Ataraxia Financial Newsletter - August 2022
Recession, Inflation, Abenomics and the US Dollar Milkshake Theory
“The world is full of things more powerful than us. But if you know how to catch a ride, you can go places.”
— Neal Stephenson (Snowcrasher)
August 19, Bangkok.
Bangkok is an incredible melting pot.
That was my first impression on my first trip here back in January 2015.
And this description of the city hasn’t changed after coming back multiple times now and also having spent a considerable amount of time here by now.
The streets are filled with people from all walks of life: whether they are tourists, businessmen, hippies, digital nomads, backpackers, retirees, lady-boys, blue-collar workers, white-collar workers or monks, people with very different fashion styles, different attitudes, different perceptions, different goals and different mindsets are all strolling up and down the same sidewalks. Dining in the same restaurants. Sipping drinks in the same coffee shops and bars. The majority of course are Thai, but there are also plenty of Chinese, Indians, Koreans, Europeans, Africans, or people from the Middle East — even Ukrainians and Russians are everywhere. Withstanding the huge diversity, the atmosphere feels peaceful, safe and friendly. Regardless of nationality, age, religion or political orientation, people here live together in harmony and treat each other respectfully and politely.
Given the black and white coloring in most aspects today, a world in a trend of de-globalization, aiming at more self-sufficiency — national priority instead of global collaboration — and the difficulties which most places in the world are facing to bring different cultures and ideologies together, Bangkok feels quite inspiring!
I have spent some time thinking about potential reasons for this. I think it all boils down to Thai culture, maybe also due to the peaceful Buddhist influence.
I am not at all an expert, but from all that I have learned and experienced, I would describe Thai culture as very traditional. Nonetheless, while being traditional and sticking to many norms in their daily life, Thais don’t have the “our way is the right way” and “you should better conform to what we think is correct” attitude, which I feel in most other countries. Instead, people here are warm and welcoming. They seem to be much more open and accepting of different opinions and lifestyles.
This attitude leads to a special atmosphere with a spirit of freedom.
Moreover, while there is a lot of poverty visible on the streets and many people just live on a minimum subsistence level, I rarely see grumpy face expressions.
There is the feeling of a generally optimistic mindset which brings about a very positive vibe.
In addition, the city looks nice. The buildings are tastefully garnished with plants and trees, so that there is actually a healthy amount of green in this metropolis. And it is combined with beautifully designed and decorated interiors with perfect air conditioning to get a pause from the pressing hot humidity outside.
Then there are these huge malls everywhere and international restaurants for every taste, even the delivery services work smoothly.
Everything is just super convenient and easily accessible. I would say that out of the countries I have been to in recent years, the convenience level here is only challenged by Taiwan.
To top it off, the modern architecture of the imposing skyscrapers, filled with rooftop bars and pools, is magnificent!
And finally, a good traditional Thai Massage on a day after an intense sprint interval training is the cream on top. I feel like a newborn.
Anyway, I love this city.
This month’s newsletter will cover the following topics:
Part l - Market Analysis:
Key Indicator Rundown
Case Study Japan ll - Abenomics
Inflation as Economic Key Indicator
Part ll - The Dollar Milkshake Theory
Part l - Market Analysis
The U.S. is now in a recession:
As can be seen above, we had two consecutive quarters of negative GDP growth. Although the decline has been small in comparison to the last short recession that happened in early 2020 in response to the Covid measures.
Over the past weeks, there has been a lot of talk about the exact definition of a recession. In the last newsletter, I wrote about how recessions are traditionally defined in the educational part. You can read the article here. The White House and the media can try to redefine the definition if it makes them feel comfortable, but if you always change a definition then it is not really useful to have a definition in the first place.
Whether 2-month negative GDP growth is a good measure for it can be debated. Let’s say there is a quarter of 10% growth followed by two quarters of -0.1% and a subsequent quarter of another 10% growth. Of course, it is kind of ridiculous to call the two quarters a recession, but the same goes for any statistical numbers that could be used instead. Moreover, I agree that there is a lot to be said about the shortcomings of the GDP number as the yardstick. However, out of all economic indicators, GDP is probably still the most accurate number to gauge the overall state of the economy.
Thus, 2 negative quarters of GDP growth mark a recession. We will see whether it is a mild one, or whether it will get more severe.
Meanwhile, despite the recession debate, the stock market has been rallying in July and reclaimed some of its losses.
“Bear market rallies can be powerful and convincing. And tempting. Don’t be tempted.”
— Dan Denning
Whether it is just a dead cat bounce, or it is the start of a substantial upward move (which would probably also lead to a positive 3rd quarter GDP growth and therefore make it a mild recession), remains to be seen.
Key Indicator Rundown
Inflation keeps rising. Both the U.S. CPI as well as the latest Eurozone CPI reached new heights in June (9.1% and 8.9% respectively). However, the U.S. numbers for July came out already and showed that the inflation stayed flat at 0% over the month, which means a slight decline in the yearly price increase which is at 8.5% now. The decline is mostly due to the decrease in energy prices. Most other items in the basket kept increasing over the last month.
More about inflation as an economic indicator will be provided later in this newsletter.Despite new record inflation numbers and a 75 bps rate hike, the 10-Year Treasury Rate declined in July and closed the month at 2.64%. The market seems to forecast lower inflation and the Fed pivoting away from its aggressive tightening cycle over the coming months. At the moment the consensus is that the next rate hike is only going to be 50 bps as compared to the previous two 75 bps hikes.
The US Dollar Index reached a new 20-year high in July, going up to almost 109. We even saw that the USD and Euro hit parity for the first time in 20 years. This puts a lot of pressure on countries and entities around the world which have debts denominated in USD.
Stock markets saw rallies with the S&P 500 up 9.11% and the MSCI ACWI up 7.07% in July. Investors seem to anticipate a more relaxed Fed policy in the coming months. In addition, the employment numbers in the U.S. have come out strong and above expectations, boosting the confidence that the recession is not that bad.
Alongside the stock market indices, both the CAPE Ratio, as well as the Buffet Indicator have increased in July and therefore remain at a historically very high level. This might indicate that the current stock market surges are more likely to turn out to be a dead cat bounce, rather than marking a bear market bottom.
The VIX has also been declining, indicating that there is less perceived fear and risk in the markets. Historically, it still remains slightly elevated, but it has lost some of its volatility for the time being.
The oil price declined over July, closing below $100 a barrel. Since then it has decreased even more and at the time of writing sits at $89. This has offered some relief for the economy and is the major reason for the slow-down of inflation and probably also one reason for the stock market rallies.
Despite all the good recent trends in the stock markets, employment numbers and lower oil prices, there is still a lot of bad economic data and headwinds from the energy sector, indicating that we might still be in the very early stages of the recession. Alfonso Peccatiello, author of The Macro Compass, provided a great analysis and interpretation of the recent economic data in “Is A Soft Landing Possible Anymore?”, published as guest article in the Pomp Letter.
After adjusting downwards in the previous month, the natural gas price has shot up again in July and increased 52%. It is up more than 108% YoY. The impacts of these rising prices are felt even more gravely in Europe, where most of the recession-signaling indicators continue to get worse.
Moreover, in Europe the energy situation is not good and some European countries are facing a quite precarious situation concerning the gas supplies for the winter. Instead of loosening up, European leaders seem still in the effort to extend their aggressive restrictions against Russian citizens, some even going so far as to ban Russian tourists. In response, Moscow uses Europe’s dependence on its natural gas to put some pressure on the Union: It has throttled back the gas supply to some countries and most recently decreased the flow through the Nord Stream pipeline to Germany by 60%, with the pretense of regulatory difficulties to sufficiently maintain the turbines. Thus, European members are in an effort trying to conserve as much gas as possible to build up their stores. Measures, such as switching off the illumination of public sights and landmarks are already undertaken. It almost seems as if Europe is willing to go back to the dark ages just in order to keep up the current political correct position of “doing something” against Putin, just for short-term gratification. Further, some countries have even started to implement air conditioning limit rules. By now, most people must have realized that none of these sanctions are going to have any effect on ending the war. Accordingly, there is a growing number of people questioning whether the consequences of the economic warfare against Russia are justifiable. As Michael Schellenberger has pointed out in a recent article, that even given the serious energy concerns, the politicians do not seem to care about their citizens and are willing to blatantly lie in order to put their political agenda first: “Lemke and Habeck declined both the offer from Westinghouse and from nuclear operators (which offered support in sourcing rods to let the remaining 3 nuclear reactors in Germany running). As such, it’s now clear that Habeck, Lemke, and other German officials have repeatedly lied, not only about the nuclear fuel rods, but also thus about the broader energy crisis.As such, anti-nuclear Greens are putting Europe in grave danger. A majority of Germans are already ready to cave in to Putin. New polling shows that German support for the boycott of Russian gas had fallen from 44% six weeks ago to just 32% last week. And now, household energy costs are expected to triple in Germany.” Government officials are openly expressing concern over the possibility of social unrest.
Magnifying Germany’s current problems and economic slowdown, is the dry summer weather, which has caused some rivers, most importantly the Rhine, one of Europe’s most important waterways for transporting goods, to become very shallow on some key points. This is a huge headache for German inland shipping and heavy industry, since it causes ships not being capable of being fully loaded, or not passing some sections at all. It affects a great range of products, from oil, gas and coal to chemical goods and grain.The gold price declined 3% in July and even dipped below $1,700 for a few days before rebounding to close above $1750. Since then it has continued to gain ground and at the time of writing is trading around the $1,800 mark.
Bitcoin saw somewhat of a rebound after its strong decreases in Mai and June. It closed July at $23,337, almost 18% higher than at the end of June and has been trading around that area since. At the time of writing it is at $23,990.
Some other developments in the bitcoin and cryptocurrency domains are:BlackRock has partnered with Coinbase. According to Investopia:
“The partnership is limited to bitcoin and will allow the firm’s institutional clients to have access to crypto trading, custody, prime brokerage, and reporting via Coinbase Prime.” Since BlackRock is the largest asset manager, this could have quite significant implications and foster the on-boarding process for retail clients to get exposure to bitcoin.As an update to the article I published in last month's issue, Celsius has now filed for chapter 11 bankruptcy. Apparently, the outstanding gap of its current liabilities, in comparison to its holdings, amounts to about $2.8 billion.
The German Crypto Exchange Nuri, which is a partner of Celsius and acted in some way, as a Celsius subsidiary in Germany with over 500,000 customers, also filed for bankruptcy. However, the company claims that it is undergoing a restructuring process and that all customer funds held in Bitcoin and Ethereum wallets are save and that the partnering Solarisbank further ensures all Euro deposits. Thus, trading and withdrawals on the platform remain possible. The question is whether those funds that were stored in their yield-earning scheme (which they provided in corporation with Celsius) will ever be available to customers in the future and if yes, at what extend of a haircut.
The Crypto-Mixing Service Tornado has been blacklisted by the US Treasury. This mixing service allows users to conceal the history of their transactions by pooling and mixing funds from different users together before sending them to the designated addresses. It is the first time that such a blacklisting is directed not against specific individuals, but against lines of code. It is an alarming sign of further state encrouchment against our privacy.
Case Study Japan ll - Abenomics
In last month's newsletter, I wrote about the financially precarious dilemma that Japan is facing. It can be read here. Just after I had finished writing it, I read about the Assassination of Shinzo Abe, who served as Japan’s prime minister shortly from 2006 - 2007 and again for a longer period from 2012 - 2020.
I don’t know much about Japans politicians, but I actually did some research about Shinzo Abe and his economic policies back in 2014, when I was taking a course about “East Asian Economies” at the Korea University Business School in Seoul. At that time, the new policy approach of his changes were still relatively fresh and there was some interest in doing research about it.
So I felt that I should write a follow up on Japan, because a) in the last issue I didn’t write much about what went wrong in Japan and how it build up to the current dire debt-situation and b) I think that Shinzo Abe’s economic agenda represents the essence of a more general misconception of how most people and politicians think about how a government can have a positive influence on an economy.
I am not intending to speak ill about the dead here — My basic proposition is that all politicians are power seeking criminals with notorious motives and questionable characters — hence, Shinzo Abe is just one of them. However, his economic policies, which became known as ‘Abenomics’, present a good case study, which can serve as an illustration of some general economic misunderstandings that are predominant across the globe.
When Abe came into office in 2012, Japan already had large deficits, the stock market still had not recovered from its collapse in the early 90s and the economic growth had been weak ever since. This means he was facing a situation in which it was difficult to reduce the debt burden without being a) more prudent and practicing some fiscal austerity by decreasing the deficit spending, or b) fostering economic growth. Abe chose to try for the second one by totally sacrificing the first.
Abenomics became known for being based on “three arrows”:
Monetary easing from the Bank of Japan
Fiscal stimulus through government spending
Structural reforms
Arrow l: Monetary Easing
According to most modern economists, an economy needs to have inflation. The Commonly 2.00% is regarded as the perfect rate of inflation, hence this is the target rate for most central banks. (I will elaborate on this topic later).
Likewise other countries, Japan also experienced high inflation throughout the 70s and early 80s, but since the 90s, they witnessed really low inflation rates mixed with deflationary periods, so that on average the prices remained very stable. This is also the reason why the Japanese Yen became known as a safe heaven currency, to hold during turbulent times.
In reality, this was a great benefit for the Japanese population, because it meant that they could fully benefit from their productivity and wage increases. Additionally, traveling to other counties with higher inflation rates was constantly getting cheaper and cheaper for Japanese citizens.
However, economists and politicians saw the low inflation as a major problem. They claimed to be worried that the cost of living was rising too slowly and people didn’t spend enough.
Thus, the first of Shinzo Abe’s arrow was massive quantitative easing by the Bank of Japan, in order to stimulate bank lending and the velocity of money and thereby also increase the rate of CPI inflation.
The following chart shows the balance sheet of major central banks as a percentage of their respective GDP:
As can be seen, measured against the GDP, the Japanese bank increased the base money substantially and outpaced other central banks by a magnificent margin.
The idea of increasing the cost of living of Japanese people in order to improve their well being, is not only contrary to common sense, but it also goes against all fundamentals of sound economic thinking.
The general goal of an economy, is to increase the standard of living. This is achieved by becoming more productive and therefore being able to lower the cost of production. If goods and services can be produced cheaper, it follows that more people can buy and enjoy them.
A good example is the cellphone industry. When the first cellphone came out, only a few rich people could afford them and the cell phone industry was tiny. Today, almost everyone has a smart phone, which is not only way more affordable, but also the usability and functionality have undergone tremendous increases. Moreover, even very poor people can afford a basic cellphone. Despite — or rather because of — the price reduction, cell phone companies have been able to increase their profits. Apple has become the most valuable company on the planet.
Thus, contrary to general perception, price reductions are beneficial for an economy and it would have been better for Japan, if the central bank would not have been handed a bow to shoot this arrow.
The question is, what was (and is) the Bank of Japan doing with all the printed money?
Arrow ll: Fiscal Stimulus
The answer is simple: Massive spending by the Japanese government to boost GDP.
(In combination with also interfering in the stock market by directly buying Japanese equities)
This is the second arrow in the Abenomics quiver.
Actually, there is nothing new or innovative about this wrongheaded strategy. Massive spending, financed by the government and monetized by the central bank is done by most governments to some extent — and has been famously tried to a large extent by countries such as Simbabwe, Venezuela and (numerous times) Argentine.
The chart shows how the total government deficit to finance the fiscal stimulus measures has constantly increased over the years, saw a massive spike in the pandemic and is forecasted to keep rising rapidly.
Some economists argue that it has been a success, since Japan has seen increases in nominal GDP after Abenomics was started. However, this conclusion does not take into account three crucial aspects:
Arguably it came at the cost of a massive increase in debt, which substantially lowers future opportunities since it requires increased amounts of the yearly budget to service these debts.
It is also not clear that the economy would not have been growing even more in the absence of these expenditures. The government investments could well have had the effect of diverting market incentives and crowding out some other (probably smarter) investment decisions, which in turn, would have likely been more beneficial for the economy in the long run.
The GDP went up in Japanese Yen. Measured in USD it is now lower than it was when Abenomics started.
Thus, also the second arrow was a complete failure. The Japanese Debt-to-GDP ratio is now at 266% and the costs of it must be paid by the already wounded Japanese population in some form. And this arrow will really hurt in the future.
Arrow lll: Structural Reforms
The third and final arrow in the quiver was aimed at structural reforms, to make the economy more competitive.
Arguably, the first two arrows have already been shot into the wheels and done their part to crumple the competitiveness of the Japanese economy. Thus, the third arrow is already predestined to miss its target.
The way to make an economy more efficient, is to make the government smaller.
If the government is small, this frees up resources that can be used more productively and long-term oriented by the private sector. In addition, it also lowers friction costs and time spent for compliance measures that have to be undertaken by entities and are a burden to the economy.
In other words, decreasing the government size, makes room for a more productive resource allocation throughout the whole economy.
While the structural reforms under Abenomics included some positive aspects, such as cutting red tape and corporate taxes, as well as lowering barriers for entering the workforce, it didn’t lead to reductions in the overhead and operational government expenses. Therefore it was also a failure.
In conclusion, Abenomics turned an already bad economic situation into a terrible one. Instead of having a positive influence, all the three arrows are aiming at the very heart of Japan’s economy. These “arrows” have already caused a lot of havoc and put Japan’s economy into a precarious situation — and they might be about to kill it.
Inflation as Economic Key Indicator
Inflation is quite a tricky topic, since there are so many different views about the definition of it and depending on the definition, there are also multiple aspects that need to be considered. In the first issue of this newsletter, published back in January, I wrote some general thoughts about it. It can be read as an article here.
Originally, inflation was defined as an increase in the money supply.
In recent years, inflation is generally just used to describe the price increase in the cost of living. This encapsulates a far broader range of components and leaves far more room for interpretation, because there are multiple factors that can result in changing prices, whereas the old definition was very precise. It focused on the underlying unit that was actually (like a balloon) being inflated — which is money.
In essence, the increase in the money supply is the main ingredient for price increases over time, but there are many other factors that predominantly influence daily, weekly and monthly price swings. Erroneously, many economists jump to the conclusion, that monetary expansions have little effect on inflation.
It is actually pretty simple: On the one side of the equation is the economic output and on the other side is the monetary supply. If the money supply is increased, it follows that each unit can buy fewer of the produced goods. In today’s complex economy, there are numerous reasons why this adjustment doesn’t materialize and appear immediately, but it is still holds true in the long term.
This chart indicates how the two tend to be correlated over a longer stretched time frame. Note that the blue line (monetary expansion) tends to increase first before it gets manifested in higher prices.
When it comes to inflation as an economic indicator, which can be analyzed in comparison to other data sets and used to gauge market developments, most people look at the Consumer Price Index (CPI) that is published on a monthly basis by government agencies in most major countries. In the US that is the Bureau of Labor Statistics (BLS).
Other often referred inflation indices are the Wholesale Price Index (WPI), as well as the Producer Price Index (PPI).
Given the complexity of an economy and how differently people go about their lives, it is obviously quite a difficult task to perfectly measure the overall rate of inflation.
It is important to be aware that the CPI is just a number derived through a certain methodological process of measuring the prices for certain goods and services. It used to be a fixed basket of the same goods, but it has changed over time. Furthermore, many things people spend money on are not included at all. As I previously wrote:
What can be said is that the way of calculating has gone through various changes over the years. Prior to 1980, it used to be a fixed basket of goods which price was measured over time. Nowadays the calculation is much more complex. For instance, so called hedonic adjustments try to adjust for technological improvements of products. In addition, if a product increases a lot in price, it is presumed that consumers will shift to buy a cheaper substitute product. Thus, many argue that these changes have made it possible for government institutions to understate the real level of inflation.
For instance, while many price increases have been set off by assumed quality improvements, the opposite has not been the case. Arguably, the quality of air traveling has decreased immensely over the last 2.5 years, but this has not been appraised by the BLS.
Moreover, the CPI does’t include real rents or investment items. These are for most people important parts of their budget and have gone up way more than the CPI over recent years.
Therefore, it doesn’t represent any ‘true’ inflation number.
I personally believe that the CPI generally has the tendency to understate the real rate of inflation which the majority of the population experiences. This is for the simple reason that the incentive structure is such, that the agencies who are deciding on the methodology and publish the numbers are benefiting from a lower CPI. This is another topic, but in essence, inflation is a hidden tax and governments benefit in various ways from it. The perfect situation for governments is to have really high inflation, while the population believes that the inflation is low and under control. This is not a conspiracy theory and I do not believe that the responsible government employees go to office with the intention of ‘faking’ lower numbers in mind. I rather believe that there are underlying incentive structures. These incentives are integrated throughout the whole bureaucratic network apparatus, with small effects in every little decision that is made.
While having these flaws, the CPI still conveys some valuable information and its monthly changes and trends — in combination with other data — provides some insights of what is going on in the economy.
I actually like Michael Saylor’s take on inflation:
He sees the CPI number more as a vector, which gives a general idea where things are heading, but can subjectively be meddled with, depending on various individual life choices and should therefore not be seen as an ultimate arbitrator for everyone. Anyway, taken as a general vector it still provides useful clues.
So what does the CPI number tell us about the economy?
A high CPI number might suggest that:
…the economy is overheating.
Companies are rapidly expanding their businesses.
Lots of hiring, there are more job offerings than people looking for work, putting upward pressure on wages.
Large amounts of capex.
Investors go higher on the risk curve, resulting for example in a surge in technology stocks.
…there is high monetary expansion going on.
Prices for everything are going up at a similar rate.
It might have the same characteristics as an overheating economy.
If caused mainly through debt monetization of government debts, then it might spiral out of control and even lead to a hyperinflation.
...there are supply shocks or supply chain constraints.
Some items experience high inflation, while other items prices stay comparatively stable.
→ All of these might cause the central bank to raise interest rates or other policies to tighten the money supply
On the other hand:
A low CPI number might suggest that the economy is:
…healthy:
If prices come down as a result of increased productivity.
…sluggish:
Low growth numbers.
If companies are pessimistic and do not hire or invest in capital expenditures.
Consumers are not spending most of their income.
…in recession:
If GDP decreases for several quarters.
The stock market is in a bear market and most asset prices are falling.
People are losing their jobs, resulting in high unemployment and the overall demand sees substantial declines.
Investors seek safe heaven investments (e.g. Treasuries).
→ These scenarios might cause the central bank to lower interest rates to incentivize spending and investment and/or stimulate the economy by quantitative easing (QE).
→ It also might trigger the government to engage in fiscal stimulus measures to boost the economy.
These are only some of the possible aspects that can be witnessed and often there is some combination of them. For instance, there are good reasons to believe that the current high inflation numbers stem from:
The massive monetary expansion and stimulus packages in response to Covid.
As well as supply chain restraints and shortages caused by the implemented Covid policies around the globe, as well as sanctions against Russia.
Furthermore, large swings in some items might have a huge contribution to the CPI number:
The chart shows that the price increases in energy and food made up almost half of the most recent 8.5% CPI rate. Further, both of them are also responsible that the YoY index number decreased from 9.1% in June to 8.5% in July. Most other contributors kept their upward trend throughout July.
Another indicative aspect is the trend. Is the CPI in a consistent upward trend month over month, did it peak, or is the general momentum downward. And, do all items move in the same direction, or are there distinctive differences:
The consistent upward trend of most contributors since 2020 might be mainly caused by the massive monetary expansions in the form of stimulus packages.
Whereas the swings of the contributor for “used cars and trucks” might be attributed to supply chain issues.
And the energy price is probably highly affected by the war in the Ukraine and the accompanying sanctions.
I will end this post with a quote that is important to bear in mind when thinking about inflation:
The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.
— Ludwig von Mises
Part ll - The Dollar Milkshake Theory
With the Dollar index climbing to over 108 in July, the highest level it has been since 20 years, it is a good time to look at the Dollar Milkshake Theory, wich offers a plausible explanation for this trend and its implications.
The Dollar Milkshake Theory was popularized by Brent Johnson, head of Santiago Capital. If you want to listen to a good podcast in which he explains his views around the theory, you can do so here.
His argument is that all fiat currencies always have the tendency to be expanded. Whenever there is any crisis, or event, where spending slows down and liquidity is tightening, central banks step in and provide stimulus in the form of creating new money. During the COVID-19 Pandemic, the injections have been massively increased to a totally new level. With the whole world working all together and inducing a massive amount of newly created money into the system, asset prices as well as debt levels have been pushed to unsustainable heights. Furthermore, always when there has been any economic slowdown and turmoil over the past 25 years, the dollar has been strengthening against other currencies.
The main reason for this phenomena is that the dollar is the global reserve currency. Thus, in times when the economic condition worsens, there is turbulence in the markets and credit gets tight, the demand for the dollar tends to increase. It is the most liquid asset and most liabilities are denominated in dollars — not only in the US, but arguably to an even larger extent abroad, through Eurodollar settled debt contracts.
In contrast, other major currencies — like the Euro, Japanese Yen, or the Chinese Yuan — might have a strong domestic demand, but internationally, they are just not used and demanded that much, at least not to a comparable extend.
Thus, if any other central bank makes monetary policy, it mainly affects only the country in question. On the other hand, if the Federal Reserve makes monetary decisions about the fed funds rate or balance sheet expansions — or reductions — it affects the whole world.
This has led to an enormous increase in dollar denominated debts across the globe. The interest, that has to be paid on these massive debts, creates a strong constant demand for US dollars.
At some point, this upward trending debt-to-GDP increase has to end in a major sovereign debt crisis.
To summarize the theory that he puts forward: A culmination in debt burdens and monetary expansion will kick off the following sequence of events:
Sovereign & General Debt Crisis
→ Money will leave bonds (globally).
→ Instead it will go into the U.S. equity market, hence, the U.S. is sucking up increasing amounts of capital.
→ Other entities find it harder and harder to get dollars.→ Their dollar denominated debt burdens rise and become unserviceable.
→ Defaults start to occur.
→ Once this liquidity crisis starts, it sets into effect a negative feedback loop.The ultimate result is that all the artificial value, that was created by monetary expansion, is finally gonna be sucked up by the US market and the USD.
Therefore, Johnson believes that the cash-flows are increasingly going to leave other currencies and go into the dollar over the coming years. Hence, the dollar index will go significantly higher. Not in a straight line, but with some pullbacks on the way up.
What we are currently seeing with countries, such as Sri Lanka not being able to service their US denominated debt, Argentine and Turkey on the verge of hyperinflation and a major currency like the Japanese Yen, depreciating more than 20% in a few months, are all aspects of the Dollar Milkshake Theory set in motion.
Consequently, according to Brent Johnson’s Milkshake thesis, a good investment strategy (at the moment) would be buying dollars, blue chip US equities, productive land (in America), gold — and maybe a milkshake. 🫗😅
Despite near-term appreciation in US assets and dollars, Johnson believes that the story ends badly for everybody. The US only outperforms on a relative basis in comparison to all other fiat currencies in the coming months and years. In the long run, it is also doomed to depreciate substantially.
I agree with many aspects of this theory. I also think that our current monetary experiment of running the entire global economy on a system of pure freely fluctuating fiat currencies will collapse. This experiment was started in 1971, when Nixon closed the gold window. It is flawed for several reasons and will fail terribly. Here is a website with charts that I highly recommend everyone to check out. It painstakingly illustrates, what a centrally planned fiat currency system does to all aspects of an economy.
I further agree, that the US dollar is probably the last domino to tumble.
Although I am not so sure that most value has to necessarily flow towards US equities for this to be true.
However, as readers who are familiar with my base thesis already know, I think that there is one asset that has an even bigger straw and will ultimately be the one swallowing it all up.
I feel like having a milkshake now. 😁
I hope you enjoyed reading this newspaper. Likes, comments and shares are highly appreciated. I put a lot of work into it and if you think the content is worth your time, please consider to subscribe, so you can receive it on a monthly basis. Its free and without commercials.
Best regards,
Disclaimer: The content of this newsletter is for informational and educational purposes only. It contains my personal views and opinions, which are not to be taken as direct investment advise. All investments have risks and you should do your own due diligence before making any investment decision. If you require individualized advice, to review your unique situation and make a tailored advice for you, then contact a certified financial planner or other dedicated professionals.