The Breakdown - Welcome to the ‘We Just Don’t Know’ Economy

Starting point is 00:00:00 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 nexus.com, and ftX, and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, August 20th, and that means it's time for the weekly recap. Now, before we get into that recap, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you you want to dive deeper into the conversation. Come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also, a disclosure as always, in addition to them being a sponsor of the show, I also work with FTX. Now today on the weekly recap, we're talking

Starting point is 00:00:52 about what I'm calling the we just don't know economy. But where we start is Friday morning. Crypto market participants woke up Friday to an absolute bloodbath. Bitcoin plunged around 7 or 8% overnight, effectively, completely reversing the gains of the last few weeks that happened in the wake of U.S. inflation coming in lower than economists expected. At the time of recording, Bitcoin is hovering around 21,500, its lowest price since July 27th, while Eath is around 1,700. It's the biggest single-day drop in percentage terms in two months, and caps, with a vengeance, what had been a slight but consistent five-day slide. Before this morning, that slide had been largely attributable to mark a market.

Starting point is 00:01:35 markets cooling their heels after perhaps getting a little over-exuberant in the wake of the U.S. inflation print. In other words, markets were very relieved to get 8.5% year-over-year inflation instead of the 8.7% that was anticipated. The fact that there was 0% month-over-month inflation growth was even more delectable. But the excitement around that has started to fade. The Fed has reinforced that they are going to do whatever it takes to fight inflation, that the talk of reversing course is premature, and, as we'll see, we've just had a slew of more worrying economic signals. In any case, on Friday, it was again inflation that drove crypto market action. Alex Kruger summed it up. Two things happened overnight. A, equity risk off driven by bad

Starting point is 00:02:21 German data. B, crypto hit air pocket after consolidating at the lows. See markets moving from focusing on the Fed to focusing on Europe. So let's talk about that bad German data. The specific data that Kruger is referring to was the producer price index. This is the prices that producers pay to make things. Month over month, economists expected the German PPI to rise 0.7%. Instead, prices were up 5.3%. Year over year, PPI hit 37.2%. Last month, it was 31.8%. And economist estimates had it coming in this time at 32.7%. So a huge shock to the upside. Importantly, producer prices are a leading indicator for inflation, because producers whose costs have gone up are forced to pass those costs on to buyers of their end products. As you will expect, the big

Starting point is 00:03:15 driver of these huge increases was energy. Energy prices as a whole were up 105% from the year before in Germany. Germany's finance minister said, quote, the significantly lower gas supplies from Russia, the persistently high price increases for energy and increasingly other goods, as well as the longer-than-expected supply chain disruptions also in connection with China's zero-COVID policy are weighing heavily on the economy's development. Now, when Kruger said that attention is shifting to Europe, part of what he's referring to is that as bad as inflation has been, the energy part of the equation is poised to just get even more complicated. Beginning October 1st, Germany is imposing new levies on gas that they anticipate will add several hundred euros to the average family's

Starting point is 00:03:59 energy bill each year. They're trying to soften the pain by reducing sales, tax on gas from 19 to 7%, but it's still being viewed by average Germans with significant trepidation. At the end of August, a couple other relief measures from Germany are coming to an end as well, including a fuel tax cut and cheaper public transit. Right now, the Eurozone's inflation is 8.9%, which is a record for the region. In the UK, though, it's even higher. Last month, inflation in the UK hit 10.1% the highest it's been in 40 years. Also the first double-digit inflation in a major economy post-COVID. A huge driver was food, which rose 2.3% just between June and July, the fastest monthly increase in 21 years. And even as the U.S. gets its peak inflation narrative

Starting point is 00:04:46 going in Europe and Britain, fall and winter energy concerns create a totally different situation. Britain currently has a cap on household energy bills that is slated to go until October. It's a limit on how much suppliers can charge. Consultants in the UK, however, are estimating that once the cap is lifted, the average energy bill in the UK is going to jump from around 2,000 pounds now to 3,600 pounds, an 80% increase. The wholesale cost of natural gas is the biggest driver. Just this week, natural gas wholesale prices increased 15%. And overall, natural gas is up 4x what it was last year at this time. Rupert Harrison, a portfolio manager at BlackRock tweeted, UK and European gas and power prices continue rising to truly scary levels.

Starting point is 00:05:32 The government will have to act on a very large scale to support households, especially those on lower incomes and also probably small businesses. The scale of this shock is hard to overstate. This is not just another energy shock or cost of living squeeze. It's a once-in-a-generation threat to the solvency of many households and businesses that could scar the economy for years to come. The Bank of England is projecting that when energy prices increase, it will absolutely crush consumer spending, which will send shockwaves into other parts of the economy. When energy is factored in, the BOE thinks inflation will hit 13%. This is how a supply shock, natural gas formerly supplied by Russia not being as easily available, turns into a demand shock outside the energy sector.

Starting point is 00:06:16 It's also worth noting that currently in the UK there is a big leadership vacuum after Boris Johnson stepped down. The next prime minister will either be Liz Truss, the Foreign Secretary, or Rishi Sunak, the former chancellor of the exchequer, who, among other things, led the shift in tone on Britain in crypto. In times like these, security of your assets should be your number one priority. If you want to offset risk as much as possible and still stay in crypto, you need a trusted partner by your side.

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Starting point is 00:08:07 Download the FTX app today and use referral code breakdown to support the show. Back in the U.S., the week ended on some similarly dreary tones as to where it had started. Bloomberg reported that the U.S. mortgage industry is beginning to see lenders go out of business. Quote, there is no systemic meltdown coming this time around because there hasn't been the same level of lending excess and because many of the biggest banks pulled back from mortgages after the financial crisis. But market watchers nonetheless expect a string of bankruptcies broad enough to trigger a spike in layoffs in an industry that employs hundreds of thousands of workers, and potentially an increase in some lending rates. More of the business is now controlled by independent lenders, and with mortgage volumes

Starting point is 00:08:49 plunging this year, many are struggling to stay afloat. End quote. Currently, home loan applications are less than half of where they were a year ago, which would be a big decline for any industry to handle, but there are some specific dynamics of mortgages that are exacerbating the problem. specifically the rise of non-bank lenders. These firms tend to be less robustly capitalized than their bank peers, which makes it harder for them to withstand market volatility. In 2004, only one-third of the top 20 lenders were non-bank. Last year, it was two-thirds. What's more, this trend has been accelerating. Since 2016, bank's share of the mortgage market has dropped from a half to a third. As with so much of our economy, the rise of these types of non-bank lending institutions can be traced

Starting point is 00:09:32 at least in part back to fallout from the global financial crisis. After that event, banks pulled back from lending, creating the opening that non-bank lenders came into. This, by the way, is a process that continues to happen until today. Wells Fargo, which at its peak originated one out of every three home loans in the U.S., is preparing a major pullback from the lending business. The bank has dealt with years of costly regulatory probes and has been subject to numerous scandals. Last month's reports show that in 2020, across the entire lending industry, lenders approved 71% of refinancing applications from black families. Wells Fargo, however, approved fewer than half, just 47%. This is almost for sure going to come up in big bank congressional hearings next month,

Starting point is 00:10:15 so basically new leadership at Wells is like, screw this. Anyway, these mortgage failures and bankruptcies were the capstone of a week that started, with a National Association of Home Builders Survey showing that Home Builder Confidence has gone down for the the eighth month in a row, something that also hadn't happened since the GFC. And yet, there were counterpoints. U.S. industrial production rose this week by more than double what economists expected. 0.6% month over month compared to an expected 0.3%. Manufacturing rose, motor vehicles rose, mining output rose, oil and gas drilling hit a seven-year high. Now, for those who think we're in a recession, this just runs completely counter to historical data around recessions, which basically

Starting point is 00:10:58 always see industrial production decline. Another example of counterpoints comes from retail sales data. Not including gas stations and auto dealers, retail sales rose 0.7% in July, which was again more than expected. Within this, there are some big shifts happening. People are moving budget from goods to services, and even the goods they're buying are more likely to be essentials than the type of things they bought in the past, but people are still buying. And this gets to what I think is starting to emerge as a new anti-narrative in some way around the broader economy. That narrative or anti-narrative is that we just don't get whatever the hell is happening. Bloomberg columnist Jared Dillian wrote a piece this week called This Economy is proving too hard for economists. He writes,

Starting point is 00:11:44 The latest buzzword among many economists and investors is noise. It's being used to refer to any piece of economic data that doesn't fit the prevailing narrative, which is happening a lot these days. He goes on. No sooner had the Labor Department said earlier this month that the economy added 528,000 jobs in July, more than double the forecast and exceeding every one of the more than 70 estimates in a Bloomberg survey, then economists dismissed the results as noise. They trotted out that word again when the government said on August 10th that the consumer price index was unchanged in July from the month before, an outcome only four of 63 economists predicted. They expected an increase. And just this week we heard a lot

Starting point is 00:12:22 of economists respond with noise when the Commerce Department said this last week that retail sales for July rose more than forecast. Dillian's point is that economists are right that it's very confusing right now, but where they're wrong is the idea that anything that doesn't fit some pre-existing model is somehow a weird dismissible outlier. He concludes everything happening in the economy right now is happening for a reason, a reason that many economists and investors are struggling to understand. None of the models used by economists are useful in predicting the aftermath of an economy that stops on a dime, jettison some 17 million, from the workforce over two weeks, and contracts 31% only to rebound just as quickly on

Starting point is 00:13:00 the back of free money government programs that injected trillions of dollars directly into the pockets of consumers to go along with negative real interest rates and quantitative easing policies from the central bank. On top of that, global supply chains were massively disrupted, creating shortages of goods, which in turn led to higher prices for those that were available. It will take a few years before all this is sorted out, and we've returned to something resembling a normal business cycle. The broad economic slowdown, we are experienced. is likely nothing more than a pullback from the artificially induced sharp recovery from the lockdowns. It may not fit the model of a conventional business cycle, but once you accept that this is

Starting point is 00:13:35 not a normal business cycle and view the data through a different lens, then the unexpected begins to make sense and not something to be dismissed as noise. End quote. It is an extremely uncomfortable thing to be flying without the rudder of past examples to lead us. But when we take a step back, the reality is that the things that got us to where we are have, as Dillian points out, not been normal cyclical factors. They've been massive, unexpected, exogenous disruptions that have a no-turning-back aspect to them. COVID, of course, massively accelerated what was already a profound shift and decoupling from the past peaks of globalization and global interconnection of the economy. The Russian invasion of Ukraine put a massive violent stamp on that unwind and is

Starting point is 00:14:23 starting to balkanize the world's energy, food, commodities markets in ways that we couldn't have predicted just a few years ago. So where does crypto fit in all of this? Well, the we just don't know is profound here as well. I think in many ways the ETH merge is the big we just don't know catalyst for the fall. It could be that the merge and the transition to proof of stake is a massively rejuvenating event. It could be the type of thing that gets people excited, opens new business lines and generally spurs new activity and dynamism. It could also create chaos. New protocol risk could be introduced as proof-of-work eth miners fork off to create something new, causing havoc with defy protocols and other parts of the ecosystem. On top of all that, it could introduce

Starting point is 00:15:08 new political risks, with ESG arguments coming notably for something like Bitcoin, and asking why if Ethereum can transition to proof of stake, couldn't Bitcoin do the same? The point is, we just don't know. And I think the more that we acknowledge that we don't know, and try to take each new input as it comes and build a new, holistic picture of what's happening outside of just trying to use predictive models from the past, we're likely to have a much better time of it. Anyways, that's my thought for this week. I hope wherever you are, you are having a nice, late summer time. I want to say thanks again to my sponsors, nexo.io, chainalysis and FTCX for supporting the show, and thanks to you guys for listening.

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The Breakdown - Welcome to the ‘We Just Don’t Know’ Economy

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