Tales of the Pirate Investor - Chapter 11
Without further ado, here is your free chapter:
Chapter 11: What makes the World Tick
“People only see what they are prepared to see.”
Let me give you my interpretation of recent economic history, for example the 1929 market crash in the US and the Great Depression, led to the New Deal which promoted economic recovery by putting Americans back to work through debt financed government spending. It rebuilt the whole country, it built much of it up for the first time: roads, airfields, power systems, railways, tunnels, bridges, cultural centres, and all kinds of things. If those institutions hadn’t been built, the US would not have been the decisive factor in the World War II (WWII) that it was. History is cumulative. The US entered WWII well after the fighting had started. Before it entered the war, the US had the infrastructure in place to serve as the Allies’ main source of weapons, and other supplies. Collecting much of its payment in gold or by allowing other countries to run debts to the US, by the end of the war, the United States owned the vast majority of the world’s gold and became the lender of choice for many countries which pulled the US out of its depressed state and increased its political and economic influence in the World.
After WWII there was a major tectonic shift in our world’s economic balance of power. The United States offered massive financial assistance to countries destroyed by the war in the form of the Marshall Plan. The plan allowed countries to rebuild themselves while at the same time cemented US influence over them. Countries had limited bargaining power as they were at the mercy of US to receive much needed assistance. The Bretton Woods agreement was signed, this established that other countries would maintain fixed exchange rates between their currencies and the dollar. In turn, the United States would redeem U.S. dollars for gold on demand. As a result of the Bretton Woods Agreement, the U.S dollar was officially crowned the world's reserve currency and was backed by the world's largest gold reserves. Instead of gold reserves, other countries would accumulate reserves of U.S. dollars. The massive loans countries needed from the US, gave the US enormous negotiation leverage, so the agreement dictated that all countries which received aid, had to buy their goods from the US and pay in dollars. The International Monetary Fund and the World Bank were established to manage these debts and payments. Upon the creation of Bretton Woods, the US was producing half of the world's manufactured goods and holding half its gold reserves. This gave rise to the Golden Age of Capitalism. It was a period of economic prosperity, with the achievement of high and sustained levels of economic and productivity growth, in spite of other countries either depleting their gold reserves or incurring high debts to pay for their post-war prosperity. The truth of the matter was that the reduction of population caused by the war, and the massive infrastructure rebuilding that was required in most countries ravaged by war, allowed for greater business and employment opportunities and more wealth to go around to less people.
For the United States, the post-war economic expansion was a continuation of what had occurred during the War: improvements in the standards of living for an entire generation. Prosperity was taken for granted; this was a period of post-war hope, optimism and conspicuous-consumption. Indeed, for many young people who came of age after 1945, the interwar experience of mass unemployment and stable or falling prices were things confined to the history books. Full employment and inflation were the norm. This period of economic growth made it possible for many governments to finance generous welfare programs. Given that most couples tend to choose to have children based on their potential earning power and relative stability this special set of post-war circumstances encouraged a high fertility rate, and gave rise to a very large baby boom in a short period of time. This so called baby boom generation would reshape society for decades.
The US and its population benefited the most from this new geopolitical structure. France, called it "America's exorbitant privilege” as it resulted in an asymmetrically unfair financial system where other countries needed dollars to buy goods and pay off its debts to the US which made it easy for the US to run consistently large account deficits. They were in fact in possession of the only “mine” of US dollars in the World, the US could produce a $100 bill for only a few cents while other countries had to provide $100 worth of actual goods or services to the United States in order to obtain dollars. Another benefit of the dollar reserve currency status was that international trade was denominated in dollars which meant that the US could buy foreign assets and pay for them in freshly printed dollars. In the 50’s and 60’s the US produced large amounts of dollars, which they used to buy up assets worldwide. Its currency did not devalue under the cover of the gold standard. This fulfilled a need for dollars by other countries for liquidity purposes and further established the US as the consumer of the World. Other countries were in fact supporting American living standards and subsidizing American multinationals in detriment of their own standards of living.
The US took full advantage of this structure and continued to flood the market with paper money. However it’s not easy for a country to just print currency then go on a global shopping spree. Other countries take notice. A negative balance of payments, a growing public debt and monetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued. Holders of the dollar had lost faith in the ability of the U.S. to cut its budget and trade deficits. French President Charles de Gaulle, at the time, announced his intention to exchange his country’s dollar reserves for gold at the official exchange rate. He sent the French Navy across the Atlantic to pick up the French reserve of gold. With growing concerns over the stability of the dollar, other countries soon followed and showed intention to redeem their gold too. Demand for gold held by the US was such that it would result in considerably reducing US gold stock and economic influence, US President Richard Nixon was forced to intervene and ended unilaterally the convertibility of the dollar to gold in 1971, which led to the floating exchange rates that exist today. Surprisingly there was no major backlash from most countries as they did not hold much bargaining power or recourse. Many argue that the US focus on both military spending and having established itself as the World’s police are ways to enforce the dollar keeps its status as the global reserve currency, and squash any threats to that very advantageous system. For example the case of Lybia comes to mind, when Gaddafi tried to switch to a new currency backed by gold, the gold dinar, in order to start selling the country’s oil in exchange of gold instead of paper dollars. To the US he quickly went from ally, to its foe.
Anyway, after the end of dollar convertibility to gold, other countries could no longer convert surplus dollars into gold and needing a place to store their dollars they began buying US Treasury securities as a safe haven. Surplus dollar countries would sell their hard-earned dollars to purchase US treasuries which pushed up the value of the dollar and kept US interest rates low and the US in turn would buy goods and services from these same surplus countries. If any of these countries required financing or aid, the US would gladly supply dollar denominated loans through the IMF and the World Bank, but these debts would become a burden because they needed to be serviced in dollars, thus creating demand for it and perpetuating the system.
Japan seemed to benefit from this system at first glance and it used these loans to rebuild its manufacturing capacity enabling it to export its way into prosperity leading to Japan’s Economic Miracle. In order to inject more capital into the Japanese banking system, the Japanese government encouraged people to save their income. The Japanese, whose culture is fundamentally thrifty and minimalistic, did so, giving the banking sector their hard-earned money to gamble with. The yen surged, spurring the Japanese monetary authorities to pump even more money into the market to devalue the currency. The Bank of Japan decided to reduce rates. The excessive monetary easing policy led to a sudden increase of liquidity. Uncontrolled money supply and credit expansion fuelled a climate of over-confidence and massive speculation, while the absence of inflation hid the danger. The results were massive price bubbles in both stock and real estate markets. In the fever of escalating real estate prices, credit standards went down. Corporations and consumers went on credit fuelled buying sprees, but they forgot that if you buy everything you want, soon you will have to sell things you need. Banks relied on the continuing growth in real estate prices, paying no heed to whether their debtors’ liquid resources or profits could meet the terms of the loans. No one seemed to recognize that real estate prices could not go upward forever. Speculation ran high. The higher the risk, the bigger the gains. Stock prices soared and it became harder and harder for speculators to miss their mark. These were high times for thrill-seeking investors. Blinded by success, the investors became careless and relied on a continuing rise in the stock and real estate markets. Speculators anticipated continuing growth and based their investments on that prediction.
The abnormal development in stock and real estate prices came to an abrupt end in the early 1990s. The Japanese Finance Ministry, recognizing that the asset price bubbles were unsustainable, raised interest rates. This move immediately shattered the real estate and stock market bubbles, leading to a sharp crash in both markets, as investors panicked and scrambled for the exits. The crash in stock and real estate markets was hard on the Japanese banking system. Defaulting on loans increased and the collateral behind these loans more often than not turned out to be worth much less than initially assumed. In an attempt to avoid losses, Japanese banks kept pumping fresh funds into debt-ridden, unprofitable firms to keep them afloat. These companies came to be known as zombie firms, they appeared to be living but were actually dead, too burdened by debt to do much more than live off further hand-outs. They compromised competition in the economic system and extended and deepened the economic crisis. More efficient and productive businesses would in a natural economic environment have pushed the less productive, incompetent aside. Looking back now, it seems incredible that when the grounds of the Imperial Palace in Tokyo were valued at more than the entire state of California, no one recognized the bubble in Japan. Tolerance for excesses was commonplace and when the bubble burst, there was an initial refusal to use taxpayer money for bailouts, but then Japan finally adopted a strategy of “quantitative easing” as the crisis intensified. It started printing money in order to buy financial assets from banks and allow them to continue extending loans to the zombie firms, to the point that many banks became zombie banks themselves: with no intrinsic value and propped up by government credit. The government created a lot of liquidity without addressing the moral hazard question or making any structural changes to the long-term financial architecture. The Japanese debt-to-GDP ratio rose to catastrophic values, it was just the zero interest rate that was keeping the budget pressure concealed. The government’s message to the public was to stop saving their money and consume more. This was the complete opposite of their advice a few years back. Japanese people were burned by the crash and held off spending, retarding economic growth and leading to a deflationary environment characterized by falling prices. In this kind of environment, debts become more difficult to pay off. Savers are rewarded with an increased buying power over time and those who buy things on credit are penalized.
Morally I believed that an occasional deflationary period is healthy for a redistribution of wealth, by allowing other participants to benefit from the mistakes of risky gambling by those with access to large loans, and gives them a chance to acquire assets at cheaper prices. But Governments and Central Banks repudiate deflation and would make everything in their power to achieve an inflationary environment. It provided them with an easy way to kick the debt problem down the line for future generations to solve, and in the meantime reward those closer to the money printing faucet, ensuring the maintenance of the status quo in doing so.
Following this period, it is clear that each subsequent generation is prone to the same excesses and market euphoria because they feel entitled to the same or greater desire for material objects, and better living standards than previous generations.
However, an economic slowdown and an overcrowding of labour markets by baby boomers made jobs harder to acquire and governments’ budget headaches begun in earnest. They had to keep fuelling the welfare state with increasing debts. Before the 2000s, when baby boomers were in their middle age, they started saving for retirement, and in the US, they would funnel their savings to the stock market through pension and retirement funds. Seeking to increase their income and savings, many started investing, seeking investments with the highest yield and return promises. So when the internet arrived and promised to revolutionize global business, investors became irrationally exuberant about its almost limitless prospects. It seemed like a Déjà vu of what had happened in Japan just a few years ago, this time the markets were reaching bubble territory from the dot com mania. To keep expectations in check with reality, Alan Greenspan announced plans to aggressively raise interest rates, which led to significant stock market volatility as analysts disagreed as to whether or not technology companies would be affected by higher borrowing costs. News that Japan had once again entered a recession triggered a global sell off that disproportionately affected technology stocks. This loss of confidence culminated ultimately on the dot com crash. Investor confidence was further eroded by several accounting scandals and the resulting bankruptcies, such as the Enron and WorldCom scandals. When the tide of the dotcom boom receded, it exposed an unprecedented underbelly of fraud and fudged accounting that had accelerated in the dying days of the bubble as bosses struggled to meet the growth targets to which investors had become accustomed.
In spite of the stock market crash, the years that followed were unusually good. It was mostly a benign economic environment, with low inflation, low interest rates and steady growth. In the US, the Federal Reserve had to come up with a way to help expand the economy after the crash, so it lowered interest rates. The rates were historically very low and the inflation rate was greater than these interest rates, meaning that the real interest rate was negative. The situation was left this way for a few years. The falling price of goods coupled with low interest rates, encouraged people to take on increasingly higher risks to get greater returns until it all went wrong. To many, this was the death knell. This is what they believe resulted in the subprime mortgage crisis. The government did succeed in its goal of increasing spending and reducing monetary turmoil by resorting to interest rate cuts. However, this resulted in an unforeseen speculative frenzy in the housing market.
At the time of the US housing boom, housing prices seemed to be rising continuously. Anybody who was investing ended up making money and all seemed fine. However, it is during this period and because of the low interest rates introduced by the Fed that the seeds of a catastrophe were sown. The subprime mortgage crisis was thus in a way the offshoot of an attempt to minimize the dot com bubble bust. History is indeed cumulative.
The excessive risk-taking and borrowing and the wrongheaded belief, yet again, that we had entered a new paradigm caused a huge implosion. The crisis had begun as interest rates began to rise. Many on the bottom found it difficult to meet mortgage payments and one of the largest sub-prime lenders went under, sparking panic. Fear also spread as it became clear that much of that toxic debt had been packaged up and sold around the global banking system. New financial instruments had been intended to spread risk and insulate individual institutions; in fact it led to contagion. The dominoes fell rapidly. Bear Stearns was bought by JP Morgan Chase, house prices began falling at the fastest rate since 1991 and the US government seized control of Freddie Mac and Fannie Mae, the two firms that underpin the US mortgage market. But it was the failure of Lehman that plunged the world into crisis. Suddenly investors feared that judgment day had arrived, and that their carelessness would have to face the reality that the boom had been built on sand. But the Wall Street lobby power was strong and they quickly convinced government’s that its institutions were too big to fail, and it was in the best interest of society as a whole if they were bailed out after their excesses. They argued that society needed these institutions to function or else the entire system would come crumbling down. Instead of allowing the system to reinvent itself, politicians bailed out the corrupt institutions that created the crisis in the first place. They were betting on the success of trickle-down economics. In theory, by bailing out these businesses and the wealthy that invested in these products, and even reducing their taxes would be a means to stimulate business investment in the short term and benefit society at large in the long term. It is clearly a flawed economic policy that favours the wealthy or privileged while being framed as good for the average citizen. There is no two ways about it, these policies assure that more resources flow to the wealthier segments of society than to the poorer ones, a clear case of socialism for the rich and capitalism for the poor. The receivers of the bailouts preach the benefits of free market capitalism when it suits them, in the form of lax regulations that enables them to profit to the tilt when they win on their bets, while their costs and risks are socialized to the maximum extent possible, guaranteed by taxpayers who foot the bill for their reckless gambling.
In my humble opinion, I argue that banks should have been allowed to collapse to let the system reimagine itself. But too many vested interests were riding on the continuation of the status quo. Central banks kept a bankrupt system afloat and didn’t purge out the excessive speculative attitude that drove us to the crisis in the first place. This is an example of the established institutions control over the system. Financial institutions got away scot-free, no penalties for who gambled and lost, nobody was sent to prison, in a matter of fact highly paid and reckless bankers who pitched the world into recession still demanded their bonuses be paid and the institutions they worked for even got rewarded with a fresh new pile of chips to keep betting, in the form of bailouts. And now we are seeing the repercussions. No incentive to change the system. Investment banking should have been detached from traditional banking activities so as not to jeopardize the whole system again. Maybe even the profit incentive which sits at the core of the capitalist system should have been rethought into perhaps a sustainability incentive. If you think about it, corporations seek to maximize their own profits and lack moral responsibility, if a person only seeks his own best interest at the expense of everyone else, he is considered a sociopath, but somehow that is acceptable behaviour for businesses. Those who gambled did not bear the brunt of consequences for their activities. By bailing out the system every time it risks going down, central banks are actually subsidizing the continuation of risky and immoral activities such as over leveraged business or gambling in the financial markets, at everyone’s expense. Capitalism works on the balance between greed and fear. If there is fear of failure through making too many mistakes or cutting corners, then capitalism works. Speculative bubbles happen when greed becomes excessive, or when fear diminishes too much. The Fed removed this fear of failure almost entirely and created a huge moral hazard, creating incentives for banks to continue taking on excessive risk.
Who should have been penalized in the aftermath of the 2008 crisis? Lenders and real estate companies that provided unsafe loans and fraudulent loan applications; Investment banks for selling securities with inaccurate ratings and for paying the rating agencies to rate these knowingly toxic products with a triple A rating; Rating agencies for deceiving the public with wrong ratings; Pension funds, traditional banks and public investment funds which invested in risky products without actual disclosure of the real risk nor sufficient capital provisions; Insurance companies for insuring these toxic products without enough capital provisions. None of these, except Lehman Brothers, suffered any serious punishments and bankers became the new pariahs leading to some inconvenient yet fundamental questions.
When more money is printed, those who are closer to the money supply faucet and receive the funds first are rewarded the most, because their purchasing power benefits from an increase, while prices of assets and goods still remain relatively unchanged. Once this added liquidity in the monetary system is widespread, and trickles down towards increasing overall wages, it will not benefit the late receivers because inflation will have already inflated prices of goods and assets, thus nullifying any potential increase in purchasing power. The lower classes are therefore eluded into a perceived nominal improvement of their wealth, while the opposite is true, if they don’t possess any income producing assets, then acquiring these has become further away from their means. Therefore the only option left to them is to continue to sell their time and keep working for a salary while those who own income producing assets will actually benefit the most from this Cantillon effect. It is, in effect, a self-perpetuating a system that conserves power and wealth where it is.
If unemployment falls “too much” and price inflation begins to accelerate and increase wages in the process, then central banks can raise rates at any time. One could argue that one goal is to keep the bargaining power of labour in check. Central banks control inflation and price stability by manipulating interest rate and currency volume. By doing this, crises can be engineered or managed to facilitate a redistribution of economic ownership and to implement legal, structural and political change.
Look at what happened in 2015. Desperate to offset the deflationary austerity in the euro area, the European Central Bank turned to expansive monetary policy just as the Fed was tightening. The dollar appreciated and America’s manufacturing industries suffered a mini-recession, contributing to Donald Trump’s victory in 2016, who seized the opportunity by galvanizing that segment of the population and promising them exactly what they wanted to hear.
Central banks’ ability to instigate crises, bubbles and ensuing depressions coupled with the capacity to decide which sectors of the economy to revive and bailout must constitute an abuse of power. In my opinion, this form of social manipulation in order to get the public to accept reforms and change is maybe something the public should be made more aware of.
To be able to keep using this tool effectively governments require a positive inflation. Governments jumpstart their economies by stimulating economic activity through boosting government spending with the belief that overall spending and loan demand by the public should rise too. Inflation can to be very good for those who have debts and own assets, but it can prove disastrous for savers and average salary earners because their savings depreciate and their wages stay the same. Whilst the cost of living goes up resulting in worse standards of living, and to top it off they will suddenly find that the finish line has just been moved further away from their grasp. With inflation, a person works their entire life to amass some capital and he is destined to lose it, invisibly, through currency depreciation over the years therefore he feels a pressing haste to spend or use his capital quickly, which then forces him to keep working to amass more, and this pressing sentiment leads people to keep working harder and faster to try and keep up. Many call this kind of inflation oppression through social coercion, a hidden tax which rewards debtors and punishes savers, thus incentivizing people to keep spending and consuming now and bringing forward future consumption, basically by putting the economy on steroids through relying on increasing debt to keep the system going. That is why governments need constant inflation, otherwise it would be forced to deal with the structural economic budgetary deficit instead of taking the easier way out of devaluing its massive debts and currency and not paying full value on their obligations. While deflation does exactly the reverse, it slows down the economy and rewards those disciplined enough to spend within their means.
The governments argue that inflation has not even reached its target of 2% per year in the past years, thus enabling them to keep pushing on down this path. But the truth is that the way central banks measure inflation is not even adequate. The most widely used measure is the Consumer Price Index (CPI), which offers a convenient way to include or exclude certain products that give a favourably low result. Therefore, the CPI is a busted barometer that does not reflect real inflation because it does not include full housing, education, health or investment assets price increases. Moreover, the weight of each expense does not reflect the average household’s reality.
On one hand governments want a high inflation to devalue their debt but on the other hand there’s a vested interest in not acknowledging the real inflation rate because then there would be no excuse to stimulate the economy further or to continue the never ending debt cycle. Moreover, payment of social welfare programs depend on inflation, so the higher the reported inflation, the more money the government needs to spend on these payments. So in fact, prices are rising but the government does not want to admit it, or else it would have to raise wages and social benefits such as pensions. This is why, for the general population, it is important to have an accurate measure of inflation because only then will people know the true extent of the negative impact on their savings and standards of living from the continuous money printing by central banks.
Another risk could be a return of hyperinflation. The current combination of monetary debasement, populism and social unrest is neither a new phenomenon nor a coincidence. The late Roman Empire clipped or shaved silver coins as it disintegrated; Henry VIII replaced silver coins with copper to pay for wars against France and Scotland; the British Empire allowed double-digit inflation to erode bondholders’ wealth following the War of Independence; the Weimar Republic precipitated an inflation spiral to pay for war reparations.
Monetary policy has in the present, like in the past, increased inequalities between the rich and poor, the old and the young and between large cities and suburban peripheries left out of the recovery. Brexit, Trump’s plan to exit trade agreements and the calls for independence across European regions all envision a return to past glory with the use of national borders, identifying an external enemy to polarise people’s angst and pursue disruptive policies in the process, while diverting people’s attention to the real core of the problem. History shows that absent redistributive policies to rebalance inequality and promote social mobility, excess spending and protectionism from populist regimes are likely to result in higher public debt, higher inflation and losses for society as a whole.
I’m not a conspiracy theorist. I try to base my opinions and beliefs on empirical evidence. So I don’t know if the new coronavirus arouse from natural phenomena or if it was manufactured and planned. What I know is that before the pandemic the equity markets were shaky, they dropped each time the fed tried raising interest rates. The economy was over burdened with debt and relying on cheap money to keep going, it was clear that the economy couldn’t handle a higher rate or else the entire house of cards would come crumbling down.
One of the biggest problems arising from governments spending tax revenues above their means, rather than setting them aside for future social liabilities, such as pensions, is that the system is very vulnerable to demographic changes, specifically longer life expectancy. There were no major issues when the retirement age was fairly close to life expectancy then there may have been as many as 8 taxpayers per pensioner. However, as life expectancy has increased the ratio between working-age people and retirees is now about 4 to 1, but it could be 2 to 1 in a few decades if current trends persist. The result of this will be that each new generation will have to pay more in contributions, retire later and receive less in actual pension allowance. As countries around the world face the problem of population aging, they find their tax revenues and what they can spend on elderly support in decline. The reality is that pensions are mostly an unfunded government liability. People think “We paid in all those years, so it’s just our own money coming back to us” and that’s a perfectly understandable viewpoint. It’s also wrong. For decades, politicians have underfunded public pensions. Governments have masked the severity of the problem by betting their investments would generate unrealistically high returns. In the US, retirement income security has traditionally been based on the so-called three-legged stool: social security, private pensions, and other personal saving. The largest chunks are by far private pensions which are heavily invested in the stock market, therefore people rely on increasing returns from the stock market, if these are not delivered, social trust in the economic system may collapse. The passive investment narrative which Wall Street keeps spinning is basically a Ponzi like system that needs continuous new money flowing into equity markets to prevent pension and retirement funds from collapsing. That is why there is such an enormous focus on stock market performance by US politicians, even though the stock market is not the economy. The big asset management firms that dominate corporate America such as Blackrock, Fidelity, Vanguard and others are positioned to benefit extremely well from this arrangement. Even if each one of these is very different in nature, for example let’s see these three: BlackRock is the world's largest asset manager and is publicly traded. The Vanguard Group is the largest provider of mutual funds and the second-largest provider of exchange-traded funds (ETFs) in the world after BlackRock. Vanguard is owned by the funds managed by the company and is therefore owned by its customers. Fidelity Investments is a private company controlled by the Johnson family. All of them benefited from central banks decisive actions to support equity markets by using tax payers’ money to bailout failing institutions, which mitigated these asset management firms’ losses. There are many other controversial situations emerging from these institutions that could be addressed, such as claims that the Johnson clan has a private venture capital firm that front runs its own customers at the Fidelity funds. For example if they invest in shares of one company and afterwards use Fidelity funds, with their market-moving buying power, to buy shares in the same company, that could be seen as propping up the values of their own holdings by using customer funds, a troubling conflict of interests.
What all of them have in common is that they all benefit from the Fed’s support of the stock market and the US government understands that social cohesion depends on the value of peoples pensions which depend on stock market returns. But this balance was predicated to receive one of its largest shocks to date: the big demographic wave of baby boomers hitting retirement. The baby boomer generation was reaching their retirement age in droves in the 2000’s and would be cashing out their retirement funds. This would lead to increasing generational stress to the pension system and a mass exodus from equity markets as boomers have already begun withdrawing their investments and went from being a productive member of the workforce contributing with steady payments into the pension system, to someone who was considered a financial burden. Any economic activities that depended on the capital courtesy of the baby boomers would be in danger. This shift would have a profound impact on society, it was the demographic time bomb that governments dreaded and which wasn’t addressed in government pension policy except through increasing debt levels to delay dealing with the problem. In plain terms, increased demand to have more people paying tax into the system, than people the government has financially dependent on it, is, in itself, the definition of a pyramid scheme. And we are heading to an inversion of the pyramid: countries that have more dependents than those healthy and eligible enough to work to support them. This reliance on internal debt to fund an increasingly larger proportion of retirees sets the stage for a generational conflict because it is the same thing as taxing the future generations and worsens their standards of living to benefit the current generation. The aging of the workforce is a significant demographic drag on the economy, and the easiest but very unpopular solutions for governments is to cut benefits and change the requirements to be eligible to receive a pension by increasing the age of retirement, or raise taxes, either of these can destroy any politicians’ career if done without a strong enough reason. It wouldn’t surprise me if someone in power and devoid of any emotion or compassion hadn’t already thought to themselves that people weren’t dying fast enough. Thanks to medicine, science, technology, innovation and sanitation we’re living longer lives than ever before, that increases the average life expectancy to far higher numbers than it has ever been. More people are surviving and for longer. This utopian dream of extending our life-span threatens the very stability of the current retirement system.
Central banks definitely needed a compelling argument to inject colossal amounts of money into the economy and keep interest rates low. The advent of the Pandemic crisis was not wasted by those in power. As someone once said “never let a good crisis go to waste” and this one was used to offset what was essentially an impending threat of economic collapse. When the pandemic first hit, and it took hold, investors rapidly sought to reduce risk and stockpile cash. Market confidence receded very quickly, and liquidity came under significant strain, over-leveraged corporations were haemorrhaging money. This massive selloff across the board was a buying opportunity of a lifetime. It was a revenge opportunity for the small guy who didn’t benefit from access to the boom of cheap money and bailouts that Wall Street had received, and could now acquire assets for a fraction of their price. For a brief moment it seemed that it was judgement day for those that gambled above their means, that the day of reckoning had come. But the Fed couldn’t allow that to happen. They had to keep the party going, the music couldn’t stop until the right people were the ones sitting on the musical chairs. It was scary how timely the Covid-19 pandemic hit and the way central banks and governments took swift action. Central banks and governments took considerable measures to support the economy and market liquidity started to flow again. Quickly enough, the markets had recovered, blatantly supported by central banks intervention. While sadly, the coronavirus was taking its toll on the older generation, providing some relief to governments’ obligations in the worst possible way. Some even dubbed coronavirus the Boomer Remover. But my job isn’t to speculate on conspiracy theories, my job is to speculate on the future price of goods and profit from their fluctuations. Nonetheless, I believe it is pertinent to understand the innards of what affects those fluctuations.
During the coronavirus pandemic in 2020, Jerome Powell, the US Federal Reserve Chairman nominated by Trump tried to save the financial markets by injecting trillions of dollars. After its initial crash, the stock market sharply turned up as trillions of dollars were used to rescue the free falling stock indexes. Such unusual measures changed the role of Federal Reserve from an independent central bank to a market operator. In close cooperation with each other, other central banks soon followed suit and threw all available monetary tools they had at their disposal, starting with conventional rate cuts. They also swiftly injected liquidity by increasing the size and duration of their lending operations to the banking system. They eased credit conditions for the real economy by offering targeted lending programs that incentivized bank lending to corporates. Resuming asset purchases was another tool used, such as public bonds. The purchases of public bonds by central banks enabled governments to provide fiscal support to their economies. All central banks in major developed economies intensified their purchase of corporate assets and started or restarted buying commercial papers of nonfinancial issuers. Leading to some widely criticized cases such as, the purchase of Hertz bonds which I already mentioned. This removes the risk of owning equities and creates a moral hazard, as companies aren’t allowed to go bankrupt, so there is no risk for the investor, he can just buy equities and ride out the dips and any volatility, waiting until the price increases above his purchase price to sell at a profit. Or he can just collect dividends every year. He just needs to wait out any corrections, prices will come back up. Central Banks will make sure of that. You can't lose in that market, it's like a slot machine that always pays out, causing some traders to even claim that “stocks only go up”, but the record highs in assets were due to the actions of central banks, that’s the reason why we’ve seen prices going from one record high to another despite completely changing narratives. Central banks’ actions to combat the financial effects of the pandemic saw them more overtly embrace asset bubbles as an acceptable consequence of their actions. The simultaneous potential bubbles in bond markets, the equity markets, and laterally in the housing markets, became known as the “Everything Rally”. The plunge prevention team was hard at work again and might have gotten addicted to propping up markets, even if the stock market is not the economy. Many warned of market psychology becoming dangerously unhinged from market fundamentals. Central banks complete dominance over financial markets may be criticised under the free market premise, and their adoption of asset bubbles, resulted in levels of wealth inequality not seen in the United States since the 1920s. The use of asset bubbles was also partially culpable for the K-shaped recovery that emerged post the coronavirus pandemic, where asset bubbles insulated the wealthier segments of society from the financial effects of the pandemic, at the expense of most other segments, and particularly the younger non-asset owning segments such as millennials. Central banks use of asset bubbles, and their resultant widening of wealth inequality, could lead to political and social unrest. But there is no obvious way for ending this one-way ratchet, which provides a floor for stock and bond prices but never a ceiling, any attempt by central banks to abandon this strategy would trigger a sharp sell-off by investors who have become addicted to monetary stimulus.
By the end of 2020, Wall Street investment banks recorded their best year in history, which makes 2020 a great year for Wall Street, but a bear market for mankind. To deal with this dissonance and incorporate it in my trading, I continued to put prices of everything in gold terms, only then could I have a sense of real value variations.
There’s a certain presumption that what can be shut down can be reopened, that the natural course of events is a rapid economic recovery. The reality is that business assets have been diminished but their liabilities have not. This is similar to what happened after 1929. There was very little economic activity. And the reason for that, is that once certain kinds of activity go down, investment in the durable goods necessary for those activities falls to zero. For example many businesses stopped using their office space during the pandemic and shifted to working from home. As a result, there’s a lot of empty office space. So who would build a new office building? Also people are probably driving less than before, so cars are getting much less depreciation on them than they otherwise would. So chances are they’re going to last longer. Cars obviously aren’t going away, but producers are dependent on the flow of new demand, and that’s also going down. You can flood the system with cash on a short-term basis, but that doesn’t solve the investment problem or the consumer-demand problem. So inevitably, there’s going to be a big reconfiguration.
As long as interest rates are close to zero, and idle money sits there depreciating due to inflation, then crazy stock valuations should continue to soar. The public, left with no other option to park their cash (currencies are devaluing, making gold too expensive, treasuries don’t offer any risk premium due to artificially low rates), has to go into equities. The problem is that the system can’t afford to have the small guy living just from his winnings in the market, or else he would stop having any incentive to slave away as a productive member of the workforce. When inflation threatens to run amok and the hyperinflation monster looms beyond central banks control, they believe they have one infallible hammer to quell it: raise interest rates. The system pulls the rug on the unsuspecting public and the bubble bursts the minute interest rates go back up. The only problem with this solution is that every over extended investor will try to liquidate at the same time, leading to a crash of epic proportions and when everyone runs for the exit, someone will be left holding the bag, transferring wealth from the many to the few once more.
Please don’t become salty about the facts I just described, they are just my interpretation, and my intention is not to cause you to plain hate capitalism or want to “stick it to the man”. I simply wish you to learn the rules of the game, so that you can better use them to your advantage and perhaps hope that more people become conscious for the need to implement economic transformation and establish a new global financial architecture, as bold in its own way as Bretton Woods was but hopefully benefiting a larger share of the population.
The general population is somewhat clueless as to how the system works, they are diverted from class conflict to other types of conflicts such as generational, ethnic, ideological, religious or other, it amazes me how the time tested playbook of creating an enemy, then pitting each other against that same enemy still works so well. Instead of questioning, people prefer to focus their lives on entertainment, consumerism and materialism and are fed illusions of the possibility of getting rich quick and promises of personal freedom just like a carrot on a stick leading a work horse. Control of thought is more important for governments that are free and popular than for despotic and military states. The logic is straightforward: a despotic state can control its domestic enemies by force, but as the state loses this weapon, other devices are required to prevent the ignorant masses from interfering with public affairs, which those in power believe are none of the public’s business anyway, because they know best what is good for them. The public are to be observers, not participants, consumers of ideology as well as products.
In order to keep this system going unchallenged, mass media serves as a system for communicating messages and symbols to the general population. It is their function to amuse, entertain, and inform, and to inculcate individuals with the values, beliefs, and codes of behaviour that will integrate them into the institutional structures of the larger society. In a world of concentrated wealth and major conflicts of class, to fulfil this role requires systematic propaganda. Moreover, media undermines markets by creating uninformed consumers who will keep making irrational choices that benefit established institutions over their own best interest.
Those entering the system are unlikely to make their way unless they conform to these ideological pressures, generally by internalizing its values; it is not easy to say one thing and believe another, and those who fail to conform will tend to be weeded out by familiar mechanisms. This sets up and maintains a system of doctrines and beliefs which will undermine independent thought and prevent a proper understanding and analysis of national and global institutions, issues, and policies. Instead of citizens, it produces consumers. Instead of communities, it produces shopping centres. The net result is an atomized society of disengaged individuals who feel demoralized and socially powerless. The beauty of our system is that it isolates everybody and you can’t fight the world alone. This is only possible by excessive influence over media and over politics, consequence of a too strong concentration of capital. The system tends to continue in this direction where wealth and power will get more and more concentrated. Democracies are susceptible to capture by those at the top, unless democracy is renewed by the masses every now and then rising up.
There was something fundamentally wrong with our system which made me understand better now those who claimed that taxes to the rich could be a tool to erode the mechanism that perpetuates wealth concentration. I don’t know what the best solution is but even if our entire economic system and all fiat currencies need to collapse for the system to be improved, I am sure we will find a solution. We shouldn’t fear its collapse, I will bet on mankind’s ingenuity and its capacity to reinvent itself any day.
End of chapter 11, read more