Today, I wish to follow-up on a couple of previous blogs with recent updates from the news.
Recently, as I predicted in my blog last month, China came down pretty hard on the Bitcoin. They basically have barred the on-line services like Baidu (BIDU) and Tencent (TCEHY) from accepting payment in Bitcoin. Furthermore, pressure was put on China’s largest bitcoin exchange from accepting Yuan in exchange for Bitcoin. I theorized that countries with positive balance sheets and balance of trade such as China had the most to fear from the Bitcoin. As a result of these actions in China, the value of the Bitcoin collapsed by hundreds of dollars in the past week.
Since my blog, I have come across other opinions, and I have refined my views of the upstart currency. More precisely, it seems that the Bitcoin is an exchange medium lacking any store of value beyond the perceptions of what people believe it is worth. For example, even fiat currencies (such as the US dollar and most all foreign government currencies) are backed by assets such as debt instruments, and further backed, in an indirect way by Special Drawing Rights (SDRs) of the International Monetary Fund (IMF) and World Bank. Also, they are implicitly backed in an indirect way to some small extent by gold.
However, the Bitcoin has no store of value backing it. Its value is simply the result of supply and demand. So, if perceptions are that it is not such a great investment, then its value should fall, because Bitcoins are not anchored by any stores of value. Despite all of its inherent weaknesses, the US dollar, by comparison, is anchored in value by “assets” which mostly consists of debt paper issued by the US treasury. Also, as I mentioned in my previous blog, the value of a country’s currency has historically been linked to the Gross Domestic Product (GDP) of a given country. The US has the highest GDP still, which is one reason its currency remains the world’s main reserve currency. (As I have also pointed out numerous times, the US dollar has many problems these days too, but for the simple comparison versus the Bitcoin, I have to spell out reasons why the world economic community accepts dollars more than other currencies.)
Also, as I think about it, the Bitcoin is not so much of a challenge to paper currencies, but more of a challenge to other forms of electronic payment systems. Electronic payers such as the credit card companies like Visa (V), Mastercard(MA) and Discovery, as well as Paypal, Ebay’s (EBAY) popular payment system, might be more threatened by Bitcoin.
However, if Bitcoin is viewed in this light, then what makes Bitcoin so special? How is it any better than Visa or Paypal? I suppose the argument can be made that Visa or Paypal requires one to convert between currencies if doing business overseas or traveling abroad–Bitcoin, if it is to be accepted worldwide, could conceivably do away with currency exchange and its costs. Otherwise, I cannot think of any advantage that Bitcoin offers over a service like Paypal.
Well, the Federal Reserve finally announced its tapering program which is scheduled to begin in January. In brief, the Fed will reduce bond purchases from $85 billion a month to $75 billion. In essence, it’s a small start, but nonetheless, a reduction in the wild money-printing that the Fed has resorted to in an attempt to induce greater growth and inflation in a weakened economy. In order to get the stock market and other risk investors on board with the pullback of the free-flowing “punch,” the Fed chairman, Ben Bernanke, announced that zero interest rate policy would continue at least until 2015 and perhaps 2016.
Bingo! As I pointed out long ago in two previous blogs well over a year ago, the Fed was planning to hold short term interest rates near zero at least until early 2016 even though the news media and market pundits acted like this could not be predicted… and the reason I said this was one of economic mechanics. In short, the Fed’s Quantitative Easing (QE) policies were sacrificing the purchase of short term treasury bills for longer term treasury notes and bonds, as well as long-dated mortgage-backed securities. In essence, the Fed was whittling down its holdings of short term treasury bills to zero!
Further, as I alluded to then, the Fed would not be able to sell any maturing long term paper until 2016, which would be the earliest date that the Fed would have capital to buy back some t-bills. Why this is important is that the Fed can’t mechanically raise short term interest rates without having the t-bills on its balance sheet; once on the balance sheet, the Fed could then sell the bonds into the open market, thus forcing interest rates higher as it has done in the past. (The Fed does have an untested back-up plan that would force banks to sell excess reserves and thus, accomplish the same task if it could not do it itself.)
I just checked the Fed’s balance sheet, and it shows a big ZERO next to Treasury Bills, so it still has no t-bills. In fact, you may wonder how does the Fed hold interest rates near zero if it doesn’t own any? That’s a good question, and all I can say is that it has a marvelous “communication strategy” that effectively compels the big market players in debt securities to keep these short term debt instruments near zero. That communication strategy basically acts to keep all members of the banking and investing communities in line so if one acts out of line, the other members, will in theory, make the renegade member pay dearly with financial losses.
However, to help soothe the nerves of the debt trading institutions that support the t-bill market, the feds do a good job of containing inflation, if only by modifying the measurements of what goes into a Consumer Price Index (CPI) or other official inflation reports. Just as important is a news media that does not question how inflation is measured officially, and so long as the accepted notion is that inflation does not exist, the Fed is able to contain short term rates for a very long time with the cooperation of all parties.
This all works fine in Washington, but I can’t help but notice that same car model I bought new five years ago now costs about 20% more–or that the same groceries I buy each week are costing me about 10% more than they did a year ago. Or how about that mobile phone bill I pay each month? Each time a member of my family upgrades to the latest, greatest smart-phone, I notice new surcharges added to my bill–permanently. From just two years ago, my monthly phone bill has jumped over 25%!
If you don’t believe that inflation is worse than officially reported, then try this: watch an old movie from 40, 50 or 60 years ago and pay close attention to any price or wage mentioned or shown in the movie. It might be the cost of a loaf of bread or a gallon gas or how much a store clerk earned–compare that to today’s prices. You will be amazed at how much more these things cost compared to only a couple generations ago! By my own back-of-the-envelope calculations, general inflation has increased by 1,000% since the mid-1950s (though I think wage inflation has lagged considerably). Yet, the calculators that use official government statistics will show inflation has increased by “only” 730%. That car of mine that I mentioned (now transferred to my college-aged son) is supposed to cost only 8.3% more, but as I say, it costs about 20% more for the same model today which also comes with fewer features in its standard offering. So why don’t more people ask where is the dis-connect?
So, what does this mean for investors? In short, the Fed will continue to keep the punch bowl out for those who seek to use local, cheap debt to create a carry trade into more rewarding payoffs elsewhere. This policy should continue to create the leverage that the bloated markets require to continue to reward the risk investors. So long as the market participants know that the Fed will keep the punch bowl out (all they had to do was read my blogs from 18 months ago!), they will know how to play the game to reap their gains.
However, the Fed is now prepared to turn off the fountain that feeds the punch bowl so that it won’t be over-flowing like it has been in 2013; but the punch bowl will be left out for another couple years at least. Or, will it? What could cause short term interest rates to rise sooner? In my opinion, only a rapidly rising inflation rate, and one that could not be hidden by government contrivances, could cause a re-think on rates. If inflation were to take off in strong manner in 2014 or 2015, this could compel market participants to start selling off t-bills at higher rates and thus forcing the proverbial punch bowl off the party table.
Indeed, the seeds for a massive inflation have been sewed into the fabric of the economy via Fed stimulus measures, but so far, those seeds have failed to induce an increase in the velocity of money circulating in the economy. If that should change, then the markets could force short term interest rates higher, and the Fed could either print money to try to contain those rates or sit idly by while the bond markets take control. If the bond markets were to get the upper hand, then a stock market crash and general asset crash could be in the cards. If, somehow the Fed were to print money to buy those rising t-bills, then the value of the US dollar itself could be called into question.
Even now, the market pundits talk of a rising dollar as the Fed begins its tapering program, but I can’t help but think that the communication strategy by these pundits is failing miserably….as I look at the US Dollar Index chart (see below), the US dollar recently experienced a “death cross” and the breakdown from a head-and-shoulders pattern, which are technical terms that mean the forex community of currency traders are selling dollars, and not buying them, as the pundits would have us believe.
Now, if only the massive communications strategy against gold could also begin to fail as it seems to be failing against the dollar supporters, then this could get to be a very interesting 2014!
It’s been a busy month for me which has not allowed much time to post my latest observations on the markets. I would like to remind readers that I do post on the Ace Talking Stocks Forum on a fairly regular basis under the name of “AceStockPlayer”, and there are a number of other traders who also post daily commentary on stocks, the markets or whatever grabs them at any moment in time…the Forum is open to public view (please read the disclaimers on the site before contemplating any actions on your part and always seek the advice of a registered stock broker or investment advisor– note that the forum does not offer any such advice–the forum represents only the opinions of anonymous posters which are not intended as investment advice.)
…and finally, I wish you a very Happy Holiday season! Thanks, and I hope you return again and again in 2014. It promises to be an exciting year around here!
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