Capital Letter — Boom, then Bust?

Capital Letter — Boom, then Bust?

A trader outside the New York Stock Exchange in New York City, February 16, 2021 (Brendan McDermid/Reuters)

The week of February 15: good long-term gloom, the mess in Texas, a trillion here, a trillion there, and much, much more, including the latest in our new podcast series, the Capital Record.

Well, the S&P may not have done much this week, but there were clear signs and signals that the conditions fueling the current bubble(s) are going to continue — and that the bubble(s) themselves are still bubbling away.

Elon Musk, in some ways the man of the bubble (I do hope that comment doesn’t disqualify me from some space tourism), got to the point.


Billionaire Elon Musk defended Tesla Inc.’s $1.5 billion Bitcoin investment on Twitter, calling the cryptocurrency a “less dumb” version of cash.

“When fiat currency has negative real interest, only a fool wouldn’t look elsewhere,” Musk said in a reference to the sub-zero returns on cash caused by negative-yielding debt. The comments pushed Bitcoin to a record on Friday, with prices climbing above $53,000.

Musk is going to Musk, but he is hitting on an uncomfortable truth. When money (and by extension, risk) is as mispriced as it now is, a lot of investments that would not otherwise make sense do so. Musk’s term “less dumb” was neatly put.

Meanwhile, from Grant’s Almost Daily:

Following another busy deal day, some 154 special purpose acquisition (a.k.a. blank check) companies have come to market so far in this young 2021, raising a total $46.7 billion according to data from SPACInsider.  That compares to $83 billion in such deals all of last year (itself eclipsing all total prior fundraising for the vehicles), and an average $44 billion in annual proceeds from conventional U.S. initial public offerings from 2011 to 2019 per Renaissance Capital.

Luckily for promoters, the current zeitgeist is helping to absorb that wall of supply. The Wall Street Journal reports that Oakland-area rapper Cassius Cuvée recently released a music video dubbed “SPAC Dream,” on YouTube, garnering the attention of investor Bill Ackman on Twitter.  It’s not just an artistic muse. Cuvée notes that roughly half of his $1 million stock portfolio is allocated to the blank check enterprises.

You can watch it here. The song includes shout-outs to “Mr. Musk” (“Elon, the trailblazer”), due diligence, the “golden cross,” “buy the dip,” and . . . ESG. I had not expected that last one, although ESG is a bubble all right — a “rational bubble,” but a bubble nonetheless.

One of my rules of thumb for determining the moment that a bubble is getting ready to burst — an update, really, on old Joe Kennedy’s story about the shoeshine boy — are signs that popular culture is getting just a little bit too deeply into Wall Street. The year 1929 saw (at least) two films with Wall Street in the title (and ruthlessness in the plot), including, yes really, The Wolf of Wall Street (“the plot concerns a ruthless trader, Bancroft, who corners the market in copper and then sells short, making a fortune but ultimately ruining the finances of himself and his friends”) and Wall Street (“Ralph Ince is Roller McCray, a steelworker turned ruthless tycoon whose tough business methods leads a rival, Philip Strange, to commit suicide”). The latter film was released a month or so after the crash, but if I had to guess was filmed beforehand.

And there have been quite a few examples since.

In a lengthy, intricate and carefully reasoned piece for Bloomberg, John Authers makes the case that this bubble may have a while yet to run. One of the signs of this may be that retail involvement (proxies, again, for Kennedy’s shoeshine boy) probably has further to go.


Traditionally, individual investors arrive at the end of a bubble and bear the brunt of the losses; they get to be the final “greatest fools” who buy at the highest price. Obviously, the GameStop excitement shows that retail money is getting involved in a big way, and having an impact. But there are more stimulus checks to come, and the evidence is that many retail investors are only now beginning to get interested in the possibilities of the “reflation trade.”


Bloomberg Opinion colleague Jim Bianco points out that in the final stage of the dot-com boom, the market narrowed sharply. While the tech sector shot for the moon, investors needed to bail out of other stocks to fund these investments. Over the last five months of that bubble, the S&P 500 excluding technology fell by more than 10% while tech gained more than 50%.

This was a change from the previous pattern. For much of 1999, possibly the maddest market year on record, tech stocks rallied without getting in the way of the rest of the market.

Now let’s take a look at the last six months. I substituted the NYSE Fang+ index as the best modern exemplar of where the excitement is. The FANGs did have a little-remembered correction in early September. Since then, their rally has been mighty impressive once more — but it hasn’t stopped the rest of the market registering decent gains.

There are no signs that the Fed is changing its view (on the contrary), and so:

More cheap money for longer, a sensible approach if you are still worried about a recession and falling prices, helps to boost reflation if it arrives. It also oils the wheels of speculation. All history’s great speculative bubbles needed cheap money, and there is enough around now to sustain another one.

Meanwhile (and obviously), keep an eye on interest rates.

The Financial Times:

The drop in US government bond prices in the opening weeks of 2021 poses a threat to Wall Street’s record run, analysts and investors have said.

High prices and vanishingly slim yields on Treasuries have provided a key support for equities since the shock of the coronavirus outbreak last year. But, stung by expectations for rising inflation, yields have swept higher, with the 10-year benchmark yield briefly touching 1.3 per cent this week, from a little above 0.9 per cent at the start of the year. Already, February is shaping up to provide one of the biggest monthly increases in yields since 2018.

Investors are now scrambling to identify the potential tipping point for equities.

“If we see a gradual increase in yields over the course of this year and next year, that is something the equity market is happy to digest,” said Kiran Ganesh, a multi-asset strategist at UBS Global Wealth Management. “If things happen a bit more quickly . . . that could lead to more substantial problems.”

The prospect of a $1.9tn stimulus package coming out of Washington, pent-up demand from months of social curbs, and loose monetary policy from the Federal Reserve have pushed inflation expectations to their highest in years. One metric derived from US inflation-protected government securities — the 10-year break-even rate — recently rose to its highest point since 2014, at 2.2 per cent . . .

For stocks, moderate inflation is typically a good thing. Sean Markowicz, an investment strategist at Schroders, calculates that US equities tend to outperform 90 per cent of the time when inflation is low but rising. Any inflation stemming from a return to normal life would also be a welcome sign that the US economy is slowly dragging itself out of its pandemic-induced slump.

Stocks may also prove more robust than in previous inflationary episodes. Yields remain low by historical standards. Crucially, the Fed has also made it clear it is happy to allow inflation to simmer without raising interest rates. But investors warn too swift an increase in prices could still knock some froth off stocks that are hovering around record highs, particularly in the red-hot tech sector . . .

Meanwhile, the Financial Times’ John Dizard has a characteristically interesting spin on the technical factors that could be driving a steeper yield curve (my emphasis added):

The last two weeks of this coming March look like a set-up for some sort of panic in the US Treasury and mortgage-backed securities markets. Not the end of the world, but something like being a passenger in an aircraft that suddenly drops several thousand metres.

The most salient and immediate signal to me has been the plunge in short-term Treasury bill rates since the beginning of the year. In the first six weeks of 2021, one-month T-bill rates have fallen by more than 66 per cent. The yield of two-year Treasuries declined by more than 21 per cent. Those are more dramatic moves than you see in any other broadly traded securities.

Unlike the Fed’s favourite instrument, bank ‘excess reserves’ on deposit with the central bank, T-bills are ‘collateral’. They can be readily lent and relent to secure other, unrelated transactions. When people or institutions in the global financial system are not feeling eager to trust each other, they demand more collateral.

The degree of that distrust appears to be rising, quickly. You can see that by looking not only at the outcome of official T-bill auctions, but at the range of bids in the auctions. Low bids mean that dealers are willing to accept very low rates, as little as 1 basis point recently, just to make sure they get some of that collateral. That historically happens at systemic stress points . . .

Not the most reassuring thought in the middle of a bubble, but the counterargument is that if it drives the Fed to come to the rescue yet again the party can resume.

That said, sooner or later, this dance is coming to an end.

Meanwhile, the broader economy ought to take off in the second half of the year, but what then? I may not agree (#understatement) with James Pethokoukis about the economic implications of lower population growth, something that in my view (most certainly not his) is to be hoped for, with the age of automation accelerating as it is (and a gentle decline, over time, would be no disaster either). But in this part of a thought-provoking piece for The Week, he is, in my view, spot on.

Referring to some comments made by President Biden on Tuesday, Pethokoukis notes:

“Now is the time we should be spending,” he also said at the town hall. “Now is the time to go big.”

Again, the “time” Biden is talking about doesn’t just refer to the current economic need for more government help (which, as I have written, is not worth nearly $2 trillion). He also almost certainly means that low interest rates and low inflation have created such a benign fiscal situation that America almost really can’t afford not to spend big, whether it’s on checks to households, aid to cities and states, or infrastructure investment. That, of course, despite record-high budget deficits and national debt.

But what if that benign fiscal situation turns hostile? What if today’s placid macroeconomic reality becomes far more volatile and unpredictable? It’s not a crazy notion. Policymakers shouldn’t assume the good times will never end when they’re making taxing and spending decisions. They should avoid huge fiscal wagers that the future will be much the same as the recent past . . .

Quite. And massive wagers have already been made. Biden is simply piling more chips on the table.

Although the Democrats will doubtless be increasing the taxation side of the equation before long, count me skeptical that it is going to do much for the growth of an economy that will also be suffering under the regulatory overreach that is already becoming a hallmark of the Biden administration. Making that overreach even worse is that it will be inextricably linked with a dogmatic “climate” agenda that will lead to malinvestment, waste, and government bloat on a colossal scale. It will retard growth and destroy jobs rather than create them, for, I suspect, little discernible effect on the climate. The prospect of prosperity built on some sort of Green New Deal is even less credible than Xi’s promises on the climate, promises on which the West now, incredibly, appears to believe, or, at least, pretends to.

Writing for Real Clear Energy, Rupert Darwall:

Soon enough, the Biden administration will face a crisis of its own making – a policy-driven jobs crisis. As Keystone XL pipeline workers are finding out, creating the jobs of the future apparently involves destroying jobs of the present. As McCarthy coyly explains, “this is all about building the jobs of the future we want, not continuing to niddle at an economy that is no longer going to be where our future lies.”

No job can sustainably pay more than the value of the output it generates without permanent subsidies. Incessantly incanting the mantra of “good-paying union jobs” doesn’t make it otherwise and can’t change the underlying economics of terminating high-productivity oil and gas jobs for low-productivity wind and solar ones. According to the American Enterprise Institute’s Mark Perry, it takes one worker in nuclear and natural gas to produce the same amount of electricity as 1.1 in coal, 5.2 workers in wind, and a whopping 45.8 workers in solar. The productivity penalty of wind and especially solar ineluctably means lower wages. “Solar jobs will be everywhere,” McCarthy said – implying that lots of poorly paying jobs will replace the high-paying ones that the administration is bent on eliminating.

The president’s executive order also states that fighting climate change will be integral to U.S. foreign policy and national security. Though regarding climate change as a dire national security threat is overblown, viewing it through a national security lens can be helpful in one respect. Like fighting a war, fighting climate change requires the deployment of vast resources to a cause yielding little or no direct economic benefit. The benefits of climate policy arise only far into the future – if they arise, for their success depends on all major economies cutting their emissions, not just the U.S. The benefits would take the form of reduced adverse impacts, not investments that generate faster economic growth and higher living standards. We sacrifice today for a less-worse future climate at some unspecified date . . .

Far from being an economic win–win, climate policy is a lose–lose. Replacing energy derived from hydrocarbons with wind and solar energy shrinks the economy’s productive potential. Additionally, decarbonizing energy means that it becomes more expensive to make stuff and do things, like heating homes and powering factories. It’s why energy costs in Europe are a multiple of those in the U.S. Decarbonization is therefore an inflationary double-whammy. It shrinks the output gap as the economy becomes less productive, and by putting more wind and solar on the grid, it makes the grid more fragile and pushes up energy costs, injecting cost-push inflation into the economy.

This will not end well.

The Capital Record
We recently launched a new series of podcasts, the Capital Record. Follow the link to see how to subscribe (it’s free!). The Capital Record, which will appear weekly, is designed to make use of another medium to deliver Capital Matters’ defense of free markets. Financier and NRI trustee David L. Bahnsen hosts discussions on economics and finance in this National Review Capital Matters podcast, sponsored by National Review Institute. Episodes feature interviews with the nation’s top business leaders, entrepreneurs, investment professionals, and financial commentators.

In the fifth episode, world-renowned economist, technologist, and supply-side guru, George Gilder, joined David to look at some hard truths as we enter a post-capitalist world, and how those who know the real definition of wealth can win the intellectual war.

And the Capital Matters week that was . . .
We like to begin the week on a grim note and Steve Hanke’s inflation dashboard (as usual) did not disappoint. I hope Steve looks at the euro one day, and the damage that sustained currency overvaluation can do, but here he tackles some myths about devaluation:

To understand the source of this myopia, consider the advertised goal of devaluations. A devaluation is supposed to increase the price of foreign-produced goods and services and decrease the price of domestically produced goods and services. These changes in relative prices are supposed to switch domestic and foreign expenditures away from foreign-produced goods and services towards those produced domestically. This is supposed to improve the devaluing country’s international trade balance and accelerate its growth rate.

For the public, this argument has a certain intuitive appeal. After all, a devaluation is seen as nothing more than a price reduction for domestically produced exports, and price reductions are always seen as a means of increasing the quantity of goods sold. When it comes to currency devaluations, the analysis is not that simple, however. Following a devaluation, inflation will pick up and so will the costs of producing goods and services, including exports, in the country that has devalued its currency. Inflation will steal away any of the potential, short-term, competitive benefits that might initially accompany the devaluation. That’s why devaluations are a delusion. And that’s why countries that are addicted to devaluations always fail to gain a competitive edge and why they are always mired in volatile, slow economic growth.

Devaluation when accompanied by serious policy reform, however, is something else, as we saw in Sweden in the early 1990s — something else, I hope, that we can discuss one day. Those with an old-fashioned understanding of Swedish politics will, I suspect, be dismayed by what they learn.

Boris Ryvkin made his debut for Capital Matters by calling for a change in the way that the Ex-Im Bank is run, rather than its abolition. That is not a view that you will often hear among conservatives but (to be pompous about it) part of the mission of Capital Matters is to provide a space where divisions on the right on economic policy can be aired.


Most of the agency’s critics argue that it distorts lending rates that should be set by the market. Those who stop short of calling for the end of the Ex-Im Bank altogether seek to balance its benefits with its costs while also acknowledging the value of risk mitigation. Is the Ex-Im Bank’s guarantee valuable if it means getting a specific transaction closed that otherwise would not have been? Yes, especially when considering not just the gain to the transaction parties themselves, but also the work provided to myriad service companies assisting with the transaction and third parties (vendors, customers, suppliers, etc.) who would wish to see the deal done.

Could the same transaction have been done without the Ex-Im Bank’s involvement through, possibly, a consortium of lenders willing to finance a risky, cross-border sale and lease venture involving companies with little-to-no market share or credibility in the end user’s country? Maybe, but at what cost? And, more important, at what cost relative to the low risk of the Ex-Im Bank’s involvement? From a transactional perspective, the Ex-Im Bank guarantee almost performs the function of a low-cost bridge loan, but without an up-front payment. There’s value in that.

To take another tack, if the Ex-Im Bank’s role in supporting U.S. exports is statistically marginal, that might suggest the agency is not useless but underused. Maybe we could take its functions that do work and redirect them to something that could provide immediate gains for U.S. policy by supporting strategically useful investment. Specifically, for certain transactions where the contracting parties cannot expressly provide in their relevant documentation that the transactional purpose is the promotion of U.S. exports, the Ex-Im Bank could be used to provide guarantees to U.S. companies (particularly emerging growth companies, start-ups, smaller joint ventures, and midsize companies) to help them (i) gain footholds in high-risk and politically unstable emerging markets and (ii) successfully compete for bids and development tenders. The most pressing area where this approach could be used today is the great game that the U.S. finds itself in with China as the latter’s state-owned enterprises provide financing at a loss to developing countries as part of the Belt and Road Initiative.

There is pushback here as well. We cannot “out-China” China, some critics claim. Just because the China Development Bank, with billions of dollars in assets, does what it does, the U.S. cannot and should not follow suit. “Countering the Belt and Road Initiative is a foreign policy issue, not an Ex-Im issue,” wrote Diane Katz of the Heritage Foundation. The U.S. should, instead, “help establish and enforce new rules of the road; promote better standards, transparency, and a new vision for regional connectivity; shine a light on the risks and consequences of the [Belt and Road Initiative] where necessary; [and] aid friendly countries subject to Chinese economic coercion.” Laudable goals, but what does this mean in the context of real transactions with real investors, lenders, credit facilities and security arrangements? If the Ex-Im Bank’s low-risk participation in an auction pitch by a U.S. company to an overseas seller or lessor (private or government) makes the difference between that company or a Chinese company getting the contract, which outcome would most benefit the U.S.? Priority should be given to getting actual deals done rather than debating frameworks from the sidelines.

The Ex-Im Bank should not be viewed as a mere commercial, bureaucratic irrelevance to be discarded. It can instead be reframed and restructured as a vehicle to aid overseas strategic investment in competition with our rivals. This could make it an asset that serves an important geopolitical or national-security purpose. Effectively managed with an eye toward concrete, transactional benefits for U.S. companies that can be converted to diplomatic influence (leaving the specifics of the deals to the diligence efforts and good-faith negotiations of the private parties), one could even argue that American taxpayers would be better served if some of the annual defense budget were reallocated from the Pentagon to a reformed Ex-Im Bank.

There has never been a time when trade and investment were not inextricably linked with foreign policy. Looking ahead, the U.S. would be better served if policymakers worried as much, or more, about expanding American companies’ market shares in emerging regions of the world and winning investment bids than about where to send the Fifth Fleet. That is certainly how our main adversaries seem to be thinking about their foreign policies these days.

Robert VerBruggen has found a strange new respect for last year’s $600 a week boost to unemployment pay:

Last year, as the pandemic was just striking the U.S., there was a minor kerfuffle over Congress’s plan to give the unemployed an extra $600 a week. Some Republicans initially assumed it was a drafting error, because it would give many laid-off workers more money than they’d made while working.

It was actually intentional. States’ unemployment systems run on creaky old technology, and they can’t quickly switch to complicated new formulas. When COVID-19 kicked a bunch of people out of work, the only way to boost their benefits — which normally replace only a fraction of their earnings — was to add a flat amount to what they’d normally get, and just about any decent-sized amount would pay at least some people more than they’d made before. The $600 boost, however, nearly tripled the usual benefit and paid the median worker about 45 percent more than he’d made while working, with lower-income workers doing better than that and higher-income workers doing worse.

It wasn’t crazy to think that this would discourage workers from getting new jobs if they could. I was concerned about it myself. But a new study shows that effect to be rather small. The unemployment top-up didn’t keep too many people from work, but it did boost spending at a time when the economy really needed it . . .

George Leef asked whether the constitution authorized minimum-wage laws (spoiler: yes):

Initially, the Supreme Court ruled against the federal minimum-wage law, but after the 1937 switch by Chief Justice Hughes to the “liberal” side (that is, statist and illiberal), the Court upheld it, along with everything else FDR dreamed up to subject the country to control by Washington, D.C. Alas, that is a legal blunder that will never be undone.

Joe Sullivan, our chart guy, asked whether the American dream was still alive:

Is the American Dream alive? Opinions vary. Interpretations either way coalesce around the fate of middle-class incomes. If you identify the middle class based on how much money a family has in the bank rather than their income in a given year, however, the answer is a resounding “No.”

Timothy Fitzgerald made the case against oil import tariffs:

Harold Hamm advocated for oil tariffs during the Trump administration. North Dakota, where Hamm’s Continental Resources is an important producer, has had low prices for years relative to national benchmarks (Keystone XL would have helped by providing another way for North Dakota oil to get to market, reducing the price differential between crude produced there and elsewhere). Yet even the tariff-happy Trump administration could not stomach oil tariffs. It has been just over five years since the antiquated crude-oil export ban was scrapped. Yet here come West Texas oil producers asking for import barriers — maybe they don’t recall their advocacy of free trade a few years ago.

The oil-tariff idea has deeper roots, going back to the Suez Crisis during the Eisenhower administration. While those may seem like halcyon days for the U.S. oil industry, tariffs did not change the trajectory of long-term decline in domestic production. All the more ironic to revive this policy now, with the U.S. a net energy exporter for the first time in 75 years. Nonetheless, some producers are preparing to mount an effort to impose a tariff on oil imports under Section 232 of the Trade Expansion Act of 1962, the same authority that the Trump administration used to put tariffs on imported steel and aluminum.

Tariffs create problems. One is that the costs largely fall on our own consumers. The second is that, to the extent they affect foreign interests, they often hit friends and allies. In the case of oil, that means Canada, Mexico, and other neighbors. Since the beginning of 2020, over 85 percent of U.S. oil imports came from the Western Hemisphere, overwhelmingly from Canada and Mexico. What about Saudi Arabia and Venezuela? What about Russia? What about the other member states in OPEC? Actually, we really don’t import much oil from any of those places — the average over the past year is about 12 percent of total oil imports from all OPEC members. That might seem like a lot of oil to a single producer, but the global oil market is large and complex. The option to buy and sell on the global market provides American firms flexibility and is likely to help domestic prices on balance.

It has been a rough year for the oil industry, but things are looking slightly better, even as clouds remain on the policy and economic horizons. The path to recovery does not wend through protectionism, certainly not when the United States is producing more energy than it can consume. Oil producers petitioning the new administration for tariffs are among the most desperate in the country, and they should prepare for disappointment.

Kevin Williamson looked at the chaos enveloping much of Texas’s electrical grid:

As practically every Texan and much of the rest of the country now knows, Texas’s electrical grid is managed by the comically misnamed Electric Reliability Council of Texas. To the extent that its reliability is the issue, what it is reliably incompetent. As Texas shivers in the dark, there’s plenty for everybody to hate in this story. But it does present an opportunity to consider three concepts that can shape our public policy for better and for worse . . .

The fundamental reason for Texas’s blackouts is correlated grid risk: The kind of winter storm we currently are experiencing — unusual but hardly unprecedented — drives up demand for electricity while simultaneously driving down the available supply of the stuff. The system can withstand a spike in demand, and it can withstand a dip in supply, but it cannot withstand both at the same time. Hence the blackouts.

In addition to the usual troubles of downed power lines and the like, electricity plants are having a hard time getting fuel or using the fuel they have, including natural gas and coal. So-called renewables such as wind power and solar perform poorly, or do not perform at all, in such conditions, while natural-gas, coal, and nuclear facilities have been shut down or hampered by pipelines, instrumentation, and other equipment that is inadequate to the current conditions. Texas has more than enough natural gas to power itself through a storm such as this one, but it does not have sufficient capacity to get that fuel where it is needed or to use it in the current conditions. If you can’t get the gas where it’s needed, you may as well not have it at all.

Texas could have an infrastructure that is better prepared for this kind of thing, but the upgrades would be expensive. Nobody wanted to pay for them a week ago. Nobody will want to pay for them a week from now. But today, millions of Texans wish the money had been spent — preferably by someone else, of course . . .

Kevin covers a lot of ground in this piece. Do read the whole thing.

Tucson, Ariz., is paying rent to itself on five golf courses and a zoo. Kevin returned to Capital Matters to explain what was going on (and not only in Tucson):

This is the municipal-government version of that jackass who took out a big bank loan to buy GameStop shares that tanked: borrowing money to purchase assets in the blind hope that your returns will exceed your borrowing costs. Given public-pension managers’ long history of making astoundingly optimistic — dishonestly optimistic — estimates of returns, we must be less than entirely confident in their ability to execute this scheme.

There are two good alternatives to these kinds of shenanigans: (1) fund pensions responsibly; (2) cut pensions benefits down to what you are willing to fund. In the long run, those are the only real choices — everything else is a sham.

Alexander Salter cast a bleak eye over the Fed’s machinations:

No so long ago, during the age of Milton Friedman, the chief concern of monetary policy was inflation. The Federal Reserve’s job was seen as a balancing act: Too low a money supply would slow spending, and too much would erode purchasing power. Of course, given the inoculation of monetary economists against anything resembling deflation, we really only worried about erring in the other direction. Good monetary policy meant open-market operations to keep the money supply on a predictable path, which gives markets a stable foundation for short-term and long-term contracting, facilitating economic coordination.

But the inflation-as-bogeyman era is gone now. Beginning with the 2008 financial crisis, operational changes at the Fed broke the link between the size of the central bank’s balance sheet and the purchasing power of money. The Fed’s assets grew from under $1 trillion in mid- to late 2008 to $4.5 trillion in early 2015, and then to $7.4 trillion today. You’d expect the massive increase in the monetary base to create inflation. But you’d be wrong. Why? Because beginning in late 2008, reserves held by depository institutions at the Fed skyrocketed. During the COVID-19 crisis, they climbed still higher. The bottom line: All the newly created money in the world won’t drive up prices if it doesn’t circulate through the economy. Right now, it isn’t.

The reason for inflation’s disappearance is the Fed’s switch from a corridor system to a floor system. Once the Fed started paying interest on excess reserves in October 2008, banks had little incentive to turn the massive amounts of newly created liquidity into loans. This was intentional. The theory of then-Chairman Bernanke’s Fed was that the ongoing crisis was propagated by a deterioration in the balance sheets of major financial institutions. The point was to take bad assets off their books (swap them for cash) in a way that wouldn’t generate inflation. The plan worked, up to a point. The financial system didn’t collapse, and prices didn’t shoot up.

But the floor system isn’t a free lunch. By focusing too much on firm-level balance sheets and not enough on broader monetary aggregates, Bernanke’s Fed inadvertently held back the recovery. Lost output and employment during post-2008 are only partly to blame on President Obama’s misguided economic agenda. Reckless innovation in monetary policy mattered even more.

More than a decade after the enactment of the floor system, economists are starting to notice other insidious features. In some ways, the lack of inflation makes it harder to discipline the Fed. Price increases are a visible phenomenon, felt by millions of Americans. Though technocrats like to pretend otherwise, central banking is political, and in politics visible results matter a lot more than invisible results. Inflation is salient. What’s going on right now isn’t, but that doesn’t make it any less dangerous . . .

Jon Hartley disapproved of Tesla’s addition of Bitcoin to its balance sheet:

This month, Elon Musk announced that Tesla had bought $1.5 billion of Bitcoin, totaling about 3 percent of the firm’s assets as of December 2020. Tesla’s decision led some television commentators such as Jim Cramer to suggest that more CEOs should add Bitcoin to their corporate balance sheets.

In reality, the speculative cryptocurrency has no role in corporate treasuries. For one, it’s almost certain that very few if any consumers are purchasing products with Bitcoin. Even if some customers were using Bitcoin, Tesla and others would be better off hedging their Bitcoin risk rather than adding to it, given the cryptocurrency’s immense volatility (it declined 75 percent against the U.S. dollar in 2018 before gaining 300 percent in 2020).

Why should companies hedge? Investing in an extremely volatile asset that is nowhere close to being a serious medium of exchange increases the volatility of that corporation’s equity. In other words, it makes that company’s stock price more volatile.

Those who argue that Bitcoin protects them from inflation amid ongoing stimulus and risks of the economy overheating should know that Bitcoin is also a terrible inflation hedge. The correlation between Bitcoin prices and inflation expectations (from Treasury inflation-protected securities) is close to zero.

As I wrote earlier, Capital Matters is a space for debate. In putting forward this view, Jon was at odds with . . .Daniel Tenreiro.

Here is what Daniel was arguing a week or so back:

The technology industry markets itself as deterministic: Entrepreneurs imagine a different future and set out to create it. But as any venture capitalist knows, it’s difficult to predict which technologies will succeed and which will fail. Indeed, the VC portfolio model treats investments as lottery tickets, assuming that nine out of ten will fail and one out of ten will be wildly successful. That’s why W. Brian Arthur described the tech industry as a casino:

“It is casino gambling, where part of the game is to choose which games to play, as well as playing them with skill. We can imagine the top figures in high tech — the Gateses and Gerstners and Groves of their industries — as milling in a large casino. Over at this table, a game is starting called multimedia. Over at that one, a game called Web services. In the corner is electronic banking. There are many such tables. You sit at one. How much to play? you ask. Three billion, the croupier replies. Who’ll be playing? We won’t know until they show up. What are the rules? Those’ll emerge as the game unfolds. What are my odds of winning? We can’t say. Do you still want to play?”

In casino-like markets, competitive advantage is derived less from technological expertise or management acumen than from an ability to choose the right games. In Arthur’s words, “Bill Gates is not so much a wizard of technology as a wizard of precognition, of discerning the shape of the next game.” On this view, companies live and die not on their technology but on their adaptability. They must divine the future and be at its forefront before their competitors.

Which brings us to today’s news that Tesla has allocated $1.5 billion of its corporate treasury to Bitcoin. The company explained the decision as an effort to “diversify and maximize returns on our cash that is not required to maintain adequate operating liquidity.” But speculating on an experimental asset is an astonishing move for a growing business that only recently started generating positive cash flows. And yet there’s an underlying logic to the move.

With a market cap surpassing $800 billion, Tesla is one of the largest and best-funded companies in the world. It is valued on earnings that won’t materialize for decades, and its investors assume it will dominate the electric-vehicle industry for decades to come. Its success will thus be determined not only by its ability to produce and sell cars, but by its ability to stay ahead of the technological curve. In Arthur’s formulation, Tesla will need to play the slots — whether it wants to or not.

By leading the way as an early corporate adopter of cryptocurrency, Tesla is committing a relatively small amount of its cash to a nascent, growing business. It is “linking and leveraging,” using its large base of investors, customers, and fans to enter a new market. If Tesla follows through on plans to accept Bitcoin as payment for its vehicles, it could tack a host of crypto-adjacent markets onto its car-building operation. This kind of risk-adjusted bet on emerging technologies is exactly what a good CEO does.

Ironically, the casino approach is new for Elon Musk. Both Tesla and SpaceX entered competitive, logistically difficult manufacturing industries and won by bringing costs down and incrementally improving existing technologies. But Musk is now the richest man in the world, and (on a perhaps overly generous reading) he appears to be adapting to his role as CEO of a tech behemoth.

“Casino-like markets!” Pearls are clutched, and Captain Renault smiles.

We began the week on a grim note, and we ended it the same way, with Brian Riedl looking at federal spending:

During policy debates, figures like millions, billions, and trillions are used interchangeably. So here is a useful distinction: A $1 million program costs just under a penny per household. A $1 billion program costs $8 per household, while a $1 trillion program costs $8,000 per household. And yet social media is filled with people aggressively endorsing a $30 trillion proposal (costing $240,000 per household) because they misunderstand the figure as $30 billion ($240 per household). Mathematical illiteracy is expensive.

The left’s consistent embrace of ever-bigger budgets has also shifted the goalposts for Republicans, whose acceptance of rising spending is never enough for critics. The GOP’s embrace of $4 trillion in pandemic-response legislation (the already-enacted $3.4 trillion plus $600 billion of the latest proposal) — which by itself far exceeds the responses of most developed countries and any economic response in American history — did not spare them from attacks as tight-fisted libertarian zealots who are unworthy being allowed in relief negotiations. This is nothing new. Between 2001 and 2004, Republicans responded to aggressive Democratic attacks of “underfunding” education by enacting No Child Left Behind and nearly doubling total federal education spending from $33 billion to $63 billion. Democrats responded by again attacking them as “underfunding” education in 2004. The bar never stops moving.

The budgetary goalpost-shifting is also evident in Democratic spending promises, where the common argument is that if Republicans can pass a $2 trillion tax cut, then Democrats are entitled to enact Medicare-For-All ($30 trillion), a government jobs guarantee ($30 trillion), a Green New Deal (as much as $16 trillion), and free public-college tuition and loan forgiveness ($3.5 trillion). The tax cuts may not have been wise or affordable, but there is a difference between cutting federal tax revenues by three percent versus increasing federal spending by 60 or even 100 percent. Perhaps the Democrats should get $2 trillion for any new spending they wish, and then the parties can call it even and end the red-ink arms race.

Democratic presidential campaigns also reflect mounting and fantastical budget promises. The party’s three previous nominees — John KerryBarack Obama, and Hillary Clinton — each campaigned on increasing federal spending by between $1- and $2 trillion over the decade. Then Joe Biden promised $11 trillion in new spending — and was perceived as a centrist because Elizabeth Warren, Kamala Harris, and others had proposed closer to $40 trillion. Bernie Sanders demanded a $97 trillion spending spree that would leave European governments in the dust. For context, the entire federal budget (outside pandemic relief) is projected to total around $60 trillion over the next decade. Even a Republican pledging to abolish all federal income and payroll taxes ($42 trillion over the decade) would not be much more fiscally irresponsible than many of the Democratic party’s leaders.

And that is why much of the debate over federal spending and taxes is so detached from reality. The enormous new spending programs — and even larger spending proposals — are not accompanied by comparable taxes. Taxing the rich is not nearly sufficient to finance this spending, and the middle class has not suddenly endorsed a doubling of its own taxes. Which means Washington politicians are betting that the national debt — which has soared from 40 to 100 percent of GDP since 2007 — can leap to 200 or 300 percent of GDP with no significant harm. But the laws of math and economics have not been repealed, and even in the unlikely scenario that interest rates remain below their typical levels, interest on the national debt is projected to consume nearly half of all federal tax revenues within three decades. If we want bold spending expansions, then get ready for bold new taxes (or Federal Reserve inflation) when the borrowing party inevitably ends.

Finally, we produced the Capital Note, our “daily” (well, Tuesday–Friday, anyway, except when it’s not: two days mysteriously went astray this week). Topics covered included: Retail spending surges, Texas freeze worsens chip shortage, Citigroup loses debt dispute, the two sides of the output-gap debate, Texas powers down, debt and more debt, government gets in the way of COVID testing, government gets in the way of food, and government gets in the way of windows.

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[By: Andrew Stuttaford

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