What do a McMansion buying spree, a pandemic, and a cryptocurrency have in common? The mainstream media will have you believe these are all unrelated phenomena and certainly will not connect the dots for you. But I know we can do better.
You see, despite the U.S. unemployment rate reaching levels not seen since the 1950s in February of this year, the economy still had not recovered from the 2008 crash. How do I know? The balance sheet of the Federal Reserve Bank, our nation’s central bank, gives us a major clue:
The balance sheet of the Fed is effectively the amount of money it creates with computers, historically in exchange for short term U.S. government treasury bills. Up until 2008, the Fed had been prudent with its balance sheet expansion (i.e. dollar creation) because it needed the world to believe that it was conservatively protecting the value of the dollar. It needed the world to believe responsible adults were in charge of maintaining dollar scarcity, because since 1971, no precious metals backed paper dollars. Paper dollars became only redeemable for paper dollars, and if you want people to believe paper dollars are valuable, you better put fancy designs on them and make people believe they don’t grow on trees (or in computers).
But in 2008 this all changed. The bankers got a little overzealous for a few years and lent out money they knew might not get paid back, because they thought they could sell their IOUs to some other sucker for a price higher than what they bought or generated them for. That sucker ended up being you, the American taxpayer.
And because the banks held so many bad loans, the liabilities of the American banking system probably exceeded the value of their assets according to generally accepted accounting principles (which were conveniently suspended to make the banks look healthier than they really were). Because what’s a little fraud when the economy really needs it? The banks were essentially insolvent (read: worthless). And because money in our economy is ultimately created through bank loans, the bankers did a hell of a job convincing congress that the economy needed them to keep going.
In normal times before the 2008 housing bubble burst, the Fed held less than $1 trillion in assets, and the total amount rose steadily as the economy grew. But after Lehman Brothers failed in September 2008, the Fed used its computers to generate over $1 trillion in the course of a few months, in tandem with the federal government extending $700 billion in bailouts (bank welfare). Both entities traded real dollars for which taxpayers like you and I are theoretically on the hook, for toxic waste held in the form of unpayable mortgages owned by banks, pension funds, and other asset managers. These acts conducted by government and Fed officials enraged so many intelligent individuals, that one or a small group of them joined forces to create Bitcoin, a decentralized currency with safeguards to protect against repeating the shenanigans of 2008. More on that later.
The narrative pushed by Wall Street at the time was that the banking system was going through a “liquidity crisis” rather than a solvency crisis. This means they claimed all was well in normal times, but they were temporarily unable to sell their IOUs at a price they were “almost certainly worth.” If this were actually true, the chart above would show a “n” or “/\” shape, indicating the Fed was temporarily printing dollars to buy bank “assets,” and then shortly thereafter, following the end of the crisis, selling those “assets” back for dollars, then removing the dollars from circulation. But as you can see from the chart, this clearly did not happen. In fact, the opposite happened.
Following the depths of the 2009 recession, as the private sector of the U.S. economy was not healthy enough to flourish on its own, the U.S. government helped plug a portion of the gap via increased spending that it financed through borrowing. As you can see we’ve borrowed a lot of money and in case you were wondering, most countries that borrow this much money never pay it back unless they control the printing press that funds them.
What does a government that spends nearly $1 trillion more than it takes in via taxation need, you may wonder? Low interest rates of course. Because a government that carries $20 trillion in debt must pay an extra $200 billion each year for every percentage point their borrowing costs rise.
So the government gets to borrow money more cheaply. What’s the big deal, you may wonder? Well all borrowing rates are linked to the borrowing rate that the U.S. government pays. The more the Fed helps the government (by guaranteeing capital market participants that it will both pay a high price AND be the buyer of last resort for U.S. government debt), the lower the rate the government pays, the lower the rate everyone pays. And you may think that’s a good thing, after all, who likes paying high interest rates? But a downstream effect of low interest rates is that money that is too cheap becomes misused. So misused that as much as 30% of recent corporate financing has been used to buy stock in the company that took the loan out. To clarify what happens in this situation, millionaire executives who get paid primarily in the form of stock options, borrow cheap money on behalf of their company to buy their own company’s stock. This increased stock demand (generated by the executives) pushes the price of their stock up and with it, the value of their options. It was an open secret that this was unsightly behavior, but most of the responsible adults looked away and hoped nobody would notice as the stock market climbed higher and higher.
And it seemed nothing would stop the market from reaching new highs. Just 5 weeks ago, the S&P 500 reached its all time high, nearly 5x higher than its 2009 lows. Everybody (read the half of America that owns stocks) felt rich! But the hidden underbelly was that these companies amassed so much debt in the run up to the market top, that a significant disruption to their business would be disastrous.
Here you can see corporate debt as a percent of GDP has never been higher
But things felt calm, even optimistic. What major disruption could come? Enter coronavirus. A disease with a growth rate unseen in a century. The economic disruption has been so severe that major investment banks (whose job it is to pitch companies and the economy in a generally positive light) are predicting a 30% drop in GDP. To put that into perspective, they’re expecting a Great Depression level decline in productivity.
So what playbook are our leaders looking to? The 2008 playbook of course. White House economic advisor Larry Kudlow is saying that as much as $6 trillion dollars (i.e. 3 Iraq wars, or as a percent of GDP, 1 Civil War or WW1) could be deployed to stop the bleeding.
Essentially what we are seeing at a grand scale is that neither citizens nor corporations are expected to save money for rainy days. There is no political will to say “life’s tough, get a helmet,” to any powerful special interest group. Rather than secure the integrity of the U.S. dollar, the Federal Reserve and the U.S. government are treating it like toilet paper (2019 toilet paper that is) and dispensing it liberally to the groups that will keep them in power.
The common counter argument is that inflation is low and if inflation became an issue, the newly created dollars could be removed. This is of course absurd, as inflation is already here, it’s just politically unacceptable to actually measure it accurately. Just ask San Franciscan families making $117,000 per year who qualify for low income housing or college students who pay about twice as much for textbooks as they paid before the crisis what their inflation rate is.
And the recently created dollars certainly could not be easily removed from the financial system, because removing the dollars from the market would require a massive sale of Fed owned debt which would spike interest rates for already fiscally challenged state, local, and federal governments. So if you worry that the seemingly unlimited creation of dollars might affect the purchasing power of your savings, congrats! It means you’ve been paying attention.
So what can you do to protect yourself? In addition to conventional investments, I personally own gold and Bitcoin. When life becomes chaotic, items that protect you and items with inherent scarcity tend to hold value. For much of human history, gold, and sometimes only gold has been money. J.P Morgan, the man after whom J.P. Morgan and Morgan Stanley are named, once said, “Gold is money, everything else is credit.” By that he meant paper dollars were IOUs or fantasy wealth, while gold was the real deal due to its historical importance and banks’ and governments’ limited ability to fudge its outstanding quantity.
And Bitcoin, which emerged specifically in response to egregious corruption on Wall Street and Washington, is seen by many as digital gold due to its security and limited quantity. It cannot be minted or printed in response to a crisis of irresponsibility. It is used by Argentinians to store value when their government and central bank prove untrustworthy, and it can be used by citizens of any nation to assuage similar fears. Unlike gold, Bitcoin is challenging for governments to find and confiscate and large amounts can be carried securely on planes and easily transferred across borders. This makes it potentially more useful than gold in a global, internet-based economy.
In all likelihood, there will be a return to normalcy sooner than people can presently fathom. But until then, I am resting securely knowing my refrigerator is stocked, my family is safe, and my gold and Bitcoin fortified financial portfolio has, and I believe will continue to maintain a vast majority of its value amidst widespread market panic.