The Breakdown - Why the Fed Keeps Denying Its Role in Increasing Inequality

Episode Date: June 12, 2020

Today on the Brief: Three Arrows holds more than 6% of Grayscale Bitcoin Trust New platform for censorship-resistant blogging Coinbase announces new token potentials as anti-surveillance hodlers flood out  Today’s main topic: Why the Fed keeps denying its role in inequality  Some key takeaways from yesterday’s Federal Open Markets Committee meeting: Interest rates are likely to stay near zero through 2022 Unemployment anticipated to average between 9% and 10% during last three months of 2020 Economy expected to contract 4% to 10% this year No specific discussion of yield curve control Inflation expected to be 1.0% this year and 1.5% in 2021, lower than Fed target of 2% According to Chairman Powell, inequality has nothing to do with Fed policy On this episode, NLW recaps the above and dives deeper on two of the points: Net inflation stats gloss over specifics, including food prices that have been rising at an annual rate of 17.5% The Fed’s pronounced role in exacerbating inequality by propping up artificially high asset prices, effectively locking low and middle income households out of the mechanism for economic advancement 

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 CipherTrace. The Breakdown is produced and distributed by CoinDesk. And now, here's your host, NLW. Welcome back to The Breakdown. It is Thursday, June 11th. And today, our main theme is going to be a recap of the Federalist. reserves FOMC meeting from yesterday, what it means for the economy, and some specific focus on

their continued assertion that there is no relationship, no correlation between Fed policy and inequality, which, as you might imagine, I have a very hard time buying. But first, let's start with the brief. First up on the brief, three arrows in grayscale Bitcoin Trust. So what's the news? Based on a regulatory filing requirement in the U.S., we have discovered that three arrows, which is a Singapore-based investment firm holds more than 6% of the Grayscale Bitcoin Trust, which holds in total something like $3.6 billion in Bitcoin. Of that, three-aero's stake is worth $192 million approximately. Why does this matter?

Well, there's a couple reasons. First is that Grayscale's Bitcoin Trust is one of the most important institutional Bitcoin actors in the space. It is the on-ramp for a huge number of people who are getting exposure to the space for the first time. So understanding who actually holds those assets and who is interested in new Bitcoin that comes into the trust is actually very important. Secondly, it suggests, and I think that a lot of people felt this way, that Three Arrow's is operating at a scale much bigger than we might have assumed. There are many of us who just kind of knew them from their great posts online or on Uncommon Core, which is a collaboration between one of Three Arrow's founders and Hasu, who's an independent researcher. They're seriously playing here.

and a really important institution, as it turns out in this space. This is validated by a bit of a he-said, she-said episode around the Deribit Exchange, which I won't get into here because it's hard to kind of piece out what is and isn't real, but go read Three Arrow's Post, go look at Michael Arrington's telling of the story. My takeaway, though, is that Three Arrows has some seriously sharp folks and is a really interesting institution in this space to watch. Next on the brief, let's talk censorship-resistant blogging. So what happened?

San Francisco-based firm Unstoppable Domains has released a new decentralized blog service they're calling D-Blog that is hosted on Protocol Labs interplanetary file system IPFS, and it comes with the crypto-crypto domain. So basically, this is an approach to blogging that is not subject to censorship from some central authority. That's at least the goal. And Unstoppable Domains is part of this movement. to create digital spaces, name spaces, now blogging spaces that really operate outside of the realm

of control of any centralized actor. If you're on Medium, for example, they could decide that your writings don't fit with or comport to their terms of service and kick you off. It's a little bit more questionable on services like WordPress and self-hosting, but even different domain hosting services, right? Different DNSes are subject to different rules or political capture depending on where you are. So the idea of unstoppable domains, which is similar to the idea of the Handshake Project, is to remove that capacity for censorship. Why does this matter? Well, it probably is clear why this matters, but censorship is a real and growing concern, particularly in different parts of the world, right? We talk about it a lot in the U.S. context of deplatforming and what the right

relationship between social media platforms and their users is. Obviously, Nick Carter's entire breakdown brainstorm yesterday was about what the rules and relationship between users. and their social media profiles should be. However, I think it's even more pertinent in places in the world that are actively going out of their way to censor people. And there are those, and it's very clear. Just today we saw, or I guess yesterday, we saw news of Zoom suspending a U.S.-based Chinese activist without really saying why. This morning, I woke up to news that a podcast app had been banned in China, which was the second one to have been banned in the last couple weeks. So censorship is a real relevant part of our digital experience. And it strikes me, frankly,

that this type of censorship might increase, not decrease, as we see a return to nationalism, a return to protectionism, a return to looking inward. You could see more and more trying to get people to tow the official party line. So I think it's a real concern, and I'm excited to see more projects in this space of uncensurable, unstoppable, unstoppable domains, namespaces, blogs, you name it. I'm waiting for the unstoppable podcast service. So let's see what happens. Finally on the brief, the up and down of Coinbase. So what happened? Well, yesterday Coinbase announced that it is looking at 19 new tokens to list, and it is using its established digital asset framework to do so. These tokens, interestingly, have had a big bounce. All of them are up between 8% and 25%

with the average being up 17%. And this is according to data from Masari. The tokens that they're looking at include tokens from projects like Aragon, Bankor, Siacoin, Wren, and more. So why does this matter? Well, I think there's two potential reasons. The first is that this idea of news being able to drive price pumps is something that we haven't seen for a while, frankly, and it kind of harkens back to the weird days of late 2017, early 2018, when news was enough to actually have these prices go up. We used to talk about the coin-based pump. That's not been a thing for quite some time, so it's interesting that that seems to have come back. I'm not exactly sure what it reflects, but it's worth noting. The second, which is much more of interest to me, is there are some accusations, let's call it,

of secondary motivations on the part of Coinbase. And what that has to do with is last week, at the end of the week, it was revealed that Coinbase is in talks with the DEA and IRS to sell them effectively a blockchain analysis software, to help them in their mission to find criminals using blockchain analysis. And this is pretty against the ethos of at least some part of the crypto community. And that part of the crypto community let their frustration be known in a pretty serious way. Over the weekend after the news, something like 22,000 Bitcoin flowed out of the Coinbase system, which sounds like maybe, you know, who knows how many Bitcoin Coinbase has, but this is remarkable because if you look at the charts for the last three months, it has been

net outflows versus net inflows of Bitcoin have been hovering at nearly zero, right? They go down a little, then they go up a little, then they go up a little. This is a huge market move down, and it really can only be attributed to that news. So a pretty significant moment for Coinbase. And so who knows whether this was actually a response to that news and those outflows versus just timing that made people suspicious. But either way, pretty fascinating that news could both drive price increases in these assets, but also news could drive 22,000 Bitcoin to flow to the Coinbase system. Shows where at least the values of a big part of this community lie. But with that, let's turn our attention to our main.

topic. All right, so to our main theme, I'm calling this episode the Fed's big inequality lie. And of course, by that I'm referring to this idea often repeated over the last few weeks that there's no relationship between Fed policy and inequality. We'll get to that, but first I want to recap a few things about what happened at this Federal Open Markets Committee meeting that was reported on yesterday. First, let's talk about interest rates. One of the major questions for any of these meetings is what's going to happen to interest rates. Are they going to stay the same? Are they going to be reduced? Are they going to be raised? Well, right now, we're at a target interest rate of between 0 and 0.25% for the overnight funds rate. And so they can't lower it without going into negative

territory, which is something that, while some people have speculated about, is something that Jerome Powell has been pretty consistently against, at least up to now. We didn't really expect, and I don't think anyone really expected to see that. However, what we were wondering is how long they were going to keep interest rates at zero. Well, the consensus seems to be that rates will stay at near zero until at least the end of 2022. All 17 officials who participated in this meeting said that they would be at zero throughout next year, 2021, and 15 of the 17 said they expected them to be at zero all the way through 2022. Powell's comments on this were that he said, we're not thinking about raising rates, we're not even thinking about thinking about raising rates.

So that's question one. Let's turn then to unemployment and their analysis of where the economy is, because in some ways, the headliner for this meeting was that they were trying to tamp down expectations, I think, of a V-shaped recovery. They were trying to have some sort of realistic analysis of how long and protracted the economic pain could be. This task may have been made more urgent in their minds based on the fact that we got the surprise of an increase in jobs in last week's jobs report instead of a decrease like we expected, although, as many are reporting, there are major errors with how they calculate this, but either way, the Wall Street and the market has been reacting to this news as part and parcel

of this larger upturn, larger V-shaped recovery sign. Well, Powell and Co. tried to really tamp that down. They said that they projected the unemployment rate would range between 9 and 10% during the last three months of this year, and realistically, the economy would contract between 4 and 10% this year, with the average landing around 6.5%, 6.25%. This morning, we had a follow-up on unemployment benefit claims, which is reported every Thursday. There were 1.5 million new unemployment benefits claims, and I thought Lynn Alden did a really good job of putting the confusion of our jobs numbers right now. She said, new jobless claims data. Initial claims, 1.5 million new claims, continuing the downward trend, but at very high levels. Continued claims, staying

roughly flat at 20 plus million. Lots of jobs churn. Some folks going back to work, others still getting laid off. One thing Powell and the Fed didn't really talk about that some had expected had to do with yield curve control. This idea of setting a specific rate for bonds and buying enough to keep the rate at that level or not exceeding that level, as opposed to QE, which is more of a buying a certain number or a certain priced amount of assets regardless of what the rates are. So they're sort of different tools in the toolkit that have slightly different impacts on the economy. Many have anticipated that the next toolkit to be deployed by the Fed will be yield curve control, and it was clear in many of the analysis coming out of this meeting that one piece of

information that the markets didn't feel like they had was the Fed's medium-term policy. Now, for some, it made sense that they didn't want to get into this at this particular meeting. Randall Krosner, a former Fed governor, said, they want to keep their powder dry in this circumstance because they really haven't any experience where they're going to see a surge in economic activity but not an economic boom. So that comes from the Wall Street Journal. And basically the idea here is that they want to keep some tools in their toolkit, right? They want to keep dry powder. And so perhaps the fact that they didn't discuss yield curve control at this particular meeting shouldn't actually surprise us. I don't think that

it means that it's not still on the table as a tool for them to use. BitStamp is the original global cryptocurrency exchange. Since 2011, BitStamp has been the preferred exchange for serious traders and investors, trusted by over 4 million customers, including top financial institutions. BitStamp is built on professional grade trading technology. Their platform is powered by a NASDAQ matching engine, and their APIs are recognized as the best in the industry. Download the BitStamp app from the App Store or Google Play,

or visit bitstamp.net slash pro to learn more and start trading today. That's bitstamp.net slash pro. CipherTrace helps grow the crypto economy by making it trusted by governments and safe for consumers and investors. How do they do it? By protecting VASPs, banks, and other financial institutions from crypto laundering risks while protecting user privacy. Years of research have created the world's best cryptocurrency intelligence with the best attribution and deepest token coverage. So if your virtual asset business isn't using Cypher Trace to manage compliance risks, you should start now. Learn more at cypress.com.

Now let's talk inflation for a minute, because this is obviously something that's chief in mind of not only Bitcoiners, but many people. We saw Paul Tudor Jones write about the great monetary inflation that he was concerned with, and that's kind of what got him into Bitcoin a little earlier this year. The Fed has a target rate of 2% inflation, and based on their estimates, they are not going to hit that rate. The median FOMC policymaker is thinking that there will be inflation. of only 1.0% this year, and that will only climb a little bit to 1.5% next year. Again, the bank's inflation target is 2% per year. I think that there are two important notes on this low expectation of inflation. The first is that we should expect this right now. Joblessness is a massively

deflationary force, and we have 20 million plus people out of work. Of course, those folks aren't buying anything right now. That is a powerful deflationary force. That is powerful enough. to offset even rampant money printing, as we've seen. So I think that's something that's important. Not just because it helps explain what's happening now, but because it should also follow from that, that if we have all this money sloshing around the system and we do see something like a V-shaped recovery, and we do see those numbers that we saw in the jobs report last week extend and continue, and we get over our disbelief and we actually see all these jobs come back, then all of a sudden this could turn from a deflationary to an inflationary environment very quickly.

So that's part one of the context maybe or a way to contextualize that inflation projection. The second part, though, is how we measure inflation matters too. And right now, I'm not even talking about asset price inflation, which is the major inflation that we saw over the last decade from the last round of quantitative easing coming off of the great financial crisis. In that context, people expected to see massive consumer price inflation as well. But instead, we got stock bubbles. Instead, we got real estate continuing to appreciate, right? We saw it in assets not just in consumer

prices or not primarily in consumer prices. But right now, we're seeing some pretty wonky things if you actually dig into the numbers deeper than the aggregate. A market watch essay or op-ed, rather, put this really nicely. A lot of the stats that people are throwing around saying there's very little inflation right now are throwing away energy and food prices. Well, energy prices haven't really mattered very much because people aren't moving to jobs, right? So in terms of its functional impact on people's lives, it doesn't really matter. It's hard to care about that as a measure of inflation right now. What does matter is that you always have to eat, and food prices have had serious growth in just the last couple months. In May, grocery prices rose 1%

as compared to April. Over the past three months total, they've risen 4.1%, which translates to an annual rate of 17.5%. That's huge inflation, right? You're talking about a, this is a majority of people's income. Low income spend 82% of their income on food, shelter, transport, healthcare, and clothing. Food is a major part of that. It's not viable to have a society where the food prices increase at an annual rate of 17.5%. Within that, specific prices are growing even faster. Beef prices are up 11% in just the last three months, which is enormous. You're talking about major, major economic dislocation if you see this sort of price increase. So when we talk about inflation and inflation being low, I think it's really important that we move beyond these headliner

statistics and actually dig into the details. And this is to say nothing of the fact that we're still living in a context where unemployment benefits have at least protected people from the worst parts of some of these issues. But a lot of these benefits, are wrapping up as we speak. A lot of them are running out either at the end of June or at the end of July. You're seeing the deferment programs for mortgages and for rents start to come due. Those things could have a hugely deleterious impact on people's lives. And all of a sudden, those food prices growing up, those grocery prices going up 1% per month are pretty significant. Which gets us to this question of inequality and the Fed's role in increasing inequality.

Sven Henrik wrote, Today was a historic day. The Fed has fully embraced its capitulation to everything markets. It implicitly encourages asset price bubbles while lying about its role in exacerbating wealth inequality. It will keep printing with no end in sight and has no exit strategy. This is, I think, pretty reflective of a huge number of commentators that I've seen on FinTwit.

And instead of just having it be these people who agree with me, who I'm quoting, why don't we just let you listen to Jerome Powell answering the question about whether the Fed has had a role in increasing inequality? Inequality is something that's been with us increasingly for more than four decades, and it's not really related to monetary policy. It's more related to, there are a lot of theories on what causes it, but it's been something that's more or less been going up consistently for more than four decades. and there are a lot of different theories. First of all, it is simply not the case that you can draw just a steady line up from,

call it 1980 and say that this has been increasing at a steady pace. There are a million different charts showing how inequality has increased significantly since 2008. And the growth in income and net worth of people whose net worth comes from assets as opposed to labor and wages has radically outstripped everyone else. So how does central bank policy actually exacerbate this? How does it increase inflation? Well, simply put, central bank policy that is designed to keep the price of money artificially cheap benefits those who can then go access that money to go buy more assets. If you keep the price of money artificially cheap, it means that you have to go put your money into the stock market. It means you have to buy more

real estate. You can't get a good no-risk savings rate, so you have to put your money to work. That's great and good for the people who have the assets available to go put their money to work to buy more assets. In fact, it's a windfall for them. Who it's not a winfall for is the more than 50% of Americans who don't own a stock because they can't own a stock because 82% of their income is focused on the things we just mentioned before. Shelter, food, clothing, right? The basic necessities of life. What this means is that we've set up a system where a huge percentage of the economy can't buy into that system.

And what happens is that they just watch as everything around them moves forward and they are stuck in the same place. Houses get more expensive and the dream of home ownership gets farther and farther away. Stocks go up and the means to actually buy into this system and participate in the gains gets farther and farther away. There are plenty of people who study this from, frankly, all parts of the political spectrum who are extremely nervous about what this brings. Christopher Cole is a volatility expert, and he tweeted, civil unrest and anger directly linked to income disparity and equal access opportunities. I said this to the New York Times in 2017. If central banks want to keep saving the day, that is fine.

But volatility will be transmuted through other forms and threaten the fabric of democracy. He went on when someone asked if there were other examples of this in history to say, the French Revolution was related in part to the fact that serfs were given land ownership but then taxed and humiliated to pay for lavish wars and extravagant monarchy. Social revolutions occur after a, quote-unquote, middle class achieves but loses status after financial crises. And if you're thinking now, yeah, sure, sure, sure, of course it's the opinion of these folks on Twitter and, you know, these specialists who are building their brands and their reputations and their practices and their consultancies around having a different perspective

than the Fed. Of course, they're going to take it this way. Let's listen to former Federal Reserve Governor Kevin Warsh discussing QE Quantitative Easing and Inequality at Stanford's Hoover Institution in 2015. Quantitative easing is fundamentally different than cutting interest rates, and that it appears to be working through fundamentally different transmission channels. No longer credit channels and lending channels appear to be the dominant way in which it impacts the economy. It appears much more to be working itself through asset prices, whether you think about

housing stocks or financial stocks. I think that is the dominant channel. And as a first approximation, if three quarters of our fellow citizens get 96% of their income from labor income, it strikes me we ought not be dismissive in saying, oh, everybody wins. When I look at the wealth creation across the financial asset world post-crisis, I view that wealth creation as being significantly above what my former colleagues predicted. When I look at what they expected in the real economy, I look at the real economic performance as markedly worse than they predicted. And so that's what I think raises these questions, makes them absolutely germane to today's discussion. And I very much do worry, as I'm sure many of people in this room do, that we've created a product not with bad

intent. We've created a product that may or may not turn out to be counterproductive. We are in the middle of this experiment as we are now, but where the gains have been extracted by the most well-to-do, by the most sophisticated, who see that the central banks are to one degree or another trying to get asset prices up to drag up the real economy. They get the joke, they have been willing to play the game, and it does strike me as though we have to think about not just the efficacy of these programs, but really who are the winners and the losers. So what's happened today? Well, the markets are off. The Dow has fallen more than a thousand points. There seems to be some internalization of both what Jerome Powell said about the potential for extended or

protracted compression and concerns about how fast we get back online. And those things are dovetailing with statistics coming from places like Arizona and California and Florida that are seeing growing rates of coronavirus because guess what? We never actually dealt with it. And if you look, it's interesting, over the last few weeks, the things that have been driving the stock market have often been kind of crazy and completely divorced from fundamentals. Obviously, we talked a couple days ago about the Robin Hood rally and bankruptcy stocks. Well, what's being hit, I think, is pretty fundamental and shows the insecurity around the real economy. Banks took a hit. Bank of America is down 6%. Goldman Sachs is off 5%. Caterpillar is off 6%. Boeing is down 10%. So these are big

industrial-type stocks as well as bank stocks that are really going down. It's too early to tell whether we're actually seeing a real correction or whether the Fed will introduce some new action and Robin Hood will stream back in and what have you. But I do think it's worth pointing out kind of the pessimist take isn't even the right word, the rationalist take, I think, on this. So I want to end by reading an excerpt from an essay by Sven Henrik, who I quoted before, that's called Crash Number 2. My variant take here, which may well turn out to be very wrong, the Fed is setting markets up for another crash. Why? Because they've set in motion a stock market mania we have not seen since

the 2000 tech bubble, but this time, while we're still in a recession. This is all about control. Can the Fed control the market equation? For now, it clearly has, but it's created a bloated pig of a market as a result. And this pig is now big and fat, and any sizable reversion can in itself shake the very confidence and optimism the Fed has sought to propagate. The Fed is peddling a fantasy, a fantasy that says money and wealth can be created out of thin air, with nothing of substance needed to back it up. No growth, no earnings, none of that. My premise. Markets and the economy can't live on multiple expansion alone, but this is what the market ran on in 2019 and is what is running on again. Like Druckenmiller, I've been surprised at the vertical

nature of this move, but unlike him, I don't attribute it to reopening optimism. I attribute it to only one thing, a stock mania created by an overzealous Fed that is trying to save the economy, but in the process is created the largest asset bubble of our time, and with that, they put in the conditions in place that markets could be faced with another crash. I may well be wrong on this, but the circus-like atmosphere in the context of historic valuations, optimism and giddiness along with bears crying, are exactly the type of conditions that have ended bear market rallies in previous periods of history. To think it's different this time is to count on it being different this time. Well, in one aspect, it already is different this time. The first stock

mania inside of a recession. Not discounted far below at all-time highs, but rather sitting on top of the largest disconnect between the economy and the stock market ever, inside of a recession, no less. I want to be clear as we close that I'm not rooting for markets to fail. I am concerned with the same types of things that I think Sven Henrik and many others in both Bitcoin world and financial world are concerned with, this disconnect between fundamentals and prices and the policies that keep it so at the expense of a huge portion of our society. We're getting a taste in 2020 of what it looks like when we don't deal with underlying structural issues, whether it's issues with a legacy of injustice and inequality and police brutality, or whether it's a structural

disadvantage when it comes to the way our medical system is organized around just-in-time supply chains that don't allow us to get the equipment that we need when it really counts. You can only sweep issues under the rug for so long before the ground becomes so bumpy that you can't stand any longer. On that happy note, I will close for the day. As always, guys, I appreciate you listening and engaging with these issues and thinking about them deeply and writing me to tell me what you think. So until tomorrow, be safe and take care of each other. Peace.