Five Years of Whatever it Takes

Doug Nolan

July 25 – Bloomberg (Paul Gordon and Carolynn Look): “Five years ago today, Mario Draghi was talking about bumblebees. The European Central Bank president’s speech in London on July 26, 2012, became instantly famous because of his pledge to do ‘whatever it takes’ to save the euro. But for all the power and clarity of that phrase, he started his remarks more obliquely. ‘The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does. So the euro was a bumblebee that flew very well for several years. And now -- and I think people ask ‘how come?’-- probably there was something in the atmosphere, in the air, that made the bumblebee fly. Now something must have changed in the air, and we know what after the financial crisis.’ At the time, the currency bloc was being buffeted by soaring bond yields in peripheral nations as speculators bet the union’s fundamental flaws would rip it apart. Draghi’s answer was to state unequivocally that the immediate crisis fell under the ECB’s responsibility and he would deal with it. ‘The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.’ That pledge was followed by a program to buy the debt of stressed countries in return for structural reforms, and in that respect the words alone proved to be enough. Yield spreads collapsed even though the program has never been tapped.”

This week marks the five-year anniversary of Draghi’s “whatever it takes.” I remember the summer of 2012 as if it were yesterday. From the Bubble analysis perspective, it was a Critical Juncture – for financial markets and risk perceptions, for policy and for the global economy. Italian 10-year yields hit 6.60% on July 24, 2012. On that same day, Spain saw yields surge to 7.62%. Italian banks were in freefall, while European bank stocks (STOXX600) were rapidly approaching 2009 lows. Having risen above 55 in 2011, Deutsche Bank traded at 23.23 on July 25, 2012.

It was my view at the time that the “European” crisis posed a clear and immediate threat to the global financial system. A crisis of confidence in Italian debt (and Spanish and “periphery” debt) risked a crisis of confidence in European banks – and a loss of confidence in European finance risked dismantling the euro monetary regime.

Derivatives markets were in the crosshairs back in 2012. A crisis of confidence in European debt and the euro would surely have tested the derivatives marketplace to the limits. Moreover, with the big European banks having evolved into dominant players in derivatives (taking share from U.S. counterparts after the mortgage crisis), counter-party issues were at the brink of becoming a serious global market problem. It’s as well worth mentioning that European banks were major providers of finance for emerging markets.

From the global government finance Bubble perspective, Draghi’s “whatever it takes” was a seminal development. The Bernanke Fed employed QE measures during the 2008 financial crisis to accommodate deleveraging and stabilize dislocated markets. Mario Draghi leapfrogged (helicopter) Bernanke, turning to open-ended QE and other extreme measures to preserve euro monetary integration. No longer would QE be viewed as a temporary crisis management tool. And just completely disregard traditional monetary axiom that central banks should operate as lender of last resort in the event of temporary illiquidity – but must avoid propping up the insolvent. “Whatever it takes” advocates covert bailouts for whomever and whatever a small group of central bankers chooses – illiquid, insolvent, irredeemable or otherwise. Now five years after the first utterance of “whatever it takes,” the Draghi ECB is still pumping out enormous amounts of “money” on a monthly basis (buying sovereigns and corporates) with rates near zero.

Keep in mind that while “whatever it takes” first radiated from Draghi’s lips, markets soon surmised that the ECB president was speaking on behalf of the cadre of leading global central bankers. After all, ECB (desperate) measures were followed promptly by the return of QE by the Federal Reserve, the Bank of Japan, the Swiss National Bank and others. It’s worth mentioning that the Fed’s balance sheet totaled about $2.8 TN in July 2012, only to rise to $4.4 TN by September 2014. Amazingly, Bank of Japan assets have expanded about three-fold since 2012 to approach $5.0 TN.

Going back to 2002, the burst “tech” Bubble was evolving into a full-fledged U.S. corporate debt crisis. Back then Fed governor Bernanke’s talk of “helicopter money” and the “government printing press” profoundly altered market dynamics. It may not have at the time been loud and clear. But putting markets on notice that the Fed was contemplating extraordinary reflationary measures was a far-reaching development for corporate debt. Facing a liquidity crisis back in 2002, Ford bonds had become a popular short in the marketplace. Almost single-handedly, Dr. Bernanke’s speeches proved a catalyst for the speculating community reversing the Ford (and corporate debt) bond short - and then going long. The impact on general market liquidity was profound. And with the corporate debt crisis resolved there was nothing to hold back the burgeoning mortgage finance Bubble.

What “Helicopter Ben” accomplished with U.S. corporate bonds, “Super Mario” surpassed with Trillions of European sovereign, corporate and financial debt. Italian bond yields ended 2012 at 4.5%, down 210 bps from July highs. Spain’s 10-yields declined about 250 bps to 5.00% in less than six months. “Whatever it takes” almost immediately transformed Italian and Spanish debt from favored shorts to about the most enticing speculative long securities in world.

Draghi’s utterance ‘The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough,’ was a direct declaration to speculators with short positions in the euro currency, along with shorts in Italian, Spanish and periphery debt. Immediately Cover Your Shorts and Go Long. Five years on, Italian yields hover around 2.10% and Spanish yields sit at about 1.50% - emblematic of arguably one of history’s most spectacular securities market mispricings. European bank stocks have gained better than 50%. Draghi not only bloodied the shorts, be ensured spectacular profits for those levered long European debt – and the riskier the Credit the greater the reward.

Central bankers should not be in the business of playing favorites in the markets. So how did it get to the point where they seek to incentivize longs (levered and otherwise) while routinely punishing the shorts? Because central bankers followed the Bernanke Fed into a policy course of using rising securities and asset prices as a reflationary mechanism for the overall economy. As we’ve witnessed now for going on a decade, that’s a slippery slope. Adopt pro-Bubble policies and there will be no turning back. Inflate an epic Bubble and you own it for the duration.

“The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly but instead it does.” The euro flew and it soared incredibly high, trading above 1.50 to the dollar in early-2008. As fundamentally flawed as the euro monetary experiment has been, it was buoyed by the fundamentally weaker dollar. The euro flew on the back of highly speculative flows, much of it flowing from an overcharged U.S. Credit system. U.S. monetary policy had been too loose for too long. Unstable finance has been nurtured for what seems like an eternity. The U.S. exported its Credit Bubble to the world.

Going all the way back to the late-nineties, Italy and the European periphery were a leveraged speculator community darling. Indeed, the Euro Convergence Trade granted huge profits to the hedge fund community. The egregious amounts of leverage employed (directly and through derivatives) was illuminated with the 1998 implosion of Long-Term Capital Management (LTCM).

The LTCM fiasco contributed to an 18-month bear market that saw the euro trade down to 0.87 vs. the dollar in early 2002. With Dr. Bernanke and his radical theories on reflationary policies arriving on the scene in 2002, it’s no coincidence that the euro then embarked on a multiyear rally. The euro traded up to 1.00 late in 2002, 1.20 in 2003, 1.35 in 2004, 1.45 in 2007 and 1.58 in 2008. It’s furthermore no coincidence that Italian bond prices tracked the euro higher. After trading at 5.5% in the first-half of 2002, Italian yields dropped to 3.22% by October 2005. Greek bonds followed an almost identical trajectory, as both already highly-indebted nations took full advantage of the market’s insatiable demand for European peripheral debt.

Draghi has lately grown accustomed to patting himself on the back. He saved the euro. He saved Europe’s big banks. He kept Greece and Italy in the euro currency. His policies have spurred European economic recovery. But Draghi and global central bankers also inflated history’s greatest speculative Bubble. Celebration will be in order only if policies can be normalized without the whole thing coming crashing down.

July 25 – BloombergBusinessweek (Jana Randow): “Euro-area governments have saved almost 1 trillion euros ($1.16 trillion) in interest payments since 2008 as record-low European Central Bank rates depress bond yields at a time when state treasurers are also reducing debt. That’s according to calculations by Germany’s Bundesbank, which is urging finance ministers in the 19-nation region to make provisions for when interest rates start to rise. Italy, the world’s third-most indebted country, has benefited most, with savings exceeding 10% of gross domestic product.”

Italy has been the biggest beneficiary of collapsing market yields. The problem is that its debt load still expanded to a distressing 130% of GDP. Italy remains only a jump in yields away from trouble, and I suspect this helps explain why Draghi has been so reticent to pull back on the stimulus throttle. After trading below 1.90% in mid-June, Italian yields surged to 2.33% earlier this month as markets began to contemplate global central bankers moving toward concerted normalization.

The FOMC this week confirmed the dovishness of Yellen’s testimony before congress.

Apparently, over the past month Fed rate “normalization” has been scaled back to perhaps one more hike this year – and that could be about it. And I just don’t buy the Fed’s recent fixation on below target inflation (GSCI Commodities Index up 4.2% this week on further dollar weakness!).

Something has raised concerns at the FOMC. Could it be European debt markets, with ECB stimulus to be significantly reduced in the months ahead. Or perhaps it’s China and their officials determined to rein in some financial excess. EM and all their dollar-denominated debt? Maybe a dysfunctional Washington has supplanted international developments on the worry list – or, understandably, it could be a combination of things.

At least for the week, global markets lost a bit of their recent swagger. While Boeing helped the Dow to yet another record high, the S&P500 ended the week little changed. The broader market underperformed. The highflying technology stocks were unimpressive in the face of general robust earnings. The VIX rose to 10.29, with some volatility beginning to seep into stock trading. Commodities caught a big bid, while bond yields began moving north again. The currencies remain unsettled.

Thinking back five years, U.S. markets at the time were incredibly complacent. The risk of crisis in Europe was downplayed: Policymakers had it all under control. Sometime later, the Financial Times - in a fascinating behind-the-scenes exposé - confirmed the gravity of the situation and how frazzled European leaders were at the brink of losing control. Yet central bankers, once again, saved the day – further solidifying their superhero status.

I’m convinced five years of “whatever it takes” took the global government finance Bubble deeper into perilous uncharted territory. Certainly, markets are more complacent than ever, believing central bankers are fully committed to prolonging indefinitely the securities bull market. Meanwhile, leverage, speculative excess and trend-following flows have had an additional five years to accumulate. Market distortions – including valuations, deeply embedded complacency, and Trillions of perceived safe securities – have become only further detached from reality. And the longer all this unstable finance flows freely into the real economy, the deeper the structural maladjustment.

Sprott Precious Metals Watch, July 2017

Trey Reik, Senior Portfolio Manager

Strategy Report

A highlight of 2017 financial markets has certainly been the explosion of interest in cryptocurrencies.

We attribute growing interest in digital currencies to a concern shared by many gold investors. In short, resentment is mounting over the financially repressive policies of global central banks.

Specifically, the imposition of negative interest rates and related official backing of increasingly cashless economies have catalyzed interest in investment vehicles outside the traditional financial system, such as precious metals and cryptocurrencies. Along the way, comparisons of bitcoin to gold have become all the rage. Because spot gold has spent the past five-and-a-half months trading within a $100-range, while the prices of cryptocurrencies have soared, some have even suggested that digital currencies are usurping gold’s role as preferred store of value.

It will come as no surprise that at Sprott, we assess the investment merits of gold and bitcoin to be substantially different. We view gold in its traditional profile as reliable store of value and productive portfolio-diversifying asset. In contrast, while we recognize that bitcoin is the first killer application of the epically disruptive blockchain technology, we view bitcoin’s current investment merits as limited to potent speculation. We absolutely believe bitcoin can play a productive role in many portfolios, but that contribution will be entirely different from that offered by gold. In this report, we have organized our thoughts around seven key differences between gold and bitcoin as portfolio assets.


Bitcoin is the market leader in the emerging asset class of digital currencies. Importantly, bitcoin is based on blockchain technology, which is essentially a distributed database used to maintain a constantly growing list of records, called blocks. Each block contains a timestamp and a link to the previous block. In essence, the blockchain permanently stores a history of all previous transactions and participants and is simultaneously updated across a vast array of global computers to provide instant and fully transparent proof of authenticity to all users. By all accounts, the blockchain is potentially the most disruptive technology since the advent of the internet. Its applications are virtually limitless. However, it is important to differentiate between the blockchain and bitcoin. They are not one and the same. Bitcoin is simply the leading brand in the blockchain’s first emerging application (digital currency). While bitcoin’s lead in the cryptocurrency market is currently substantial, there is no guarantee bitcoin will ultimately prove to be the widely adopted crypto winner. Bloomberg (7/12/17) informs us that a grand total of three of the 500 largest internet merchants currently accept bitcoin for payment, down from five one year ago. The digital currency industry is in its early infancy, and many of the world’s smartest and most resourceful scientists, entrepreneurs and financiers are laser-focused on developing superior technologies to address bitcoin’s perceived shortcomings. It is ironic that Mark Andreessen, one of the most powerful voices for the blockchain and cryptocurrencies, was also a cofounder of Netscape. Just as Netscape was once the undisputed market-leading browser in an emerging technology called the internet, bitcoin is now the undisputed market-leading crypto in an emerging technology called the blockchain. It is far too early for definitive evaluation of bitcoin’s long-term prospects, much less to compare bitcoin to gold as a store of value!


Quite simply, gold is gold. For over 5,000 years, an ounce of gold has been exactly the same: an ounce of gold. There are no variations or imitations. Central banks hold gold because of its extraordinary density, rarity and immutability. Central banks do not hold diamonds or priceless art because of their infinite variability.
There is no society on earth which does not regard gold as valuably precious. Gold is virtually indestructible. Only a few very powerful acids can destroy it, and gold does not even melt below 1,943 degrees Fahrenheit. Gold never tarnishes. Gold is immutable.

Bitcoin, in comparison, is a string of code generated by software protocols and cryptographic algorithms. While a sophisticated programmer might take comfort in the technological impregnability of the blockchain, this type of intellectual security eludes many investors outside the Bay area and lower Manhattan. In essence, bitcoin is shrouded in a dense cloak of ambiguity because few people comprehend the underlying protocols. Of course, this does not prevent legions of speculators from flocking to bitcoin’s often irresistible chart pattern. That is a given in contemporary, correction-resistant markets. As far as a store of value for accumulated wealth, however, we have yet to encounter significant investor testimonial on bitcoin’s behalf. With respect to bitcoin’s immutability, we are somewhat troubled that the operation of the bitcoin network is becoming increasingly concentrated in the hands (actually the massive computer farms) of a limited number of programmers. Because humans always eventually do what is best for themselves, this concentration may lead to unforeseen changes in the bitcoin network, perhaps a lot sooner than most recognize (more on this later).


Because gold investment decisions are often fueled by emotion, precious metals have earned a reputation for volatility. Gold’s commodity characteristics expose the metal to the trading patterns of limits, stop losses and the aggressive trading tactics popular on the COMEX. 

Additionally, over long spans, gold can post high-percentage moves reflecting changing economic and monetary conditions. From a 2/16/01 low of $253.85, spot gold climbed 656.81% to a 9/6/11 high of $1,921.15, before falling 45.53% to an intra-day low of $1,046.43 on 12/3/15. 

Of course, these moves took ten-and-a-half years and four-and-a-quarter years, respectively, to unfold. Despite these high-percentage changes, gold has remained throughout the years an effective store of value as measured by a myriad of divisors, from the cost of a men’s suit, to barrels of oil and everything in between.

The extreme volatility of the cryptocurrency asset class, to us, belies any legitimate role as store of value. Figure 1, below, plots the percentage losses for the leading 50 digital currencies during the three weeks ended 7/16/17. Admittedly, these declines occurred after spectacular multi-month gains (in many cases by many-hundreds-of-percentage-points). Nonetheless, no asset class with broad-based declines in a three-week period measuring between 40% and 70% should logically be confused with a store of value.

Figure 1: Three-Week Historical Price Performance of the 50 Largest Cryptocurrencies by Market Capitalization (7/16/17) [Nick Laird]

With respect specifically to bitcoin’s volatility, roughly every year or so the currency experiences a rapid upward shock, followed by an equally rapid downward correction, reminding us far more of an enticing trading opportunity than a store of value. In one particularly vertiginous run in late 2013, bitcoin exploded 446% in less than a month from an 11/1/13 close of $208.18 [Bloomberg BGN “close” is 5 pm EDT] to an 11/29/13 close of $1,137, before falling 53% to a 12/17 close of $533.71. More recently, on 3/2/17, bitcoin ($1,257.94) surpassed the spot gold closing price ($1,234.31) for the first time, before catapulting to $2,999.98 on 6/12/17. From the shape of things in Figure 2, below, bitcoin appears to be rapidly unwinding early summer gains. We suspect many millennials are experiencing their first gut-wrenching encounter with market speculation.

Figure 2: Performance of Bitcoin (7/15/16-7/17/17) [Bloomberg]

Our final observation about the volatility and shallow depth of cryptocurrency markets is to highlight the flash-crash of the second leading crypto brand, ethereum on 6/22/17. On that afternoon, apparently catalyzed by a $30 million market-sell-order, and then a cascade of over 800 stop-loss orders, ether units briefly crashed from $315 to $0.10 (on very high volume) on leading cryptocurrency exchange GDAX. Of course, since the beauty of the blockchain is that all transactions are pseudonymous, verified, and irreversible, there was no NYSE floor governor to wander over to a post, investigate the matter and cancel trades. What’s done is done! Curious about the sudden dip in the entire crypto class during the ethereum fiasco, we ventured to the web for a little color. Because established investment banks don’t comment much on day-to-day crypto developments, we cite the ethereum reddit posting of a user named “emansipater” to shed some light on developments:

The badly designed Status ICO [Initial Coin Offering] clogged up the network yesterday with a huge number of high gas fee transactions, most of which are failing but still filling up the blocks and preventing normal tx’s from getting in. In addition, dwarfpool [sic] and perhaps others have set bad defaults on their client software that both actually cost themselves money and also prevent the network from automatically adapting to larger gas volumes the way it’s supposed to. Furthermore, evidence is accumulating that f2pool [sic] was actively manipulating transactions bound for the Status ICO, which they participated in themselves, exacerbating the problem. Experts explained weeks ago that bad ICO designs are vulnerable to such attacks, but this appears to be the first time it was actually executed in the wild. So now, even though the Status ICO is over, there are still a huge number of transactions clogging up the network and the only way to get transactions in is to pay huge fees (which most of the exchanges probably don’t want to do). Until it clears out, people are going to be missing ENS auctions, unable to withdraw from many wallets and exchanges, etc., etc., etc.

Does this narrative evoke store of value? To us, this just sounds a lot like human beings being human beings.


For thousands of years, gold has been an alluring target for plunder and theft. Just this past March, thieves used a ladder, a rope and a wheelbarrow to cart away a $4.2 million, 100kg (220lbs), 24-karat gold coin from an apparently lightly-guarded Berlin museum. To most individual or institutional investors, however, there exist a full range of bulletproof options for bullion safekeeping, from one-ounce coins (safe-deposit boxes) to 400-ounce bars (vault networks). In contrast, bitcoin still presents nettlesome hurdles for safekeeping. As infallible as blockchain code may be, bitcoin storage methods still involve a wide range of internet-type vulnerabilities. The most infamous bitcoin loss was the theft of 850,000 bitcoin (valued at $450 million) from Mt. Gox in February 2014. At the time of the theft, Mt. Gox was by far the largest exchange for bitcoin trading, handling up to 80% of daily volumes. While 200,000 bitcoin were subsequently recovered from a cold storage wallet (think “memory stick”), Mt. Gox proprietor Mark Karpeles (once referred to as the king of bitcoin) just pled not-guilty on 7/11/17 as his embezzlement trial began in Tokyo District Court. Stay tuned for interesting crypto-market-moving trial developments related to this infamous bitcoin mystery.


In a seminal New York Times Op Ed on bitcoin’s relevance ( ), Marc Andreessen suggests that the truly disruptive breakthrough of bitcoin is that its technology enables a “distributed network of trust” in which the blockchain allows “one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure.” In essence, the blockchain empowers trust in substitute for knowledge of counterparties. This trust element is absolutely the key in enabling decentralized commerce, eliminating legacy needs for traditional trust-providers such as banks and credit card companies (which charge high fees and are increasingly hacked). We concede that the level of trust provided by the blockchain may be sufficient for speculative transactions such as flipping around bitcoins for a profit. However, we believe that for bitcoin (and the blockchain) to reach full potential, an element of institutional trust and oversight will eventually be required. Of course, to many bitcoin enthusiasts, introduction of such conventional oversight is anathema to bitcoin’s raison d’etre.

Gold, on the other hand, is an investment asset with a strong legacy of trust and oversight. Gold coins and gold bars are minted and refined to precise parameters for size, weight and purity. 

Institutional volumes of bullion are generally stored in the literal epitome of trustworthiness: impenetrable vaults. Similarly, individual investors generally store their gold bullion at repositories which have earned their utmost confidence, such as local banks or established bullion custodians. To us, the blockchain will never inspire widespread investor trust until some form of institutional oversight is introduced.

Whatever trust exists in the bitcoin network today relies on the dependability of the laws of math. A strong investment cue for bitcoin investors is clearly their lack of confidence in the human frailties of fiat-currency stewards. In essence, the laws of math enforce the scarcity of bitcoin, while the laws of nature enforce the scarcity of gold bullion. However, an interesting example of how the concept of trust affects bitcoin and gold differently is the ongoing race to combine the two mediums into a digital gold currency. We believe the success of a gold-backed cryptocurrency depends on the centralized, institutional component of a custodian at which the physical gold will be stored, audited and regulated. Indeed, the physical gold component actually precludes the decentralized, peer-to-peer spirit of bitcoin. At the same time, it is just this centralized oversight which places gold ownership in an entirely different class of trust than bitcoin will ever command.


An intellectually attractive aspect of bitcoin’s design is its strictly limited supply. Bitcoin’s total circulation is hard-capped at 21 million units. As of 7/15/17, bitcoin in circulation totaled 16.5 million units. At current mining run-rates, the bitcoin computer network mints 12.5 new bitcoins every ten minutes, or 1800 new units per day, or 657,000 per year. This implies a current annual inflation rate of just below four percent. Interestingly, embedded programming in the bitcoin network halves the rate of bitcoin creation every four years, with the next 50% reduction occurring June 2020. Strict limits on the amount of potentially issued bitcoin lend a discipline and scarcity-value to bitcoin notably absent from global fiat regimes. Indeed, bitcoin enthusiasts suggest bitcoin’s comparable scarcity makes it a more compelling store of value than gold.

We offer two thoughts about bitcoin’s scarcity-value relative to gold. First, bitcoin’s meteoric price appreciation ($1,000 worth of bitcoins in July 2010 were worth $60 million on 6/12/17) has spawned one of the fastest growing “industries” of competing products we have ever witnessed. 

As of 7/15/17, crypto-monitoring website reports the total number of cryptocurrencies and crypto asset-tokens had ballooned to 973! Total crypto-market-capitalization now registers just under $75 billion (of which bitcoin registers just under $35 billion). Hedge Fund Alert reports (7/12/17) that the number of cryptocurrency hedge funds is fast approaching forty! In short, while the ultimate number of bitcoins may be limited in supply, there is absolutely no limit to competing cryptocurrencies.

Second, while bitcoin may represent an attractive portfolio diversifier for individual investors, its relatively tiny market capitalization is unlikely ever to compete with the depth and liquidity of gold markets, in which the above-ground stock totals roughly $7 trillion (minus always fungible jewelry and central bank holdings, roughly $2.7 trillion).

Looking Forward

One aspect to gold’s value as both a monetary reserve and a portfolio-diversifying asset is the high degree of visibility into gold’s future market fundamentals. The above-ground gold stock is quite large and extremely stable, annual mine production measures only 1.6% of the above-ground supply and no product or asset can conceivably replicate all of gold’s functional attributes. Bitcoin, on the other hand, may not even make it another month without significant changes to its network composition. In essence, after years of private bickering, two rival factions of crucial bitcoin network operators must choose by 8/1/17 between two competing software paths. Bloomberg (7/10/17) provides invaluable scope and clarity to the crux of the biscuit:

Behind the conflict is an ideological split about bitcoin’s rightful identity. The community has bitterly argued whether the cryptocurrency should evolve to appeal to mainstream corporations and become more attractive to traditional capital, or fortify its position as a libertarian beacon; whether it should act more as an asset like gold, or as a payment system.

The seeds of the debate were planted years ago: To protect from cyberattacks, bitcoin by design caps the amount of information on its network, called the blockchain. That puts a ceiling on how many transactions it can process -- the so-called block size limit -- just as the currency’s growing popularity is boosting activity. As a result, transaction times and processing fees have soared to record levels this year, curtailing bitcoin’s ability to process payments with the same efficiency as services like Visa Inc. To address this problem, two main schools of thought emerged. On one side are miners, who deploy costly computers to verify transactions and act as the backbone of the blockchain. They’re proposing a straightforward increase to the block size limit. On the other is Core, a group of developers instrumental in upholding bitcoin’s bug-proof software. They insist that to ease blockchain’s traffic jam, some of its data must be managed outside the main network. They claim that not only would it reduce congestion, but also allow other projects including smart contracts to be built on top of bitcoin.

Perhaps in recognition of ethereum’s recent challenge to bitcoin’s lead status, the two rival bitcoin factions in June seemed to coalesce around a compromise software offering named SegWit2x, in exchange for general agreement to double the block size limit. The new software was recently released, and it will now be white-knuckle time in the bitcoin community through the end of July, as respective network operators choose whether to adopt the new software. On 8/1/17, the UASF (User Activated Soft Fork) faction, the hardliners, will begin to poll adoption of the new software. If fewer than 80% of network operators have adopted, there will likely be a hard-fork, splitting the bitcoin blockchain into two parallel blockchains, in essence into two versions of bitcoin. Arthur Hayes, proprietor of Hong Kong bitcoin derivatives venue BitMEX sums our thoughts perfectly, “It’s a high-stakes game of chicken.”

Our strong suspicion is that the various factions of bitcoin operators will “get it together” between now and month-end. It certainly appears in their collective interest to do so. We look forward to observing both these developments as well updates from the Mt. Gox Tokyo trial. It is a pregnant time for bitcoin and cryptocurrencies in general. If nothing less, we expect these developments to foster wider investor appreciation of the ephemeral nature of individual cryptocurrency protocols. In the meantime, as the Fed turns its attention to the potentially stifling effects of their recent rate hikes on deteriorating U.S. economic activity, we remain confident our precious-metal positions will serve us well in coming quarters.

Hard Power Is Still King

By Allison Fedirka

The concept of power lies at the center of geopolitics. Power, simply put, is the ability to achieve one’s desired outcome. When it comes to countries, the degree of power a country has determines whether it can fulfill its national imperatives – those almost eternal goals that a state cannot help but pursue – or whether it is subordinate to other states.

Many people believe that power can be broken down into two forms: soft power and hard power. Since Joseph Nye popularized the notion of soft power in the early 1990s, it commonly circulates in discussions about international relations. It is typically accompanied by a belief that hard power is a thing of the past (specifically the pre-World War II world) and that states in this “civilized” age engage in diplomacy and trade to get what they want. But some things never change, and there’s still no substitute for hard power.

True Strength

Traditionally, hard power includes things like geography, natural resources and military might. Soft power consists of components like technology, education, culture and economic ties. Conceptually, hard power is about coercion, and soft power is about persuasion.

Coercion occurs when country A has enough leverage over the interests of country B to control it – to force it to behave a certain way, even if that means going against country B’s will. Take Russia’s relationship with Belarus. Russia is the primary supplier of oil and gas to Belarus, which is almost entirely dependent on imports to meet its energy needs. Any time Minsk threatens to act in a way contrary to what Moscow wants, the Kremlin threatens to cut off its energy supplies. Unsurprisingly, Minsk eventually complies, even if that means doing something it doesn’t want to do, such as paying higher prices for natural gas imports.
Nine French Alpha jets in a “Big Nine” formation release smoke in the colors of the French national flag during the annual Bastille Day parade in Paris on July 14, 2017. LUDOVIC MARIN/AFP/Getty Images

On the other hand, persuasion occurs when country A lacks leverage over country B but still wants country B to behave a certain way. The absence of leverage means country B must decide on its own to comply with country A’s desire. This approach is often ineffective because, when there is no pressure to act one way, a country will do whatever is in its best interest, not what is in the interests of someone else. Gestures go only so far. Still, countries engage in soft power strategies because soft power provides a way to potentially achieve an objective at a lower cost than the alternative, and because hard power isn’t always an option. The U.S. courting Brazil to enter World War II on the side of the Allies is an example of the first cause, and China’s current relationship with the Philippines is an example of the second.

Brazil was neutral for most of World War II. Its government and its people were split on whether to back the U.S. or Germany, and many people don’t even realize that Brazil did eventually send troops to Italy to fight for the Allies in the final months of the war. Brazil was of interest to the U.S. because its northern coast would help cement control over the Northern Atlantic and would open up control of the Southern Atlantic. The U.S. soft power campaign consisted of diplomatic visits, trade and cultural exchanges, such as creating films featuring Disney’s Ze Carioca (Donald Duck’s suave Brazilian counterpart) and Carmen Miranda (the Brazilian bombshell with her own star on the Hollywood Walk of Fame) for consumption in both countries.

The soft power approach gradually swayed Brazil toward the U.S., culminating in a diplomatic gesture: severing ties with the Axis powers. But Brazil stopped short of declaring war. In response, Germany initiated a submarine campaign targeting Brazilian merchant ships. It sank dozens of ships and cost hundreds of lives. In the end, it was Germany’s hard power response that spurred Brazil to enter the war on the side of the Allies.

A modern-day scenario, and one that shows soft power being used when hard power isn’t an option, is China’s approach to the Philippines. To guarantee its supply chains and trade routes, China needs direct access to the Pacific Ocean and South China Sea. The islands that make up the Philippines stand in the way of this access, so it is in China’s interest to control those islands – or at least to be able to influence the people who control those islands. Complicating matters for China is the fact that the U.S. military is the security guarantor for Pacific water traffic, and the Philippines relies heavily on the U.S. for trade and security cooperation. Though China could overpower the Philippines, it cannot take on the U.S. to win control over the Philippines. Instead, it has resorted to channeling large investments and other trade deals to win over Manila. At best, this may lay the groundwork for future levers over the Philippines, but for now, Manila has decisively sided with the United States, which guarantees its security but does not directly challenge its sovereignty and is a strong economic partner.
Soft Power Doesn’t Make Great Powers

Nevertheless, many remain fixated on soft power. Just this week, a U.K.-based consultancy firm called Portland, in cooperation with the USC Center on Public Diplomacy, published a report ranking the world’s top 30 countries by soft power. The ranking is based on the composite score of soft power elements: culture, digital footprint, government, engagement, education and business/enterprise. The first thing that stands out is that European countries dominate the list, and these countries outrank others that are geopolitical heavyweights. Ireland outranks Russia, and Greece is above China. In fact, Russia, China and Turkey are all in the bottom six of this top-30 ranking. That two small European countries are considered more powerful than three much larger countries – countries that are major geopolitical centers of gravity – should automatically raise questions about the credibility of soft power.

A second observation is that most of the countries at the top of the soft power ranking – France, the U.K., the U.S. and Germany – are also among the world leaders in hard power. The U.S. has regularly demonstrated that through hard power measures such as sanctions or military activity, it can coerce other countries to change their behavior. Germany is the economic powerhouse of the European Union and has threatened economic measures against smaller EU countries, especially Greece, to coerce them into supporting EU regulations. France’s cultural influence – a component of soft power – does have global reach, but the foundation for this cultural influence was colonization, a product of hard power.

Soft power reads well on paper, but its dependence on persuasion makes it largely inconsequential in the world of geopolitics, whereas hard power dictates reality and the course of events.

What the Decline of the Dollar Means


The value of the dollar has fallen steadily this year, helping American companies that sell to foreigners and hurting American consumers of foreign goods and services. Credit Matt Cardy/Getty Images        

The value of the dollar has fallen steadily since the beginning of 2017, erasing a sharp rise immediately after President Trump’s election.

To take one example, the number of euros that can be obtained for one dollar has declined to the lowest level in more than a year. The dollar has also declined against the British pound, the Japanese yen and the Chinese renminbi.

Is that bad? It sounds bad.

The exchange rate is a price — the price of money. When the price of milk goes down, that is good for families and bad for dairy farmers. When gas prices fall, commuters are happy and Exxon Mobil is sad. When the dollar drops, there are also winners and losers.

The winners are American companies that sell goods and services to foreigners — manufacturers like Caterpillar; tourist attractions like Disney World; technology companies like Facebook — because those customers can exchange their currencies for more dollars.

The losers are American consumers who now must pay more dollars to obtain foreign goods and services.

Of course, many Americans are in both categories. They may benefit at work and suffer at the supermarket.

Why is the dollar losing value?

The dollar strengthened after the presidential election because investors expected Mr. Trump and congressional Republicans to increase domestic growth by fulfilling campaign promises to cut taxes and reduce regulations, among other measures. The reversal of those gains reflects diminished confidence that Mr. Trump will be able to deliver.

“Trump Weakens the Dollar” was the main headline in the German financial daily Handelsblatt on Wednesday.

So we’re back where we started?

Trade-weighted U.S. dollar index              

Source: Federal Reserve Bank of St. Louis | By The New York Times

It is important to put the recent decline into a broader context. Over the last six years, the dollar is still up about 28 percent.

The climb started in 2011 as the American economy began to recover more quickly than the economies of the rest of the developed world. Domestic growth was sluggish by historical standards, but things were worse everywhere else. The United States was “the cleanest shirt in the dirty laundry basket,” said Jim Paulsen, chief investment strategist at the Leuthold Group, a Minneapolis investment firm.

There was also a rush into dollar-denominated assets. At the beginning of 2011, Mr. Paulsen noted recently, the interest rate on the benchmark 10-year Treasury note was a little lower than the available return on a portfolio of debt issued by other major nations, including Britain, Germany and Japan. By 2016, the Treasury rate was as much as five times higher than the global portfolio.

The rest of the world now appears to be doing a little better. The International Monetary Fund said in June that it was cutting its forecast for the growth of the United States economy, but stronger growth elsewhere would offset the impact on the world economy.

Should the United States push down the dollar?

Mr. Trump has said that he would like the dollar to decline in value.

“I think our dollar is getting too strong, and partially that’s my fault because people have confidence in me,” he told The Wall Street Journal in April.

Some economists think he is right.

The value of the dollar, relative to other currencies, is supposed to reflect the strength of the American economy, relative to other countries. But exchange rates can be distorted by investors, which in turn can distort patterns of economic growth. And there is some evidence the price of the dollar remains above its actual value, which tends to encourage imports and discourage exports.

The dollar was overvalued by about 8 percent in May, according to William R. Cline of the Peterson Institute for International Economics. The continuing slide has shaved a few points off that estimate, but the currency probably remains somewhat overvalued.

Could the United States push down the dollar?

Exchange rates are determined by open trading on financial markets. Some governments actively participate in those markets to influence the value of their currencies. The United States in recent decades has mostly stayed on the sidelines.

Recent administrations have focused instead on pressing other nations to stay out of the market. The Bush and Obama administrations, for example, made progress in persuading China to allow the value of the renminbi to appreciate against the dollar.

The Trump administration has not articulated a consistent policy on these issues.

How is the value of the dollar measured?

The dollar can be exchanged for a wide range of currencies. At last count, the United Nations recognized about 180. The Federal Reserve calculates an average of exchange rates by weighting rates based on the volume of trade with the United States, so the price of dollars in Japanese yen is more important than in Icelandic kronur.

Justin's note: For today’s Dispatch, we’re handing over the reins to Bonner & Partners Editor at Large Chris Lowe. This essay is crucial reading for anyone with a US bank account.

Read below to learn how the US government has already put capital controls in place, and how it uses mounds of red tape to keep you from your financial freedom...and from knowing the truth.

Financial Martial Law

By Chris Lowe, editor at large, Bonner & Partners

Already, as an American, you are not free to spend your money as you see fit. (For a full breakdown, see “Bank Secrecy Act Regulations Explained” below.)

JPMorgan Chase—the country’s biggest bank—has banned cash payments for credit card debt, mortgages, and car loans. It has also banned the storage of “any cash or coins” in safe deposit boxes.

Bank Secrecy Act Regulations Explained

By Bonner & Partners analyst Joe Withrow

The Bank Secrecy Act (BSA) requires US financial institutions to assist federal agencies in preventing money laundering.

All financial institutions are required by law to keep records of all financial activity, including cash purchases of “negotiable instruments”—checks, money orders, etc.

These records are open to government inspection at any time. They are also subject to periodic audits by both federal and state governments.

All financial institutions must immediately file a Suspicious Activity Report (SAR) with the federal government whenever a customer engages in transactions the institutions deem strange or inconsistent with normal behavior. This is open to interpretation.

There are also specific BSA regulations requiring financial institutions to file government reports.

They are:

Currency Transaction Report (CTR): A CTR must be filed for each deposit, withdrawal, exchange of currency, or other payment or transfer by, through, or to a financial institution that involves a transaction in currency of more than $10,000.

Multiple currency transactions must be treated as a single transaction if the financial institution has knowledge that: (a) they are conducted by or on behalf of the same person and (b) they result in cash received or disbursed by the financial institution of more than $10,000.

Report of International Transportation of Currency or Monetary Instruments (CMIR): Each person (including a bank) who physically transports, mails, or ships, or causes to be physically transported, mailed, shipped, or received, currency, traveler’s checks, and certain other monetary instruments in an aggregate amount exceeding $10,000 into or out of the US must file a CMIR.

Report of Foreign Bank and Financial Accounts (FBAR): Each person (including a bank) subject to the jurisdiction of the United States having an interest in, signature, or other authority over one or more bank, securities, or other financial accounts in a foreign country must file an FBAR if the aggregate value of such accounts at any point in a calendar year exceeds $10,000. A recent district court case in the 10th Circuit has significantly expanded the definition of “interest in” and “other authority.”

Designation of Exempt Person: Banks must file this form to designate an exempt customer for the purpose of CTR reporting under the BSA. In addition, banks use this form biennially (every two years) to renew exemptions for eligible non-listed businesses and payroll customers.

There are also plenty of regulations about opening a bank account in the US…

Form W-9 Request for Taxpayer Identification Number and Certification: Applicants must be able to provide a taxpayer ID and certify under penalty of perjury that their ID is correct. The bank is required to enforce the IRS’s “backup withholding” rule if applicable. This means it must withhold customer funds if the IRS determines that you failed to provide a valid taxpayer identification number or failed to pay taxes on 1099 income.

Identification Requirements: Applicants must provide their name, permanent address, taxpayer identification number, and date of birth to verify their identity. Applicants must also submit a valid driver’s license, state ID, passport, or other primary identification documents.

Office of Assets Control (OFAC) Compliance: The bank must make sure the applicant is not on OFAC’s prohibited individuals list. This list includes individuals who have engaged in transactions with governments or individuals located in Cuba, Burma, Myanmar, Iran, and Sudan.

Unlawful Transactions: Applicants must certify that their account will not be used for internet gambling or any other illegal activity.

And all US banks now view large cash withdrawals as suspicious.

Under the Bank Secrecy Act, if you withdraw $10,000 or more in a day, your bank is required to file something called a Currency Transaction Report with the Financial Crimes Enforcement Network (FinCEN). This is a special bureau within the Department of the Treasury that’s tasked with combatting money laundering, terrorist financing, and other financial crimes.

And your bank is required to file something called a Suspicious Activity Report with FinCEN if it believes you are trying to avoid triggering a Currency Transaction Report by withdrawing smaller cash amounts. This puts all cash withdrawals under the microscope.

And taking out cash from the bank isn’t the only activity the government deems suspicious.

Other actions that will trigger a report being filed with the feds include: depositing $10,000 or more in cash with your bank…a foreign exchange transaction worth $10,000 or more…taking more than $10,000 in cash into or out of the US…receiving more than $10,000 in cash in a single payment as a business…or having more than $10,000 in accounts outside the US during a calendar year.

And even if you manage to get your cash out of your bank, having it on your person also makes you a target of the authorities.

Under civil asset forfeiture laws, police and federal agents can confiscate any cash you might have on you if they merely suspect it was involved in a crime. They don’t need to bring criminal charges against you or prove any wrongdoing. And they can keep any seized cash for themselves.

According to The Washington Post, since 2007, the DEA alone has seized more $3.2 billion in cash from Americans in cases where no civil or criminal charges were brought against the owners of the cash.

And forget about opening up a bank account offshore to diversify your risk of these kinds of clampdowns.

The Foreign Account Tax Compliance Act, or FATCA, became law in 2010. It imposes a lot of red tape on foreign banks with US clients. And the costs of complying with all this red tape means opening up bank accounts for Americans no longer justifies the benefits of overseas banks.

As a result, it’s now extremely difficult for Americans to open accounts overseas. It’s de facto capital control, even if the government won’t admit it.


Chris Lowe
Editor at Large, Bonner & Partners

A “Macroneconomic” Revolution?

Anatole Kaletsky

LONDON – Next month will mark the tenth anniversary of the global financial crisis, which began on August 9, 2007, when Banque National de Paris announced that the value of several of its funds, containing what were supposedly the safest possible US mortgage bonds, had evaporated. From that fateful day, the advanced capitalist world has experienced its longest period of economic stagnation since the decade that began with the 1929 Wall Street crash and ended with the outbreak of World War II ten years later.
A few weeks ago, at the Rencontres Économiques conference in Aix-en-Provence, I was asked if anything could have been done to avert the “lost decade” of economic underperformance since the crisis. At a session entitled “Have we run out of economic policies?” my co-panelists showed that we have not. They provided many examples of policies that could have improved output growth, employment, financial stability, and income distribution.
That allowed me to address the question I find most interesting: Given the abundance of useful ideas, why have so few of the policies that might have ameliorated economic conditions and alleviated public resentment been implemented since the crisis?
The first obstacle has been the ideology of market fundamentalism. Since the early 1980s, politics has been dominated by the dogma that markets are always right and government economic intervention is almost always wrong. This doctrine took hold with the monetarist counter-revolution against Keynesian economics that resulted from the inflationary crises of the 1970s. It inspired the Thatcher-Reagan political revolution, which in turn helped to propel a 25-year economic boom from 1982 onward.
But market fundamentalism also inspired dangerous intellectual fallacies: that financial markets are always rational and efficient; that central banks must simply target inflation and not concern themselves with financial stability and unemployment; that the only legitimate role of fiscal policy is to balance budgets, not stabilize economic growth. Even as these fallacies blew up market-fundamentalist economics after 2007, market-fundamentalist politics survived, preventing an adequate policy response to the crisis.
That should not be surprising. Market fundamentalism was not just an intellectual fashion.

Powerful political interests motivated the revolution in economic thinking of the 1970s. The supposedly scientific evidence that government economic intervention is almost always counter-productive legitimized an enormous shift in the distribution of wealth, from industrial workers to the owners and managers of financial capital, and of power, from organized labor to business interests. The Polish economist Michal Kalecki, a co-inventor of Keynesian economics (and a distant relative of mine), predicted this politically motivated ideological reversal with uncanny accuracy back in 1943:
“The assumption that a government will maintain full employment in a capitalist economy if it knows how to do it is fallacious. Under a regime of permanent full employment, ‘the sack’ would cease to play its role as a disciplinary measure, leading to government-induced pre-election booms. The workers would get out of hand and the captains of industry would be anxious ‘to teach them a lesson.’ A powerful bloc is likely to be formed between big business and rentier interests, and they would probably find more than one economist to declare that the situation was manifestly unsound.”
The economist who declared that government policies to maintain full employment were “manifestly unsound” was Milton Friedman. And the market-fundamentalist revolution that he helped to lead against Keynesian economics lasted for 30 years. But, just as Keynesianism was discredited by the inflationary crises of the 1970s, market fundamentalism succumbed to its own internal contradictions in the deflationary crisis of 2007.
A specific contradiction of market fundamentalism suggests another reason for income stagnation and the recent upsurge of populist sentiment. Economists believe that policies that increase national income, such as free trade and deregulation, are always socially beneficial, regardless of how these higher incomes are distributed. This belief is based on a principle called “Pareto optimality,” which assumes that the people who gain higher incomes can always compensate the losers. Therefore, any policy that increases aggregate income must be good for society, because it can make some people richer without leaving anyone worse off.
But what if the compensation assumed by economists in theory does not happen in practice?
What if market-fundamentalist politics specifically prohibits the income redistribution or regional, industrial, and education subsidies that could compensate those who suffer from free trade and labor-market “flexibility”? In that case, Pareto optimality is not socially optimal at all. Instead, policies that intensify competition, whether in trade, labor markets, or domestic production, may be socially destructive and politically explosive.
This highlights yet another reason for the failure of economic policy since 2007. The dominant ideology of government non-intervention naturally intensifies resistance to change among the losers from globalization and technology, and creates overwhelming problems in sequencing economic reforms. To succeed, monetary, fiscal, and structural policies must be implemented together, in a logical and mutually reinforcing order. But if market fundamentalism blocks expansionary macroeconomic policies and prevents redistributive taxation or public spending, populist resistance to trade, labor-market deregulation, and pension reform is bound to intensify. Conversely, if populist opposition makes structural reforms impossible, this encourages conservative resistance to expansionary macroeconomics.
Suppose, on the other hand, that the “progressive” economics of full employment and redistribution could be combined with the “conservative” economics of free trade and labor-market liberalization. Both macroeconomic and structural policies would then be easier to justify politically – and much more likely to succeed.
Could this be about to happen in Europe? France’s new president, Emmanuel Macron, based his election campaign on a synthesis of “right-wing” labor reforms and a “left-wing” easing of fiscal and monetary conditions – and his ideas are gaining support in Germany and among European Union policymakers. If “Macroneconomics” – the attempt to combine conservative structural policies with progressive macroeconomics – succeeds in replacing the market fundamentalism that failed in 2007, the lost decade of economic stagnation could soon be over – at least for Europe.

Review & Outlook

The Wolves of Long Island

The SEC does its job in taking down a pump-and-dump stock scheme.

By The Editorial Board

Photo: Getty Images

Government prosecutors love to hunt for big cases on Wall Street, which are great for publicity, but an often-neglected duty is to protect small investors on Main Street. So it’s noteworthy that the Securities and Exchange Commission recently blew up a Long Island-based boiler-room scheme.

Last week the SEC charged 13 individuals with using high-pressure sales tactics to bilk more than 100 small investors—including many senior citizens—out of some $10 million in savings. The U.S. Attorney for the Eastern District of New York followed with criminal charges.

According to the SEC, the alleged swindlers—many of whom had been banned from the brokerage industry—set up a sham financial-services company on Long Island. They used this “boiler room” to buy, trade and inflate the price of penny stocks in microcap companies. Penny stocks trade over the counter at less than $5 a share and are often thinly traded, which makes them easier to manipulate than blue-chip securities on the big exchanges.

The alleged scammers purchased large blocks of shares and then “pumped” them to potential investors with harassing emails and phone calls. One conspirator emailed: “We are not brokers but a financial RESEARCH firm who continues to produce winner after winner in an UP or DOWN market! I need to speak with you about how this program will impact your portfolio in a POSITIVE way. BUT I cant help you if I cant speak with you.” Another said the stocks were “guaranteed winners” and the “buy of a lifetime.”

The boiler boys also used “washes”—e.g., buying 100 shares of a stock at $5 a share with one co-conspirator while selling the same number of shares for the same price to another. This drove up the stock price and created the impression that shares were actively being traded though ownership wasn’t changing hands. Once prices hit a certain level, they dumped the stocks, realizing $14 million in gains while costing victims millions.

When a victim complained about his losses, one con artist allegedly told him: “I am tired of hearing from you. Do you have any rope at home? If so tie a knot and hang yourself or get a gun and blow your head off.”

The SEC was established during the New Deal to protect mom-and-shop investors from fraudsters. But the agency has lately become better known for its headline-making prosecutions of Wall Street barons for white-collar crimes like insider trading, though their alleged victims are often other well-heeled and sophisticated investors. The agency also won plaudits from progressives for rules requiring disclosures on executive pay. But the SEC was asleep when Bernie Madoff and Allen Stanford were bilking investors out of their life savings.

New SEC Chairman Jay Clayton told us last week that he plans to make protecting small investors from scams like the Long Island boiler room a priority, and the agency deserves credit for bringing these cases back to the center of SEC enforcement.

10 Years Gone

by: Eric Parnell, CFA

- Then as it was, then again it will be.

- It was exactly ten years ago today that the U.S. stock market reached its pre-crisis peak.

- While the course may change sometimes, the song remains the same.
“Then as it was, then again it will be
And though the course may change sometimes
Rivers always reach the sea”
- Ten Years Gone, Led Zeppelin, 1975
Then as it was exactly ten years ago today. The date was July 19, 2007, and the U.S. stock market closed at another new all-time high. The world was awash with liquidity, risk asset prices were steadily rising, and investor worries were few despite evidence of accumulating risks beneath the global financial system. What subsequently followed over the next 18 months was not only the reemergence of downside risk but the near collapse of the global financial system. Could such a fate possibly be again ten years on?

The Last Time Rivers Reached The Sea

The skies were once clear and all was supposedly well. Ten years have gone since July 19, 2007.
What is so special about this date in particular? It was the date that the U.S. stock market as measured by the S&P 500 Index (SPY) reached its peak before the beginning of the end that soon came to be known as the financial crisis.
Sure, the S&P 500 Index (IVV) closed marginally higher a few months later on October 9, 2007, but by then the die had already been cast, volatility was spiking, and the game was over. When reflecting on the financial crisis and the years that have followed since the deluge of central bank liquidity tamed its flames, the date that I use to mark the beginning of the end is July 19, 2007.
I still remember to this day the mood across capital markets at the time. The summer was hot and stock investors were brimming with optimism. Corporate earnings were steadily rising on both an operating and GAAP basis at the same time that stock valuations were still fairly reasonable in the 16 to 17 times trailing 12-month earnings range. And while 2007 Q1 GDP had been somewhat soft, it was set to rebound to above a +3% annualized rate in the second quarter of the year.

At the same time, inflationary pressures were largely contained at around 2% despite the fact that commodities prices (DJP) including energy (USO) were on the rise. Moreover, the U.S. Federal Reserve was contemplating an easing of monetary policy in order to address some of the pressures that were accumulating in the economy associated with the housing industry. Strong economic growth, low inflation, rising earnings, reasonable valuations, and a potential shift toward more accommodative monetary policy from the U.S. Federal Reserve in the months ahead.
Put simply, what was not to love about investing in risk assets including U.S. stocks (DIA) ten years ago? The subsequent surrender of more than half of total portfolio value over the next twenty months provided the answer.
The Course May Change Sometimes
“Blind stars of fortune, each have several rays
On the wings of maybe, down in birds of prey
Kind of makes me feel sometimes, didn't have to grow
But as the eagle leaves the nest, it's got so far to go”
- Ten Years Gone, Led Zeppelin, 1975
So where are we today, exactly ten years gone from this previous stock market peak? The S&P 500 Index is once again set to close at a new all-time high on July 19, 2017 at a level on Wednesday that is nearly +60% higher than it was ten years ago on a price basis alone. For many investors, it has left them with the understandable feeling that they need not grow from this prior near catastrophic experience. Simply stay the course, endure the short-term volatility that may occur along the way no matter how dramatic, and drift on the rising tide that is the U.S. stock market over long-term periods of time.
If only investors across much of the rest of the developed and emerging world had been so fortunate as their U.S. counterparts over the past ten years. It also stands to reason whether the U.S. stock market eagle has finished its journey or whether it still flies on the wings of maybe after so many years.
So where do we stand today? The U.S. stock market is soaring just as it was ten years ago.
Of course, just because the U.S. stock market peaked exactly ten years ago does not mean it is about to do the same today. A number of factors are completely different today than they were ten years ago.
Let’s begin with a few indicators on the positive side.
First, whereas volatility had been steadily on the rise from historical lows for many months prior to the July 2007 peak, volatility remains at historic lows today.
This leads to an important point, which is that we will likely need to see a sustained rise in stock price volatility before the S&P 500 Index reaches a final peak. This point was also true leading up to the tech bubble peak back in 2000.
Also, whereas the U.S. Treasury yield curve as measured by the 2/10 spread had already inverted and was starting to steepen again leading up to the stock market peak in July 2007, the yield curve is still flattening and has yet to invert today.
While this suggests the stock market eagle has further to go today, it should be noted that the yield curve was still moving toward flattening and further into inversion at the time when the U.S. stock market first peaked during the tech bubble in March 2000. Nonetheless, the fact that the 2/10 spread is still in the 75 to 100 basis-point range suggests time for further flattening may lie ahead.
Of course, some characteristics of today’s market pale in comparison to July 2007.
The first relates to valuations. For while stocks were trading at around 16 to 17 times trailing earnings back in July 2007, today they are trading in the 22 to 25 times earnings range. While some seek to explain today’s valuation premium away by citing historically low interest rates, it is worth noting that equity risk premiums based on the 10-Year Treasury yield are still at best comparable. Moreover, short-term interest rates are on the rise thanks to the Fed, and according to many (myself not included) are headed higher across the yield curve.
The second relates to monetary policy. Whereas the Fed was headed toward easing monetary conditions in July 2007, it is moving assertively toward tightening monetary conditions today.
Of course, overall monetary conditions remain increasingly easy thanks to the continued liquidity pumping from the European Central Bank and the Bank of Japan, but this is also expected to measurably subside, not expand, in the near term.

The third relates to the economy. Prior to the onset of the financial crisis, U.S. economic growth as measured by real GDP was simply more robust in the 2% to 4% range versus the chronic 1% to 2% growth that we have been experiencing for so many years today. Put more simply, the markets in 2007 still had a decent engine, whereas today it has already been sputtering on liquidity and fumes for years now.
Overall, the course is different today than it was ten years ago. But just as it was, then again it will be that fundamentals will eventually matter as rivers always reach the sea eventually. So too will accumulating systemic risks. This does not appear likely to begin on July 20, 2017 or even over the next couple of months for that matter. But what history from ten years ago reminds us is that it does not take long for the market tides to suddenly turn, for a world awash in liquidity to suddenly turn bone dry, and for the unexpected to turn into the traumatic for those that are not prepared.

Holdin’ On, Ten Years Gone

On a closing note, one thing that has not changed over the past ten years is the blind eyes of central bankers. Read the following and manage your portfolio downside risk accordingly.
"We believe the effect of the troubles in the subprime sector on the broader housing market will be limited and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system"
- U.S. Federal Reserve Chair Ben Bernanke, May 17, 2007
“Would I say there will never, ever be another financial crisis? ... Probably that would be going too far. But I do think we're much safer, and I hope that it will not be in our lifetimes, and I don't believe it will be”
- U.S. Federal Reserve Chair Janet Yellen, June 27, 2017
Oh no, you didn’t! For those investors that are sleeping well at night depending on the omniscience of global central bankers, beware.
The Bottom Line
It has been ten years gone since the last stock market peak and the very beginning of the onset of the financial crisis in the U.S. stock markets. While the course has changed dramatically in the ten years since, and it is likely that today’s market still has time to grow, in many respects the song remains the same. Enjoy the good times while they last, for capital market history has shown that liquidity fuel love inevitably gives way to reality and how things are ultimately meant to be.