The Breakdown - “The Fed Meetings Are a Dead Spectator Sport” Best of The Breakdown September 2020

Episode Date: October 3, 2020

A recap of September, which NLW calls a transitional month between the post-lockdown excitement of the summer and the growing macro insecurity around second wave fears and election volatility.  Featuring some of the most interesting insights from our guests, including: Luke Gromen on the four options for countries that can’t pay their debts Tavi Costa on the Fed’s new “mandate” to keep asset prices high  Raoul Pal on why “monetary policy is over”  Sven Henrich on the ever-weakening economic cycle Corey Hoffstein on the fundamental supply-demand mismatch that exacerbates exogenous shocks Michael Saylor on why he moved his company’s cash reserves to bitcoin

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by crypto.com, nexo.io, and elliptic, and produced and distributed by CoinDes. What's going on, guys? It is Saturday, October 3rd, and that means it's time for the Breakdown Weekly Recap. However, because it is the first Saturday, day of the month, instead of the weekly recap, we're going to do the monthly recap. September was an interesting transitional moment. You had a real sense of almost in-betweenness or liminality creep into the major discourse, and moreover creep into the sentiment. And what I mean by

that is that you had seen a summer where we were charging back after the spring's COVID-19 related shutdowns, but the fall was starting to hit a different note. On the one hand, that had to do with the fear of a rise or a return or a second wave of COVID-19. On the other, it just had to do with the end of the easy phase of a recovery where the jobs that were coming back were much harder won, not just the things that had been lost immediately in the short term. Layer on top of that, the fear or nervousness or just general lack of clarity that comes with a presidential election, and you had the right sort of mixture for a big question mark, let's say. My guests in September, I think articulated from a macro perspective a lot of that in

betweenness with a special emphasis on the immobility really of the Federal Reserve, this central actor in the economic system we've constructed, to actually move and change things, both in the short term and in the long term. Let's kick our conversation off where we kicked off September as a month with Luke Groman. In this clip, he gives us a clear-eyed look at the options from here, with the here being a debt burden that we can't possibly pay back. To me, the punchline is that if you look back over the last 100, 120 years, any time you get sovereign debt levels as high as they are now in the U.S.

and more broadly across the developed world, there's four outcomes 100% of the time. It's restructuring slash default. It's inflation, it's financial repression, or it's hyperinflation. That's it. Those are your choices. And so if we can assume that the United States is not going to restructure or default as treasuries, which I think is pretty safe, we can set that one aside. Historically, and this ties into the political reform side, or excuse me, political courage size and lack thereof, if we were going to reform entitlements in the United States, the time to have done so was prior to 2008, because post-2008, after you bailed out the banking system, you made it politically impossible

for all intents and purposes to reform entitlements, because you can't cut payments to retirees after you've bailed out Wall Street. And even if that was maybe theoretically possible, up until now with what we're seeing happen across cities in the United States. This year, I think the ability to restructure that portion of our obligations is gone. So now you're left with inflation, financial repression, which is I would lump in with inflation. It's just another form of it, or hyperinflation. And so when I sort of break it down that way, or it's different this time. This will be the first time in 120 to 200 years that you've got a massive amount of sovereign debt, and it somehow doesn't result in one of those four.

I suppose that is possible. There are ways it is possible, but I think it's a very minimal chance. And so that ties back into the tweet that you're referring to where I think we're in a transitional period. I think Powell's speech represents, I guess, if we think about it as, you know, trying to swing from one trapeze to the next. I think this speech was maybe either preparing to let go of one trapeze or actually letting go of one trapeze and trying to grab the next one. And hopefully he doesn't miss it.

Macro-analyst Tavi Costa picked up the same theme of a certain inevitability of inflation based on the debt levels being where they are, but also discussed the assets most likely to benefit in that context. I think what a lot of people are missing in my view is more of the structural problems in the economy related to the debt problems that we have in corporations and the government as well. I think there's no way out of this aside from inflation. And the real question is when are we going to see that kind of response or consequences from the policies we've seen so far. I think that the Federal Reserve right now is painted into a corner in which it has to continue to buy assets to prop up equity markets. It almost has two new mandates is to keep valuations of equity markets afloat.

And at the same time, suppress interest rates to continue to allow companies to borrow at cheap prices and the government to also borrow at cheap prices. And so I think this is all happening at the same, which I call this a, it's a dynamic that we're seeing in which is an explosive mix for precious metals in general. It's a supercharge environment for precious metals in my view. And any monetary alternative for the monetary system, which Bitcoin would be part of that too. This episode is brought to you by crypto.com, the crypto super app that lets you buy, earn, and spend, crypto all in one place and earn up to 8.5% per year on your Bitcoin. Download the crypto.com app now to see the interest rates you could be earning on BTC and more than 20 other coins. Once in the app, you can apply for the crypto.com metal card,

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What's more, interest is paid out daily, and you can add or withdraw funds at any time. Get started at nexo.io. For Northman trader founder, Sven Henrik, the real issue is that investors have been trained not to take, take real economic plight seriously. In his estimation, this creates an ever-weakening market cycle. Well, that's what they've done. I mean, you can actually hear the Fed themselves using the word and empower himself, you know,

to calm markets, you know, that they hate volatility in the sense that, you know, it reflects two-way price discovery. And, you know, for the last 12 years, we've seen them step in. Every single correction has ever been the Fed has stepped in one way or the other, or obviously global central banks as well. And part of my complaint in general has been because they are now in a mode where they've been forced to adopt this stance,

to constantly step in, to always be afraid, because this is really what this is all about. They have, on the one hand, trained investors to not ever take any corrections seriously. Nothing will last more than a few weeks, right? even in the March crash that we had, they stepped in so hard. December 2018, when we had that 20% drop on the heels of the Fed actually trying to raise rates and reduce their balance sheet,

as soon as markets dropped hard, they stepped in and stopped it, right? That's what they do. And so investors have been trained not to take anything seriously. And I understand, and that's been working. I always keep buying the dip and so forth. But the perpetual machine that's been created as a result of that is that we see this exorbitant market valuations. One of the metrics I've been using is market cap to GDP. Now you can argue about market cap to GDP based on technology companies having a global footprint and so forth.

But what we've seen here in this run-up here in September was insane. We got to 187% market cap to GDP. And so my point is they are the perpetual. bubble machine because they're afraid they cannot take any volatility markets and they're afraid of, I guess maybe the corner they box themselves into it because as soon as you get a right sizing of markets, it has a negative impact on the economy. And since they constantly view themselves in the business of managing the economy via market and market trajectory, you know, we keep getting building ever larger bubbles, not only on the asset valuation side,

but also on the debt side because they keep enabling it. And that's my worry because we're ending up, you know, coming out of this crisis here, not only with the largest market valuations ever, but also the highest corporate debt and the highest financial debt in the U.S. And that to me is creating a ever-weakening economic cycle. And that's kind of confirmed is what we've seen in the last 20 years because, yeah, we keep lowering rates and we raise it.

ever incrementally to lower highs. And so the economy is zomifying itself. Right now, obviously, they have all these companies buying, you know, or they are buying junk debt of all these companies. And you have all these companies, these zombies companies running around that don't generate any profit or their debt obligations or higher than their profits. So my critique has always been, well, are they actually doing any good here? Because, you know, it's, the system never gets to cleanse itself properly.

Real Vision founder Raul went even farther on the Fed's immobility, saying that monetary policy is over. Look, Americans are terrible at not looking outside of America. But look at Mark Carney from the Bank of England. He resided over the Bank of England for, I don't know how many years, eight years, ten years. Never saw a rate rise. He can do anything. And we have to get used to this. Monetary policy has finished.

Yes, can they tweak a bit of QE more, but we know it doesn't really work. So there's nothing they can do, not until, and we can talk about this later, until we blend fiscal and monetary by the use of digital currencies, particularly, you know, the Fed coin, for example, not until we get to that day, do the Fed really have anything to do. So their job now is just don't let anything blow up. If it blows up, like the credit market, their job is to provide liquidity. But there's nothing else they can do anymore. So it's a world where there's no real point listening to the Fed.

The Fed are told us very clearly. They're not going to raise rates ever again. You know, that could change. If we structurally change how the economy is driven, you know, by set up as fiscal policy and, you know, universal basic income, maybe that changes. But if nothing changes, the Fed are never going to raise rates again. They can't. Because if you remember from the last time we went through the rate cycle, what happened

happens is everyone puts more leverage on at the lower rates. So then you can't raise rates because you blow them all up. And if you just remember what's just happened in the last three months was record borrowings from corporates. So the leverage is just ratcheted up a whole level, another level at the lowest all-time rates, which makes it now impossible to raise rates. So if they were to raise them 100 basis points, the economy goes straight into recession. So yeah, the Fed meetings is a dead spectator sport.

For newfound researches, Corey Hofstein, the issue isn't just the Fed. It's a convergence of factors including the Fed, the rise of passive investing, and the rise of the volatility trade, which together have the net impact of making markets move more aggressively on both the up and the downside. To summarize, really, the whole piece was trying to look through a lens of the markets that's ultimately about supply and demand. right that if I were to really try to put it into into one core idea it's I'm not talking about the market is is it overvalued is it undervalued is fed policy right or wrong quite purely I think all of

these ideas come back to the core concept of what impact do they have on market supply and market demand and when is there a meaningful mismatch either a mismatch that is building over time slowly and is is bound to explode or a mismatch that occurs sort of instantaneously because of different pressures. And I think for me, what I found is, again, it doesn't matter which of these narratives you look at, which one you have more confidence in, which one you have less confidence in. It's all creating the same supply demand mismatch that ultimately seems to be playing out when you get some sort of exogenous shock like we saw this march. When it comes to the implications of all of this that we've been discussing, debt, inflation,

changing market cycles, at least one public company is trying to get, out ahead of it. One of the biggest stories of the month was when micro-strategy announced that they had moved 425 million of their cash reserves into Bitcoin. CEO Michael Saylor explains here. It seems to me as a casual observer that you could estimate the asset inflation rate starting in March for the next five years at 20% a year, 20% a year. 25% a year. That's the cost of capital. And you are now, if you're sitting on top of a billion dollars, you're going to take a $200 million hit per year. How many companies can generate $200 million in after tax income per year to cover the hole that they're digging in the ground?

So that's my journey, right? That's, it wasn't important until it was important. And then when it got important, it got really important. And then I, as I said before, I just came to this horrifying realization. I was sitting on a $500 million ice cube, and it was melting at least 10% a year, but probably 20% a year. 10% of year is magic, by the way, because we're making, you know, We're thinking we're going to generate 50 million after tax or cash flow and we're going to put it in the bank.

And if you're going to melt 50 million of my treasury while I put 50 million in the bank for the next decade, I'm also just right off the decade as a lost decade. I watch these crypto Twitter guys and they look at what we just did and they're like, oh, what happens when they dump it? Like they bought all this Bitcoin. That's bearish. They might sell it and that'll be bad for the market. Or when is he going to sell it?

If it goes down by 5%, is he going to lose interest? And I think they don't get it. I bought it for the next 100 years. I didn't buy it to sell it ever. Of course, now here we are in October. Election volatility was already a thing, and then President Trump announced late Thursday night, early Friday morning that he had been diagnosed with COVID-19,

throwing an entire new set of questions around this election. Given that, it's basically impossible to tell what will happen over the course of the next month, but you know we'll be here keeping track of it. So until then, thank you for listening. If you're enjoying the show, I really appreciate all the ratings and reviews. And until tomorrow, guys, be safe and take care of each other. Peace.