The Breakdown - Fight the Fed or Love the BRRR? [Long Reads Sunday]

Episode Date: June 21, 2020

A reading of two pieces How I Learned to Stop Worrying and Love the Money Printer by Jill Carlson | CoinDesk + Fight the Fed Jesse Felder | The Felder Report 

Welcome back to the breakdown, an everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond. This episode is sponsored by BitStamp and Cipher Trace. The breakdown is produced and distributed by CoinDesk. And now, here's your host, NLW. What's going on, guys? It is Sunday, June 21st. And last Sunday, I tried something where I, instead of bringing you a normal show, I brought you a bone episode that was a read of an essay that I thought was really interesting. Well, I got good feedback on it,

and I was thinking about it a little bit more, and I have been for the last two years writing a weekly newsletter called Long Read Sunday that looks at the most interesting essays in finance, macro, Bitcoin, et cetera. And so I figured that actually doing a Sunday essay read might be pretty on point, right? And so I'm going to try it for a few weeks. We'll see if you guys like it, if it's value-add content, and we'll figure it out from there. So this week I'm actually doing two shorter pieces that are, they're not necessarily opposed to one another, but they do represent slightly different takes on the same issue,

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The first is from Jill Carlson, and this was an essay printed on CoinDesk called How I Learned to Stop Worrying and Love the Money printer. This was written in April, so it's totally possible that Jill's perspective has changed or that just we've learned more, but I wanted to share it because I think it was one of the earliest pieces to run counter to the kind of dominant Bitcoin inflation fear narrative as it related to the dollar and is useful for that reason. We Americans love to complain about the economy, about policymakers, about bailouts, about the Federal Reserve. But whenever I travel abroad, I am struck by the immense privilege of having the U.S. dollar as my native currency.

I have yet to find a cabby, a hotel clerk, or indeed a banker in any part of the world who will not gladly accept the greenback as a form of payment. countries from Argentina to Zambia, I have found demand for dollars when I have come up short on the local currency. The demand for dollars was never more evident to me than in the course of the research on Venezuela I conducted with my colleagues at the Open Money Initiative. We went into the research hoping to learn how tools and technologies like Bitcoin were being used by Venezuelans facing the collapse of their own currencies. What we found over and over again was instead rampant demand for only one weapon in the face of hyperinflation, the US dollar. We spoke to young entrepreneurs

who leverage convoluted networks of friends and relatives to reach someone with a U.S. bank account through whom they can keep some of their wealth in greenbacks. We spoke to some of these account holders de facto informal bankers for entire communities who have to maintain paper records detailing their nephew's girlfriend has $200 held in their account and their ex-wife has $50 with them. We spoke with money changers in Venezuela who worked tirelessly to meet demand for U.S. dollars, even smuggling hordes of cash across the border. The demand for U.S. dollars is not only present in extreme circumstances as in Venezuela, nor only at the level of the individual. It is most notable at the nation-state level.

Since World War II, the U.S. has enjoyed the role of supplying the world's reserve currency. This meant something different in 1944 than it does today, but the result is what matters here. The U.S. dollar is the standard unit of account for currencies and commodities globally. When central banks around the world seek to manage the strength of their own local currencies, they do so relative to the dollar, buying or selling U.S.D. When India imports oil from Iraq, that oil is priced in U.S. dollars. Dollars are everywhere. Thanks to these dynamics, many countries and international institutions also borrow in dollars.

When Brazil or Indonesia or Ukraine borrows money from investors and creditors, they often do so in dollars as opposed to reals or rubias or hervinias. This generally enables countries to borrow at a lower interest rate than they would otherwise be able to access. This also means, however, these countries have a structural and ongoing demand for dollars because that is the currency they will have to use to pay off the interest in the principle on this debt. Countries and global corporations issuing dollar-denominated debt are exposed to currency risk.

If the U.S. dollar appreciates materially relative to their local currencies, which represents the majority of the cash inflows, then these borrowers can find themselves in trouble. For this reason, most countries maintain dollar reserves. But these are not always sufficient to cover all of their dollar denominated obligations spurring further dollar demand. Last month in March, the global implications of the COVID-19 pandemic became increasingly clear. The value of the dollar spiked. Hedge funds, retail investors, international borrowers, and everyone in between made a dash for cash. As the world hurried to liquidate stocks and sell credit, it sought to liquidate these assets for one thing, U.S. dollars. In trading, a sale is never just a sale. It is also the purchase of something else.

In this case, everyone was selling everything for dollars. In a world that already has high demand for dollars, due to both psychological and structural forces, the implications of strong dollar appreciation are enormous. The Federal Reserve, which is tasked with managing the supply of dollars in the world, did the only thing it could do in the face of this. Turn on the taps. Over the course of just a few weeks, the U.S. Central Bank cut its target interest rate to zero, pledged unlimited asset purchases, and implemented a slew of other measures that were absolutely unprecedented, even relative to the measures it took in the wake of the 2008 financial crisis. These actions have been memorialized and criticized in the form of the popular meme, Money Printer Go Burr.

The idea behind the criticism is that the U.S. is abusing what Ray Dalio in a Reddit AMA recently called the world's most important asset, the printing press of the world's reserve currency. Critics implicitly liken the Fed's unprecedented easy monetary policies, policies that seek to weaken the U.S. dollar, to the policies of Weimar Germany or Maduro's Venezuela. They fear out of control inflation and an absence of political will to ever turn off the presses. Those fears may not be baseless over the long run. But even having spent a material part of my career researching inflationary crises, working in emerging markets, and holding Bitcoin, I'm not currently worried about excessive money printing.

The fact is, we need the Federal Reserve's money printer to burr right now. The U.S. dollar over the last five years has already maintained relative strength against global currencies. The economic crisis brought on by the outbreak and spread of COVID-19 has only further spurred this strength. What strength actually means here is a shortage of dollars relative to demand. If that demand is not met, then companies and countries around the world face a liquidity crisis. Dollar strength, if allowed to persist, can also result in long-term deflation, which hurts economic growth at home. Denouncing excessive borrowing and money printing is a tempting stance based on the salience

of images of hyperinflation, wheelbarrows of cash and trillion-dollar bills. The images of deflation are fewer and less likely to, strike fear into our hearts, but they should. Condemming money printing is also enticing as a superior moral stance. It seems to advocate responsibility, accountability, and rationality. In a world that is inherently short of dollars and is only becoming more so, refusing to increase supply is anything but responsible and rational. Someday, after a vaccine is found, when we were all once more commuting to work on the subway and toasting each other at bars, it will become important for the U.S. to find the political will to shut down its money printer. We will have to wind down that which today is

necessary. We will have to hike interest rates. I am not confident that will happen. At that point, I will become concerned about dollar devaluation. But not today. Today we need to keep the dollars flowing. The second piece I want to share is Fight the Fed by Jesse Felder, who was on the show just a couple weeks ago, and it starts with a quote from Warren Buffett from November of 1999. In my opinion, you have to be wildly optimistic to believe that corporate profits as a percentage of GDP can, for any sustained period, hold much above 6%. One thing keeping the percentage down will be competition, which is alive and well. In addition, there's a public policy point. If corporate investors in aggregate are going to eat an ever-growing portion of the American economic pie, some other group

will have to settle for a smaller portion. That would justifiably raise political problems, and in my view, a major reslicing of the pie just isn't going to happen. 20 years after this was written, the wild optimist had been proven right, and Buffett's faith in reversion to the mean proven wrong. Corporate profits as a percentage of GDP soared above 6% in the first quarter of 2002, and outside of a brief dip during the fourth quarter of 2008, have remained above that lofty mark for nearly two decades now. Competition, it turned out, was not, in fact, alive and well, as Bridgewater wrote last year.

Antitrust policy has been loosened to the point at which many firms have been able to buy up their rivals and create oligopolis, if not duoplies and monopolies, across a number of industries. Globalization and demographics certainly played a part as well, but there is one other cause that I think fails to garter the attention it deserves. monetary policy over the past couple of decades has also shifted towards aggressively and directly supporting capital. It's true that the Fed doesn't really have the tools to support labor directly. While part of its dual mandate is to promote full employment, it can only do this through the capital markets by lowering interest rates and buying up securities. In this way, extreme monetary policy is the ultimate in trickle-down economics, the idea that when the wealthy benefit inordinately, their spending an investment will eventually benefit everyone else.

The results, however, speak for themselves. explicitly targeting wealth effects over the past two decades. First, the housing bubble under Island Greenspan and then the everything bubble under Ben Bernanke and Janet Yellen. The Fed has pushed household net worth as a percentage of GDP to record highs. Capital has benefited to a degree never before seen in our nation. Meanwhile, labor share of income has fallen to its lowest level in history, and wealth inequality is very possibly even greater than it was a century ago.

Where Buffett got his prediction right is in the political problems he foresaw. Both political parties are moving to the extremes, conservatives towards nationalism and towards socialism. This is an inevitable outcome of the major replacing of the pie we have seen over the last 20 years, and it will eventually lead to another reslicing that is more equitable. The backlash against wealth and income inequality and the fallout of the pandemic are the driving forces behind the trends already moving towards a renewed antitrust framework and a rethink of globalization and the offshoring of critical production. However, while these are important areas to focus on, we should not forget to include the most powerful institution on the planet and its own policies

that have done at least as much to dramatically skew the economy in the financial markets. Extreme monetary policy has not only artificially inflated capital, but has also greatly exacerbated the boom-buss cycle, leading to two once-in-a-generation economic crises in just over a decade. Inflating asset prices and encouraging increasing indebtedness beyond what the natural economic cycle can support is not a sustainable way of trying to manage the economy. Even former Fed Chair Janet Yellen lamented after the financial crisis,

quote, somehow we need to go to an economy that is using its resources, operating at full employment, but doing so in a way that isn't reliant on bubbles. The economy has only become far more dependent upon bubbles in the capital markets since then. So for those looking for ways to level the playing field that has been tilted greatly in favor of capital over labor, I would humbly suggest they include the Federal Reserve and its role in exacerbating the underlying problems. Without a holistic approach that includes a rethink of extreme monetary policy,

any proposed solution may only prove to be half measures. All right, guys, happy Father's Day. Thanks for listening.