Ecoinometrics - September 28, 2020

The Fed playbook...

How is the global economy going to recover from 2020? Will there be a long term disruption of the global supply chain? When will the world get out of the coronavirus crisis? 

That’s a lot of questions no one can answer. 

But regardless of all that we already know what the Federal Reserve is going to do. 

Why? Because they are running the same playbook as in 2008.


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The Fed playbook

I don’t want to say that the Fed is a one-trick pony but… I mean… just look at the chart of the evolution of the balance sheet since the 2008 crisis.

Twelve years later do you see any similarity with what happened in the past?

The playbook is simple:

  • Crisis happens and a massive amount of liquidity is injected into the system.

  • After the initial jump it takes a few months for things to stabilize.

  • Then comes the systematic QE program which expands the balance sheet at a steady pace with no end in sight.

And when I say no end in sight I really mean it. There is no way the Fed will ever unwind their balance sheet.

From 2008 to 2018 they grew their total asset value to $4.5 trillion from less than $1 trillion. 

In 2018 they attempted to “normalize” the monetary policy. That failed. Even before the coronavirus crisis it was clear that the returning to pre-2008 monetary conditions was going to lead to big troubles in the financial markets. 

Remember the “not QE” moment at the end of 2019? That aged pretty well.

But what does that mean looking forward?

To answer that it is worth taking a closer look at 2008 vs 2020.

First the net amount of assets added to the Fed’s balance sheet since the start of the intervention in 2020 is absolutely staggering: $2.9 trillion in a few months… it took five years to add that much after 2008...

However when you look at it in terms of percentage growth then suddenly 2020 is not so impressive.

Check it out.

A mere 67% balance sheet expansion versus 150% in about the same amount of time after 2008. 

The end game after 2008 ended up being a total balance sheet growth of almost 400%. 

Now, the bigger the market, the more liquidity you need to inject to reach your goal. That’s the law of diminishing returns and that’s why you better pay attention to the percentage increase rather than the net value of the Fed’s intervention.

If the Fed continues to apply the same playbook it is likely that the total balance sheet will grow to $15 trillion of US dollars in the next 10 years.

What that means is that the rate of debasement of the US dollar is accelerating.

Have you ever seen a hockey stick? 

Here, I present to you the hockey stick graph of the M2 money stock since 2008. I think it’s pretty clear that we have changed pace.

Up until now the money supply used to grow at an average of 6% per year with some occasional spikes at 10%.

For 2020 we are already at 20%. That’s more than 3 times the average!

Regardless of how the real economy turns out, something is pretty clear. Thanks to the action of the Federal reserve, there is no way for the US dollar to preserve its purchasing power over the long run.

You can’t rely on cash to preserve your wealth. But that’s no big deal since Bitcoin fixes this.


We print it digitally

The US Federal Reserve has two objectives:

  • Get inflation to 2%.

  • Get the unemployment rate to some low level.

One way of pushing (official) inflation to 2% is by printing more cash. You just put more money in the system, debase your currency and you expect this will drive prices higher.

There is only one issue with that. The point at which the money enters the system!

This is the Cantillon effect in action.

The Fed injects liquidity in the banking system. The banking system is at best pushing this liquidity towards financial assets. The result is asset price inflation which is not helping towards the stated goal of the Federal Reserve.

But there is a solution.

What if instead of pushing money to the banks they could deliver cash directly to each US citizen?

That’s the one of the biggest incentives for the Fed to develop a digital dollar where each citizen end up with a digital wallet owned by the Fed.

If we end up with a Fed controlled digital dollar be ready for even more damage to the economy as the Fed attempts to control every aspect of the citizens spending.

Judging by how often this is talked about we might not be so far from it…

Read the article.


Inflation is already here...

The main issue with inflation is that the Fed is trying to make it say things it can’t. 

How is inflation calculated? 

You divide products and services in a number of categories: food, housing, education and so on.

For each category you take a basket of goods (which is evolving over time) of which you track the price evolution. That gives you inflation numbers for each category.

As an example in August inflation was +4.5% for the medical care category, +4% for food but -4% for transportations and -17% for gasoline.

Those categories are then given weights and the weighted average of the inflation for each category gives you the CPI.

So to arrive at the final number on which the US monetary policy is based you have to go through a lot of averaging and arbitrary choices.

But different groups of people experience inflation differently. Jeff Bezos does not feel inflation the same way a family of blue collars with 3 kids does. 

Job, location, age, family composition all these things and more make it so that looking at the weighted average that is the CPI makes you miss most of what is really important.

Depending on who you ask, inflation is already here.

Read the article.


Government controlled digital currencies

Here is a BBC article on how the digital yuan could come to become a global digital currency replacing the US dollar...

This is not the first article in mainstream news to talk about how government controlled digital currencies are the future and how this could change the world.

Those articles are usually missing one important point though.

The digital versions of government controlled currencies are just an upgrade of the same old system. Same political structure, same incentives, same central banks.

Bitcoin is your only way out of the system.

Read the article.


That’s it for today. If you have learned something please subscribe and share to help the newsletter grow.

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Cheers,

Nick


The Ecoinometrics newsletter decrypts Bitcoin’s place in the global financial system. If you want to get an edge in understanding the future of finance you only have to do two things:

  1. Click on the subscribe button right below.

  2. Follow Ecoinometrics on Twitter at https://twitter.com/ecoinometrics

Done? That’s great! Thank you and enjoy.