So what’s next: inflation or deflatio n?

Monday, 8 November 2021 — Laramie, Wyoming

[6 min read]

Dear Reader,

Remember last week when I showed you how financial markets have been nothing but a giant zero interest rate simulation for years now? Well, the simulation continues this week! The US Federal Reserve announced last week it would ‘taper’ its monthly bond purchases over the next eight months, eventually getting down to zero in June 2022.

But what about interest rates? Will those go up? The Fed, unlike the Reserve Bank of Australia, doesn’t practice yield curve control. And the RBA, bowing to market expectations for higher inflation AND interest rates, doesn’t practice curve control anymore either. So what’s next: inflation or deflation?

The truth is, nobody knows. In the current simulation, central banks have engineered a synchronised global bubble in just about everything (except gold and silver). For example, Yale Economist Robert Schiller’s Cyclically-Adjusted Price-to-Earnings Ratio (CAPE) hit 40 after US markets closed. Its all-time high is 44.19, reached in December of 1999.

It’s not far away from a new high then. That’s what you get when money is easy and cheap. You get broad-based inflation in financial assets, including houses. But what will the world look like in 18 months? And if you had, say, $150 billion in cash, what would you do with it right now?

Those two questions come from two investment greats, Stanley Druckenmiller and Warren Buffett. They remember the old world and the old gods before this simulation began. Druckenmiller points out that the challenge for macro or value investors — or any investor really — is not to figure out what’s happening right now. It’s to try and imagine what the world will be like in 18 months. Why?

Markets are supposed to be forward-looking. They’re mechanisms for discounting the price of future cash flows (assuming a business generates cash). If you want to know what to buy now, you have to figure out what’s going to be throwing huge wads of cash 18 months from now — but isn’t ‘priced’ for that right now.

Easier said than done. It’s hard enough to figure out what next week is going to look like, much less 18 months from now. What will interest rates be? What will the price of oil be? Will the pandemic even be over by then? These are all questions the ‘macro’ investor thinks about and then acts upon. Hold those thoughts.

Now, imagine you’re Warren Buffett. Your holding company, Berkshire Hathaway, has US$149 billion in cash. But you don’t know what to do with it. You’ve said in the past that cash is a lousy position — the world’s ‘worst investment’. You’ve spent over US$51 billion buying back shares in your own company over the last three years.

But because you’ve amassed a portfolio of businesses run by owner/operators, and because those businesses tend to generate high returns on capital and lots of cash, you keep piling up the cash. Even after turning a US$36 billion investment in Apple into over US$120 billion, you still can’t find investments big enough for your cash pile. What do you do?

Of course, most of us don’t have the problem of investing hundreds of billions of other people’s money in the market. You don’t have a lot of choices when you’re moving around that much money. Vern Gowdie and I discussed this last week on a Zoom call. Institutional money managers HAVE to be in the market whether they like or not. Money managers don’t tend to get paid to leave money in cash.

But that might be just where you want to be 18 months from now. Aside from niche opportunities in hard assets — commodity producers that might benefit from both inflation and problems in the global supply chain — there’s not much that’s cheap. And parking lots of money in bonds as interest rates rise — not to mention with a huge global debt bubble — doesn’t seem attractive either.

It’s a dilemma. In the last two monthly editions of The Bonner-Denning Letter, I’m looking at what to do with cash right now. We have a fairly large allocation to cash as an asset class in our model. That model, as you might guess, is defensive — based on the observation that a mean-reverting crash would wipe out at least 50% from major stock market indices at this level.

It’s possible that in this simulation, when central banks are the buyers of last resort in credit and equity markets, there will never be a 50% crash again. It’s possible. But in our view, not likely. Why?

Because the coming 18 months will show that in this simulation, with record-low interest rates and asset purchases by global central banks, you get a toxic financial, social, and political mix. Asset prices to the Moon. You get huge gaps between the 1% and the middle class. And then?

And then you get real inflation in food, fuel, housing, and costs that hit everyday people. That kind of inflation, historically, is the precursor to political and social instability. And in THAT world, you want to own real assets and have a large cash buffer. It won’t look stupid then.

Regards,

Dan Denning,
Editor, The Rum Rebellion

The Bonner-Denning Letter is co-authored by Fat Tail Investment Research founder Dan Denning and legendary investment writer and publisher Bill Bonner. It connects the dots between markets, politics, and history as one of the only macroeconomic, 'top-down' newsletters in Australia. For a big picture perspective on the past, the present, and your investment future, click here for details on how to subscribe.

‘There is growing evidence that this project has rugged. Please do your own due diligence and exercise extreme caution.’

CoinMarketCap website,
referring to Squid Coin

First, just for our own amusement, let’s look at more of the nuttiness caused by the Federal Reserve’s fake money and fake interest rates.

Then, we’ll take up the question posed on Friday: will the Fed bring an end to the madness?

It’s this question that is most important to investors.

If the answer is ‘yes’, then it’s time to go into the safe room, with a stock of food, water, and ammunition.

If the answer is ‘no’…then…well…you can hold out a while longer.

Rug pull

Last week, another new crypto appeared on the metaverse radar.

This was not particularly interesting, in itself — there were more than there were more than 13,000 of them already.

But this one had a very catchy name — the Squid Coin [SQUID] — which sounded for all the world as though it was related to the Netflix hit Squid Game.

It also suggested some kind of game playing, which sounded as though it might be fun…maybe even profitable.

Plus, it advertised a glowing recommendation from Elon Musk, who said — according to the Squid Coin website, at least — that he thought this one was going to the Moon.

One other feature is worth mentioning: Squid Coin welcomed buying with open arms…but it treated selling like a visit from a parole officer. Whoever heard of a currency that you couldn’t freely spend or trade? The whole thing was puzzling…and preposterous.

Nevertheless, propelled upwards by these booster rockets, Squid Coin quickly launched into space. It rose from pennies to US$2,860 per coin in a matter of days…and made the early adopters millions richer. For a moment. On paper.

Vanishing wealth

None of this would have been very surprising. The crypto world is lousy with goofy coins…and millionaires.

But as we described on Friday, when the money goes…everything goes, including all sense of what anything is really worth.

And sometimes, they’re not worth anything at all, which is just what the Squid Coin ‘investors’ found out at the start of this week. According to the press reports, the coin’s anonymous creators had done the old ‘rug pull’ scam on them.

One investor lost his entire life savings in the Squid Coin scam. And some investors are blaming the media for fuelling the coin’s meteoric rise.

But the Squid Coin had no relationship to the popular Squid Game TV show. It had, therefore, no right to use the name and trade off the popularity of the series.

Nor had Elon Musk ever heard of Squid Coin…until it appeared bearing his endorsement like a papal seal.

And then, as quickly as the coin and its creators rocketed up into the thin atmosphere of great wealth…they disappeared, apparently absconding with their ill-gotten gains. The coin then plummeted back to Earth.

Pity the poor ‘investors’ who expected to buy new houses in Santa Monica with their Squid Coin winnings.

Wacky world

They should have taken a flier on DWAC instead. Digital World Acquisition Corp is a SPAC…a special-purpose acquisition company. In this case, its special purpose was buying Donald Trump’s new company — Trump Media & Technology Group.

And when word of the purchase got out, DWAC shot up. Shares rose from US$10 to US$175.

As a general rule (in our rulebook, at least), all SPAC deals are bad deals. But who knows? There was no trace of it in the documents made available to the public, but DWAC might even eventually come up with a way to make money.

And in this wacky world, you don’t need to make money to get money. What money do the cryptos make? What money do the NFTs make?

What money has Elon Musk made? What money did Nancy Pelosi or Mitch McConnell make? Between the two of them, they gained US$105 million in new wealth since 2004. Where did it come from?

Invisible debt

You either make it or you take it. And the Fed is helping people take it on a scale never before seen in the US.

In August 2019, the Fed had total assets (a rough measure of how much money it has ‘printed’) of US$3.7 trillion. Now, it has US$8.5 trillion. The difference, nearly US$5 trillion, was added in just 25 months.

Not a penny of that money was earned…made…or saved. Instead, it is taken from the public…embezzled in the form of future inflation.

And today, think of all the fortunes that depend on it — all the dopey business models…all the SPACs…all the cryptos…all the debt refinancing…all the federales’ boondoggles.

During that same 25-month period, US debt increased about US$6 trillion too.

Putting two and two together, we see that almost every penny of deficit spending by the US government was financed by the Fed’s money printing.

That is why there is so little opposition to today’s US$3 trillion deficit — nobody thinks he has to pay for it.

A great scam

What a marvellous flimflam.

The gist of the ‘rug pull’ scam is making people think they have something they don’t really have…wealth that doesn’t exist, for example.

It’s the game of choice for today’s crypto grifters…and for the Fed too.

They ‘print’ money — crypto or paper — and pass it out as though it were the real thing.

And then the public gets the rug pulled out from under them.

Regards,

Bill Bonner,
For The Rum Rebellion