The Millennial Economist

Just putting the pieces together on what could be a stagflation scare over the summer and into the fall. Longer term I think these trends bear watching, especially the water scarcity/food supply issue.

Delta variant will likely emerge at some point and claims are now stalling out some: http://bonddad.blogspot.com/2021/06/the-decline-in-new-jobless-claims.html

Supply chain issues keep cropping up, this recent one driven by a Covid outbreak in southern China. Those who think the supply issues will quickly go away are mistaken in my view: https://www.cnbc.com/2021/06/15/china-covid-cases-causing-higher-shipping-costs-delayed-goods.html

Further, retail inventories are razor thin. Not prepared for increased demand from an economic reopening:

Inventory to sales:

House prices continue their upward trend: https://www.calculatedriskblog.com/2021/06/the-housing-conundrum.html

And finally the big one. Continued drought and severe temperatures brought on by climate change. I encourage you to read this article, as it is obvious that policy makers are not taking this issue seriously at all. And left unsaid is a majority of water usage is from essentially growing water intensive crops in the desert.

End result? Increasing cost of water, more severe restrictions around water usage, and higher prices.

Crypto prices will stay rangebound to down as long as the regulatory push in China is ongoing. Miners will be forced to leave China if it continues long enough.

It will be interesting to see how this plays out as the price of lumber is through the roof. I think easily into the fall, then everyone will have a chance to take a step back and see the obscene levels that *everything* is priced, plus the prospect of an economy that is past its acceleration phase. Then we’ll get a repricing lower, how low remains to be seen.

I’ve been meaning to get some thoughts out on Tether and the recent drama surrounding the stable coin.

The recent uproar started with this medium post: https://crypto-anonymous-2021.medium.com/the-bit-short-inside-cryptos-doomsday-machine-f8dcf78a64d3

Several responses have attempted to debunk it, with some decent responses and some not so much.

To me however, the fundamental argument in the initial post and responses are a red herring: “Tether is not transparent and there are not enough dollars backing the amount of Tethers in circulation”

While the 1 to 1 backing is a credibility issue, it does not necessarily affect the proper functioning of Tether.

If we think of what Tether and all stablecoins are doing, it is running a currency peg against the US dollar. As such any stablecoin issuer essentially becomes a foreign central bank. To maintain that 1 to 1 peg against the dollar, Tether needs to adjust the supply of Tethers in circulation to meet the necessary demand.

Too much demand for Tether relative to the dollar and Tether appreciates, breaking the peg; too little demand and Tether depreciates, breaking the peg. So how does Tether manage supply? Like any foreign central bank it needs to issue more Tethers to satisfy demand (in FX terms sell Tether, buy dollars) or buy Tethers back to satisfy lack of demand (buy Tether, sell dollars).

As you can probably guess, you don’t need a 1 to 1 backing of the currency you are pegging to in order to perform these operations. In fact, if demand for your currency is robust (i.e. increasing Tether demand) the operation is easy. Simply create more Tethers out of thin air and sell them into the market for dollars.

However, where pegs get in trouble is a “run on the bank” scenario and this is where reserves become very very important. History is littered with instances of central banks running a peg, foreign currency reserves running thin, then the peg breaking in spectacular fashion. The 1997 Asian financial crisis is a good example: https://en.wikipedia.org/wiki/1997_Asian_financial_crisis

So the issue here isn’t with Tether having less than 100% backing by US dollars, but does Tether have adequate reserves to defend the peg in times of stress? When cryptos are appreciating then managing the peg is easy, but if Tether and stablecoins continue to grow and then there is another large crypto bear market, this will be the true test.

Another unknown is that the cryptocurrency ecosystem is fairly closed. What I mean by this is it is fairly easy to get US dollars in, but more difficult to get them out, especially in the US. *cough Binance.US cough*

So in this crypto bull market, if it is already difficult to convert crypto to dollars and pull them out into a bank account, how much more difficult do you think it will be in a bear market when there is a run on the exchanges? If suddenly everyone wants dollars and not any form of cryptocurrency, it could get ugly for stablecoins. This could then turn into a negative feedback loop, pulling down the whole econsystem. Probably a 1% probability if that, but that is the tail event.

This is a fraud that hasn’t explicitly been called a fraud, but it will be. Great additional analysis here:

https://www.epsilontheory.com/the-best-way-to-rob-a-bank/

This is an old article that I found via the Farnum Street blog. Extremely well written and forces you to consider the uncomfortable question: “would I do better with a coach?”

Investors love to use history as a guide for predicting possible market outcomes. Fundamental analysis and technical analysis both use history to inform the investor of extremes in valuations or price, and possible turning points.

The problem with using history as a guide is that the truly great money making opportunities have no historical precedent. I am constantly battling with myself not to get too hung up on history and think about possible outcomes in the context of the present.

Think about it. Notable market events become history because at the time, there is no historical precedent! Market participants have no idea that an unprecedented event is unfolding. In hindsight it all seems obvious, but at the time, uncertainty reigns. Think of the crash of ‘87, the tech bubble and the housing bubble to name a few. Most recently was the shut down of the entire global economy due to a pandemic.

If you read books on great investors and how they made their money, they often capitalize on opportunities where there is no historical precedent. They elaborate on this concept with their words but more often in their actions. They think of what is possible based on the present conditions and position accordingly. George Soros famous shorting of the British pound comes to mind. Or the great trend traders of the 70′s and 80′s riding unprecedented commodity bulls at the time.

This is the exact definition of Soros’ version of reflexivity. When the actions of market participants affects the securities fundamentals. In this case, bidding up a stock to such a degree the cost of capital is negative, thus spurring growth.

I love this quote:

Dobelli concludes with some advice worth taking to heart.