“When you are wrestling for possession of a sword, the man with the handle always wins.”
— Neal Stephenson, Snow Crash
Tuesday, February 28th., Ulm, Germany.
After spending 5 months in central America, with blue skies, warm temperatures and sunny weather day after day, I am back in cold Germany (where I haven’t seen any blue sky for a week now). ❄️
I am here for a month to spend some time with my family and friends, before heading south east again.
But until then, I will probably lose all of the nice tan that I got. 😭
When it comes to the economy, the interest rate is the sword that dictates the direction in which the market is going.
And the one who is holding its handle is Jerome Powell.
The concept is actually pretty simple: If he cuts interest rates, the market goes up, if he raises them, the market goes down.
Moreover, the market not only moves when the sword actually swings, but it tries its best to anticipate the swing and move proactively.
In recent years the importance of the fundamentals of companies has decreased substantially. Instead of spending the time to analyse companies and the viability of their business models, most investors nowadays spend their time by forecasting how hawkish or dovish Powell will react to whatever economic news are published. The art of the game is not anymore to pick the best stocks, but rather the attempt of trying to be the best predictor of central bank policy.
The main topic that everyone — not only analysts and investors — is still worried about is inflation.
Other than a stock price, or the variations in derivative based option trading, inflation actually has a huge direct influence on the life of everyone.
Since the CPI declined in January, this should be a positive sign for the economy, shouldn’t it?
But wait… it declined less than economists expected…
…thus, Jerome Powell might feel tempted to keep raising interest rates…
…and/or keep them elevated for longer…
…and accordingly the stock market went down.
Here are the key indicators for February:
Most people think that we have seen the heights of this inflation cycle and that it is now trending downwards towards the magic 2% mark.
I doubt that we will get there in the coming years.
As I have written repeatedly in previous newsletters, the debt levels are at a point where they rely on cheap money in order to be sustained, rolled over and not to collapse.
These debts not only include government debts, but also corporate and household debt. It is estimated that the total global debt has surpassed $300 trillion.
This is about 350% of the total global output as measured by GDP — unsustainable.
Or, rather only sustainable by a massive money increase! Which is of course still unsustainable in the long run.
Let’s just take a look at the most prominent case.
Here is the visualization of the US Government’s budget of 2022:
At the current interest rates, the “Interest On Debt” will steadily increase. Actually this steady increase will happen quite rapidly, given the short duration of the average Treasuries which the Treasury department has to roll over. Most of the other items on the spending side are linked to inflation and will automatically adjust (increase) in accordance with the CPI. Further, if interest rates stay high, this means less revenue for companies, hence lower profits and way lower taxes.
Thus, the already massive annual deficit is likely to substantially increase.
This is called a debt spiral.
And the only way out is a sustained period of high inflation.
Thus, I think Powell will pivot and move the handle of his sword at some point…
…to slash the interest rate and allow the monetary expansion to continue.
Moreover, history also shows that inflation tends to be more tricky to defeat than central bankers might imagine. Throughout the last two periods of high inflation, both in the 40s and 50s after the Great Depression, as well as in the 70s and 80s, there were periods where it seamed as if the inflation was over, before it reappeared ravaging again:
Recently there has also been a lot of talk about the measurement of inflation, since the U.S. Bureau of Labor Statistics has once more changed its measurement mythology of the CPI.
This caused a lot of debate about whether this might lead to higher or lower inflation numbers. In general, the government has various incentives to report a lower number. Hence, there is a general assumption that changes will finally lead to lower CPI prints.
I also wrote about this topic on several occasions before. For instance, here is an abstract from my first newsletter last January, where I wrote the following:
Whether the CPI is actually giving a somewhat reliable inflation number is another highly debated topic. 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. ShadowStats tracks the CPI in the old fashioned methodology and comes up with U.S. inflation numbers approaching 15%.
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.
And:
Finally, inflation is a very individually dependent phenomena. Every person has a very different basket and therefore it is hard to pinpoint a general number. The real inflation that each person experiences will always be very unique to the location, the circumstances in life and the spending habits.
Inflation is a tricky thing and as Michael Sailor famously stated, it is better to be understood as a general vector than as a precise scientific measurement:
In any way, we are likely to see more of it over the coming years.
The fundamental underlying problem of the entire financial system is that it is based on fiat money, which can be manipulated and expanded.
It is managed by central banks, who in turn are appointed and controlled by politicians. These politicians all personally benefit from “printing” more money:
To grab power and enhance their territory (e.g. Putin).
To make promises and get votes by pretending to care for some high morals (choose any western democracy).
Just to enrich themselves (choose any king or dictator throughout history).
In the end, all of these actions have the same effect — massively expanding the money supply.
This process has massively distorted the whole economy and perverted the entire behavior throughout the markets.
This brings us back to the sword analogy…
…the problem is not who is winning in wrestling for the handle, the real problem is that there is a sword to begin with.
Stay tuned.
PS: Last month I wrote about the lighting network and its promising potential to facilitate and scale Bitcoin based transactions in the future. I highly encourage everyone to check out this nice little 10 minute documentary by Natalie Brunel.
It perfectly gives a short overview about the recent developments and puts it in a perspective to all the main global events that have taken place over the crazy previous two years.
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.