stupid.

When a large house party is going on, and the guests were getting their beers from the fridge and finally one person opens up the fridge and finds out that, there are no more beers left, It cannot be concluded - he drank all the beers. Similarly the economic recession that is creeping in the world now, is triggered by the Coronavirus pandemic but it is not the only cause. The virus will be gone in a few months. But the economic recession would prevail not just months but for many years to come.

Before the virus ever came into the picture, the economy was so weak. The signs were obvious for the people who looked at it. The rosy picture the mainstream media and the government gave about the economic growth that was completely out-of-place was so obviously misleading. For those people who looked at the right metrics, the data never improved in-spite of all the positive rhetoric peddled by the financial media.

The primary reason, why the western economies look more vulnerable to a crisis like a pandemic is that - they economic breathes  on consumer spending. Unlike the Asian economies, the western nations run on credit cards. Even a bottle of water is purchased with credit cards. With some people using credit cards for convenience, the vast majority of the people use it as a means to delay the payment to future income. The saving economy has the supreme savings as a cushion and can recover from the pandemic sooner. With all business establishments closed and almost no economic activity happening on the ground, the western consumer who is already overburdened with debt has come to the final square. The last thing that was holding him is the job paycheck. With the paycheck now in question, and with no savings from the past, the future looks grim. There is no other way for him to get out of situation unless the government throws him some lifeline money.

This consumer spending on credit has been the major driver of growth. 80% of the American economy is consumer spending. This spending was exacerbated by the artificial low cost of borrowing. Interest rate is the "price" of the money. This is very important for any market economy. Post-2008, interest rates never could go back to normal. We started off with the Fed's funds rate in 2006 that stood at 5.5. It was reduced to 0 in 2008 under George Bush's Presidency and never moved from there until the last year of the Obama Presidency. It went back to 2.5% post-Trump election optimism. The EU's bank-to-bank lending rate never when above zero after they got there in years. Every time they try to make it normal but conveying their intentions to normalize monetary policy - the stock market would slump. Finally the Fed/ECB got boxed in. Overtime it became pretty clear that the low-interest is the only reason there is any growth in western economies. For all those people who looked at it right - It was obvious that the western economies were being propped up by low interest rate and QEs. These easy money polices were not the training wheels to kick-start the economy but it were the only wheels. This created mal-investments across the economy during this boom years. The western government and the Central Bankers knew - that withdrawing the easy money policy will definitely create a recession. So they were just locked.

The economic numbers that came out during this boom time, were to be taken with caution. For example in the US, because a person is unable to get a good paying full-time job, he ends up doing 3 part-time jobs. This makes the jobs count for the month to go up by three. When he loses couple of those jobs, they don't add him to those number of people who lost jobs that month, because he still manages to hold on to that one part-time job. It was just a numbers game. They refined the methodology of counting to make it appear better than what it was. They also do publish the numbers calculated by old methodology, but they don't get enough media attention. The headline number was the most important number for the financial channels and the media. Every time you dig through the numbers, it was apparent the jobs being created were phony. There is always a slide in the count of manufacturing jobs and they get compensated by increase in leisure jobs - like restaurants, bars, hospitality, etc. The surprising part is - how long they managed to do that without a recession. In the end - we had the longest bull market (without a correction/recession) for a decade. The economy growth was touted to be the best in the history of the world. Even the GDP as measured by the government, did not hit the annual 4% mark. Until February of this month - It was hailed the greatest economy ever. Warren Buffet very famously told - when the tide recedes, we will know who was swimming naked. Unfortunately as the virus arrived on the stage, the whole of US economy was exposed naked.

The jobs created during the boom years, were low-paying, service sector part-time jobs. It was always suppose to be gone even at the slightest sign of trouble. 17 million people filing for initial jobless claims is the last 3 weeks explains the quality of jobs that prevailed.

The boom was so big, it has only come down the first leg. The market is at the same level now, when Trump was a candidate. Remember, he called these numbers - the big fat ugly bubble. So market is still over valued.

Filling people's account with free money is not the solution to the problem. That will create more problems that it really solves. The right thing to do is to allow companies who cannot sustain the economic shock now to fail gracefully now itself. Things might get bad. There will be consequences to that actions. People might lose jobs, plants will be shut. Within sometime very soon - things will recover.

The Fed is buying all the bonds it can. This is not limited to the US treasury or the mortgage backed securities any more. It includes pure private sector bonds like corporate bonds. It is buying municipal bonds with an unlimited bag. Fed is the only buyer of these bonds. No one in the market will buy it - because its toxic. Most of them will go to zero. That is the reason it doesn't have a natural demand. The 2T Fed program announced 9th April will buy all bonds including junk bonds. With the Fed buying it all for any price, the whole bond market is phony. There is no longer normal price discovery which the market always does well.

This situation mirrors the start of the economic depression in the west that started in 1929 and did not go away until the second world war was over. The post-second world war was the real economic boom for the many decades to come. What we are starting at, is a long, prolonged period of negative growth that will fundamentally question the American way of financial capitalism that is practiced by the west.

While everything is blamed on the virus now, what will eventually happen is - over the next few months the virus would gradually subside and cease to exist. Lot of people would even forget the name of it and find it difficult to remember its name covid-19. The economic pain created by the unprecedented bubble in the last decade and the reactions by Fed to boost it further citing the covid-19 reason will be enormous and will mirror the great depression. The overdose of fiscal and monetary stimulus practiced will erode the value of the US dollar and eventually kill it.

With a multi-ethnic society like the USA and UK, to an extent EU, financial prosperity is almost the only reason the rule of law is enforceable. Without the economic prosperity, the culture of capitalism (the way it is practiced) cannot be sustained. The richness is what unites the people. The more poorer they become - racial discriminations start to come to the open. The 1929-style economic recession where bulk of the people were white-Europeans did not create social problems in big scale. But now with all western countries heavily populated with multi-ethnic population, particularly Asians - who happen to have more job skills than their white citizens., social issues will prop-up. So the challenge for the governments in the west is not only to quell the economic effects of the slowdown but also the social effects. This can be done only with stringent laws, but only if the government cooperates by enforcing them. With right-wing governments in place, there is a possibility of cohesion based on religious and racial superiority which will have a cascading effect on how societies operate. You see around this world - people who look alike stay together. There are historical reasons for it. The liberal western capitalistic societies in the last 3-4 decades benefited from arriving work forces (immigration) from all around the world and they tolerated it because of the economic prosperity they brought to the nation. With their nations gradually becoming welfare nations - the sharing of limited welfare is no longer sellable to the white majority population. Also the fact that the coronavirus originated in China may lead to a general dislike of Asian people who are already integrated in the western societies causing racial hatred and general dislike for years to come.

Sustaining the economic prosperity is vital for multi-ethnic western societies to thrive. With a long, deeper economic recession in the horizon, things look bleak in social perspective as well.

Whenever things go wrong at the nation level, two things happen. One is - Everybody knows something is terribly wrong. The second one is more important - Everyone knows that Everybody knows something is terribly wrong. The western world may just be getting there, if not there already. 

Sunday, March 29, 2020

Survival of Financial Capitalism

When I wrote my earlier article last week, the US Fed funds rate was 1% and I accurately predicted they are going to 0 sooner than we think. Even I didn't expect that to happen within the next 6 hours. The Fed jumped in and reduced the rates to zero in one go (Hasn't happened in history) and relaunched QE. Not only that - 1.5 trillion stimulus program and a daily 1 trillion repo. The stock market completely ignored this. In fact the fall in that week was the biggest fall for a week since 2008 - when the financial crisis was at its peak. It managed to recover more than 20% this week.

The COVID-19 pandemic is sweeping the world big-time. Human tragedy is beyond the definition of sadness. The threat from COVID-19 really looks like a lifetime event for many of us. Natural calamities like these are unavoidable as nature dictates them. Looking at the economical angle - it looks lot bleaker.We will focus on the economic aspects alone here.

The world economy was so vulnerable in the build up to this crisis, it just happened to be the coronavirus that exposed the underlying mal-investments of the last decade. 

The layoffs have started in the US. The initial job less claims was more than 3.2 million. The All time high of that number is 660,000. The million number - is unheard of in history. Once the pandemic fear recedes, these jobs will definitely return but not all of them would. That is the worry. The GDP is also set to contract because of the virus. There are dire predictions floating around like negative 24%. We just have to wait as it unfolds. Singapore initial estimates on first quarter GDP is a negative 10% which is little more than what was witnessed during the financial crisis of 08.

The world has seen this many times - public property being privatized and private property being nationalized. This happens when existing economic models get transitioned. Mikhail Gorbachev in 1984, privatized what were government managed industries for decades. Private player rushed to buy it. However It did not stop the collapse of the Soviet Union. It was just a transition from one form of economic model that was failing to an alternative model which is perceived to be "working". Bottom line - It is just a transition from one form of society to another form of society because of the obvious signs of lack of productivity in existing human labor. What is happening in the US today of nationalization of loss-making private entities, is no different from what Gorbachev did in 1984 for USSR except that it is exact reversal.

Many things were common
  1. Heavily indebted Federal government
  2. Decreased labor productivity - service sector industry focused economic model finally ran out of steam, proved by the fact that more women in labor force than men and a LOT of part-time jobs and not enough full time jobs
  3. Majority of the population with no savings
  4. Lack of confidence in government entities 
When the Soviet union failed economically in the 80s and 90s, it had a warhead of 10,000 nuclear arsenal. Always a proof that military might is not a replacement for mass labor productivity of the country.

The US government does not want the stock market to go down. It is well aware, if the stock market goes down, private companies would fail. With all the pension funds, global investment money into the US market - it will send all the fund values spiraling down. This will lead to mass exit of capital from the US market. Ben Bernanke very famously told during the 2008 economic crisis - the reason for ZIRP and QEs was to create the "wealth effect". When the markets go down in confidence and sells off - this wealth effect is lost causing a downward spiral.

The truth is no matter what they do, they cannot alter the trend of the market in anyway. If it goes higher - they can make it go little over., if it goes lower - they can slow it down. That is all they can do. Trend cannot be reversed.

The last thing that is holding the US economy together is the VALUE of the US dollar. The dollar index (DXY) is floating around the 100 mark. It was around the 95 handle just couple of weeks ago. The sell-off in the market has triggered a liquidation, and there is a natural need for the dollar as most financials are denominated in dollars. With the "Cash is King" mentality setting in, that money is going to look for alternative investments. If the US stock market continues to go down - the cash will not go there. With the Covid-19 situation getting worse by the day across the globe including the US, the cash is not going into risky assets. Eventually it needs to chase an investment - this could possibly be gold. When that ride happens - it would signal the demise of the dollar. When dollar loses confidence and goes to say the 70 handle (we were there in 2011 post financial crisis) - we are going to see a sea change in the movement of big money across the globe. With the currency risk not hedged by investment from Europe, Japan and Asian investment firms in the last decade there is going to be serious losses for them as their local currency gain value against the dollar. For example, Switzerland Sovereign fund is one of the top 10 investors in apple shares. Apple shares have tanked 25% in the last month. The fund has gone down by a quarter. If the dollar falls and the local currency (Swiss Francs) appreciates against dollar, the loss accelerates because of the currency exchange. With a stable or appreciating dollar the investment is better off and it is beneficial. But the fund cannot withstand a dollar depreciation scenario. Ideally huge investment funds, hedge their investment against currency risks, but the last decade of easy money policy has left them too complacent to follow it. When these loses happening, the global rush outside of the dollar will happen causing more problems for the US markets.

Even though the political establishments can blame the coronavirus for the current state., people who were aware of the bad economic policies of the past decade can easily see, that the virus is just a trigger. The Covid-19 situation will be gone 4-5 months from now. We are seeing Wuhan already returning to normal. As the virus situation recedes what is left is - the huge debt and the economy in its terminal state. The 1.2 Trillion stimulus programs will try to keep the economy afloat, but what happens if they don't work. Inflation will go beyond 3%. Once that is consistently higher, the existing bonds that yield less than 3% are going to be clobbered. Fed will buy it to create a market - but it won't work.

The rest of the world particularly the Asian economies will recover sooner as they are in a better place than the US.

Merely printing money for economic boom never works. If that was the case - every country in the world that can print its own money and can avoid economic set backs. US dollar being a global currency does not give the nation a right to print their way out. Money is just a medium of exchange for productive goods and productive labor. Without the underlying productive entity - the money itself is of no use. Sending $1200 check to all its citizens cannot work. At the peak of the financial crisis, Bush sent these stimulus checks. That did not stop the collapse of Lehman Brothers in September of 08 and the subsequent financial crisis. Similarly this check would also vanish in memory. Believe me - every country wants to send its citizen a check, but there is a small problem with that - no country can afford that.

US government is the biggest debtor in the history of this world. It's plan to bail out other smaller players would have worked in 2008., and will not work this time. The bottom might come out of the US dollar causing general currency issues. With all fiat money in play - all currencies of the world will lose confidence. We are going back to the gold standard.

Lenin very famously told - The best way to destroy the capitalist system is to debauch the currency. The capitalistic west will eventually realize that and it just might be too late. 

Sunday, March 15, 2020

The start of the end

In February all US stock market indexes were at an all time high. The time was right for President Trump to go to Congress for the State of the Union speech and declare victory over the economy. He would once again justify how awesome the economy is and why the prosperity of the people in the last three years of his Presidency was the best ever in US History. He glorified the rise of the stock market and took full credit for it. Little did he knew then, that the very market he glorified will tank into the bear market in record time. In fact, all indexes hit the bear market territory in the first two weeks of March. Market going to bear market was nothing new but the pace at which it got down from the peak into the bear market is unprecedented. The fear of Coronavirus (Covid-19) becoming a pandemic and dangerously spreading across the world swiftly, triggered the collapse of the markets.

As of today 15-March, We are seeing wide swings on daily trading swinging between + or - 4% on any day. In the process we have almost 10% down and up days within a week. The major indexes haven't seen this kind of swings unless you want to go back to the 1929 era of the great depression.

President Trump's reelection is almost 100% dependent on a good economy in build up to the elections in November. If the economy is in recession, it is almost certain that he will end up as one-term President. To avoid that - Trump would be ready to do extreme intermediate steps to postpone the crisis. The mere idea of payroll tax cut or a tax holiday is a direct reflection of that.

The US Federal reserve has kept the economy on cheap money post financial crisis of 2008, and it never managed to get back to normal interest rate in the last 12 years. They couldn't do it, because they were well aware doing that would cause a recession. Chairman Powell however did manage to get to 2.5% mark - almost half of historic average. Once the late rate rise was too much for the economy to manage, he had to pull it back to 1.5%. As stocks began to tank in the first week of March, the yield on the longer term treasuries began to tank. As the 10-year was dangling around the less than 1% mark, he really didn't have a choice but to make a unplanned 50 bps of emergency cut and bring the Fed funds rate to 1%. What scared chairman Powell the most was there were 7 days market freeze for the investment grade corporate bond. There were no buyers and hence no sellers. Within a week, the yield has further dropped down to 0.3% and back up to the 1% mark. The bond market is still pricing in a 50 bps points on the March 18th Fed meeting. They will cut it further I think. Sooner than we think, they are going back to zero percent. As stocks tanked the bond market crated with yields rising for non-government bonds. The spread looks lot scarier. The Fed has also promised to jump in to buy everything with its $1.5 Trillion QE program announced last week. The TARP in 2008 was $700 billion and it was very famously rejected by Congress initially. The bailout fund this week is almost double of that. This essentially is an admission that the problems are bigger than 2008. What is really interesting is - Can the Fed play its card this time. The last time it worked was because - Bernanke, the Fed Chairman then told Congress - the QE was not debt monetization but was TEMPORARY. But from past experience the QE programs always is repeating and every program dwarfs any previous programs in dollar value. The recent announcement of $1.5 Trillion QE programs is all previous QE program combined in dollar terms. They plan to bail out every industry possible. What needs to be observed is - the dollars don't make business viable but the productivity of the labor makes a business useful, viable and hence profitable.

President Trump is unleashing a "Bailout nation" in the guise of National Emergency because of the Covid-19 pandemic. The bond market went up in smoke last week. Trump really didn't have a choice. He had to come and put a floor to the fall. With fiat currency system in place, these government bond yields don't make sense. In fact these government papers trading at the lower yield is not an issue. The pressing issue is the opposite trade. The yield on the junk bonds are rising more than the fall in the US treasuries. That is the worrying part. The corporate bond market is so leveraged that it cannot handle rising rates. Corporate bonds that have junk status and have ratings just above junk are doomed to fail big time. With this trade "We will buy anything out there in the bond market" is the Fed's new rhetoric. They will go on to say, that it is temporary and they will sell it out during the good time. They couldn't do it fully last time, they will never be able to do it next time as well. Will the market buy it, is the $1.5Trillion question.

In the build up to the 2008 financial crisis - falling house prices was the pin that pricked the debt bubble. The bursting of the bubble exposed the over-leveraged debt market primarily mortgage debt. The mortgage debt market exploded initially in the subprime sector and then it spread to the entire mortgage market. The financial companies - that were part of the industry got burnt first like countrywide and then it spread to Fanie mae and Freddie mac - the quasi government enterprises., finally targeting the banking hierarchy from local & regional banks to international banks like Citi. This will solved by government bailouts to the financial sector.

The bailouts from the last great recession and the subsequent building up of national, corporate and household debt has created a far bigger crisis now than in 2008.

The plot that is playing now, is the Coronavirus is the pin that pricked the debt market, which is many fold bigger than what it was in 2008. First it would hit the easy targets and then finally the full scope of the economy. People ask that FANG stocks are doing ok, in spite of the big market correction. My answer to them is - first the soldiers get killed and then the generals. They are all highly leveraged and substantially over-valued. They will go down significantly as well.

The irrational exuberance on steroids of the last decade finally seems to have started to end.

What to look for? What will confirm this? Looks at the weekly jobless claims numbers. It has to go beyond the 255K number. The jobs number for April and May are getting important. With the economic activity almost coming to a standstill on the fear of contracting the virus., that number should go up. If you seen the job reports numbers from the last 10 years, bulk of the jobs were created in the hospital and leisure sector of the economy. With this sector annihilated - there should be thousands and thousands of job losses. With US job market dominated by women workforce (non-labor intensive) that men, the jobs would disappear sooner.

Bailouts would work, if a part of the economy is struggling and the other part is doing good. With the entire stand-still happening, bailouts won't work. Open ended bailout commitment is a sign of weakness and not strength. Moreover the US government is the biggest debtor in the planet. It offering to bailout other smaller debtors just insults rational intelligence.

Sunday, February 23, 2020

Reality check 2020

The 30-year Treasury yield this week dropped to its all-time low of 1.89%. The Bond market is sounding alarm bells of a recession. Turns out investors are Ok to settle for 1.89% on their investment for the next 30 years. This is in-spite of the government annual inflation number being 2.3%. What this essentially means is - the investor who buys the 30-year and decides to hold it for next 30 years is guaranteed to lose money. In bonds the price and the yields move in opposite direction. So the lucrative offer is yields fall further and the price of the bonds surge more and then our investor can dump the 1.89% yielding Treasury to a new investor. One day or the other, you really run of fools. Because of government mandating banks to buy the long-term securities as investments - this forced buying creates a market. But with exploding US debt - again at historic highs, there is never short of these papers in future. US Government has already borrowed close to $23T and there is no sign from Washington DC that the spending is going to slow anytime soon. President Trump doesn't give any importance to national debt and so are the democratic nominees who will challenge him in November. We are in a phase historically where this is a complacent notion - Debts doesn't matter. Greece's debt didn't matter until they mattered. The debt market is a lender's market. Under consumption creates savings. Savings create lenders. Buyers would always be there. The existence of lenders is a pre-requisite for a debt market.

Banks buy Treasury as long term securities. They are mandated to do that. Without the mandatory rule to buy it, there is no natural want for it. Foreigners are also piling into the US treasuries. They are looking for yields outside their currencies. With interest rate either being zero or less, the 1.89% is more lucrative to say a Japanese investor or a European investor. Unlike before, these trading are happening without a hedge and poses a dangerous pattern. With their local currency (Yen or Euro) gaining against the Dollar will wipe out this thin wafer of < 2% interest and this essentially has become a necessary requisite for the boom to continue.

Switzerland Sovereign being amongst the top 10 investors in Apple is the same story but they choose the more risky route in Stocks.

The Fed has been buying short term securities from the overnight repo market. There are 2 things that are distinctly noticeable here. First, the Fed does not want to call these purchases QE. It continues to maintain a stand that these purchases do not amount to a QE program where they bought long-term bonds for $85B every month, Secondly they are unable to hide the balance sheet accumulation of nearly $500B since September of 2019. This is the same effect as the previous three QE programs except that the accumulation is without any upper limit. Any QE(n) program needs more money than QE(n-1) - this has always been the case. It is no different this time and hence it QE for sure. Banks like JP Morgan and Bank of NY Mellon - who have tremendous advantage being primary brokers benefit disproportionately from these overnight repos. They peddle money for the Fed basically, and it shouldn't be a surprise that JP Morgan reported its best ever profit during this time.

With all indexes - Dow, S&P and Nasdaq all hitting all time highs everyday, the stock market keeps going higher and higher. Just as trees do not grow to the sky., this will have to stop at some point.
Tesla stocks vaulting to $900 is the new mania around. It is the heavily shorted stock in American history. The excess flow of liquidity is chasing these speculative stocks. It has not only overtaken the market share of a car-major  like Volkswagen in a few trading days, but is in a striking distance from going ahead of Toyoto. Usually when bubbles are at its peak., we see mania companies going this way signaling its climax. Tesla story really looks one. The tech IPOs drying up is also notable after the weWork fiasco. From $90B valuation to being bailed out by its bigger investor just within few weeks. Even in 2000 bubble, the dotcoms failed first and the Nasdaq crashing was after a while. With Nasdaq about to hit the 10K mark - it looks it has ran out of steam.

The rise in price of gold this year is more than 8%. It is probably the best performing asset class of 2020. Gold has hit an all-time high against pretty much every currency except for the US dollar. An ounce of gold is at $1662 which is almost $300 less than its all time peak. The recent surge of gold may not be surprising for some people like me, but the surge of the DXY along with it to 100 is very interesting. Usually they trade opposite to each other because gold is traded in US dollars and they tend to go in opposite directions. One has to finally cave in. The Argument to gold is - if it can rise at this pace with the dollar getting strong., it should rise a lot faster on a sliding dollar which may happen soon. So looks gold finally is coming out as inflation hedge.

Coronavirus is still in its early stages and its impact may be longer and harder looks like. Car sales in China has plunged by 92% since the new year. This looks a pandemic that might have economic impact. As of now, even though it looks serious enough., to me I think, that market has used this reason to rectify an over-bought, genuine sell-off. Coronavirus looks very nastier than initially thought. It definitely can put China's economic order out of place temporarily and this obviously will have an impact on the rest of the world.

It is very possible that the US fed might intervene and reduce rates citing Coronavirus. When that happens, we will all know that the Fed has not only economic cures but also medical cures. Let's wait and see on this. It is possible that the Fed may reduce rates and keep inflating the bubble. Whether investors will buy it this time also is a serious doubt.

The US market has not priced in anything yet, on a Bernie Sanders Presidency which increasing looks very possible. Republicans who think Sanders is the easiest democratic candidate to beat for Trump should be really cautious what they wish for. This is exactly what the democrats thought of Trump in 2016 and we all know what happen after that. Bernie has been a life long socialist. If he wins, it would be an admission that 29 years since the collapse of the Soviet Union in December of 1991, finally Socialism has made it to the shores of the United State of America. Bernie is not hiding the fact that he is a socialist. He has been a socialist all his life and is on record all his life saying He doesn't believe in capitalism and believes in cooperation instead. If Bernie's appeal resonates with ordinary US citizens and they vote for him, it should be admission of failing capitalism in the US. Unlike candidates who promise socialism and govern from the center., Bernie is very different I suspect. He will govern from the left. Any democratic system leads to a socialistic society eventually. This is because there are more employees who vote that employers. That is one reason, the US constitution notably doesn't have a word called democracy. It was founded as an republic. Somewhere in the last half-a-century, the democratic political system in the US has lead to socialistic leaders. 

An economic slowdown is long overdue in the US. Market is just looking for an excuse to sell. The excuses can be - Coronavirus impact in China and rest of the world, Dollar index sliding by 10-20% on sign of a US slow down, Opinion polls that indicate Trump losing Presidency in November of 2020, Earnings shock and bursting of the junk bond/corporate bond market. One of them might happen sooner than you think. There is no rule they don't happen all at the same time.

Tuesday, June 25, 2019

The Fed trap

The Fed stepped-in to assure the market this week by saying, it will do what it takes to support the present economic expansion. It looks pretty much a July cut is on the horizon and more likely more cuts this year and again next year. Markets exactly wanted to hear that, and started rallying. The S&P hit an all- time high the same day. What is different this time is, in the past - when the S&P and the broader indexes hit historic highs, the Fed would increase the interest rate to cool down the economy. On contrary - the Fed is promising to decrease it, to keep the economic expansion going. Ever expanding expansion of the economy ie., prolong current boom. Particularly with the way the world economy operates these days where there is constant boom and bust cycle - it is a given that the boom market will always lead to a proportional bust market. If we go with that theory - the longest ever bull market that we are in, should definitely create a longest bear market. The longest bear market can only be preceded by a crisis scenario.

The US stock market is roughly 140% of GDP. Historically, it has always been 30-60%. The great crash of 1987 - often referred to as black Monday, stocks crashed 20% on a single day. Even though the crash wiped out the share value by a fifth, it did not affect the real economy in a big way, because the stock market merely reflected less than 30% of GDP. After easy money for more than 10 years, we have an economy were asset prices are GDP. Financial assets are biggest chunk of it. Any stock market correction, is deemed to reflect an economic correction. The fed has the numbers and knows it. Fed Chairman Powell really got a first glimpse of the economic scare in the last quarter of 2018. There were no takers of the junk market bonds for 41 days, after the Fed insisted on its policy of auto-pilot. The economy was spilling over, with all indexes (dow, nasdaq, s&p and russel 2000) all going down 20% essentially starting the bear market. Once Powell raised the rates in December, it was the last rate hike of the cycle.

The last time, the Fed promised to cut interest rate (after a series of rate hikes) was in 2007. The funds rate at that time was little more than 5%. The Fed had the luxury of reducing the interest rate by 500 basis points to provide a boost to the economy - and still could not avoid a financial crisis in 2008. The Fed brought the interest rate to 0% in 2008. Even that wasn't sufficient to recover the economy from its historic slump. The Fed introduced QE not once but thrice in the next four years. What is interesting is - every QE-n was bigger that its QE-(n-1). From what has happened with those monetary experiments - we can clearly derive that with the current rate of 2.25-2.5% of Fed funds rate, the Fed doesn’t have enough room like last time. It only has just half the ammunition. Going to zero alone is not sufficient. QE has to come sooner rather than later. Also - the economy should have its head above water during this whole period. Any lapse in liquidity or promise to liquidity will choke the economy. It’s a really tricky spot to be in, for Fed chairman Powell. He just can't afford a mis-step. A slowdown will expose all the mal-investments of the last decade., fueled by the fed itself.

As I have already mentioned in my earlier blogs, Ben Bernanke and Janet Yellen are primarily responsible for having persisted with easy money policy for too long. When testifying to the Congress when introducing the US economy to QE., the then Fed chairman Ben Bernanke told the congress that he is not monetizing the debt. He told QE and ZIRP are temporary. Balance sheet accumulation is temporary. Also promised that as economy starts to recover, he will somehow wind down the 4 trillion debt and restore it to its pre-crisis levels. None of them are true. The Fed's balance sheet is just below 3.85 trillion and with fed about to reduce the interest rates, we can safely assume that the debt on fed's balance sheet is not going to go lower than that. Ben Bernanke initiated the mess, Janet Yellen continued with that mess, and it fell on Powell to do the clean-up act, which was way overdue and impossible. Just say the Fed doesn't raise interest rates in July as expected by the market - the stocks are going to plunge. In fact the market wants a 50 bps cut rather than the usual 25 bps. The market is holding a knife at the Fed's throat.

On the political side, President Trump cannot afford is allow the recession to set in. It affects his reelection campaign of 2020 and in general the scope of the economy. No one knows that better than President Trump. As candidate Trump in 2015 he told correctly that the whole economy is one big fat ugly bubble based on ZIRP and QE.  He promised to act on the rising US trade deficit with all its trading partners and is taking some action on it (which may or may not be right). Candidate Trump also acknowledged that the shrinking of the work force participation percentage which has dropped significantly since the financial crisis of 2008. The government released unemployment rate doesn't capture this variant and its published to be lower than what it actually is. Trump during his campaign repeated multiple times, that the real unemployment rate is lot higher than what is officially reported and he even says it is as high as 20% or more. He was so right on that and it resonated with the US electorate. After coming to office though, Trump began to endorse the very same bubble economy as economic prosperity and even took credit for doing it. In fact - He calls it the Best economy in the history of the United States. The numbers do not support it whatsoever.  Because he owned the boom, unfortunately he will have to own the bust too.

The 10-year treasury yield which is used as reference rate for many long-term bonds, notably the US mortgage rates is trading at 2%. The Bond market is right - they are predicting that a 2% interest on a 10-year bond is more lucrative than the annual percentage growth that is going to happen in the next decade. But what it doesn't price in - is the inflation effect. The inflation rate is hitting the 2% level already. It will most likely make its ascend north. The Fed has already indicated that the inflation effect is "transitory of 2%" - which translates to - the inflation is going beyond the 2% mark very soon. With that happening around the corner, there is absolutely no reason for the longer term securities to have a coupon rate of less than that. In general - the longer dated treasury's interest rate are heading higher. It started to happen in last quarter of 2018 and that is where the stock market panicked. Any interest rate hike on long term bonds directly affects the leverage on corporate borrowing. With rising interest rates - rolling over existing debt is not an option anymore and the earnings will have to go down.

The slowing US economy usually takes the dollar with it. The dollar index has broken key levels since the Fed's meeting and is drifting downwards. Gold on the other hand, is breaking the $1400 an ounce and marching higher. To retrace its historic high, it needs to go to $1930 an ounce. It is definitely going there. It has made the price of gold for Asian economies higher. For example, In Indian currency, with the current exchange rate tied to the dollar index, the price of gold has already hit a historic high of Rs. 3580/- for a gram of gold. If we project it proportionally, if the price of gold hits the $1930 dollar mark, the corresponding rupee price for a gram of gold is Rs. 5000/-. This is politically not acceptable and panic would set in for a gold-rush or mania in the Indian gold market. So the only way to avoid this is to allow the Indian Rupee to appreciate against the falling dollar. It is possible then that the price of Indian rupee can move from its current Rs. 70/- rupee mark to say something around Rs. 50/-. That would be logical. The other asset class that is responding better to a falling dollar is bitcoin. As it stands now, it is already over 11K. When bitcoin as an asset class loses confidence and investors are jumping out, the trade is going to the traditional safe haven asset like gold, which is only going to accelerate the price higher in dollar terms.

In the month of May, the US government spent more than any month in its history. The debt accumulated every month is astronomical and has no historical precinct. The debt accumulated in 2018 (budget deficit and unfunded liabilities) is more than the nominal GDP (GDP not adjusted to inflation). This means that, if hadn’t for the rise in national debt (zero borrowing),  US economic expansion would have recorded a negative growth for the year.

If it can go wrong, it will. When it does, it will do so in spectacular fashion: breathtaking collapses, ghastly whitewashes and complete annihilation of confidence. Even though it was always on the cards, it appears more imminent that ever before. As Peter Schiff rightly puts it - Having the economy on ZIRP and QE are addictive in nature. Even though it feels good, they cause more harm than good. Withdrawal symptoms after heavy addiction are always painful. A recession is the absolute cure. Re-introducing ZIRP and QE again to make it work, may not work anymore!