In December last year we pointed out an obscure speech by a Federal Reserve governor and speculated that they were testing the water on a higher inflation policy. It was the first drip feed that the US inflation target will exceed 2%. The governor in question, Lael Brainard, said the Fed might target an average rate of 2% rather than an absolute rate.
She followed up in February this year, by then it had become a “flexible averaging approach”. Then March happened and we heard nothing until this week. Brainard had this to say:
“research suggests that refraining from liftoff until inflation reaches 2% could lead to some modest temporary overshooting, which would help offset the previous under-performance.”
Another Fed governor joined the chorus with the Wall Street Journal on Tuesday:
“I don’t see any need to act any time soon until we see substantial movement in inflation to our 2% target and ideally overshooting a bit.”
These are important developments. The mood music gets louder and I imagine that Jerome Powell will jump on board soon with an official policy announcement that 2% no longer means 2%. The consequences are quite far reaching:
- Interest rates are staying very low for a long time to achieve the desired inflation, so years.
- With an interest rate of 0.25% and an inflation rate of 3% (which would be compensatory as the Fed desires), we are talking about a real interest rate of minus 3.25%
- The rewards are to the indebted and not to the savers, which makes sense since America is in a great deal of debt. Why not reward themselves?
It’s a trap of course. Since the policy will require massive intervention to keep the interest rate as low as it will need to be to drive inflation upward. That will large scale bond buying by the Federal Reserve, which will drive more money into the financial system and continue to pump up stock prices. That again solves another problem around funding the retirement of Americans whose pension funds rely on those prices.
This unravels in one of two ways, and likely both:
1. Failed US bond auctions. When the government starts selling debt and the market demands a much higher interest rate than the official rate. The market will of course require compensation for the higher target rate of inflation
2. This will require bigger interventions from the Fed in the bond market to suppress the interest rate. In turn this will produce more price pressure, which will require higher compensation for bond issuance. Back to 1.
…….and very quickly, a vicious cycle begins. When those cycles begin, they are fast and no amount of intervention can stop them.
So, even if you don’t like bitcoin, buy some gold or land or rare watches or the Mona Lisa. Something scarce anyway.
Grayscale (the world’s largest bitcoin fund) reported last week. They included some quality snippets in their deck too and this one was eye catching.
The chart columns are rather well laid out in terms of target markets for digital assets which together, (all of them, bitcoin included) are only worth $261 billion. Indeed digital assets barely register on the chart.
There is $7.6 trillion of value in “Alternative Assets” for pension funds. 29x.
The gold market is 50x digital assets.
Negative yielding debt $13.4 trillion. 50x.
US retail trading platform Robin Hood has a useful tool. It allows you to track the number of users holding a particular stock against its price. In the chart you are looking at Tesla, in March there were 150,000 Tesla stock holders on Robin Hood. Today there are half a million and Tesla’s stock price has risen from $400 to $1,800. Elon Musk has now started selling red shorts on the Tesla website for all those short sellers who got burned by the charge in price. No kidding, here’s the link if you’d like a pair.
Tesla now has a market cap of $300 billion dollars, nearly double that of Toyota on $175 billion. Toyota sold 10 million cars in 2019, Tesla sold 367,500. A Tesla costs A$100,000, a cheap Toyota costs A$10,000. It doesn’t matter though, in today’s world the money counts and all the money is with Tesla.
The situation is repeated here in Australia, a record number of retail investors bought the dip this year. In Australia, the largest stockbroker is Commsec, a division of the Commonwealth Bank which has enjoyed record account opening numbers in the first half of the year. Indeed the regulator has noticed too, announcing in May that retail accounts were running at three times the level of activity of the prior year.
For so many years now, the stock market has gone up. Every fall has been followed by a strong rally and to be fair, buying when the panic is on has been a very good move. As we stand in July 2020, it has been a very good move once more.
The only problem is that when everyone learns something and acts on it, it ceases to be an advantage. By definition you cannot make a lot of money since, outside of average returns, it is a zero sum game. Everyone knows stocks bounce hard after a sharp fall, everyone knows it’s the best time to buy and when everyone knows it, it ceases to be so. We’ll see and having said all of that I still am not brave enough to short Tesla, even though I want to.
For example, take WhatsApp. It uses old fashioned PGP public, private key encryption. Your phone’s WhatsApp app has a private key on it, it signs your messages. If messages purport to come from you and don’t have the correct key they won’t be delivered. Twitter doesn’t work like this, twitter does not use encryption. Hence if someone hacks your account remotely they can pretend to be you as happened last week on a mass scale.
Blockchains on the other hand have another feature, they use encryption in a number of ways but in particular to tie transactions together such that they rely on their predecessors. So, your bitcoins are someone else’s spent bitcoins and it is fundamental that the chronological order of these transactions is preserved. Twitter relies only on the sender being who they say they are, predecessor tweets don’t impact future ones. Simple encryption signatures are fine for this.
So, if you think you need a blockchain, you probably don’t and you could just use old fashioned encryption. Clearly some of the biggest companies in the world don’t even do that, which is odd because the software is free and resides on every computer these day.
In the meantime, bitcoin made no announcements, it’s parliament didn’t meet, it still has a staff of zero and it didn’t borrow any money. It rose, 0.7% in the same period.
We will revisit this at the end of the next quarter.