This special guest commentary was written by Christopher Whalen. It was originally posted on The Institutional Risk Analyst.
During our travels over the past two weeks, we tried to keep up with the financial press, particularly the growing sense of unease felt by many observers with the relentless rise of valuations for equities and other asset classes engineered by the Fed and major central banks. Suffice to say the number of queries we receive about bank stocks being overvalued has soared.
CryptocurrencY Schemes...
Last week saw some real gems from the world of crypto currencies. Bitcoin and the enabling technology known as “blockchain” are just the latest shiny objects to fascinate the less cautious members of the investing public. The folks at Grant’s Interest Rate Observer flagged this precious headline from Bloomberg News:
“This Company Added the Word ‘Blockchain' to Its Name and Saw Its Shares Surge 394%"
The world of “investing” in blockchain schemes has always given us a feeling of amazement, but tempered with a tinge of chagrin for those credulous souls caught up in this web of intellectual fraud. Sure blockchain has some interesting attributes, but other than enabling the bitcoin phenomenon, it has limited uses that make commercial sense. Blockchain rather blatantly violates the Three Laws of technology investing – cheaper, better, faster – but nobody seems to care.
Even more amusing than blockchain, however, is the fact that some of the sponsors of various “initial coin offerings” of nouvelle crypto currencies have taken the position that the ICO is an act of charity and that the investment received is a “non-refundable donation” rather than a distribution of a stake or equity in the issuer.
While ICOs seem to be clearly at odds with the anti-fraud provisions of the Securities Act of 1934, so far the Securities and Exchange Commission and Department of Justice have been unwilling to put an end to the marketing of these schemes in the US. The SEC rightly describes crypto currencies as “tokens” that may be considered securities under US law, yet the widespread public confusion over these get rich quick schemes has overwhelmed the government’s willingness to call out this activity.
The "Value" of A Dollar
One reason why so-called crypto currencies have gained such a following is that there is no real money to be found anywhere in the world. In the US, the legal tender laws of the 1860s forced members of the public to accept paper money – greenbacks – “for all debts, public and private,” this to help finance the Civil War. When Franklin Delano Roosevelt confiscated gold held by the public in the 1930s, paper money ceased to be a store of value directly convertible into gold or silver by individuals.
Today what people refer to as “money” operates as a means of exchange and a unit of account, but the dollar ceased to be a store of value decades ago. An item purchased for $20 in 1913 when the Federal Reserve System was created would cost nearly $500 today, a cumulative rate of inflation of 2,400%. So much for central bank independence. At least the Treasury notes that circulated in the US prior to the Civil War paid interest. Today’s greenbacks issued by the Federal Reserve System are just memorials to dead presidents.
More recently, central bankers have decided to confiscate private wealth represented by even fiat paper money via such means as negative interest rates and market intervention disguised by misleading labels like “quantitative easing.” As we’ve discussed before, negative interest rates imply the global confiscation of private financial assets for the benefit of debtors, especially public sector debtors.
Of note, in his last blog post, John Taylor examines a thesis advanced by Allan Meltzer that QE was a policy of competitive devaluation. The US moved first, and others followed, as one of our colleagues noted last week. But the only thing that has resulted is a vast flow of capital back into the US economy. With almost $10 trillion in negative yielding bonds globally, dollar assets have become a refuge from global confiscation by the European Central Bank and Bank of Japan.
Mark Twain alleged that “there is no distinctly native American criminal class except Congress,” but we wonder what would he say about the bureaucrats at the Federal Reserve Board, ECB or the BOJ? Indeed, when you survey the world of investing, it is hard to get annoyed with the starry-eyed followers of bitcoin. Call bitcoin virtual tulips. The crypto adherents at least have decided to reject the authoritarian world of fiat paper currencies issued by insolvent governments and instead embrace an alternative standard.
Back to Bitcoin
Professor Larry White wrote in a blog post entitled “Blockchain + Gold”: “The Bitcoin system has the great virtue of securely sending value directly from stranger to stranger. It is open to anyone, anywhere in the world. The sender does not need to trust the recipient, nor any bank or other institution, to accurately record the transfer.”
And what can you say about those individuals who lack the courage to take a flutter in bitcoin, but comfort themselves by talking about the “benefits” of the inefficient blockchain tech behind it? Bitcoin holders at least have the possibility of gain, but “investors” in blockchain are literally shoveling money into the furnace. Several years on and many billions of dollars later, we still have yet to see one example of a blockchain outside of the bitcoin instance that makes any economic sense.
Anniversary of a Shotgun Marriage
Meanwhile, we would be remiss if we did not note the ten-year anniversary of the shotgun wedding of Merrill Lynch and Bank of America (BAC). We got several queries about the anniversary of this combination last week. One investment manager confessed during a private session in an office on Park Avenue that BAC was his best performing position, but then asked nervously if a 50% run up in less than a year is “cause for concern.”
We referred to the excellent piece by Chris Cole of Artemis Capital, who notes that the “investment ecosystem has effectively self-organized into one giant short volatility trade like a snake eating its own tail, nourishing itself from its own destruction.” Cole goes on to note that in addition to central banks buying $20 trillion in public and private assets, public companies have repurchased almost $4 trillion in stock – this by issuing debt.
“Like a snake eating its own tail, the equity market cannot rely on share buybacks indefinitely to nourish the illusion of growth,” notes Cole. Ditto.
Of course big bank stocks are “overvalued” in terms of earnings or revenues, but do such measures really matter in a world without value? When you have global central banks gunning all asset prices in a desperate effort to avoid a sovereign debt default starting in Japan and then Europe, pedestrian metrics like price/earnings ratios and net-present value have little relevance.
Remember, the reason that the Fed slammed Merrill Lynch into BAC a decade ago was in a desperate effort to preserve the US Treasury’s access to the bond market. In those dark days of 2008, primary dealers were collapsing left and right. Dealers operated by Washington Mutual, Bear, Stearns & Co, Countrywide and Wachovia all evaporated in a matter of days.
When all's said and done, the Federal Reserve Board cares not about inflation or employment or the safety and soundness of banks and the financial system. The paramount concern of the Fed is to preserve the ability of the US Treasury to issue more debt and thereby keep the great game going awhile longer.
The growing pile of public debt in the US is why price stability will never be part of the mix -- unless and until the Treasury is forced to live within its means. This is also why dollar-alternatives like bitcoin, imperfect and even fraudulent as they may be, will continue to capture the attention of those seeking to escape the economic tyranny of fiat paper money.
EDITOR'S NOTE
This Hedgeye Guest Contributor piece was written by Christopher Whalen, author of the book Ford Men and chairman of Whalen Global Advisors. Over the past three decades, he has worked for financial firms including Bear, Stearns & Co., Prudential Securities, Tangent Capital Partners and Carrington. This piece does not necessarily reflect the opinion of Hedgeye.
