Andrea Zacher

In 1971 I was married while in college. I distinctly remember inflation in gasoline and food prices. I also remember wage and price controls because our landlord made us “rent to buy” furniture from his cousin as a way of increasing our rents. I have no recollection of what was happening with wages, but my research shows there was a huge surge in labor costs.

In all these cases, scarcity created inflation.

Like many of you, I am confused about the inflation we are experiencing in 2021, especially wage inflation. With 9 million job openings, and 9 million unemployed workers there appears to be balance and no possibility of labor scarcity. 

I can see why many Fed watchers buy into the temporary nature of the workforce imbalance. All will be well in September when unemployment subsidies expire and kids go back to school.

I am less sanguine about central banks’ ability to control outcomes given so many known labor variables, and at least three or four that could arrive as surprises. I also have absolutely no confidence the Fed really has the chops, like Volker in the 1980s, to fight wage inflation by persistently raising interest rates.

Population Growth, Aging Boomers and Generation Z

The current Pandemic and its first variant come at a time when there are meaningful demographic, societal and lifestyle changes in the United States.

A July 31 article in “Barron’s” by Lisa Beilfuss entitled “The Labor Shortage Is Worse Than It Looks, and Help Isn’t on the Way”, questions the soft landing and predicts high wages for the foreseeable future. Her thesis is wage inflation from labor scarcity will be pernicious because of these trends:

• Baby Boomers are retiring
• Birthrates in the U.S. are falling
• Stay at Home Parenting may not end
• Entry Wages have already moved up
• Safety Net Programs, Like Child Care Credit, will persist
• Resurgence of Infections will discourage physical work

On top of these trends we will all probably agree the world is no longer our back-up employment pool. Tariffs, immigration policies, nationalism, re-shoring and trade wars will limit the amount of goods and services that can be outsourced for cheap labor.

There is also a fear Generation Z will not work in lower paying jobs like restaurants, hospitality and manufacturing.

Baby Boomers Are Not Coming Back To Work

The Baby Boomers are retiring. The Pandemic accelerated the trend, and now they are no longer a dependable replacement for the 9 million unfilled jobs. The oldest boomer is now 75 years old. That cohort was attentive to the dangers of the first round of infections and they already have credible fears about the delta variant. I would be surprised if they are a pool from which unfilled jobs can be had at any price.

Here is early confirmation of that trend from “The Daily Shot” on August 2:

A Second Wave May Bring Children Home

The second wave risk also impacts children, schools and daycare. From everything I have read this second wave is much more contagious than Covid-19, and is making younger people sicker than the first wave. Why would we expect a return to normal schooling when the infection rates are likely to sky rocket in September? Stay at home parenting (mostly Mom’s) is unlikely to go away and that means fewer workers.

Automation Is Coming, But Short Term Will Not Help

There is a whole swath of GDP like hospitality and industrial that requires physical presence and physical work. The hybrid work model doesn’t wash dishes, make beds or run production equipment. According to the National Restaurant Association the restaurant segment alone accounted for 10% of the US workforce in 2019. It relies on lower wages to make its business model work. Short term, automation will not fill the gaps.

Will Gen Z Go To Work For Minimum Wages?

There is a fear Generation Z will simply not work in many of the industries where jobs are plentiful like retail, manufacturing, or hospitality. This cohort is estimated at 90 million people under age 25. When McDonald’s is advertising $15.00/ hour plus benefits and the 18-20 year olds are not showing up there is a problem.

Ms. Beilfuss says the job switching reservation price now exceeds $70,000. This would suggest the entry level wage and benefits for 2000 hours is no longer $30,000. The inflation in rents, food, and homes may compel a much higher entry wage. Is it also possible the Gen Z pool won’t budge for less than $20.00/hour wages and benefits? Here is research from Glass Door about Gen Z’s top ten job interests and positive attributes (“Pros”) they seek in employment:

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One thing is certain about Gen Z, they don’t want most of the entry level jobs that are available in hospitality and manufacturing.

Worldwide Cheap Labor Interruptions

Covid-19 has muted immigration, and tariffs have ignited a re-shoring rhetoric.  Whether labor demand follows the rhetoric is still to be seen, but it is just one more variable impacting possible wage inflation.

Wages have already increased by 10-20% for most of the manufacturing companies in our portfolio. Scarcity in the workforce and a mismatch of skills and interests puts any business with a production model in an impossible labor situation where the only long-term solution will be higher wages.

The Fed says it has a firm grasp on the tiller, but I don’t think they are prepared for a few rogue waves like a massive gap in skills matching and the number of workers who can or will show up in person. The only way to get them to work is to raise wages and wage inflation is the hardest kind to cure.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

In the late 1960’s a large population cohort, the so called “Baby Boomers”, had an existential choice between fear of loss and the hypnotic call from Woodstock. Here is the first verse of Joni Mitchell’s epic song ” Woodstock” that captured the moment:

I came upon a child of God

He was walking along the road

And I asked him where are you going

And this he told me

I’m going on down to Yasgur’s farm

I’m going to join in a rock ‘n’ roll band

I’m going to camp out on the land

I’m going to try an’ get my soul free

The Boomers participated in Woodstock, smoked pot, wore bell bottoms, had love beads and grew long hair. It sure looked like a whole generation of children from World War II parents was going to opt out and forget about getting a job.

Then a funny thing happened. They graduated from college or grad school and they were no longer targets for the draft board. They were sufficiently estranged from their parents that they set out on their own.

Guess what? They had to find a job because there was no alternative. There was no concept of governmental safety nets or student loan forgiveness. You had to cut your hair and go to work.

The Great Resignation Of 2021

Fifty years later in the aftermath of the worst pandemic America has experienced since 1918, there is a new trend that is documented in a report published by Microsoft in June of 2021 entitled “The Next Great Disruption In Hybrid Work”  It predicts a large percentage of the world’s work force has or will quit their job:

“With over 40 percent of the global workforce considering leaving their employer this year, a thoughtful approach to hybrid work will be critical for attracting and retaining diverse talent. To help organizations through the transition, the 2021 Work Trend Index outlines findings from a study of more than 30,000 people in 31 countries and an analysis of trillions of productivity and labor signals across Microsoft 365 and LinkedIn.”

The Microsoft Report has some interesting conclusions:

• Flexible Work Is Here To Stay
• Leaders Are Out of Touch With Employees
• High Productivity is Masking an Exhausted Workforce
• Gen Z is at Risk of Dropping Out Completely
• Talent is Everywhere in a Hybrid World

I have since read numerous follow on explanations for this employment migration. NPR, BBC, CNBC, Tech Republic, The Guardian, ABC, The Boston Globe, Forbes and The Foundation For Economic Education all have theories:

• Stay At Home Parenting
• Long Commutes
• Fear of Workplace Safety
• Sign On Bonuses
• Work/Life Balance
• Higher Pay
• The Nuclear Family

The Real Reason Workers Are Quitting

But only one explanation makes sense to me. Workers are quitting because they can!!!!

Government safety nets and manufactured prosperity like unemployment insurance, moratoriums on evictions and mortgage foreclosures, rent controls, delay in federal tax payments, surging asset valuations for many asset classes like homes and common stocks all come together to eliminate fear of loss.

The “Foundation For Economic  Education” makes the most interesting observation:

“Obviously, without the guarantee of a cushy taxpayer-funded unemployment payment, many of these employees would not have the luxury of simply quitting their jobs. They would have to increase their value if they wanted to demand new working arrangements on the market, or build their way into new career paths while still holding down employment in the meantime.”

Three rounds of stimulus payments totaling more than $850 billion may have simply overwhelmed worker responsibility for self improvement as a stepping stone to a better job with aligned benefits. It may be easier to quit and figure it our later when the subsidy runs out.

How Will This End

I am not sure how the “great resignation” will end, but it portends different relationships between employers and employees with hybrid work at the core of that relationship. It also foretells an uneasy competition between the private sector creating jobs, and central authorities providing many good reasons not to work.

The hypnotic call of getting paid not to work will likely overwhelm fear of loss to become the siren song of 21^st century, and the new generation will be back on that road to Yasgur’s farm.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

Just when you are about to give up on the American people’s ability to make sound financial decisions they surprise you. Conventional wisdom suggests when you win the lottery three times in a 12-month period you buy a car, a house, and a boat. That was what the economists thought would happen when they recommended three rounds of stimulus as a financial shot in the arm of the American consumer.

According to a recent article from Forbes in June of 2021, written by Zack Friedman “Here’s How American Spent Their Stimulus Checks” the recipients did something unexpected:

With each new influx of cash the recipients spent less, saved more and paid down debt. This is a nightmare for fiscal policy makers and reminds me of what happened in Japan after their real estate crash in the 1980s. Their whole nation became savers.

Not surprisingly, the average monthly savings rate for every month since March of 2020, has increased dramatically and the cumulative “excess” savings now stands at more than $2.5 trillion according to “The Daily Shot” and “S&P Global Market Intelligence”:

Stimulus checks don’t stimulate anything other than financial peace of mind and a good night’s sleep unless it has a “use it or lose it” conditionality.  One of the reasons central banks all over the world are now considering their own digital currencies is digital accounts could evaporate if the stimulus is not spent by a certain date.

What policy makers had hoped for when they allocated more than $850 billion of stimulus was an irresponsible, financially illiterate group of recipients. Not surprisingly, the economists were out of touch with the strong survival instincts of the electorate.

If you want a barometer reading on the U.S. consumer’s outlook, I would say the barometric pressure is falling below 29.00, and the consumer is predicting rain turning stormy. Rainy day mentalities lead to rainy day savings.

The above commentary is for informational purposes only. Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

I am sure all of you have noticed man’s best friend is one of the most popular trades during the Pandemic. My brother’s family now has four dogs. My sister has three. My daughters have multiple pets.  Research shows Gen Z and the Millennial cohorts are buying up pets as fast as real estate is selling in Cleveland. The only group that is not is the aging baby boomers who, like the McCreary family, have decided that pets are too big a responsibility and way too expensive for a fixed income. Here is an excerpt from The American Veterinary Association describing the explosion of pet ownership during the pandemic:

The American Pet Products Association reported in its latest “COVID-19 Pulse Study” that 11.38 million U.S. households have gotten a new pet during the pandemic. Furthermore, the human-animal bond remains strong, with 3 out of 4 pet owners saying that spending time with a dog, cat or another animal species helps reduce their stress and increases their sense of well-being during COVID-19.

Pet Markets Have Their Own “FANGS”

Pet ownership may be easier to understand than the stock market, but its popularity with the masses has similar characteristics:

• Getting a dog or cat is usually pretty easy and many pets are free just like trading on Robinhood
• Pets have a high ESG score except for cows producing methane
• Average monthly budget outlays for dogs ($450) and cats ($53) are like monthly interest on your margin account
• RTW (return to work) will be harder on pet management than WFH
• Time for day trading and pet care will likely decline at the same rate
• The high-end pet market has its own set of “fangs” with Labrador Retrievers, Golden Retrievers, German Shepherds, Goldendoodles and Chihuahuas being popular holdings
• Puppy mills with low barriers to entry will thrive
• Inflation will make the monthly cost of pet ownership start to feel like a variable rate second mortgage
• Like getting rid of grandma, exiting your pet “fang” positions will be nearly impossible

Equity Research Expects Big Growth

Whether the popularity of pet ownership is at risk apparently is not in doubt for equity analysts from various firms following that industry. Take the company ZOETIS (ZTS, NYSE). According to equity research from Raymond James published on May 6, 2021, this worldwide leader in commercial and consumer medical products for animals is currently trading at 25x projected EBITDA.

According to Raymond James, it is expected to have slightly more than $7.5 billion of 2021(E) revenues divided into two segments: $3.04 billion for “Livestock” medical products, and $4.45 billion of medical products for “Companion Animals” like dogs, cats and horses. The biggest growth market is the USA, but China pet ownership is thriving. 

Raymond James projects that ZTS “Companion Animal” revenues will grow to $6.5 billion by 2025, while livestock revenues will remain flat. The compound average revenue growth rate on the meds for pets segment is 9.9%. The same period projected CAGR for net income is even higher.

But These Products Are Expensive

Even though the world is awash in liquidity and pet ownership is a logical antidote to the stress of Covid-19 isolation and WFH, we are not talking about pet food, toys, collars and chews. These are dermatological, anti infective, and pharmaceutical products as well as vaccines and animal health diagnostics.  Liquidity has fueled the pet trade, but can it really sustain a 10% growth rate for dog, cat and horse meds?

Add Some Betta To Your Portfolio

I consulted my 11-year-old granddaughter about the pet ownership and care market. She wants to be a veterinarian, and her family has beagles and she knows they are really expensive. Day care, food, grooming, flea and tick meds, pet treats and toys all add up. I asked her for some advice for new owners who may find the cost of pet ownership in an inflationary environment is a backbreaking discretionary expense.

She recommends getting a Betta fish, which is a Japanese breed that only has to be fed once a month and sleeps most of the time. No meds, collars, toys, or treats and they are perfectly happy if you return to work. Monthly cost of ownership is probably under $5.00 including aquarium upgrades. Her father closed the circle for his daughter by explaining that Betta fish, like some of his favorite value stocks, also have a very low Beta.

Betta fish soon may become a popular RTW trade on Reddit, possibly combined with a paired strategy of shorting numerous cats and dogs found in all corners of the stock market.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

I am thrilled for the true believers in the Reddit crowd who have learned to manipulate the stock market. Their formula appears to be working well with notable successes like Hertz, GameStop and now AMC.

In almost every case the cookbook recipe reads like this:

• Find an asset that is essentially worthless from a fundamental standpoint, but with good name recognition
• Toss in a scarcity of float and owners in a liquidity crunch
• No extra spice needed if there is a hedge fund with a massive short position
• Find a sponsor like Roaring Kitty (a real person) and pump the idea of a coordinated buying on Reddit or other social media
• Take the pledge to never sell and demonstrate you mean it
• Then sell some on the way up to get your investment back
• Mix and Repeat, Mix and Repeat, Mix and Repeat, Mix and Repeat…

I would be even more impressed had these “chefs of the coin” come up with the idea on their own.

Put The Apron On Powell and Mnuchin

Having learned the golden rule that any good investment scheme available to you and me is usually benefitting some really smart guys, I immediately knew Roaring Kitty did not publish this cookbook. He had great inspiration from the Chairman of the Federal Reserve Bank and The Secretary of the Treasury.

In March of 2020, when the world economy hit the brakes, billions of dollars of worthless assets were created almost overnight. Lack of liquidity in trading markets, investor panic, collective ownership through ETFs, and huge counterparty risk on derivative assets like collateralized loan obligations were mixed together in an unappetizing asset goulash. The Chefs on call were Powell and Mnuchin.

Their recipe was dusted off from 2008, and included lowering interest rates for bank short term liquidity. However, the enormity of the appetite for liquidity proved the ’08 salt and pepper seasoning inadequate. This time there were a few more ingredients in the spice rack including special purpose vehicles (SPVs) to buy assets on the open market. It would have been illegal for the Fed to do so if those assets had not been “adequately secured,” so Chef Powell asked Chef Mnuchin to have Treasury make sequential $10 billion equity infusions in several of the most important liquidity providing SPVs.

Without getting caught up in the mind numbing, and possibly illegal, structures, the two Chefs pledged the full printing power of the US Mint as liquidity for every asset class. It was a coordinated worldwide effort to create liquid markets for every asset class, especially those assets which were fundamentally worthless. The Chefs also made it clear that they would keep buying until they were controlling prices in every market. Their SPVs started buying and only stopped when all markets had returned to normalcy.

The Fed Is Now Unwinding at a Profit

While I could not find any information about specific assets or prices, I know Powell and Mnuchin (now Yellen) are quite pleased with the result based on a small invested amount and the high return on investment. Triple C credits were bought in March of 2020 at substantial discounts to par and now the market for junk bonds is treating that same credit like gold. Here is how Brian Chapatta writing for Bloomberg Opinion on June 2, 2021 described the round trip:

“The central bank said late Wednesday that it would start to gradually sell the $13.7 billion portfolio of U.S. corporate debt and exchange-traded funds it amassed through its Secondary Market Corporate Credit Facility, which was created during the worst of the pandemic-inspired market meltdown in March 2020. The facility marked an unprecedented intervention for the Fed because it effectively pledged to plow hundreds of billions of dollars into company debt if no one else would. That backstop, even if it wasn’t fully used, quickly restored investor confidence, led to a ferocious rally in practically every corner of the bond market and encouraged record-breaking amounts of debt sales from investment-grade and high-yield borrowers alike.”

There are Fed footprints in the flour, however, and once again speculators have been saved. This time it is primarily weak companies issuing more market debt, albeit at lower interest rates and more favorable terms of payment because of the SPVs. While the Fed did not directly intervene in equity markets, its $120 billion per month purchase of its own debt has created money that ended up in home purchases and red-hot equity markets. In many ways Powell and Mnuchin/Yellen are now executing the pump and dump strategy you see in GameStop and AMC. They are still acting like buyers by printing money, but selling into the inflationary liquidity they have created.  Here is how Mr. Chapatta describes the moral hazard:

“What’s more, the Fed’s facility may have served as something of a stealth rescue of the mutual-fund industry. Just before it was announced on March 23, investors pulled a record $35.6 billion from U.S. investment-grade bond funds, a record $12.2 billion from muni mutual funds, $2.91 billion from high-yield funds and $3.45 billion from those tracking leveraged loans in the span of just a week. Can this kind of exodus happen again if the takeaway from March 2020 is that the central bank is just around the corner? And what are the risks of that kind of complacency?”

Meme Asset Recipe Still Being Written

All I know is the “meme asset” market was not invented by Reddit and Roaring Kitty, and I also know it now has expanded to include many billions of questionable financial assets. If the Reddit crowd thinks imitation is the most sincere form of flattery, maybe they should be getting out like Powell and Yellen before the Fed stops injecting liquidity?

On the other hand, maybe the Fed knows it can’t raise interest rates or remove the “all asset” safety net? In fact, maybe inflation is just the right spice with a sprinkling of yield control to keep interest rates low? The experiments in the kitchen supported by taxpayer checkbooks will likely continue. The aroma from the kitchen is quite appealing, especially to the owners of meme assets.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

If you explore the history of money, you begin to understand why crypto currencies are beginning to compete with monopolistic monetary systems dominated by central banks.

First Money Was Jack And the Beanstalk Model

The first system was a “Jack and the Beanstalk” economy where a farmer could physically trade a cow for something else like silver, sheep or seed corn, or, if you were a speculator like Jack, magic beans. It was a peer-to-peer economy without central supervision, permission or middlemen and ordinary citizens could dream of waking up with a beanstalk leading to a pot of gold.

However, that decentralized system did not work if you had to travel with your cow across the ocean to trade for silk so the English came up with a centralized system. The East India Company was chartered by Elizabeth I as the exclusive trading organization between England and Asia.

If you wanted to trade your cow in England for silk in Asia, the East India Company would make that market by issuing its letter of credit in pounds for the cow at a port city like Liverpool and an individual could take a ship to Asia and present the letter of credit to the East India Company office there and shop for silk in the native currency.

The system had lots of middlemen who charged fees along the way for providing currency, much like Western Union today. It worked based on trust and the implicit backing of the Queen of England. It was a permitted monopoly and the beginning of crony capitalism as a successful partnership model for expansionist governments and eager capitalists everywhere.

Banks Became The Next Private Monopolies

Over time, private banks replaced the East India Company, but the concept was the same. Banks were chartered by states and governments as private monopolies .You could sell your cow for silver and deposit it in a bank and the bank would protect your silver and post your balance for all of its branches to allow you to make withdrawals. The banking system was scalable and centralized, but not secure. Every 10 or 12 years too many of the banks would fail and the wealthy owners of these implicit monopolies would be wiped out. Too many bankers were lending depositor money for magic beans and depositors did not trust the banking system. Runs on the bank were commonplace.

A New Cartel Gets The Power To Print Money

To promote confidence in the system, centralized banks representing governments began to emerge. They put their full faith and credit (and the taxpayers’ wallet) behind the always failing banking system. For example, The Federal Reserve System in the United States was secretly created in Jekyll Island in 1913. A flimsy, unreliable decentralized banking system comprised of geographic monopolies became more stable and secure once it was controlled by a central bank.

In addition, this new central bank was largely unsupervised. The Federal Reserve Act granted it central authority to create money. The only supervision was its Board of Governors appointed by the President.  Taxpayers underwriting the money creation did not have a seat at the table. Congressional approval was not necessary.

However, runs on the bank could now be handled by Federal Reserve cash infusions. Bank owners were happy and depositors were happy, but monetary expansion was still hobbled by the pesky gold system where money creation was tied to gold reserves.

System Decouples From Gold

That would change in 1933 when FDR abrogated the gold contract and again in 1971 when Nixon abolished the gold standard completely. Suddenly, money creation was not only unsupervised and unregulated, but its expansion was no longer tethered to a finite resource like gold.

Today, central banks all over the world manage fiat economies by dictating the currencies that will be accepted for commerce and by lending their money creation support only to those currencies. Central banks worldwide have followed the United States’ playbook and also gained the power to create money.  We are now experiencing an era of unprecedented monetary expansion

Not Much Had Changed Since the 1600’s.

These central banks are also influenced by the same money cartels that influenced the creation of The Federal Reserve System. Unsurprisingly the same implicit monopolies emerged. The East India Company was reincarnated as Goldman Sachs and JP Morgan.

Thirty years later there was the Dot Com Crash

Thirty-seven years later there was The Big Recession

Without Fanfare Bitcoin Was Introduced In 2009

Thirty-eight years after the monetary system went off the gold standard Satoshi Nakomoto introduced Bitcoin and the decentralized blockchain ledger that validates ownership.

Since then more than 100 different crypto currencies have been created most of which work on the idea of ownership being validated by the users, not by fiat or the implicit guarantee of a third party. These systems are also permissionless and without boundaries.  Because it is digital and connected by the internet it is accessible all the time all over the world.

An Immutable Constitution

Along the way communities of supporters and believers began to warm to its democratic principles where a centralized source of power and wealth is not picking winners and losers and where the value of the new currency is based on a limited supply and an immutable constitution. For the first time since Jack and The Beanstalk implicit monopolies were being challenged by a peer-to-peer system where the upstart users were in control, but no single party had undue influence or control.

Validators of blockchain authenticity were paid in that currency. Security was based huge computing power based on large investments in hardware and electricity. The incentive to corrupt the system was overridden by the huge expense of gaining a 51% control and the possible loss of huge financial gains from Bitcoin’s rapid appreciation.

Internet, Moore’s Law and Populism Define Its Future

The implications for crypto have become clearer for me. The cost of computing power has fallen according to Moore’s Law to match the security model for blockchains based on proof of work which requires increasing computer power and huge amounts of energy. Proponents are “hodlers” meaning they are long term holders and will never sell. Scarcity is not only built into the constitution that limits the creation of Bitcoin to 21 million, but also in the trading characteristics of its supply and demand.

Crypto alternatives are decentralized, permissionless, borderless, worldwide, “always on” and proven.  Bitcoin is called digital gold because it has a finite supply. It has a predictable creation schedule and its blockchain has never been corrupted. It is co-existing with fiat systems because it is accepted as a legitimate store of value. Ethereum is emerging as the most logical disrupter of currencies and permission based middlemen.

Populists all around the world are tiring of wealth creation in the 21^st century not having advanced much from crony capitalism based on who you know and getting implicit monopolies like the East India Company did in the 1600s. Too many “magic beans” from bailed out speculators started showing up on The Fed’s balance sheet in 2008 and again in 2020

Finally, a younger cohort all around the world supports crypto. They remind us every day of their power to spin straw into gold. First it was Bitcoin, then Hertz, GameStop and AMC and most recently Dogecoin. This cohort understands the power of scarcity and concerted action.

You Can’t Buy Pizza

Detractors are mostly insiders like Jamie Dimon and Charlie Munger.  People who say Bitcoin is a fraud because you can’t buy pizza with it miss the point that you would never spend something viewed as a store of value appreciating at triple digit rates every year when you can spend US Dollars worth less every day.

The only question is which currency is really the magic beans. Crypto “hodlers” think they know the answer.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

Although the recent inflation message from Chairman Jerome Powell in response to Congressional inquiries is heartening, it does not jive with some really lopsided conditions I am seeing that remind me of the 1970s. Here is what Chairman Powell said on March 23, 2021 as he and Treasury Secretary Yellen testified before Congress:  

“We’ve been living in a world of strong disinflationary pressures for the past quarter century. We don’t think a one-time surge in spending leading to temporary price increases would disrupt that.”

Later in April, in response to written questions from Florida Senator, Rick Scott, he addressed the concern about inflation exceeding the policy objectives of 2%:

“We do not seek inflation that substantially exceeds 2 percent, nor do we seek inflation above 2 percent for a prolonged period.”

While I am always reassured by a central banker of Powell’s pedigree, I am not sure our leaders in Washington get out much, and they may not see some of the hints of inflation the rest of us are experiencing.

My first head shaker is how Cleveland can have the fifth highest year over year home price appreciation in the USA according to a recent Case-Shiller report (April 27, 2021), and how Detroit can even be on that list?

I can understand San Diego, Tampa and Phoenix where the sun shines more than 300 days a year, but why Cleveland and Detroit where the sun hasn’t appeared more than 300 days in this decade, and where Ohio is losing a congressional seat because of population decline?  When Cleveland and Detroit make this list, the Fed may have found the inflation it is seeking.

This is confirmed by my brother’s search for a home in Cleveland. He reports there are multiple bids for every house property, and everything sells above asking price. He cannot find a home at any rational price. I told him he could buy an 18 room Red Roof Inn on Route 8 for the same prices he is seeing now.

This Is Not A “Base Effect” Anomaly

I guess Mr. Powell doesn’t see meaning in the average year over year national average price appreciation of 12%. Normally, in a “big dipper” economy like we had from March 2020 to March 2021, that percentage increase could make sense because the base prices were so depressed. However, this recession came with real estate price supports, like moratoriums on mortgage foreclosures, and a healthy mortgage lending climate at almost every bank. So, the base prices mostly stayed intact.

I then reread Chairman’s Powel’s quote and he is only promising the Fed does not “SEEK” inflation above 2% but I guess 12.5% in Cleveland is ok if you are not seeking it and we should not be alarmed?

Finally, Something Fed Can Manage

Mr. Powell reminds me of a beleaguered freedom fighter who is out of weapons after having laid siege to an impregnable city called DEFLATION for 25 years.  Suddenly he has “shelled out” enough money to walk through its front gate with a big sword of INFLATION. His joy is infectious. He has finally created something he can manage. Here is another excerpt from Mr. Powell’s response to Senator Scott:

“We understand well the lessons of the high inflation experience in the 1960s and 1970s, and the burdens that experience created for all Americans. We do not anticipate inflation pressures of that type, but we have the tools to address such pressures if they do arise.”

Signs Of Inflation Abound

Common sense would suggest we all think about the biggest driver of inflation. In almost every instance, like 1970-1974, it is scarcity in goods and services. So what is scarce?

Think about labor. The various unemployment safety nets are crowding out entry level employees. The federal employee minimum wage may rise to $15.00/hour by Presidential decree. Every surviving restaurant in America is looking for help, and is thinking about robots instead. The manufacturing sector is struggling to fill open positions.  Manufacturing price increases are becoming commonplace and more frequent.

Raw materials are up. Anything associated with your home and its care is up. Silicon chips are up. Natural resources and commodities, including oil, are up.

Services are up, and good luck finding anyone to do that work.

Netflix is up. The price of Apple products is up.

Higher education has gone virtual, but tuition prices are still growing.

Constraints On The Fed

I agree the Fed has the tools to fight inflation (increase interest rates and stop injecting money into the economy) but the real question is whether they are so constrained by underfunded public pensions, leveraged equity markets, retail stock ownership, and political pressures they won’t have the will.

Buckle your seat belts. We may soon understand how scary a fully fueled, self-driving economy can be.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

My winter experience in Southwest Florida included watching the “BMFR” index redline at levels of conspicuous wealth not seen in my lifetime. For those of you who do not visit the Naples area, the BMFR index is the number of Bentley’s, Maserati’s, Ferraris and Rolls Royce’s you see on a regular basis on Fifth Avenue. There is even an event called Ferraris on Fifth, where vintage car collectors can display their collections.

This year with Covid-19 shutting down normal interactions the car show was a major event. Porsches, Jaguars, Tesla’s and Corvettes were also in abundance, but considered to be more of a ride for the proletariat.

Needless to say, I kept my Mini Cooper in the garage all weekend and since then have only been driving it at night.

International Owners Propose A New Soccer League

On the international business front there was also a display of conspicuous wealth as owners of major soccer (really “football”) franchises unveiled a plan to create a “Super League” comprised of 20 teams in a cartel business model like the NFL. This reorganization would have eviscerated the existing system where winning big money in the Champions League (a long playoff) turned on doing well in your country league or else qualifying through a grueling play-in format. A few of the clubs like Liverpool did not enjoy being denied automatic access to The Champions League due to Liverpool’s poor Premier League win/loss record. Liverpool was just eliminated from Champions League this year after losing a quarterfinal play in match.

The rationale for the new league was “more dough” for international scions/owners/oligarchs/oil sheiks who also redline on the BMFR scale. Maybe they were trying to have a system more like the NFL where good and bad teams alike all prosper, and where team revenues rarely go down.

Kings Bested by Knaves

The fan reaction was immediate and quite clear. Here is one post I read from a fan of Liverpool who commented on an apology by John Henry, owner of the Boston Red Sox and Liverpool, about failing his fan base. John Henry’s apology can be read here https://theathletic.com/news/john-henry-liverpool-apology-super-league/ypRzOthfzTgJ from a publication called “The Athletic” in an article written by James Pierce on April 21:

FAN “Oliver B. No, they don’t need to consult every single fan, that would be impossible. And no, they don’t need to consult on every single club decision (IE do we buy a certain player) but there are certain decisions that alter the future of the club in a drastic way (the super League, ticket prices) and there are decisions that will clearly hurt fans due to the working-class roots of the club and city (furloughing staff and Trademarking Liverpool). These are the sorts of decisions they need to consult fans on, in order to avoid making decisions that a) make them look incredibly stupid, short sighted, ignorant and horribly arrogant, b) show they know nothing about the history of the club and c) don’t care about the fans.”

Similar fan reactions all over Europe led to immediate withdrawal from the Super League by really talented clubs like Manchester City, and Chelsea. The self-anointed 12 quickly became 6 clubs as all of the English participants blinked and walked back a really unpopular idea. By the time I was writing this blog the Super League had disbanded after 48 hours.

Post Covid-19 Fans Rule

This is a pretty amazing immediate repudiation by the masses of a tone deaf, money- driven scheme by BMFR owners. The ability of fans to assemble and react almost immediately speaks to the power of communication tools like social media and the rise of populism as an economic hammer. Major League Baseball also blinked on populist reaction to alleged voter suppression in Georgia by pulling the All-Star Game from Atlanta. Corporations are tailoring their investor relations and corporate messaging to appease an angry crowd.

Merit and Achievement, Not Privilege

To understand the enormity of this repudiation it is also necessary to understand the European footballers have a business model that rewards merit and achievement. Hopefully, repudiation is also about the little guy having a chance.

Access to the really lucrative “Champions League” playoff brackets is based on annual domestic league standings. Powerhouse teams like Liverpool can be eliminated from The Champions brackets if they don’t finish in the top 4 of the Premier League, and nascent teams like Paris St Germain, who was runner up in Champions last year, can take their place and earn as much as 100 million euro from just one tournament.

Teams with big payrolls and big stars will not automatically qualify for The Champions League if their domestic league performance is poor, although they can gain a spot by succeeding in a play in bracket. This would be like the NFL allowing Canadian football teams to displace fan- based teams like Green Bay or Cleveland Browns in the NFL Playoffs and force brand names like the Patriots to try to re-qualify through a last chance bracket.

I wonder whether fan populism will now topple cartels like Major League Baseball and the NFL? Even though their wealth is redlining on the BMFR scale, empty stadiums tend to grab owners’ attention.

As we emerge from our Covid-19 caves and rejoin business, commercial and personal worlds, I have begun to wonder what institutions, interactions, professions, entertainment and lifestyles will be altered in a material way. For most of my life I have been on a hamster wheel of expected behaviors like showing up for work, interactions being face to face, and going somewhere other than home for socializing and entertainment. I never had any reason to consider whether that lifestyle was effective or fulfilling. It was just what you were expected to do.

Business Interaction In Flux

I have written in prior blogs about diminishing business travel and meaningful changes in spending on conferences, business entertainment, and customer retention https://capitalworks.net/covid-19-challenges-the-hamster-wheel-of-sales-marketing/. However, budgets for customer acquisition will probably increase as business reopens and “showing up” for face-to -ace introductions becomes a critical part of new business. Many of our portfolio companies have reduced sales expenses by curtailing “hamster wheel” business travel where time is consumed in travel to meet with existing customers. This line item will be slow to return given the apparent adequacy of online meetings for maintenance of relationships.

Business lodging is probably going to be a casualty as well. There are simply too many rooms for the permanent reduction in overnight business travel. Some entrepreneur will figure out how to repurpose that excess supply.

Medical Experiences Are Also Changing

Medical interactions are also changing. Covid-19 forced many non-surgical interactions with medical professionals online. I wonder about radiology and dermatology where super computers have databases for analyzing x-rays and scans that are more accurate than trained professionals. The biopsy process is at risk for suspicious skin growth. You can take a smart phone picture and data analytics can name the cells.  On the other hand physical therapy will be booming. Active aging comes at a price. The backlog of deferred physical therapies right now is like the “Ever Given” back up in the Suez Canal.

Our Spiritual Fulfillment May Be Virtual

The spiritual life may be undergoing major changes as well. I was shocked at the response I got when I asked several friends who were serious church goers before the Pandemic what they were going to do for Easter. They apparently have found spiritual satisfaction online. A couple in Florida has daily interactions online with broadcasts from Boston and Cleveland. They shocked me when they said they will never go back to accepting the mediocre spiritual content offered up by the parish church when there is such a robust alternative online. My father used to contend that religion was not meant to be entertainment. That opinion may now be turned 180 degrees. For the spiritual experience to survive, it may have to provide engaging and entertaining content including music, song and sermon. This could devastate religious communities already in decline from pedophile priests and swindling preachers.

Going To The Office Is Never Going To Be The Same

Going to office will mean something different as well. More and more employees will walk downstairs at 5:15pm in their apartments or homes and announce “Honey I am Home.” Collaboration spaces and conference rooms will remain, but the idea of the individual office is changing fast. If securities traders can survive in their profession https://capitalworks.net/an-insiders-tutorial-on-programmatic-trading, without any physical proximity, how hard can it be for the rest of us who are not required to make moment to moment decisions worth millions of dollars every 15 minutes? 

The whole business commuting ecosystem is probably going to shrink.  Parking budgets will be slashed. Commuter infrastructure like trains and buses may no longer operate for the primary convenience of the weekly commuter. Anticipating this possible shift, the current infrastructure legislation proposals for public transportation may have to be re-imagined.

Segmentation of Entertainment by Cohorts

National Parks, state and local greenspaces, cityscapes, beaches, and even outdoor recreation in declining sports like skiing and golf made a dramatic Covid-19 comeback. For the short term these are all popular alternatives to indoor entertainment.

I am not sure about more crowded venues like theme parks, movie theatres, stadiums, art museums, performing arts centers, and race tracks?  

Outdoor dining has also become preferable for an older generation who now perceives their longevity is at risk in crowded environments. Group interactions may balance out at about 60/40 physical versus virtual depending on the age cohorts involved. There may be a whole new segmentation of entertainment experiences for the various age cohorts as well. I know for certain I will be limiting my indoor, crowded experiences for a long time. I trust most of my age cohort to act responsibly because of mutually assured destruction, but I am not sure younger cohorts have the same risk equation.

One lesson from the Pandemic is PROXIMITY IS PERILOUS in a connected world where virulent flu seems to be as regular as rain. I am also concerned for the first time about germ warfare. Its disruptions are devastating and hard to trace. History has shown it can change the balance of world power. Germs have toppled some of the most advanced cultures like the Incas. That cannot be lost on groups intending to generate terror and fear.

Education Has Also Changed

Maybe nursery school, kindergarten and grades 1 and 2, will still mostly be face to face education, but after that I think education will be a mix of in person and virtual. The older the cohort, the more likely the experience will be virtual. The big question is what will people pay for 4 years of college when 60% of the experience may be virtual? Technology is inherently deflationary and the virtual product may be perceived as second rate.

Getting Off The Hamster Wheel

We have all been off our normal wheel long enoughto start asking these kinds of questions. Many things I have done without thinking over the last 70 years are no longer automatic. In many ways spinning that old wheel was its own purpose. Covid-19 has left many of us questioning why, where and when we want to jump back on.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

I have a friend who has spent most of his career upgrading the plumbing on Wall Street.  He is not a pipe wrench plumber, but rather one of the architects of the programmatic trading platforms for some of the 40 providers of liquidity that comprise the US stock market.

He now works for a prestigious principal trading firm where he leads a group that designs and implements both the hardware and software used for proprietary trading. His group will also provide similar infrastructure and software programming for customers of his firm.

I had the great pleasure of interviewing him about Covid-19 risk mitigation and how his world has been changed by retail traders. Let me introduce you to Algo Rim, whose name will be shortened to AR for purposes of this interview.

Rob: AR, thank you for helping us all understand the world of algorithmic systematic or “programmatic” trading. My first question is risk management during the Pandemic. How could you manage risk for your firm and its customers when your group was dispersed and you had to make quick decisions?

AR: Our firm is one of the 20 significant liquidity providers who make up what the consumer calls the stock market. Before Covid-19, our traders managed risk and made critical decisions in a face to face environment. The challenge after our offices shut down was to redesign our risk management systems to manage for the six sigma risk events. We put together a whole new playbook of policies and procedures to eliminate the need for risk management decisions in real time by the trading partners.

Rob: How did it work?

AR: We were quite surprised we were able to manage without any major problems, but we were highly focused on the possible disasters. It was all “need to have, not nice to have.”

Rob: How about March of 2020, when the stock market lost more than 30% of its value in a matter of weeks and then reversed and started rising again?

AR: Our programs worked the way we expected and we survived. We were able to get out early and then return when the order flows reversed.

Rob: This must be attributable to your hardware and software advantage as a programmatic trader? So what is programmatic trading? I don’t think most of us really understand it?

AR: Programmatic trading relies on a high speed, reliable flow of data that can be parsed and analyzed in nanoseconds. The speed is based on an infrastructure we use. The software is based on proprietary trading programs. Trades are executed on the basis of data analytics.  “If-then decision making” is faster than a blink of an eye. That is really fast.

The key inputs for risk management and profitability for us are an infrastructure advantage, a data flow advantage, and an almost automatic decision making execution advantage.

Rob: This reminds me of the book by Michael Lewis called “Flashboys”. Is that what your group does?

AR: Yes, but infrastructure is only one part. We have our own high-speed system like the traders in his book and we will also design a system for our customers who are professional investors. We can customize outcomes based on high-speed receipt and analysis of data.  You can work with us on just the plumbing, or all aspects of your customized trading solutions. It all happens at warp speed, and it is not unusual to close out trades the same day. Two days can be a long term position for any programmatic trader.

Rob: Are the other market makers using similar tools?

AR: Most retail investors don’t understand the stock market is really 14 separate exchanges and 40 private trading venues and a few single dealers. Together they represent a market ready to provide liquidity to both sides of a stock trade. But most of them are also using the high-speed plumbing and have massive data inputs to help them avoid getting stuck with a losing trade.

When you ask Fidelity to buy or sell 500 IBM and Fidelity goes to one of these venues for liquidity, the market makers are informed bidders and often hold a data advantage. This is especially true of the big providers like Citadel.

Rob: The new normal however, is the perception that the Robinhood “wolfpack” is defeating the high speed programmatic traders, and bringing down hedge funds with short positions by using social media to coordinate short squeeze “attacks”.  Is this right?

AR: There is a massive divergence between what you see and what is really going on. The Robinhood story, for example, is more about the stock market’s plumbing, Robinhood sold its GameStop trades to large liquidity providers like Citadel.

Citadel has the same high-speed plumbing as the other markets makers, so it began to develop a highly accurate picture of the retail book of orders. This information advantage enables the market markers to know where and how they want to trade. They have the speed, size and information advantage to make the best bet almost all the time, and they do not have the customer relationship with the retail customer because Robinhood sold the customer trade.

Rob: But is the Robinhood experience a true reemergence of the retail trade?

AR:  Yes. We could not believe our statistics, but now 25% of the liquidity in the market is coming from retail. Retail firms will be pressed soon to act like programmatic traders by allowing customized buy and sell programs with trading authorities, but it will still be mostly $2.00 stocks and fractional shares.

The long game is still controlled by a small group that has invested in high-speed infrastructure, has proprietary trading algorithms’ and bottomless capital.  Robinhood is like a little league team playing 160 games with the Yankees. Robinhood may win a few games, but the Algo Rims will always have a winning season.

Rob: Final question. Should we have concern about the concentration of market liquidity leading to long term volatility?

AR: The new paradigm is a really small group of market makers with an information, size and speed advantage with absolutely no obligation to provide liquidity. The programmatic and high frequency traders will be the first group to see a reversal and the first group to get liquidity.

The high frequency and programmatic trading firms represent 40-50% of the daily liquidity. When they disappear it could be a long drop before the value buyers step in to reverse the fall.

But the existing circuit breakers work and traders will have time to pause and reflect.  Whether the retail crowd can settle markets in freefall is yet to be seen.

Rob: Thank You Algo Rim.

If you think trying to understand Bitcoin (BTC) and its blockchain is difficult, wait until you have your first encounter with decentralized banking or insurance products. It will seem as daunting and risky as climbing Everest without a sherpa.

Because I am not qualified to guide in this emerging territory, I have asked Will Mason, founder of Upswing, LLC and an entrepreneur with knowledge about the space, to help me. Will’s commentary is shown in italics.

Will’s first step was to send me an article from Coinbase from January 2020 entitled “A Beginners Guide To Decentralized Finance (“DEFI”). Here is the link: https://blog.coinbase.com/a-beginners-guide-to-decentralized-finance-defi-574c68ff43c4

Here are a few kernels of insight.

• Decentralized finance products are like an app running on an incorruptible blockchain containing the rules of association for that application. Insiders call these apps “dapps”.
• The Blockchain is completely open source code for anyone to audit.  It is permission-less, public, transparent, and provides a very quick settlement.
• These smart contracts can transact a loan or a payment using a stablecoin whose value is pegged by smart contract to any currency, like the USD or with tokens that run on the network. This enables an internal, universal, borderless currency for the specific dapp. People can swap in and out of tokens of their own choosing without any permission. This is where UniSwap is one of the most important parts of the DEFI landscape as will be discussed below. 

Banking the Unbanked

“Using DEFI applications and stablecoins that operate on those blockchains, people around the world, who have never used a bank, will have access to banking services with their mobile phones.  If you live in a corrupt, poorly run government, it won’t matter much.  Many people in the U.S.A. will not realize the necessity of this.  Most of us are quite comfortable putting money into a bank and not worried about seizure by the government.  This is not the case for most of the world.  The ability to transact in algorithmic or collateral backed stablecoins or in a blockchain’s native currency, such as bitcoin or ether, will slowly but surely remove all fiat from the vast majority of transactions.  Smart contracts will allow the sender to send tokens to the receiver instantly, with instant settlement, in a completely public and transparent way, and there is not much any government can do about it.  A perfect example of how this will change things is in remittance.  Western Union’s business model will be challenged.  Why send money through Western Union, get charged a high fee, and have my family member have to go into a Western Union bank in Honduras where gangs are waiting outside  Yes, this happens all the time.  People not only pay a fee to Western Union, but they also have to pay a fee to the local gangs. With alternatives like Bitcoin, stable coins or tokens the unbanked are likely to choose anonymity, lower fees and no physical risk.“

Blockchain’s Security Doubles According To Moore’s Law

The key to all permission-less, decentralized networks, aside from popularity, is security. Security for the blockchain ledger supporting all the BTC transactions since inception follows the power of Moore’s law, which has demonstrated that computing power doubles every 2 years. Here is how Will Mason describes the level of security underpinning the Bitcoin blockchain ledger:

“If we set a difficulty rating of 1 for the first Bitcoin block ever to be mined, what is the difficulty rating now?  11 years of logarithmic adoption and by logarithmic enhancements in computing power bring the difficulty rating now to a staggering 21.7 trillion.  Another way to look at this is the network is 21.7 trillion times more secure then when it started.  This will only continue to grow, and at substantial rates.  More people are adopting it, which brings a higher price, which brings more miners, which secures the network more, which will make more people adopt it; so on and so forth.  This circular feedback loop is still in its infancy.”

Uniswap Is A Decentralized Trading Place

We are used to centralized trading markets being open 5 days a week with hours between 8am and 4pm depending on the exchanges. These trading markets are private businesses and they are usually publicly held and owned by stockholders. NYSE, NASDAQ, AMEX, CBOE, and ICE are all regulated by governmental watchdogs. Some critical parts of the centralized trading system are self regulated like the Depositary Trading & Clearing Corporation. Sometimes these exchanges are fined for not following trading rules and there are periodic audits. However, their information is private and there is little visibility by users into their day to day operations.

Coinbase is one such centralized trading places. Coinbase is privately owned and is in the process of preparing for an Initial Public Offering of its shares. It is regulated by state and federal agencies but it has horrible accountability to users. If a Bitcoin transaction has a glitch, good luck getting anyone to answer your email or call.

I am showing Will Mason’s description of Uniswap below. You will see it is organized and validated quite differently:

“Decentralized exchanges are exchanges with no middle point.  They are a Dapps (Decentralized Apps) that facilitate the exchange of tokens.  Using smart contracts, users can connect their web 3.0 wallet to the interface and swap one token for another with instant settlement. 

These decentralized exchanges run off a blockchain network like Ethereum, Solana, Binance, or Cardano, and there are LP’s (liquidity providers) who earn fees for providing liquidity to pairs of tokens.  Why would people provide this liquidity?  Every transaction that goes through Uniswap is charged .3% of the token that is being exchanged.  Those tokens are given to the LP’s who are providing liquidity.  The biggest liquidity pair on Uniswap right now is WBTC (Wrapped Bitcoin)- Ether.  This currently has $363m worth of liquidity and did $32m in volume over the last 24 hours, generating $96k in fees.  That $96k in fees is paid to the LP’s.  Whatever percentage of the LP pool you are is what percentage of the $96k you get.

Uniswap, which is the biggest decentralized exchange (DEX) on the Ethereum network, is currently doing $1 Billion in volume a day.  Yes, a day.  More than Coinbase.  The more people who use Uniswap, the more fees, which drives more liquidity providers; so on so forth.  At https://info.uniswap.org/home, you can look at total volume, volume for specific pairs, and the amount of liquidity that is locked up on Uniswap as well.  I have personally provided liquidity to several pairs to help bootstrap certain dapps.“

Blockchains operate with their own native currency, which can at times be somewhat volatile.  Stablecoins, such as USDC (which is backed by actual dollars), are the main medium of exchange on any blockchain.  This stable medium allows transactions for insurance products, banking services, and the purchase of goods with significantly less volatility.

Obviously, the aspiration is to eliminate the conversion risk and have the stablecoins become a replacement themselves for the Euro, USD, Renminbi etc. Right now that regime change is just a twinkle in a Bitcoin miner’s eye but centralized finance systems are being tested by the Covid recovery. There may be a Defi product in your wallet sooner than you think.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

My generation’s interaction with money, wealth, art, music, communication, commercial real estate, credit, finance, personal real estate, insurance and social interaction has mostly been through trusted third parties like Chase Bank, Goldman Sachs, Fidelity, Sotheby, National Title, Experian, Moody’s, Berkshire Hathaway, Depositary Trust Clearing Corp, ASCAP, Facebook, Apple and Google. These middlemen often have well established oligopolies based on controlling information, resources, capital, authentication, licensing or titling rights.

For the most part, my generation is hooked on middlemen. We would prefer calling someone at one of these brand name organizations rather than dealing with the issue ourselves. We like the idea of someone being in charge who can adjudicate disputes and resolve conflicts. We also have a whole set of industries devoted to influencing people in charge from lobbyists to PR firms.

In a recent article by Tyler Cowen, an economist at George Mason University, writing for “Bloomberg Opinion” on February 7, 2021 entitled “The Future Will Be Decentralized”, Mr. Cowen identifies the first decentralized organizations as the internet and blockchain. He may have forgotten “word of mouth”, but I get his point that no one person or entity owns or controls. For him centralized organizations are Facebook, Twitter, Amazon, Google and Apple. As public companies they are all built on a hierarchy where someone is in charge.

Forget Your BTC Password?

Decentralized organizations are peer to peer like Bitcoin and Ethereum. There is no final appeal to a higher power when you forget your password for Bitcoin. This may be one reason why Fidelity has been exploring custody of Bitcoin? A whole generation of its clients will never trust themselves to procure, store, use and dispose of Bitcoin. The margin of error is too high, and once a mistake is made, the BTC could be lost forever. Speaking about the transformations from centralized to decentralized models, Mr. Cowen comforts me when he admits he would rather put coins in the parking meter than download the parking app:

“Having grown up in an analog world, I find these ambitious visions both unsurprising and bewildering. On one hand, I have seen the transition of so much activity to the digital world that another major revolution should not shock me. On the other hand, (a possibly atavistic) part of me likes knowing that someone or something is in control, whether it’s a government, a bunch of people in Mountain View, or even just my dean.

“Life on the blockchain” feels alienating in a way that goes beyond old-style Marxist concerns. (Remember, I am the kind of guy who prefers to slip coins into the parking meter rather than download the app.) When I ask myself what services I am really missing, I find I’m far more interested in a new Chinese restaurant in my town than new open-source platforms to enable innovations I will never quite understand.”

Creators May Have A Different View

If you are an artist, a song writer, an author, an investor, a collector, a home owner, or a small business owner, you are completely reliant on a centralized authority to help you monetize your intellectual or physical capital. If you want to sell art you have to go through a dealer to sell. The economics favor the dealer, not the creator. If you want to sell your home, you need a realtor. The economics favor the realtor who profits from the flow without any capital at risk. If you are a song writer, ASCAP charges you for monitoring usage of your songs. If you are a collector, you have to sell through a dealer under terms favorable to the dealer who has no capital at risk. If you want to sell your business, a similar mismatch of risk and upside exists.

Economics Favor Creators

New digital platforms are being created to sell digital art. Take a look at SuperRare https://superrare.co/ which is a market place for creators. The economics favor the creator. If digital art is sold its authenticity is supported by an Ethereum based blockchain, with an immutable identifier so your art cannot be forged. SuperRare is paid 15 – 20 % of the original sale price and the creator keeps ownership of the rest. Thereafter, SuperRare creates a market for the previously owned art and awards 10% of each subsequent sale proceeds to the artist. Two problems are solved for the artist. She gets most of the original economics for the first sale, and a tail percentage of each successive sale. It is now an income producing asset and it can never be duplicated.

Can You Put Digital Art On Your Wall?

My only question about digital art is how do you hang it on your wall? We go to museums to view great art for a human connection captured by the painter or sculptor. I do not yet see it duplicated by the SuperRare business model.

The Pieta on my iPhone is not the same as viewing it in person. Michelangelo’s masterpiece captures in stone the universality of a mother’s grief at the death of her son in a way SuperRare cannot duplicate.  The analog world still has a place, albeit with poor economics and risk of theft or forgery. However, the digital world is accelerating and there will be conflict as it challenges the analog world built on well-paid and trusted middlemen. Get ready for viewing your digital art in a virtual reality gallery!

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

Someone’s investment gyroscope is completely out of whack. For most of my investment life I have tried to discover unseen gems among the trash heap of abandoned stocks. These might be stocks with good revenue growth, low debt, high cash flows, a defensible position relative to other competitors and few financial analysts following their story.

However, nothing in my experience prepared me for the “pump and pump” crowd that creates fools gold from spinning straw like Hertz, Game Stop and AMC. The business model is also unique. Find a lousy company with a massive short position and coordinate a “short squeeze” by convincing thousands of followers to buy call options on the stock or the stock itself on margin.  As the short seller is squeezed by the rising prices it must buy stock to cover its margin account deficit positions or add new capital to a trade going awry.  Because the short sellers in Game Stop (GME, NYSE) had sold 110% of the outstanding stock they were actually creating a “naked short” position making them vulnerable to the Captain Crunch of All Squeezes.

I had two immediate questions about Game Stop. What are its fundamentals? If its fundamentals are bad, how will the legion of retail investors ever get out of their position?

Fundamentals Are Poor

Game Stop (GME, NYSE) had a $30 billion market capitalization as of January 28, 2021. Looking over the last 4 years, its fundamentals are bad. It has declining revenues, declining earnings, declining free cash flow, declining dividends and insistent creditors who have removed more than $1.0 billion of capital, but are still owed $1.5 billion. Net debt to EBITDA is now 6.2x.  It has had 5 CEOs in 4 years, and it restated its audited financials for 2018 and 2019. Here is a chart from “The Daily Shot” on February 1, 2021 showing historical sales and earnings:

A Pump and Dump Strategy For Sure

A “pump and dump” strategy makes sense if you can organize a “Captain Crunch” wolf pack of concerted day traders who buy, squeeze, inflate the stock price and then sell to a greater fool. But a “pump and pump” strategy, where you become a long term holder only makes sense if you can sustain the new valuation and then do a public offering or another capital raise at the new, nosebleed market cap. In 2020 I wrote about Hertz (HTZ, NYSE) demonstrating that a bad company cannot access the public markets https://capitalworks.net/hertz-bankruptcy-whos-in-the-drivers-seat/.  Why would Game Stop be different?

Remember Who Owns The Casino

Major Wall Street firms own the Depositary Trust & Clearing Corp (DTCC). This is a private monopoly on the capital requirements, trading restrictions, clearing and custody of almost all the stocks and bonds in the world. It monitors all brokerage firms, including firms like Robinhood, for activity injurious to the safety and soundness of the capital markets. After all this is their casino.

The DTCC stepped into the GME manipulation and said Robinhood was insufficiently capitalized to underwrite the thousands of retail investors who were buying GME call options and stock on margin.

When you buy stock on margin and the stock goes up, there is no problem. But if the stock declines, you must have collateral worth $2X the margin debt. If a retail investor gets a margin call, she must add new capital to maintain the $2X ratio or Robinhood must sell her stock position. The problem with a retail investor base like Robinhood is insufficient outside capital to handle a margin call and the market interest in buying GME quickly evaporated. Robinhood and its capital providers had to absorb the losses in the short term and pray it can liquidate its GME position to pay back its banks. Robinhood may be caught with a large GME position at a high valuation and no counter party to buy on fundamentals. It had to suspend trading to try to save its franchise.

As a consequence, Robinhood has been forced to raise $3.4 billion of new capital which it will deposit with DTCC to allow it to continue in business. I guess Robinhood now understands it is a minor brokerage firm serving at the pleasure of the best firms on Wall Street and the video game trading it promotes just got toxic.

However, it may still own way too much GME from defaulted retail accounts and the price is falling. There is no way out of the squeeze and it may end up just like Lehman Bros.

So the damage from a video game trading foray is massive. The hedge funds who had the naked short position got wiped out, Robinhood and other accommodative online brokers that permitted margin trading in GME are facing massive capital calls, most of the retail investors will lose their investment, and the ownership in GME has come full circle. The short position is now back to 40%.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

I wish I could join the throng of euphoric pundits who are now advocating Modern Monetary Theory (“MMT”). Most of them equate MMT with the ascendancy of central banks and their invincibility procuring worldwide prosperity even in the face of one of the swiftest business reversals in my lifetime. Politicians also see it as a pathway for transformational social programs like a guaranteed national income, cancellation of student loans, and the new Green Deal. Thoughtful economists are now conceding money printing is OK as long as it does not become inflationary.

Another Expert With A New Paradigm

Unfortunately, I have been around long enough to have witnessed too many “it is different this time” moments spanning multiple decades. First it was Michael Milken and Drexel Burnham and a seminal white paper from an expert about junk bonds being completely safe. Next it was the dot com bubble where any business plan with a modem could raise public capital. Soon thereafter it was the Big Recession where real estate mortgages on poor properties issued to people with substandard credit were transfigured, like the Wedding Feast at Cana, from jug water to fine wine.

Now you have another white paper episode from a professor at Stony Brook University, Stephanie Kelton who says Federal debt creation does not matter as long as you are issuing debt in your own currency and you are managing inflation. I have not read anything from Ms. Kelton on the question of whether a profit seeking enterprise actually has to be buying that debt for it to be benign instead of the current practice of the Treasury issuing bills, and notes at artificially low interest rates and the Federal Reserve Bank “buying” them. It is estimated that $2.3 Trillion of the Federal debt issued to provide Covid response stimulus is just book entries from the Treasury to the Fed with no third party price discovery.

Janet Yellen is now telling us that stimulus has to “go big or go home”, suggesting that the paltry “stimulus response” to the Big Recession slowed the return of prosperity.

Respected Investors Are Cautious

How about a few contrary theories from respected investors who are seeking profits without speculation, and are smart enough to understand these modern theories?  Seth Klarman, James Grant and Jeremy Grantham are three such giants.

Seth Klarman, the founder of Boston based Baupost Group, a hedge fund with $30 billion under management sees it as a competition between the private sector and the public sector. Here is a summary of his recent letter to his own investors created by The Financial Times on the consequences of money printing:

“Mr Klarman referred to the Fed as an “800-pound gorilla” that has priced out investors who typically provide liquidity in moments of distress. The biggest problem with these unprecedented and sustained government and central bank interventions is that risks to capital become masked even as they mount,” he said.

James Grant in his January 22, 2021 Interest Rate Observer newsletter also questions the central bank playbook: “Prices convey information; artificial prices convey misinformation; interest rates are prices. Ergo suppressed interest rates misinform. They inflate asset values, misallocate capital and fill some pocketbooks while emptying others”.

Jeremy Grantham in his most recent newsletter “Waiting For The Last Dance” also spots a bubble and writes about the herd psychology that underpins the frantic dash to the cliffs:

“This time, more than in any previous bubble, investors are relying on accommodative monetary conditions and zero real rates extrapolated indefinitely. This has in theory a similar effect to assuming peak economic performance forever: it can be used to justify much lower yields on all assets and therefore correspondingly higher asset prices. But neither perfect economic conditions nor perfect financial conditions can last forever, and there’s the rub.”

I have seen a similar competition between governmental stimulus like unemployment insurance and moratoriums on mortgage defaults and rent evictions. The government is making it difficult to find employees and, inadvertently, is inducing businesses to invest in technologies to replace workers. By delaying or suspending creditors rights to keep people housed and fed, the government is making certain parts of the real estate investment landscape highly unattractive. Who wants to build multi-family housing where rents are controlled by the public sector? But if the interest rate for that loan is the lowest ever and I can pass the credit test…well maybe I will give it a try!!!

A recent example is a company we know that manufactures windows. It cannot find enough employees to meet the unexpected high demand for new housing and repair and remodel projects. Its competition for employees is partly a few new employers entering the local economy, but it is also the stimulus programs that incent not working like direct payments, unemployment insurance, mortgage default and rent eviction moratoriums.

The government has no cost of capital as long as the Treasury can issue bills and notes that are purchased by The Federal Reserve Bank at a rate set by The Fed. In essence, the risk free interest rate is zero. That is not true for private sector debt, all of our creditors are quite focused on monthly payments of principal and interest, and while the interest rates are low and the advance rates are aggressive, the debt must be repaid.

So far, I have not read anything from any economist examining the MMT experiment about the crowding out of productive business, but I see it as a significant risk. Here is a chart from The Daily Shot showing the correlation between money supply and stock prices:

Looking at the stock market, the bond market, the proliferation of SPACS, the housing market, Bitcoin and other crypto as validations of money printing presupposes, someone is actually thinking that deeply. Most investors are simply assuming the FED can control interest rates and, implicitly, will underwrite all markets like it just did in March of 2020. There is evidence of the same frantic fear of missing out on the next wave that I have witnessed in every one of the prior bubbles. But I will leave you with Grantham’s assessment from his recent newsletter. He is the expert. He has been wrong, but convicted, for more than a decade. That is courage:

“However, for any manager willing to take on that career risk – or more likely for the individual investor – requiring that you get the timing right is overreach. If the hurdle for calling a bubble is set too high, so that you must call the top precisely, you will never try. And that condemns you to ride over the cliff every cycle, along with the great majority of investors and managers.”

Who knows when but I am in the camp that it won’t be different this time. This is just an amateur’s opinion, but so far I have always had to repay my debts one way or the other.

The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

Bitcoin looks like a juicy federal and state revenue source for 2020. Based on the chart shown from the buybitcoinworldwide.com website below, there has been approximately $304 billion of capital appreciation in the cryptocurrency since January 1, 2020. It is pretty much a guess about what portion of that appreciation has been “realized” in 2020, which is why IRS needs taxpayers to self report:

This all stems from the IRS position that Bitcoin (BTC), and all other forms of crypto are capital assets. So, it is a legitimate question to ensure that realizations are taxed. The IRS has clarified that simply transferring BTC between your personal wallets will not be considered a taxable event and not a reportable event in your 1040. It is like transferring custody of stocks from Ameritrade to Fidelity. Here is the 1040 question each of us will have to answer:

I think the issue is certainly about revenue, but it is also about discovering who owns Bitcoin. Early record keeping about knowing your customer was hit or miss. Starting at inception in 2010 many criminals, drug traffickers, and tax dodgers utilized BTC as a store of value and a medium of exchange, but it was a minor blip on global GDP.  Bitcoin promised anonymity and freedom from a closed system where central banks controlled fiat currencies. Early adopters had to convert fiat to BTC and they all ended up in places like Coinbase which developed “fintech” trading platforms that bridged fiat and crypto.

By 2018, the dominant dealer in crypto was Coinbase, and it has announced an intention to file for a public offering of its shares in 2021. It will be interesting to see if there is disclosure about what percentage of Coinbase customers are actually “known” under banking investigation standards created by money laundering legislation enacted in 2013. I expect things were pretty lax from 2010 to 2017 when BTC first spiked to $20,000. During that period it was ridiculed by just about every leader of the fiat economy including JP Morgan’s CEO Jaime Dimon, who called it a “fraud” likening it to the “tulip bulbs”, a craze in Denmark in 1637 where a single rare tulip sold for more than a house. Mr. Dimon has since reversed his opinion. It is clear the leaders of the fiat regime have a lot to lose if there is a challenge to their implicit monopoly.

Revenue Opportunity For Feds and States?

The potential revenue prize for 2020 is probably pretty small. I tried to make a few assumptions about realized gains starting with the common belief that 10% of BTC has never traded. So that leaves 90% that may be trading of which it is estimated 5 % may be lost or destroyed.

Assume the best case for the taxman – that one third of the appreciation in Bitcoin from Jan 1, 2010 to December 31, 2020, was realized as a lump sum in 2020, and the cumulative basis is $0 (best case for Feds), and the effective federal tax rate was 25% (blend of ordinary and capital gains rates), and a 5 % state tax rate. The revenue potential for Feds might be $92 billion, and $18.5 billion for the states. That is not a lot of revenue compared to the potential tax receipts from the US stock market. Its value as of December 21, 2020, was in excess of $50 quadrillion and it appreciated by almost 13.5% in 2020. The big juicy tax target is not Bitcoin, especially because there are paltry records about who owns it and what gains were realized when.

But Bitcoin remains relevant as a hedge against failure of fiat currency systems all around the world. For that reason and the absolute ceiling on the amount of Bitcoin that can be created, it will continue to appreciate in my opinion.

Past performance is not indicative of future results. The above commentary is for informational purposes only.  Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.