So there is this panic going on right now in the market...
Even "safe haven" assets like gold and silver and U.S. Treasury funds are down. Even what might seem like the most contrarian asset in existence--bitcoin--is down...
PGIM Stable Value Bond Fund: (https://www.morningstar.com/funds/xnas/pdbax/quote)
Almost every chart you look at will have the same shape today over a 1 month time frame, stocks, bonds, gold, silver, real estate, bitcoin. Every asset class is going down.
Why is this?
It is because of the liquidity illusion, like Warren Buffett once said, "Only when the tide goes out do you determine who's been swimming naked."
Stocks, bond, gold, silver, real estate, and bitcoin are all integrated into the global market, which is then mutualized and liquified like a giant smoothie with all of the effort and ugliness of managing individual assets that may or may not be immediately salable masked behind ETFs, bond funds, etc. managed by professionals who are bound by integrity to make available as much money as possible to people who want to exit their funds when asked to do so. However, when the house is on fire, everyone wants to exit at the same time. So the exits are jammed, the websites crash, the phone lines are overloaded and people get trampled.
In economic terms, people lose money.
A lot of it.
What is the underlying problem? What fundamental truth can we learn from this?
Jonathan Tepper has an
excellent blog article which succinctly sums it up:
The Irish Potato Famine is one such cautionary tale of the danger of monocultures, or only growing one crop. The potato first arrived in Ireland in 1588, and by the 1800s, the Irish had used it to solve the problem of feeding a growing population. They planted the “lumper” potato variety. All of these potatoes were genetically identical to one another, and it was vulnerable to the pathogen Phytophthora infestans. Because Ireland was so dependent on the potato, one in eight Irish people died of starvation in three years during the Irish potato famine of the 1840s.
Ultimately, his key point is regarding risk:
Risk is like energy and cannot be destroyed. It can only be transformed.
The potato of the modern economy is the "fund" or the "exchanged traded fund" in the case of stocks, or as some people refer to it as "indexing."
Why does indexing fail in times of crisis?
Because we have mutualized risk across wider swaths of the economic system. It is socialized capitalism. Mutualized risk is the reason every complex system fails under extreme load. It is the
sandpile theory of complex systems at work.
The global economy is a giant sand pile. Each time a transaction is made a grain is added to the pile. Corporations succumb to greed by borrowing money as low rates and buying back stock. Pension funds are forced to go into riskier assets by dangerously low interest rates. Over time the pile grows until it reaches the size where it becomes intrinsically unstable until a tiny pebble, like COVID-19, is dropped into the pile and the whole thing comes crashing down around us.
Risk mitigation strategies exist to help us avoid these things. It is why microservices are being used today to replace mutualized monolithic applications in the web services world. It is why redundancy exists in the physical engineering world. It is why diversification exists in the world of investing.
Why does diversification fail in times of crisis?
Because in times of crisis, funds are obligated to return money to those demanding it; and as a result are obligated to sell of any asset the is liquid enough to be sold, regardless of its intrinsic value. And so the correlation between previously uncorrelated assets approaches 1 and people lose a lot of money.
And so the good, the bad, and the ugly all get liquidated together into the underlying currency, which is the U.S. dollar in most cases and brings us to our final chart:
So, why is this chart going up when all others are going down?
Because it is backed by the U.S. government, which has the ability to provide infinite liquidity in the form of new money created out of thin air and released into the wild. In the past, this has taken the form of "quantitative easing" where the Federal Reserve created money and gave it to banks as reserves hoping that they would lend it out to the broader economy, which in 2008 could not afford the debt anyway. So the economy sank and people suffered.
I have a quote that I have been refining:
Investing is not about timing the market. It is about having the discipline to exit before the top and re-enter after the bottom and the knowledge of where to hide in between.
The sticking point is "where to hide in between" since that changes each crisis. Right now, the hiding place is in U.S. dollars or cash.
The problem here is that we are repeating the same mistake again. The U.S. government has crossed Mario Draghi's line and now seems willing to do "whatever it takes" to resolve this crisis.
For better or worse, we are on the threshold of a
paradigm shift. We are about to step into the completely untested world of Modern Monetary Theory and print ungodly amounts of money and throw it out of the helicopter. Where this helicopter money goes will determine the depth and breadth of the evolving depression, but this money printing mutualizes risk as the highest level, that of the underlying currency.
I suspect that MMT will dampen this depression to only a severe recession, but in doing so we will be setting ourselves up for an even bigger fall in 5-15 years from which the U.S. government will not recover. History doesn't repeat, but it does rhyme, and I suspect that U.S. as we know it will not exist in 20 years. We will find our inner-Roman Empire soon.
