BY DAVID SPENCER
Featured in Escape Artist Insiders Magazine | July 2021 Issue
We are standing at the precipice of history. Without a doubt, the year 2020 will be remembered as the year the world changed. Coronavirus, financial turmoil, economic lockdowns, a mental health crisis, riots & protests across the country, institutional confidence wearing thin, and unabated money printing while stock markets surged to never-before- seen highs. The story does not seem to add up, so let’s discuss the details one at a time. We will take a chronological approach just to make sense of it all. Our story begins on September 16th, 2019.
During that month, the Federal Funds rate skyrocketed overnight to over 10%. According to officials, this spike was caused by corporations in need of liquidity to make 3rd quarter estimated tax payments. The Federal Reserve quickly stepped in to settle the markets and continued to provide billions in liquidity into the overnight market. Despite the official “lack of liquidity” story, the Federal Reserve continued to provide support for months.
On December 31st, 2019, COVID-19 was introduced to the world. Did nature deal us a fatal blow? We were told the deadly virus had zoonotic origins, but officials failed to see eye-to-eye on many issues including the battle against the Coronavirus. This deadly disagreement occurred in a U.S. political climate that was ripe for strife and, predictably, chaos ensued. The response to COVID-19 shut down the economy and sent millions home without a plan.
Over a year later, the narrative of the virus’s zoonotic origin is now under question. We are now learning about Gain of Function research and wondering why it was allowed. This type of research is designed to make viruses more deadly and more likely to infect humans, all in the name of science. As questions begin to mount, the e-mails of Dr. Fauci are calling his every word into question. What did he know and when did he know it? A story is beginning to unfold.
The economic support that started in September continued (and was expanded) when COVID-19 stopped the economy in its tracks. Although the stock market is touted as an indicator of economic health, it continued to climb while the “real” economy was literally “homesick” — the disconnect could not be more pronounced. Fiscal and monetary stimulus continued, with near-zero interest rates and much needed stimulus checks distributed to Americans across the country.
For the first time, tensions in supply chains stopped Americans from getting their precious “things and stuff” in a timely manner, if at all. Dozens of ships off the California coast remained stuck, waiting for their turn to be unloaded while en route ships likewise parked off the coast with loaded hulls. The reason? The dockworkers went home. Now, a queue sits off the coast of California, waiting for enough hands to unload these massive ships. Meanwhile, the Suez Canal came to a standstill due to a grounded ship. This unprecedented hiccup in world trade caused prices to respond slightly, but no shock was experienced. I posit this “bubble” in the supply line needs some time to work its way through to the consumer. Perhaps then we will see a rise in prices that are in line with economic theories. These theories, though, are now under question as many of our mainstays in finance come to an end. Enter LIBOR.
LIBOR stands for the London Interbank Offer Rate and acts as the base for trillions of global contracts. The nuts & bolts of the LIBOR Scandal are beyond the scope of this article, but it was sensational — at least as sensational as microfinance gets. In short, three men were exposed as running a simple cartel that rigged interest rates. The world thought the LIBOR was an index that represented “market sentiment,” but it turned out that it was three bankers in a room, smoking cigars. The LIBOR Scandal that became known in 2012 was supposed to conclude with the death of the index in December 2019, ushering in a new era of transparency in interest rates and global finance. LIBOR is supposed to be replaced by SOFR (Secured Overnight Financing Rate), a new rate that is based on a much more robust market. The beginning of a new era.
This new era would be delayed due to COVID-19 and the term “great reset” would begin to fall from the lips of global bodies like the United Nations, the Bank of England, the World Economic Forum, and the Bank of International Settlements. All signs point to the inclusion of some form of digital asset or cryptocurrencies as a pivotal aspect. China is the first major country to implement a central bank digital currency and, in an effort to incentivize usage, has even implemented a lottery to compel citizens to download their digital yuan app. Bitcoin in China, though, is outlawed and citizens are hesitant to discuss it on government-monitored communication mediums. This technique is being primed in the US with the application of stimulus checks. People have become accustomed to Uncle Sam sending money and the government is keen to make collection more convenient — your “fed-coin” digital wallet will be coming soon.
With an eye to inflation, we can use the concept of hedonic adjustment to correlate a rise in price with an equal rise in quality. For example, proponents say that your computer is twice as expensive than in the past because it is twice as fast. There is some sense to this idea — is the car you drive today twice as good as a car that you purchased ten years ago? I would argue that yes, it is. If a car’s price doubles, then the utility of the car should be twice as much. This idea suggests that the dollar has retained the same purchasing power; that is, I am getting more car for my dollar. That is a good argument and is the logic we have been fed for a while. My question is, does my 2×4 now build twice as much wall as it did 12 months ago? Where is the hedonic adjustment there? Does my eight feet of pipe how carry 16ft of volume? I think not.
Two plus two is four and five minus one is four, but it does matter how you get there — either approach gives you the same result: rising prices. But the method by which you arrive is quite different. This analogy illustrates the fact that while we can see the same result, that does not necessarily mean that there is only one conclusion. There may be more than one way to explain the current situation we find ourselves in. Are we watching bitcoin skyrocket or are we watching the dollar collapse against the emerging asset class of digital assets?
We can see that there is a battle waging for the supremacy of market movers. Traditional traders battle for control against “Redditors” to see who has more influence over the market. We saw the impact of Reddit, as traditional investors were sent reeling as information was shared at a speed that made competition between “Redditors” and Wall Street a race worth watching. What does it mean when the retail investors feel sophisticated enough to challenge Wall Street? True or not, the illusion of power is all it takes to be massively disruptive, as we have seen with the AMC and GameStop sagas. Will this continue? What will be the next target? Is this a situation that will lead to mutually-assured destruction? Is this the market equivalent of nuclear titfor- tat?
Back to the reset. All around us central bankers and regulators speak openly of the reset that, previously, was a topic limited to conspiracy theorists. Do we know what this looks like? History tells us that the powers-that-be are not keen on tipping their hand until they are a few steps ahead. Is there a historical comparison? Do we have examples of economic resets in the past? Was this the case in Bretton Woods? Calls are rising for a new “Bretton Woods.” — what exactly does this mean? A “reset” could mean several different things. Is it the famed Debt jubilee? I think not, Debt is the basis of the entire financial industry today and to pull that rug seems a bit too drastic.
Is the “reset” a new paradigm for the sovereigns? Perhaps we will leave the petrodollar and arrive at a new global standard for international trade. There is already an eastern bloc (i.e., China, Russia, Iran, Iraq, and many other smaller countries) that have begun trading in currencies other than the dollar. This activity is flying in the face of international rules for trading in dollar-regulated oil. This activity also circumvents the sanctions placed on both Russia and Iran. If these countries transacted in dollars, they would be subject to unilateral sanctions imposed by the United States. However, with the introduction of an effective “Petro-yuan,” these countries have circumvented US sanctions. Predictably, the United States does not seem happy with this outcome.
The ultimate enforcement of these sanctions involves —in fact, promises—the use of force. It remains to be seen if the US public will support action against the largest countries in the world to support the petrodollar. The US public has turned a blind eye to oil spats with smaller countries since it does not affect the daily lives of Americans. However, the adversaries that the US is engaged with now have numerous levers with which to open the eyes of the American who is glued to the 24-hour news cycle or, more likely, the fantasy of reality TV. When the Amazon prime orders no longer arrive in one day, then the average American will raise their heads. The lifestyles we enjoy are so lavish that even the slightest interruption will cause the minds of Americans to look around and wonder “why is there no ice cream to accompany the cake?”
It used to be a favorite saying of mine that it is good to live in interesting times. I am not so sure anymore. There is much to decipher, particularly given the difficulty of acquiring reliable information. There is turmoil in every facet of our lives, from our money to our health. Protests rage worldwide, there are rumors of wars, famine, pestilence, drought, and political upheaval. No one can tell the future and that is not my goal here. My goal is simply to aid you in seeing the situation in which we find ourselves as investors and global citizens.
The outcome of all of the above remains to be seen. This is not intended to be a doom & gloom scenario. I am laying out some of the factors that I see as influential forces moving our world today. Dark clouds on the horizon can often lead to much chaos and destruction. But from chaos comes order. You cannot have rainbows without rain, and you have to break the egg to make the cake. All that sounds fine & dandy when you talk about rainbows and cake but, as they say in Florida, a hurricane is just rain and wind.
I could not tell you if we are in for a rain shower or a hurricane. I plan to be ready for either and then look for the rainbow. I am confident that the rainbow will come, no matter the severity of the storm.