Chart of the Year: Bitcoin, the logical end for stimulus policies

Last year it was the near-doubling in US 10-year interest rates.  In 2015, it was the oil price fall.  This year, there is really only one candidate for ‘Chart of the Year’ – it has to be Bitcoin:

  • It was trading at around $1000 at the start of 2017 and had reached $5000 by August
  • Then, after a brief correction, it stormed ever-higher, reaching $7000 last month
  • On Friday it was trading around $19000 – fortunes are being made and lost all the time

The beauty of the concept is that nobody really has a clue about what it is all about.  You can read the Wikipedia entry as many times as you like, and still not gain a clear picture of what Bitcoin is, and what it does.  But why would you want to know such boring details?

All anyone has to know is that its price is going higher and higher.  Plus, of course, there is the opportunity to laugh at stories of people who bought Bitcoins, but then lost the code – for an excellent example by a former editor of WIRED (with a happy ending), click here.

But there is another side to the story, as the second chart suggests.  “Mining” Bitcoins now uses more electricity than a number of real countries, like Ireland, for example:

  • On Friday, Bitcoin’s current annual consumption reached 33.73TWh – equivalent to Belarus’ 9 million people
  • Each transaction produces 117.5kg of CO2, as the network is powered by cheap coal-fired power plants in China
  • It also uses thousands of times more energy than a credit card swipe 

And, of course, interest is growing all the time as people rush to get rich.  Today sees the start of Bitcoin futures trading on the CME, a week after they began on the CBOE and CME.  Bloomberg suggests Exchange Traded Funds based on Bitcoin will be next.  In turn, these developments create more and more demand, and push prices ever-higher.

Comparisons have been made with the Dutch tulip mania in 1836-7, when prices peaked at 5200 guilders.  At that time, Rembrandt’s famous Night Watch painting was being sold for 1600 guilders, and at its peak a tulip bulb would have bought 156000lbs of bread.  Bitcoin probably won’t equal this ratio until next year, if its current price climb continues.

Of course, one key difference between tulips and Bitcoin is supposedly that there were always more tulips to buy – whilst there are just 21 million Bitcoins available to be mined.  And apparently, around 80% of these have been mined. Bitcoin enthusiasts therefore suggest Bitcoins will have increasing scarcity value.  But, of course, anyone can create a crypto-currency and many people have – such as Bitcoin Cash and Bitcoin Gold, and the Ethereum family.

Yet already, Bitcoin’s market capitalisation* is getting close to that of the “tech stocks” such as Apple, Alphabet (formerly Google), Microsoft, Amazon and Facebook as the chart from Pension Partners shows:

  • On 7 December, less than 2 weeks ago, its market cap was already higher than major US stocks such as Home Depot and Pfizer
  • On Friday, it hit $323bn, above Wal-Mart and P&G and close to ExxonMobil
  • This also made it worth more than the IMF’s Special Drawing Rights
  • And the total market cap of the 10 largest crypto-currencies has now reached $500bn, equal to Facebook

This is an amazing amount of money to be tied up in an asset which has no intrinsic value.  After all, what is Bitcoin?  It certainly isn’t real, although the media like to picture it as a gold coin:

  • Although it is called a crypto-currency, its volatility makes it unattractive as a currency – major changes in a currency’s value can easily cause businesses (and countries) to go bust, and Bitcoin’s value has moved by 1900% just this year
  • Nor is it a method of settling transactions, as its value is increasing all the time – obviously a good deal for the person who receives the Bitcoin when its price is rising, but why would any sensible person pay with a Bitcoin?
  • So essentially, therefore, Bitcoin is simply a speculative asset, where its value is based on the “greater fool theory”, which says “I know its not really worth anything, but I am clever enough to sell out before it hits the top”

The “story” behind its boom is also powerful because it is linked to the great investment theme of our time, the internet.  We have all seen the fortunes that can be made by investing in companies such as Apple.  Now, Bitcoin supposedly offers us the chance to invest in the Next Big Thing – a new currency, entirely based on the internet.

BITCOIN HAS MANY PARALLELS WITH OTHER MANIAS IN HISTORY, SUCH AS THE SOUTH SEA BUBBLE 
The Bitcoin mania has many parallels, such as with the South Sea Bubble from 1719 – 1720.  Its power was also based on “the greater fool theory”, and its linkage to the great investment theme of its time – the opening up of foreign trade.  As the chart from Marc Faber shows, one of its early investors was Sir Isaac Newton – one of the most intelligent people ever to live on the planet, who discovered Newton’s laws of motion and invented calculus.  Newton doubled his money very quickly when he first invested, but then re-invested at a higher price – and lost the lot.

Of course, all the dreams associated with Bitcoin and the other crypto-currencies may come true. That is part of their attraction.  Another part of their attraction is for criminals, who can launder money without being traced.  So most likely, prices will continue rising for some time as more and more people around the world see a chance of getting rich very quickly.  We have never seen a global mania before, so nobody can tell how long it will last.

The question for governments, however, is what would happen to the economy if the mania collapsed?  Only China has so far banned Bitcoin trading, as Pan Gongsheng, a deputy governor of the People’s Bank of China, explained:

“If we had not shut down bitcoin exchanges and cracked down on ICOs several months ago, if China still accounted for more than 80% of the world’s bitcoin trading and ICO fundraising, everyone, what would happen today? Thinking of this question makes me scared.”

Having let the mania develop this far, other governments  are in a difficult position – millions of people would complain if they closed down these currencies today.  And most governments are reluctant to intervene as, in reality, crypto-currencies are essentially the creation of central bank stimulus policies, as explained by US Federal Reserve chairman, Ben Bernanke, in November 2010:

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.” 

But by letting the mania continue, the potential impact from its collapse will increase.  Added together, crypto-currencies already have the same market cap as Facebook – and could soon overtake Apple to become the most valuable “stock” in the world.  Yet unlike Apple, they have no sales, no income and no assets.

Bernanke and the major central banks wanted to stimulate investors’ “animal spirits”, so that they would take on more and more risk.  Crypto-currencies are therefore the logical end result of their post-crisis strategy. The end of the Bitcoin mania, whenever it occurs, will therefore also mark the end of stimulus policies.

 

*Bitcoin’s market capitalisation is its equity valuation – the current dollar price multiplied by the number of Bitcoins in existence

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Central banks’ reliance on defunct economic theory makes people worry their children will be worse off than themselves

“Average UK wages in 2022 could still be lower than in 2008” 
UK Office for Budget Responsibility

While Western stock markets boom under the influence of central bank money-printing, wages for ordinary people are not doing so well.  So it is no wonder that Populism is rising, as voters worry their children will be worse off than themselves at a similar age.

The chart above is the key to the story.  It shows births in the G7 countries (Canada, France, Germany, Italy, Japan, UK, USA) since 1921.  They are important as until recently, they represented around 50% of the global economy.  Equally important is the fact that consumer spending represents 60% – 70% of total GDP in each country.

As the chart shows, the absolute number of consumers saw a massive boost during what became known as the BabyBoom after the end of World War 2:

  • The US Boom lasted from 1946 – 1964, and saw a 52% increase in births versus the previous 18 years
  • The Boom lasted longer in the other G7 countries, from 1946 – 1970, but was less intense
  • In total, there were 33 million more G7 births in 1946 – 1970 versus the previous 25 years
  • This was the equivalent of adding a new G7 country the size of Canada to the global economy

Today’s dominant economic theories were also developed during the BabyBoom period, as academics tried to understand the major changes that were taking place in the economy:

  • Milton Friedman’s classic ‘A Monetary History of the United States’ was published in 1963, and led him to argue that “inflation is always and everywhere a monetary phenomenon”  
  • Franco Modigliani’s ‘The Life Cycle Hypothesis of Saving‘ was published in 1966, and argued that consumers deliberately balanced out their spending through their lives

Today’s problem is that although both theories appeared to fit the facts when written, they were wrong. 

We cannot blame them, as nobody during the 1960s realised the extraordinary nature of the BabyBoom.  The word “BabyBoom” was only invented after it had finished, in 1970, according to the Oxford English Dictionary.

Friedman had no way of knowing that the number of US babies had risen by such an extraordinary amount.  As these babies grew up, they created major inflation as demand massively outgrew supply.  But once they entered the Wealth Creator 25 – 54 age cohort in large numbers and began working, supply began to catch up – and inflation to fall.

Similarly, Modigliani had no way of knowing that people’s spending began to decline dramatically after the age 55, as average US life expectancy during the BabyBoom was only around 68 years.

But today, average US life expectancy is over 10 years higher.  And as the second chart shows, the number of households in the 55+ age group is rocketing, up by 55% since 2000.  At 56m, it is fast approaching the 66m households in the critical 25 – 54 Wealth Creator cohort, who dominate consumer spending:

  • Each Wealth Creator household spent an average of $64k in 2017, versus just $51k for those aged 55+
  • Even this $51k figure is flattered by the large number of Boomers moving out of the Wealth Creator cohort
  • Someone aged 56 spends almost the same as when they were 55.  But at 75+, they are spending 47% less
  • Older people already own most of what they need, and their incomes decline as they approach retirement

Unfortunately, today’s central bankers still base policy on these theories, just as Keynes’ warned:

“Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back”.

The result is seen in the third chart from the Brookings Institute.  It highlights how labour’s share of income has collapsed from 64% in 2000 to 57% today.  The date is particularly significant, given that the oldest Boomers (born in 1946), reached 55 in 2001 and the average US Boomer became 55 in 2010.

  • Fed Chairman Alan Greenspan tried to compensate for this paradigm shift from 2003 by boosting house prices – but this only led to the 2008 subprime crisis which nearly collapsed the global economy
  • Since then, Fed Chairs Ben Bernanke and Janet Yellen have focused on boosting the stock market, as Bernanke noted in November 2010:

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

But fewer Americans own stocks than houses – only 54% versus 64% for homes.  So “printing babies” cannot work.

The real issue is that the dramatic increase in life expectancy has created a paradigm change in our life cycle:

  • It is no longer based on our being born, educated, working, retiring and then dying
  • Instead, we have a new stage, where we are born, educated, work, and then retrain in our 50s/60s, before working again until we retire and then die

This transition would have been a difficult challenge to manage at the best of times. And having now gone in the wrong direction for the past 15 years,  we are, as I warned last year, much closer to the point when it becomes:

“Obvious that the Fed could not possibly control the economic fortunes of 321m Americans. Common sense tells us that demographics, not monetary policy, drive demand. Unfortunately, vast amounts of time and money have been wasted as a result. The path back to fiscal sanity will be very hard indeed.”

 

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“Exponentially rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways”

Shiller Jun17

Companies and investors have some big decisions ahead of them as we start the second half of the year.  They can be summed up in one super-critical question:

“Do they believe that global reflation is finally now underway?”

The arguments in favour of this analysis were given last week by European Central Bank President, Mario Draghi:

“For many years after the financial crisis, economic performance was lacklustre across advanced economies. Now, the global recovery is firming and broadening…monetary policy is working to build up reflationary pressures…we can be confident that our policy is working and its full effects on inflation will gradually materialise.”

The analysis has been supported by other central bankers.  The US Federal Reserve has raised interest rates 3 times since December, whilst the Bank of England has sent the pound soaring with a hint that it might soon start to raise interest rates.  Most importantly, Fed Chair Janet Yellen told a London conference last week that she:

Did not expect to see another financial crisis in our lifetime”.

The chart above from Nobel Prizewinner Prof Robert Shiller confirms that investors certainly believe the reflation story.  His 10-year CAPE Index (Cyclically Adjusted Price/Earnings Index) has now reached 30—a level which has only been seen twice before in history – in 1929 and 2000. Neither were good years for investors.

Even more striking is the fact that veteran value-investor, Jeremy Grantham, now believes that investors will have “A longer wait than any value manager would like, including me” before the US market reverts to more normal valuation metrics. Instead, he argues that “this time seems very, very different” – echoing respected economist Irving Fisher in 1929 who suggested “stock prices have reached what looks like a permanently high plateau“.

But are they right?

Margin debt Jun17One concern is that central bankers might be making a circular argument.  We saw this first with Fed Chair Alan Greenspan, who flooded stock markets with free cash before the dot-com crash in 2000, and then flooded housing markets with free cash to cause the subprime crash in 2008.  His successor, Ben Bernanke continued the free cash policy, arguing in November 2010 that boosting the stock market was critical to the recovery:

“Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

The second chart highlights how the Fed’s  zero interest rate policy has driven the rally since the US S&P 500 Index bottomed in March 2009:

  Margin debt in the New York market (money borrowed to invest in stocks) is at an all-time record of $539bn ($2017)
  It has increased 197% since March 2009, almost exactly matching the S&P’s rise of 216%
  Stock market capitalisation (the total value of stocks) versus GDP is close to a new all-time high at 133%

Meanwhile, the Bank of Japan now owns 2/3rds of the entire Japanese ETF market (Exchange Traded Funds). And the Swiss National Bank owns $100bn of US/European stocks including 26 million Microsoft shares.

Global debt Jun17Unsurprisingly, given central bank policies, the world is now awash with debt.  New data from the Institute of International Finance shows total world debt has now reached $217tn – more than 3x global GDP.  As a result, respected financial commentator Andreas Evans-Pritchard argued last week:

“The Fed caused the dotcom bubble in the 1990s. It caused the pre-Lehman subprime bubble. Whatever Ms Yellen professes, it has already baked another crisis into the pie. The next downturn may be so intractable that it calls into question the political survival of capitalism. The Faustian pact is closing in.”

Index Jun17

Evans-Pritchard’s concern is echoed by Claudio Borio, head of the central bankers’s bank – the Bank for International Settlements (BIS).  Under his predecessor, William White, the BIS was the only central bank to warn of the subprime crisis.  And Borio has warned:

Financial booms can’t go on indefinitely. They can fall under their own weight.”

WHO IS RIGHT – THE CENTRAL BANKS OR THEIR CRITICS?
This is why companies and investors have some big decisions ahead of them.  Of course, it is easy to assume that everything will be just wonderful, when everyone else seems to believe the same thing.  Who wants to spoil the party?

But then there is the insight from one of the world’s most famous analysts, Bob Farrell, captured in the headline to this post.  The chart of The pH Report’s Boom/Gloom Index highlights how the concept of the Trump reflation trade has sent the S&P into an exponential rally – even whilst sentiment, as captured in the Index, has been relatively subdued.

You could argue that this means the market can continue to go higher for years to come, as Grantham and the central banks believe.  Or you could worry that “the best view is always from the top of the mountain” and that there are now very few people left to buy.  And you might also be concerned that:

 Political uncertainty is rising across the Western world, as well as in the Middle East and Latin America
  Oil prices are already in a bear market
  China’s growth and lending is clearly slowing
  And Western central banks also seem set on trying to unwind their expansionary policies

We can all hope that today’s exponentially rising markets continued to rise.

But what would happen to your business and your investments if instead they began to correct – and not by going sideways?  It might be worth developing a contingency plan, just in case.

 

Debt, demographics set to destroy Trump’s GDP growth dream

US debt Apr17Unsurprisingly, Friday’s US GDP report showed Q1 growth was just 0.7%, as the New York Times reported:

“The U.S. economy turned in the weakest performance in three years in the January-March quarter as consumers sharply slowed their spending. The result fell far short of President Donald Trump’s ambitious growth targets and underscores the challenges of accelerating economic expansion.”

And as the Wall Street Journal (WSJ) added:

The worrisome thing about the GDP report is where the weakness was. Consumer spending grew at just a 0.3% annual rate—its slowest showing since the fourth quarter of 2009… As confirmed by soft monthly retail sales and the drop off in car sales, the first-quarter spending slowdown was real“.

The problem is simple.  Economic policy since 2000 under both Democrat and Republican Presidents has been dominated by wishful thinking, as I discussed in my Financial Times letter last week.

The good news is that there are now signs this wishful thinking is finally starting to be questioned.  As the WSJ reported Friday, BlackRock CEO Larry Fink, who runs the world’s largest asset manager, told investors:

“Part of the challenge the U.S. faces, Mr. Fink said, is demographics. Baby boomers, the largest living generation in the country are aging, reaching retirement age.  “With our demographics it seems pretty improbable to see sustainable 3% growth.””

And earlier this year, the chief economist at the Bank of England, Andy Haldane, suggested that the importance of:

“Demographics in mainstream economics has been under-emphasized for too long.”

Policymakers should have focused on demographics after 2001, as the oldest Boomers (born in 1946) began to join the low-spending, low-earning New Old 55+ generation.  The budget surplus created during the SuperCycle should have been saved to fund future needs such as Social Security costs.

But instead, President George W Bush and the Federal Reserve wasted the surplus on futile stimulus policies based on tax cuts and low interest rates.  And when this wishful thinking led to the 2008 financial crisis, President Obama and the Fed doubled down with even lower interest rates and $4tn of money-printing via quantitative easing.

This wishful thinking has therefore created a debt burden on top of the demographic deficit, as the chart confirms:

  Between 1966 – 1979, each $1 increase in US public debt created $4.49 of GDP growth, as supply and infrastructure investment grew to meet the needs of the Boomer generation
  Debt still added to GDP in 1980 – 1999 during the SuperCycle: each $1 of debt created $1.15 of GDP growth
  But since 2000, debt has risen by $13.9tn, whilst GDP has risen by just $4.6tn

Each $1 of new debt has therefore only created $0.33c of GDP growth – value destruction on a massive scale

It is therefore vital that President Trump learns from the mistakes of Presidents Bush and Obama.  Further stimulus policies such as tax cuts will only make today’s position worse in terms of debt and growth.  Instead, he needs to develop new policies that focus on the challenges created by today’s ageing population. as I suggested last August:

“3 key issues will therefore confront the next President. He or she:

□  Will have to design measures to support older Boomers to stay in the workforce
□  Must reverse the decline that has taken place in corporate funding for pensions
□  Must also tackle looming deficits in Social Security and Medicare, as benefits will otherwise be cut by 29% in 2030

It has always been obvious that the Fed could not possibly control the economic fortunes of 321m Americans. Common sense tells us that demographics, not monetary policy, drive demand. Unfortunately, vast amounts of time and money have been wasted as a result. The path back to fiscal sanity will be very hard indeed.”

Fed’s economic models applied to a past era

FTThe Financial Times has kindly printed my letter below, welcoming the Fed’s decision to address the impact of demographics, but arguing that it needs to focus on demand issues, given the impact of today’s ageing populations.

Sir, It is good to see the US Federal Reserve is finally beginning to address the impact of demographics on the economy, after years of denying its relevance. But as John Authers confirms in his excellent analysis of the Fed’s new research paper (“The effects of ageing”, The Big Read, October 26), its continued focus on supply-side issues means it is looking down the wrong end of the telescope.

The Fed’s approach might have made sense in the past, when demand was on a growth trajectory as the baby boomers joined the 25-54 cohort, which drives wealth creation. But today’s problem is growing overcapacity, not lack of supply, given that the ageing baby boomers already own most of what they need, while their incomes are declining as they enter retirement.

The problem is that the Fed’s economic models were developed at a time when the population effectively contained only two main segments — the under-25s and the 25-54 cohort. From a policy perspective, the number of over-55s was too small to be of interest. But this is no longer true, as increasing life expectancy means the baby boomers can now hope to live for another 20 years after reaching retirement age.

Equally important is that since 1970, fertility rates have been below the replacement level of 2.1 babies per woman in the developed world. Thus the relative size of the wealth creator cohort has been reducing for the past 45 years, while the numbers in the 55-plus cohort have been increasing. The result is that the ageing baby boomers are now nearly a third of the developed world’s population.

Policymakers therefore need to urgently refocus on the demand-side implications of ageing, if they want to craft suitable policies for this New Normal world.

Paul Hodges
Chairman,
International eChem

Markets question central bank power as Great Reckoning nears

NYSE marginTimeTIME magazine covers often capture the mood of a moment.  And that was certainly true in February 1999, with their now famous cover picturing then US Federal Reserve Chairman, Alan Greenspan, under the heading “The Committee to SAVE the World“.

In a further sign of the times, Greenspan was flanked by the US Treasury Secretary and his Deputy, Robert Rubin and Lawrence Summers.  The message was clear – the central bank led, and the government followed.  And their remit was indeed global, as Time commented:

As volatility has upset foreign markets and economic models, the three men have forged a unique partnership to prevent the turmoil from engulfing the globe”.

The cover set the pattern for the next 15 years:

  “Dotcom crisis in 2000″ – call for Greenspan; “Subprime crisis in 2008″ – call for his successor, Bernanke
  Regional crises were the same. “Eurozone debt crisis in 2012” – call for ECB President, Draghi; Japanese deflation in 2013 – call for Bank of Japan Governor, Kuroda; “Brexit crisis in 2016″ – call for Bank of England governor, Carney

But now, it seems that its not just the UK markets that are losing faith in their former super-heroes:

  US 10 year rates have risen by a third from their July low to 1.8%
  German rates have gone from a negative 0.2% to a positive 0.06%
  Even Japanese rates have risen from a negative 0.3% to a negative 0.05%

These are major moves in such a short space of time, especially when one remembers these bonds are supposed to be “risk-free”.  Clearly markets are starting to worry that they may not be “risk-free” after all.

In the past, the central banks had made the task of managing the global economy seem very easy.  These incredibly powerful men (and today, one woman), seemed able to resolve any financial crisis with a nod and a wink to their friends in the markets, backed up by an interest rate cut and a round of money-printing.

And, of course, markets wanted to believe what they were being told.  After all, hadn’t Greenspan invented the “Greenspan put”?  This was a phrase derived from the Options market, which meant traders knew he would ride to the rescue if ever markets looked like falling out of bed.

It is true that sometimes (as with subprime) central banks appeared rather slow to realise that a crisis was brewing. But as soon as they did notice, they went straight into action to make sure prices went straight back up again, as Greenspan’s successors followed “The Master of the Universe’s” teaching.

His departure was followed by the “Bernanke put”, and then the “Yellen put”, when Janet Yellen took over at the Fed. Traders therefore learnt to borrow as much as possible after 2000, as Doug Short’s chart shows of margin debt on the New York Stock Exchange.  Being bold was best, when you knew the central bank would always cover your back.

But today, many traders worry that their super-heroes can’t actually create the promised growth?  They wonder how governments can pay back the vast sums of money they have borrowed for the monetary experiment?  How would markets react if, one day, a major economy proved unable or unwilling to pay its debts?

And they are not alone in worrying.  Even the IMF has woken up to the fact that borrowing has now doubled to $152tn since 2000, and is still rising.  15 years is, after all, a long time for an experiment to run, without producing the expected results.  At some point, the funding tap must be turned off.

This is the Great Reckoning in action.  Clearly some traders and investors now don’t believe that monetary policy can deliver the promised results.  And as I noted on Friday, even one of the US Federal Reserve Banks has now come close to accepting our argument that demographics – not central banks – really drive the global economy.