Should You Invest in the Bitcoin Futures ETF? Tread Carefully.

By Daren Fonda and Avi Salzman

Illustration by Steven Wilson

Stock investors may be feeling a tad jealous of their crypto cousins. Bitcoin, the largest cryptocurrency, blew past its record high this past week, reaching new heights around $67,000, up 50% since Sept. 30. Bulls now see a path to $100,000.

Just a few weeks ago, Bitcoin was in the doghouse—hit by regulatory fears in the U.S., a crackdown in China, and mounting criticism over the carbon footprint of “miners” that process transactions and add new coins to the supply. But the fear, uncertainty, and doubt—that’s FUD in cryptospeak—has been swept away, or at least under the rug, as excitement builds over a new milestone: Bitcoin is cracking one of Wall Street’s favorite products, exchange-traded funds, opening a channel into a market worth $9 trillion. What’s good for Wall Street, however, isn’t always good for investors.

After years of false starts, a Bitcoin-futures-based exchange-traded fund, the ProShares Bitcoin Strategy ETF (ticker: BITO), debuted Tuesday on the New York Stock Exchange. It racked up a record $1.1 billion in assets in two days, but it already has company. Another futures ETF, the Valkyrie Bitcoin Strategy (BTF), launched on the Nasdaq on Friday. Other futures ETFs that could win approval soon include funds from VanEck, AdvisorShares, and ARK 21Shares.

The flurry of futures ETFs may be a turning point for Bitcoin and the broader crypto investment space. Bitcoin came to life as a piece of libertarian digital agitprop—a decentralized money-transfer system aimed at swiping power from central bank fiat money and the broader financial establishment. That ethos still prevails in crypto, which remains both threatening and alluring to Wall Street. JPMorgan Chase CEO Jamie Dimon recently described Bitcoin as “worthless,” even as the firm’s investment bank and wealth management divisions aim to profit off it.

Love/hate feelings aside, Bitcoin and Wall Street are converging for mutual gain. “With a $2 trillion market value and 200 million users, the digital asset universe is too large to ignore,” observed Alkesh Shah, head of crypto strategy at Bank of America, in a recent coverage launch of crypto. Venture capital poured $17 billion into digital assets through the first half of the year, up from $5.5 billion in all of 2020, he notes.

ETFs could be the next stage of crypto’s colonization. Wall Street is eager to sell, trade, and create derivatives around the product, opening up new revenue streams. “What you see Wall Street doing with these ETFs is sucking Bitcoin in with its tractor beam,” says Ben Johnson, head of ETF research at Morningstar.

A true marriage of Bitcoin and ETFs would be funds that own the crypto directly, rather than futures—a market used to price commodities such as oil and wheat. ETFs with “physical” ownership of Bitcoin already trade in Canada, racking up $2 billion in assets. 

And they’re far more efficient than futures funds, which come with unique drawbacks. 

While front-month futures tend to track spot prices closely, funds may fall far behind due to cost frictions, taxes, and limits on position sizes.

A physical Bitcoin ETF isn’t expected to be approved soon by U.S. regulators, for both political and practical reasons. 

But the crypto markets are rising on hopes that even futures-based ETFs are a big win for the industry, pushing crypto deeper into the financial heartland. 

Other cryptos are rallying, including the second-largest, Ethereum. 

Coinbase Global (COIN), the largest publicly traded crypto brokerage, is up 32% this month despite the prospect of traders shifting to commission-free Bitcoin ETFs rather than paying up to 4% for a trade through Coinbase.

Filings for more crypto-futures ETFs are almost certain to follow, now that the Securities and Exchange Commission has signed off on the first Bitcoin products. 

Global ETF assets hit $9 trillion globally in August, including $7 trillion in U.S.-based funds. 

If crypto ETFs captured 1% of the global market, they would be worth $90 billion, a little less than 10% of Bitcoin’s recent market cap of $1.1 trillion.

“In theory, that’s your addressable market,” says Johnson. 

“Just the existence of a Bitcoin futures ETF could drive demand among people who view this as a validation of the underlying asset.”

Investors already have plenty of ways to get crypto, of course. 

They can buy it directly through trading apps; buy a closed-end trust that trades over the counter, such as the Grayscale Bitcoin Trust (GBTC) or Bitwise Crypto 10 Index fund (BITW); or even less directly, by owning shares in companies that own Bitcoin, like MicroStrategy (MSTR). 

Futures-based ETFs are another derivative, and now another artery into the market.

But the ETF packaging is coveted since it opens up a channel for advisors, human or digital, to add crypto in managed accounts. 

Bitcoin ETFs can slide seamlessly into a portfolio, working within existing tax-reporting and rebalancing software. 

Robo-advisors like Betterment could add it to automated accounts. 

The company is looking at how to offer crypto “responsibly,” a spokesperson tells Barron’s. 

Crucially, advisors can charge management fees on Bitcoin ETFs far more easily than if Bitcoin were held outside a managed portfolio.

More than 20% of advisory clients own Bitcoin, but only 3.5% keep it with an advisor, according to a survey conducted this year for the crypto investment firm NYDIG. 

Moreover, 73% of clients would move their crypto to an advisor if possible, the survey found. 

“It’s a step in the right direction—allowing advisors to access Bitcoin through traditional financial-services plumbing,” says Nate Geraci, president of The ETF Store, an advisory firm in Kansas.

Fund companies view a futures product as a bridge to the ultimate prize: an ETF that owns Bitcoin directly, much as gold ETFs own the physical metal. 

Grayscale Investments and Bitwise Asset Management, two of the largest crypto fund sponsors, both filed in the past few weeks for ETFs; Grayscale aims to convert its trust and Bitwise is pushing for a new ETF.

Both filings are packed with research arguing that the futures and spot markets (where actual assets are traded) have matured enough to meet SEC standards for direct ownership. 

Backers also argue that the futures and spot markets are now largely in sync, cutting down the potential for market manipulation or arbitrage from one to the other. 

If Bitcoin futures are good enough to be in an ETF, they argue, so should the coins themselves.

“The futures and spot markets reference the exact same prices,” says Matt Hougan, chief investment officer at Bitwise. 

“From a 30,000-foot view, any market manipulation that would affect futures would be similar to spot. 

We’ll eventually get physical Bitcoin and Ether ETFs and crypto will be a fully normalized asset.”

ProShares CEO Michael Sapir with Douglas Yones, head of NYSE Exchange Traded Products, and other guests at the ringing of the opening bell on the New York Stock Exchange to celebrate the first U.S. Bitcoin-Linked ETF. / NYSE

That view isn’t universally held in Washington. 

The SEC has been clear that the path for crypto ETFs is through futures—a highly regulated U.S. market. 

Spot markets and exchanges, the basis for direct ownership, pose more challenges. 

Spot markets for stocks, such as the NYSE or Nasdaq, are long-established and well regulated by authorities around the world. 

Much of Bitcoin’s trading volume takes place on newer exchanges, many of them abroad and outside the reach of U.S. watchdogs. 

It’s also thriving on automated platforms such as PancakeSwap and Uniswap, which aren’t even registered as money-transfer exchanges like Coinbase is.

For regulators tasked with surveillance, Bitcoin remains something of a cipher. 

Yes, they have had some success tracking illegal activity, notably in recovering payments for ransomware attacks. 

And yes, transactions are all visible on the blockchain. But the movement of cash to crypto and back to cash, especially overseas, runs through a digital labyrinth. 

Crypto can also hop from country to country in wallets that resemble suitcases of cash condensed into thumbnail drives.

Crypto trading, lending, and payments are also expanding on gaming platforms and other decentralized venues beyond regulators’ reach. 

“It will be difficult for regulators to keep playing catch-up,” says Chris Matta, president of 3iQ, an ETF sponsor in Canada.

The crypto industry would love Washington to clear up the patchwork of rules, enforcement actions, and regulatory agencies keeping tabs on the industry—establishing a crypto “czar” to oversee it all. 

But there’s no bipartisan consensus in Congress on how to regulate crypto, and the SEC, under Democratic Chairman Gary Gensler, has been talking tough—arguing that the SEC should exert sweeping authority over many tokens, exchanges, and DEXes, or decentralized exchanges, like Uniswap. 

The SEC recently blocked Coinbase from expanding into lending products. 

If Gensler approves a true Bitcoin ETF, it would be a U-turn from an agenda he has staked out for months.

How did the futures ETFs push through? 

Partly by meeting standards in the Investment Company Act of 1940, the overarching framework for fund-company registrations. For direct ownership of physical assets, ETFs have to go through the Securities Act of 1933, says Hougan. 

That means additional requirements for funds to be approved, notably a surveillance mechanism of underlying markets for regulators to protect against manipulation. 

That could still prove challenging since the spot markets are far more decentralized and freewheeling than regulated futures; Bitcoin, by its nature, subverts national boundaries.

“Every company that has tried to launch a direct ETF has run aground on the ’33 Act reef,” says Hougan. 

Gensler could still use it to keep a direct ETF off the market on his watch.

Illustration by Steven Wilson

While regulators may be comfortable with futures, the ETFs themselves can be murky. 

The ProShares ETF owns a mix of futures and money-market funds. 

It holds 25% of its assets in a Cayman Islands subsidiary, a common structure for futures funds to avoid U.S. federal taxes. 

But because of margin and position limits on futures, it’s unclear how much Bitcoin a fund can actually own without violating regulatory requirements. 

Also unclear is the impact of offshore tax rules on the portfolio.

Perhaps more problematically, futures ETFs may not closely match the spot returns of the crypto over long periods. 

Futures are rolling contracts that a fund must continuously buy as old ones expire—a costly process that becomes more so when contracts for future delivery are priced higher than the front month, a situation known as contango. 

Futures in contango impose “negative roll yields” that erode long-term returns.

Criticism of the “roll effect” is overblown, ProShares CEO Michael Sapir tells Barron’s: “Right now, you’re talking about 20 basis points [0.2%] to roll from the current contract to the next.” 

That’s hardly an overwhelming drag in the context of Bitcoin’s long-term gains. 

Futures are also a deep, liquid market whose nominal volume is 40% greater than the largest U.S. spot exchange. 

And some research indicates that the futures market is a leading indicator of spot.

Still, commodities ETFs can go awry for several reasons. 

A recent standout was the United States Oil fund (USO), which plunged 44% over a few days in April 2020 as crude oil prices briefly went negative. 

That selloff was triggered by collapsing oil demand due to Covid-19 and producers facing an unprecedented storage crunch. 

But Bitcoin isn’t exactly known for orderly trading, and it’s unknown how the futures or ETFs would trade in a massive flight out of crypto—probably not well.

Bitcoin futures have other quirks. 

Starting with the November front-month contract, the CME will limit the amount of Bitcoin futures that a buyer can purchase to 4,000, dropping to 2,000 three days before expiration. 

Moreover, it’s unclear if a fund can own more than 5,000 contracts of any length in total. 

Each contract represents five Bitcoins, capping total ownership at 20,000 Bitcoins. 

At recent prices that represent $1.2 billion worth of Bitcoin, only slightly more than the ProShares fund’s assets. 

ProShares has applied for a waiver from those position limits with CME, which did not have a comment on when it will decide.

If the CME holds the line, the ETF may have to find other mechanisms for exposure. 

Sapir says the fund could shift assets into later-dated contracts, swaps, or structured notes. 

The prospectus indicates another possibility: The ETF could invest in unspecified crypto equities. 

Asked if that might include miners like Riot Blockchain (RIOT), or holders like MicroStrategy, Sapir says, “We’d be looking for equity securities that we think have a high level of correlation to the performance of Bitcoin. 

And if it did, we would consider it.”

For all these reasons, advisors and other professional investors are giving futures ETFs mixed reviews. 

“I suspect this ProShares ETF will have significant dispersion from the actual Bitcoin price,” says Matthew Allain, CEO of advisory firm Leo Wealth and an early crypto adopter. 

He says he has no plans to buy the ETF for clients, preferring direct exposure. 

“It’s not a product that’s appropriate for what we’re trying to achieve in cryptos,” he says.

Others are waiting to see how they perform. 

A vote of confidence would come if the ETFs do a better job of tracking Bitcoin than the Grayscale Trust, which has been a laggard, says Matt Kilgroe, president of Cyndeo Wealth Partners in Florida: “We need time to watch how they unfold.”

Brokerages could win and lose from Bitcoin ETFs. 

Coinbase has rallied as Bitcoin’s price exploded, driving higher volumes and trading fees. 

Piper Sandler analyst Richard Repetto says the ETF brings “more credibility and attention to the crypto space.” 

Another major brokerage, Interactive Brokers (IBKR), is getting into crypto trading, launching a platform this week.

Interactive Chairman Thomas Peterffy doesn’t seem concerned about competition from ETFs, arguing that investors will want to hold actual Bitcoin as a kind of “doomsday protection,” similar to the role that gold has long played. 

The ETF is “completely useless for that purpose,” he says.

Still, if investors can trade Bitcoin ETFs for free on apps like Robinhood or Webull, they may be less inclined to pay commissions for direct exposure. 

Coinbase charges a hefty fee for a Bitcoin trade, while Robinhood captures fees in payment for order flow. 

Other brokerages take a spread, or cut, on the price difference between buys and sells. 

Interactive charges 0.12% to 0.18%.

The hype around Bitcoin belies the fact that it still faces tall hurdles to financial legitimacy. 

Real-world uses are expanding—notably in emerging markets as an alternative currency—but it’s still a digital token without tangible value, living on borrowed regulatory time. 

China and other countries view Bitcoin as an imminent threat to their monetary sovereignty; China recently banned all commercial crypto transactions as it expands a digital version of its own currency.

Bitcoin miners are still consuming vast megawatts of electricity, giving it a carbon footprint bigger than some countries. 

While the U.S. is home to more miners using renewable energy, the industry could still be subject to new carbon taxes or other fees. 

ESG investors may balk at Bitcoin’s carbon toll, which grows with its market value.

One other consideration: Bitcoin tends to plunge after a jump pegged to a positive development. 

After shooting up in anticipation of futures in 2017, it tanked shortly after they launched; Bitcoin also fell more than 20% in the days after Coinbase’s stock hit the market in April. 

Three days after the first Bitcoin futures ETF launched, the price of the coin was down 10% from its high, succumbing to profit-taking as the euphoria over ETFs faded.

The west is the author of its own weakness

China presents a threat to the liberal global order but the bigger danger lies in the discrediting of democracy

Philip Stephens 

                   © Efi Chalikopoulou

Call it the age of optimism. 

Twenty-five years ago, when this column first appeared, the world belonged to liberalism. 

Soviet communism had collapsed, the US claimed a unipolar moment, and China had joined the market economy. European integration had banished the demons of nationalism. 

The UK would soon be dubbed “Cool Britannia”.

You did not have to think the wheels of history had stopped turning to judge that the 21st century would be fashioned in the image of advancing democracy and a liberal economic order.

Today’s policymakers grapple with a world shaped by an expected collision between the US and China, by a contest between democracy and authoritarianism and by the clash between globalisation and nationalism. Britain is again the sick man of Europe. 

If this sounds insufficiently bleak, you can add the existential threat of man-made global warming.

The easy explanation is that the west fell prey during the 1990s to hopeless naivete. 

Victory in the cold war went to its head. Living standards were on the up. 

It was still possible, pre-Facebook, to imagine the internet as a global community for good. 

In any event, it is the human instinct to project the present into the future. 

Doesn’t history travel in straight lines?

Europe was no innocent in this respect. 

The continent’s liberal internationalists made common cause with US neoconservatives in promoting a great democratising mission. 

America had guns but the EU had its own “normative” power. 

Large swaths of the world were set to become, well, European.

The great unwinding since has seen the US-led post-cold war order give way to the return of great power rivalry, populists of far right and far left raising the standard of nationalism against European integration, and a mercantilist scramble for national economic sovereignty. 

In an era of authoritarian “strongmen”, headed by China’s Xi Jinping and Russia’s Vladimir Putin, democracy is in a defensive crouch.

And now western policymakers risk another big mistake by identifying China as the most pressing challenge to the ancien regime. 

The US and its allies, we are told, must concentrate their energies on gathering their resources to see off the threat. 

What we need is more submarines in the South China Sea.

Given Beijing’s belligerence, the argument is beguiling.

It is also displacement activity, an excuse not to admit what has really happened since the 1990s. 

Yes, China has grown at a much faster pace than almost anyone imagined. 

But the explanation for the weakening of western democracies lies largely in the west.

America’s wars of choice in Afghanistan and Iraq are part of the story. 

They were intended as a salutary demonstration of US power. 

Instead these vastly costly and unpopular conflicts served to delineate the limits of the Pax Americana. 

The sole superpower promised to remake the Middle East. 

Instead, as we saw last month in the fall of Kabul, Washington has been forced to cut and run. 

The rest of the world notices these things.

The failure in the Middle East, however, pales into insignificance against the damage inflicted by the 2008 global financial crash. 

Historians will record the crash as a momentous geopolitical as much as an economic event — the moment western democracies suffered a potentially lethal blow.

The failure of laissez-faire economics was visible before the collapse of Lehman Brothers. 

The incomes of the not-so-well-off had long been stagnating under the pressure of technological advance and open markets. 

It was obvious, too, that the rewards of globalisation were being reaped by the rich and super-rich. 

The crash, though, crystallised what had become, in effect, an elaborate shakedown.

Those looking for an explanation for Donald Trump’s presidential victory, for the UK Brexit vote, or for populist insurgencies across Europe need reach no further. 

The excesses of the financial services industry and the decision of governments to heap the costs of the crisis on to the working and lower middle classes have struck at the very heart of democratic legitimacy.

What Trump understood, as did populists elsewhere, is that the voters’ respect for established politics is rooted in a bargain. 

Public faith in democracy — in the rule of law and the institutions of the state — rests on a perception that the system at least nods towards fairness. 

There have been reforms to that end since the crash, but little to suggest they are enough.

There was nothing wrong with the ambition of the post cold war optimists. 

It remains hard to see how the world can work without liberal democracy and a rules-based international system. 

What the optimists missed then, and the China watchers overlook now, is the hollowing out of trust in democracy at home. 

Of course, China is a potential threat. 

A second presidential term for Trump would be a much more dangerous one.

It may be that history will conclude that the excessive optimism of the 1990s is being mirrored today by too much pessimism. 

That’s a judgment I intend to leave to others. 

For a political commentator, 25 years in the same slot is long enough. 

So this is my last column. 

I will continue to write from time to time as an FT contributing editor, but otherwise intend to go in search of a better understanding of, well, history.

Diplomacy by other means

Israel again rattles its sabre at Iran

A military response is readied as hope for a nuclear deal fades

TWO BY TWO they roared into the sky over the Israeli desert—American F-16s, British Typhoons, French Rafales and more—to confront an unseen enemy called “Dragonland”. 

The foes of wargames are fictitious. 

But in the minds of the hosts, the monster is real: Iran. 

Israeli officers were at pains to say the exercise was “generic”. 

Yet Dragonland’s force, with its drones and air-defence missiles, was akin to Iran’s. 

Exercises to defeat it “are part of the capabilities that are needed to face Iran,” noted one general.

The “Blue Flag” exercises at the Ovda air base in the Negev desert are a form of military diplomacy, and a signal that Israel has friends. 

Israel is becoming the hinge of two emerging military groupings: an eastern Mediterranean one to fend off Turkey; and a Middle Eastern one to deter Iran. 

The number of Blue Flag participants has grown—seven countries, including India, exercised with Israel this year. 

The United Arab Emirates’ air-force chief came to watch as an honoured guest.

Whether any of these friends would help Israel in a war with Iran is unclear. 

But the proposition may be tested sooner than some expect. 

Sabre-rattling is growing louder as Iran’s nuclear programme gathers pace and American diplomacy falters. 

America has warned that it would look at “other options” and this month it tested a new bunker-buster bomb. 

The Israeli air force has begun rehearsing attack plans; the government is allocating more money to the armed forces to confront Iran. 

In Manama on October 1st the Israeli and Bahraini foreign ministers posed for pictures in front of an American warship. 

Iran has responded by staging air-defence exercises and warning Israel of a “shocking response” to any attack.

Israel has entered what some call the “dilemma zone”—weighing up the danger of Iran going nuclear against the prospects for diplomacy, the complexity of mounting a military operation, Iran’s likely retaliation, and the response of America and regional partners. 

Israel will not say what its “red lines” are, but Western diplomats think it may take a decision to act by the end of the year.

Israel has been here before, notably in 2009-12, when it threatened to bomb Iran but stayed its hand. 

Now, though, Iran is even closer to having the wherewithal to make atomic bombs. 

That is in part because in 2018 Donald Trump abandoned a nuclear deal, known as the Joint Comprehensive Plan of Action (JCPOA), that limited Iran’s nuclear programme and opened it up to enhanced inspections in return for the partial lifting of international sanctions. 

Iran says it seeks nuclear technology only for civilian purposes, yet its uranium enrichment has advanced to the point that its “breakout time”—the time it would need to make a bomb’s-worth of fissile material—has shrunk from a year to about a month. 

(Making a warhead to fit on a missile might take another 18-24 months.

Iran seems uninterested in America’s call for a return to “mutual compliance” with the JCPOA. 

The UN’s International Atomic Energy Agency says its monitoring of Iran’s activities is no longer “intact” because the regime is refusing to let it replace damaged cameras.

Israel has twice bombed its enemies’ nuclear facilities—striking an Iraqi nuclear reactor in 1981 and a Syrian one in 2007. 

But these were single air raids. Taking out Iran’s nuclear facilities would be far more difficult because they are dispersed and some are buried underground. 

Iran has also acquired Russian-made S-300 air-defence missiles. 

As one Israeli general puts it, an attack plan against Iran is “not just one system, but a system of systems.” Execution is “not something you can prepare in just a month”.

Israel’s operational challenges range from identifying the location of Iranian facilities to their level of fortification and whether anti-aircraft defences must first be destroyed. 

Israel would be operating some 1,500km away from its bases, requiring air-to-air refuelling for many aircraft over potentially hostile territory. 

Some analysts believe it is all beyond Israel’s capabilities. 

Israeli military planners claim otherwise, saying they can do enough damage to set back Iran’s nuclear programme by some years.

Israel’s task would be easier if its new Gulf allies were willing to help by, say, allowing overflights, providing bases or assisting downed pilots. 

But the more Iran’s neighbours get involved, the likelier they are to become targets of retaliation. 

Iran has threatened to close the Strait of Hormuz, through which much of the Gulf’s oil passes, if attacked. 

Its conventional military capacity may be limited—some of its aircraft date back to the Shah’s days before his overthrow in 1979. 

But it has built up a force of ballistic and other missiles, and has resorted to asymmetric tactics, eg, sabotaging ships near its waters.

It also sponsors proxy militias—in Iraq, Syria, Yemen and Lebanon—that give it military reach across the region. 

Hizbullah in Lebanon has thousands of rockets that can be rained down on Israel’s cities. 

More worrying, Hizbullah also has guided missiles and drones that can strike accurately—as Iran demonstrated in 2019 when it attacked Saudi Arabia’s oil-processing facilities at Abqaiq. 

Israel, military officials note, is a “100-target country”—with just a handful of power stations and desalination plants, and a single international airport. 

Hitting these would cause “strategic damage”. 

Many Gulf states are even more vulnerable.

Much will depend on President Joe Biden, who says he will not allow Iran to go nuclear on his watch. 

Military action by America would be more powerful than an Israeli raid, not least because it has larger bunker-busting weapons. 

And even if it just gives Israel the green light to act alone, America might not be able to stay out of the fighting. 

If Iran responds by widening the conflict, as many expect, America would be called upon to keep the sea lanes open, defend allies and even protect itself. 

Its forces in Iraq and Syria are exposed to attack (an American base in Tanf, in Syria, was hit by armed drones on October 20th). 

Having withdrawn from Afghanistan this summer, saying he wanted to end the “forever wars” in the Muslim world, Mr Biden will be loth to get sucked into another one.

Israel’s best hope is that its threat of action, combined with concerted Western diplomatic and economic pressure, will persuade Iran to agree to a diplomatic deal. 

“Iran can be deterred,” insists one Israeli official, “It does not want to be North Korea.” 

The danger is that the mullahs conclude that only nukes will keep their regime safe.

Putting Public Finance on the Right Side of History

With the urgency of the climate crisis becoming clearer by the day, governments and multilateral lenders must end public financing for fossil fuels and increase their support for renewables as soon as possible. This year's United Nations climate-change conference offers the perfect opportunity to lock in such commitments.

Werner Hoyer, John Murton

BRUSSELS – The economics of renewable energy have improved beyond recognition. 

Solar power is now the cheapest form of electricity in history. 

Over 90% of power-generation capacity added around the world last year was in renewables. 

But to stand a chance of limiting global warming to 1.5° Celsius above pre-industrial levels, the world’s energy systems must transform even faster. 

And that requires governments and public financial institutions to stop supporting fossil fuels and instead emphasize international support for the clean-energy transition.

The science is clear. 

To meet the 2015 Paris climate agreement’s 1.5°C target, the global energy transition needs to progress 4-6 times faster than it currently is. 

Fossil fuels still supply 84% of the world’s energy and account for over 75% of global emissions. 

The International Energy Agency’s Net Zero by 2050 roadmap shows that global energy systems must be fossil-fuel-free by 2040. 

Yet since the Paris agreement was concluded, G20 governments have provided more than three times more public finance for fossil fuels ($77 billion) than for renewables every year.

This year’s catastrophic storms, floods, and wildfires have shown why we need climate action now, not later. 

And because future prosperity lies in clean energy investment, there is also a clear economic development case for redoubling our efforts. 

Wind and solar are now cheaper than new coal and gas power plants in two-thirds of the world. 

The dramatic cost reduction over the past decade has transformed global energy options, particularly in the very poorest countries, where renewables-based mini grids offer real opportunities to alleviate energy poverty and provide energy access.

Boosting investment in renewables is also vital to creating jobs, driving economic growth, and reducing air pollution. 

According to the International Renewable Energy Agency, deploying renewables at scale could help create 42 million jobs worldwide by 2050. 

This additional employment will be crucial for delivering a resilient, green recovery from the COVID-19 pandemic, especially in countries with young, fast-growing populations.

But, of course, jobs will also disappear as we abandon fossil fuels. 

We therefore must take steps to ensure that every community benefits from the transition. 

This will require carefully designed policies to support a managed shift away from older forms of energy generation. 

Global solidarity will be critical. 

We must do much more to provide everyone with the necessary technologies, expertise, investment support, and financial strategies.

Fortunately, we already have solutions to the problem. 

At the United Nations Climate Change Conference (COP26) in Glasgow in November, governments and financial institutions must commit to supporting cheaper, cleaner, no-regrets energy, and to ending all international support for fossil-fuel-based power. 

This should not be too difficult, given that many legacy energy investments will inevitably become stranded assets.

We are already starting to see significant progress in this direction. 

In May, G7 member states committed to cease all of their international financing for coal projects by the end of 2021, and to “phase out new direct government support for carbon-intensive international fossil fuel energy.” 

Moreover, South Korea, Japan, and now China – the world’s largest providers of international coal financing – have also agreed to stop funding coal projects overseas.

Equally important, more than 85 countries (plus the European Union) have submitted updated national climate pledges, as outlined in the Paris agreement. 

These show a clear trend toward higher renewable energy use and lower reliance on fossil fuels by 2030. 

But many of these countries will need substantial technical and financial support to hit their targets.

The United Kingdom and the European Investment Bank have both committed to making international support for the clean-energy transition a high priority. 

In 2019, the EIB became the first multilateral bank to announce an end to all financing for fossil-fuel energy projects (by 2021). 

The bank has been increasing its investments in clean energy, including in developing countries to support their transition. 

In Kenya, EIB investments have helped build the largest wind farm in Africa, providing clean and affordable energy to the region.

Similarly, in March, the UK government put an immediate end to new public support for overseas international fossil-fuel energy projects, fully shifting investment into renewables. 

This decision has already started to unlock significant opportunities, building on existing support for clean energy provided by the country’s export credit agency, UK Export Finance. 

This includes over £140 million ($189 million) of financing for UK exports to Ghana, which will help Ghana pursue major national infrastructure projects, including an initiative for solar-powered clean water that will reach more than 225,000 people.

We now must build on this momentum to ensure that COP26 is a success. 

More commitments are needed to align international public support fully with the Paris goals. 

We can achieve the necessary solidarity by bringing governments and public-finance institutions together behind a joint statement proclaiming support for clean energy and a phase-out of fossil fuels.

We invite governments and public-finance leaders to join us in supporting this statement. 

The cost of climate inaction would be catastrophic. 

We have reached a critical juncture for our planet. 

COP26 must be remembered as the moment when we took decisive action to safeguard our shared future.

Werner Hoyer is President of the European Investment Bank.

John Murton is the United Kingdom's COP26 Envoy.

The China Sleepwalking Syndrome

If the Sino-American relationship were a hand of poker, Americans would recognize that they have been dealt a good hand and avoid succumbing to fear or belief in the decline of the US. But even a good hand can lose if it is played badly.

Joseph S. Nye, Jr.

CAMBRIDGE – As US President Joe Biden’s administration implements its strategy of great power competition with China, analysts seek historical metaphors to explain the deepening rivalry. 

But while many invoke the onset of the Cold War, a more worrisome historical metaphor is the start of World War I. 

In 1914, all the great powers expected a short third Balkan War. 

Instead, as the British historian Christopher Clark has shown, they sleepwalked into a conflagration that lasted four years, destroyed four empires, and killed millions.

Back then, leaders paid insufficient attention to the changes in the international order that had once been called the “concert of Europe.” 

An important change was the growing strength of nationalism. 

In Eastern Europe, pan-Slavism threatened both the Ottoman and Austro-Hungarian empires, which had large Slavic populations. 

German authors wrote about the inevitability of Teutonic-Slavic battles, and schoolbooks inflamed nationalist passions. 

Nationalism proved to be a stronger bond than socialism for Europe’s working classes, and a stronger bond than capitalism for Europe’s bankers.

Moreover, there was a rising complacency about peace. 

The great powers had not been involved in a war in Europe for 40 years.

Of course, there had been crises – in Morocco in 1905-06, in Bosnia in 1908, in Morocco again in 1911, and the Balkan wars in 1912-13 – but they had all been manageable. 

The diplomatic compromises that resolved these conflicts, however, stoked frustration and growing support for revisionism. 

Many leaders came to believe that a short decisive war won by the strong would be a welcome change.

A third cause of the loss of flexibility in the early twentieth-century international order was German policy, which was ambitious but vague and confusing. 

There was a terrible clumsiness about Kaiser Wilhelm II’s pursuit of greater power. 

Something similar can be seen with President Xi Jinping’s “China Dream,” his abandonment of Deng Xiaoping’s patient approach, and the excesses of China’s nationalistic “wolf warrior” diplomacy.

Policymakers today must be alert to the rise of nationalism in China as well as populist chauvinism in the United States. 

Combined with China’s aggressive foreign policy, a history of standoffs and unsatisfactory compromises over Taiwan, the prospects of inadvertent escalation between the two powers exist. 

As Clark puts it, once catastrophes like WWI occur, “they impose on us (or seem to do so) a sense of their necessity.” 

But in 1914, Clark concludes, “the future was still open – just. 

For all the hardening of the fronts in both of Europe’s armed camps, there were signs that the moment for a major confrontation might be passing.”

A successful strategy must prevent a sleepwalker syndrome. 

In 1914, Austria was fed up with upstart Serbia’s nationalism. 

The assassination of an Austrian archduke by a Serbian terrorist was a perfect pretext for an ultimatum. 

Before leaving for vacation, the German Kaiser decided to deter a rising Russia and back his Austrian ally by issuing Austria a diplomatic blank check. 

When he returned and learned how Austria had filled it out, he tried to retract it, but it was too late.

The US hopes to deter the use of force by China and preserve the legal limbo of Taiwan, which China regards as a renegade province. 

For years, US policy has been designed to deter Taiwan’s declaration of de jure independence as well as China’s use of force against the island. 

Today, some analysts warn that that this double deterrence policy is outdated, because China’s growing military power may tempt its leaders to act.

Others believe that an outright guarantee to Taiwan or hints that the US is moving in that direction would provoke China to act. 

But even if China eschews a full-scale invasion and merely tries to coerce Taiwan with a blockade or by taking one of its offshore islands, all bets would be off if an incident involving ships or aircraft led to loss of life. 

If the US reacts by freezing assets or invoking the Trading with the Enemy Act, the two countries’ metaphorical war could quickly become real. 

The lessons of 1914 are to be wary of sleepwalking, but they do not provide a solution to managing the Taiwan problem.

A successful US strategy toward China starts at home. 

It requires preserving democratic institutions that attract rather than coerce allies, investing in research and development that maintains America’s technological advantage, and maintaining America’s openness to the world. 

Externally, the US should restructure its legacy military forces to adapt to technological change; strengthen alliance structures, including NATO and arrangements with Japan, Australia, and South Korea; enhance relations with India; strengthen and supplement the international institutions the US helped create after World War II to set standards and manage interdependence; and cooperate with China where possible on transnational issues. 

So far, the Biden administration is following such a strategy, but 1914 is a constant reminder about prudence.

In the near term, given Xi’s assertive policies, the US will probably have to spend more time on the rivalry side of the equation. 

But such a strategy can succeed if the US avoids ideological demonization and misleading Cold War analogies, and maintains its alliances. 

In 1946, George Kennan correctly predicted a decades-long confrontation with the Soviet Union. 

The US cannot contain China, but it can constrain China’s choices by shaping the environment in which it rises.

If the Sino-American relationship were a hand of poker, Americans would recognize that they have been dealt a good hand and avoid succumbing to fear or belief in the decline of the US. But even a good hand can lose if it is played badly.

Joseph S. Nye, Jr. is a professor at Harvard University and author of Do Morals Matter? Presidents and Foreign Policy from FDR to Trump.

Tesla Surpasses $1 Trillion in Market Value as Hertz Orders 100,000 Vehicles

Hertz’s major bulk purchase could help Tesla get more of its cars into the hands of mainstream consumers

By Dave Sebastian

Hertz said that, starting in early November and expanding through the end of the year, customers will be able to rent a Tesla Model 3 at airports and other locations in major U.S. markets and some cities in Europe./ PHOTO: CINDY ORD/GETTY IMAGES

Tesla Inc. TSLA 12.66% became the latest U.S. company to cross the $1 trillion milestone in market value as its stock price has more than doubled in the past year on surging sales and rising profit.

Helping Tesla cross the mark Monday was news that Hertz Global Holdings Inc. HTZZ 10.04% had ordered 100,000 vehicles from the electric vehicle maker to stock its rental-car fleet, a major bulk purchase that could help the car company get more of its cars into the hands of mainstream consumers.

In crossing the $1 trillion mark, Tesla joins Apple Inc., Microsoft Corp. , Inc. and Google-parent Alphabet Inc. Facebook Inc. was part of the group, though its share price has since retreated. 

Tesla, which last week posted its third consecutive quarter of record profit, is now valued more than the next nine largest auto makers by market cap.

Tesla’s stock hit an intraday high of $998.74, giving it a market value of $1.004 trillion. 

The stock has since slid to $994.48, up 9.3% on the day. 

Any close above $995.753 would put it above the milestone.

The Tesla order is part of a broader effort by Hertz to give customers more battery-powered options on rental-car lots.

The Estero, Fla., company said that starting in early November and expanding through the end of the year, Hertz customers will be able to rent a Tesla Model 3 at airports and other locations in major U.S. markets and some cities in Europe.

Electric vehicles will comprise more than 20% of the company’s global fleet with the current order, Hertz said Monday. 

The rental-car company said it introduced electric vehicles into its fleet in 2011.

Tesla’s stock surged around 7% in Monday morning trading, lifting the company’s shares to an intraday high of $979.80.

The order represents a major chunk of Tesla’s annual production volume, which has been growing in recent years.

The electric-car maker produced more than 509,000 vehicles last year, delivering about half a million of them globally in 2020, according to company filings.

Analysts expect those numbers to continue climbing as the company aims to start making vehicles at two new factories this year. 

Based on its deliveries through September, it is in a position to deliver nearly 900,000 vehicles to consumers in 2021 and analysts forecast shipments to rise to 1.4 million in 2022 as the new factories start cranking out vehicles.

The purchase, which would make hot-selling Teslas available to rental customers, could also help Hertz elevate its profile as it anticipates relisting on a major stock exchange by the end of the year. 

Hertz shares, which currently trade over the counter, rose more than 7% to $26.45.

Hertz said it is also installing thousands of electric-vehicle chargers in its network. 

Those who rent a Tesla Model 3 will have access to 3,000 Tesla supercharging stations in the U.S. and Europe, the company said.

Hertz said it expects a combination of level 2 and DC fast charging in about 65 markets by the end of 2022 and more than 100 markets by the end of 2023.

“Electric vehicles are now mainstream, and we’ve only just begun to see rising global demand and interest,” said Mark Fields, Hertz’s interim chief executive. 

Mr. Fields, a former Ford Motor Co. CEO, took the role earlier this month.

Financial terms of the deal between Hertz and Tesla weren’t provided. 

Based on list prices, the cost to Hertz would top $4 billion; however, historically it is common for such bulk orders to include a discount for the rental-car company.

Hertz is making the investment after emerging from bankruptcy under new ownership. 

It filed for bankruptcy in May 2020 as the debt-laden company suffered from a collapse in reservations.

As part of its restructuring, Hertz exited bankruptcy with more $5.9 billion in new equity capital, a large portion of which was raised by new owners Knighthead Capital Management LLC and Certares Management LLC. 

At the end of June, it had $1.82 billion in cash and cash equivalents, according to company filings.

The rental-car firm is looking to raise more capital through a stock offering planned for the fourth quarter of this year. 

Hertz, which revealed the offering earlier this month, said the terms haven't yet been determined. 

It intends to list its common stock on the Nasdaq under its pre-bankruptcy symbol “HTZ.”

The expansion into electric vehicles is part of what the company defines as “the new Hertz,” which focuses on electrification, shared mobility and a digital-first experience, the company said. 

Hertz’s new owners seek to overhaul the century-old company, implementing new software to improve inventory management and better forecast customer demand.

Hertz warned that efforts to electrify its fleet could be hampered by factors outside its control, such as the shortage of semiconductor chips and other constraints.

The company said it has partnered with Super Bowl champion Tom Brady for a marketing campaign for the electric-vehicle rentals.

Bloomberg News reported on Hertz’s order earlier Monday.

Within the past year, Hertz’s business has bounced back as travel restrictions were lifted and more Americans got Covid-19 vaccines. 

At the same time, Hertz and other rental-car companies have struggled to keep up with the surge in bookings, lacking vehicles to provide customers as the broader car business confronts a shortage of new vehicles. 

The shortfall has pushed up rental-car prices and left renters with fewer options.

Tesla is building a network of charging stations for its vehicles to augment those that some owners are having installed at their homes to get power into their vehicles. 

Tesla users, at times, have complained about long wait periods at charging facilities.

“While we certainly have work to do in expanding capacity in some congested areas, average congestion on the network has decreased over the past 18 months,” Tesla’s head of engineering, Andrew Baglino, said on an earnings call this month. 

The Tesla charging network, he said, has doubled over the past 18 months and the company plans for it to triple over the next two years.

Tesla says on its website that it has more than 25,000 charging stations world-wide, principally in North America and Europe.

Tesla Chief Financial Officer Zachary Kirkhorn said on the earnings call that the first customer deliveries from the two new factories—one near Austin, Texas, and another in Germany—aren’t necessarily expected this year and that the pace at which production scales up is still somewhat uncertain.

While the Hertz deal should allow more people to drive Teslas, it comes as scrutiny of Tesla’s advanced driver-assistance features has intensified. 

On Monday, the head of the National Transportation Safety Board doubled down on earlier criticism, chastising Tesla for not addressing what the agency views as safety deficiencies in the company’s driver-assistance technology.

“[O]ur crash investigations involving your company’s vehicles have clearly shown that the potential for misuse requires a system design change to ensure safety,” NTSB Chair Jennifer Homendy said in a letter to Tesla Chief Executive Elon Musk.

The NTSB investigates crashes and makes safety recommendations but doesn’t have regulatory authority. 

The agency has urged Tesla to take additional steps to limit how drivers are able to use the company’s advanced driver-assistance technology, which doesn’t make vehicles autonomous.

Tesla didn’t immediately respond to a request for comment about the letter.

—Rebecca Elliott contributed to this article.

 When Tools Stop Working

By John Mauldin 

Because I believe in the division of labor, I rarely use hand tools today. 

In the ‘80s and ‘90s, I had two 4 x 8 pegboards on my garage wall full of tools along with my large Craftsman toolbox. 

I had the right tool for every job around the car, house, and yard. 

I worked on the plumbing, electricity, built rooms, and flooring. 

My current friends might not believe it, but I was quite handy back then. 

It was almost a bit of a fetish.

Now, I know others can wield them more efficiently and I’m pleased to let them do so. 

My tools of choice today are my computers, iPad, and phone. 

I am much more productive with my current tools than trying to fix a light switch.

The right tool in the right hands can do miracles. 

However, it gets more complicated when you want to work on the markets and the economy. 

Hammers work because nails don’t unpredictably reshape themselves. 

The economy does. 

Fiscal and monetary authorities must rely on tools that don’t work consistently and may not work at all. 

As we’ll discuss today, this is a big part of our current dilemma.

We’d all like to think it has an easy explanation and a quick solution. 

Readers tell me all the time: “John, the problem is really ______.” 

Unfortunately, it’s not one problem. 

We face a swirling mess of different problems, interacting in ways we don’t fully understand. 

We do have some clues, though. 

It now looks more and more like August/September marked some kind of turning point. 

Economic data has weakened considerably since then.

You know what I think of economic models, but they have a kind of objectivity. 

The numbers do what they do. 

It’s probably important that the Atlanta Fed’s third-quarter GDPNow estimate crumbled from 6.1% as of August 23 to 0.5% on October 18. 

That’s a whale of a change in less than two months.

Source: Atlanta Fed

Note the chart also shows a consensus of private forecasts dropping at the same time, though not quite as dramatically. 

Clearly something changed in the last 60–90 days. 

Here are some possible factors, in no particular order.

  • Increasing supply chain snarls
  • Jumping energy prices
  • COVID-19 Delta variant case surge
  • Evergrande and China housing crackdown
  • A hasty US Afghanistan withdrawal
  • End of enhanced US unemployment benefits
  • Difficulties for pending infrastructure bills
  • Oh, yes, the return of 5%-plus inflation which deducts from Nominal GDP to get Real GDP.

We can’t pin it on any one of these. 

They all had some influence, along with others not listed, adding up to the lower growth estimates. 

And let’s note, “lower growth” isn’t the end of the world. 

If Q3 real GDP growth is 0.5%, it won’t be what we hoped but it won’t be recession, either.

The economy is performing well in many ways. 

Plenty of jobs are available, new businesses are being launched, companies are profitable (third-quarter earnings season has started off with a bang!) and stock prices are strong. We could do much worse. 

But we could also do better, and the missed opportunities are frustrating.

Today’s letter will be the first of at least two parts. 

Next week I’ll describe where I think this is heading, and how we still have a chance to save the recovery if certain people/institutions make the right choices. 

But first, I want to establish three important points. 

They are foundational to my outlook. Here they are, summarized in one sentence.

We are facing demand-driven inflation as a consequence of misguided monetary policy and misdirected fiscal stimulus.

That may sound simple and obvious, but this one short sentence has a lot to unpack. 

We’ll start below.

Demand Is Booming

Last week I wrote about the growing Logistical Sandpiles problem. 

It shows no sign of improvement. 

That’s not good, but I think this situation is also a clue to our deeper problems. 

The ports and railroads are clogged because the economy is demanding more goods, and this demand is driving inflation pressure.

My friend Jim Bianco explained what is happening in a magnificent Twitter thread you should read. 

I’ll excerpt his key points and charts below.

“The Los Angeles and Long Beach ports collectively unload just under one million containers a month. For the last year, they have been running at/near a record pace.

In other words, they are running as fast as they can. The problem is they are at their limit.”

Source: Jim Bianco

“There are also problems getting these containers off the dock.

Unfortunately, there is a trucking shortage, which has led to soaring trucking rates (chart below). 

Demanding more trucks at 3 am to get these unloaded containers off the dock is going to be a taller order.”

Source: Jim Bianco

“This is leading to a backlog of ships anchored off LA. 

And since these containers are taking longer to unload, shippers now have to factor in this dead time anchored off shore. 

This is a disincentive to ship, so the number of empty containers are piling up in the ports.”

Source: Jim Bianco

Source: Jim Bianco

“This is leading to a recent fall in container rates. 

No one is in a hurry to ship these containers back to China for reuse if they are going to just sit anchored off LA for many days. 

Then one has to struggle to find a truck to haul it away.”

After illustrating the problem, Jim explained the cause.

“Simply, demand is booming. 

Below is personal consumption since ‘09, its trendline, and residuals (actual-trend). 

Consumption is off the charts at $662B > trend.

Again, we want a record amount of stuff and the supply chain cannot handle it.”

Source: Jim Bianco

Interestingly, Paul Krugman highlighted some of the same problems but he notes a different distinction: Consumers have shifted their buying from services (experiences) to materials and specifically durable goods.

Source: The New York Times

This makes sense as the government sent trillions of dollars of “hot money” directly to consumers and/or businesses. 

Restaurants, hotels, and airlines were generally off the market, vacations were crimped, so people bought “stuff.” 

Thus, those ships off the shores of California contain extra goods that both manufacturers and shippers hadn’t planned for.

Jim thinks prospects for near-term relief are nil, and it will generate more inflation.

“Many assume increasing the throughput of the supply chain to meet overstimulated demand over the short term is doable.

But if the problem is the supply chain is at capacity now, expanding will be hard/impossible over the next several months. (JM: And if you are a business, do you increase your capacity for what will likely be a short-term demand increase?)

So to bring everything into balance, prices will rise until enough demand is destroyed to bring everything into line with the limits of the supply chain.

We might be seeing this happening as Q3 growth expectations are crumbling as prices are soaring.”

Source: Jim Bianco

Source: Jim Bianco

John here again. 

Let me add a couple of notes. 

First, as noted above, the consumption growth Jim describes is partly a consumption shift. Thanks to COVID, Americans have reduced spending on services (restaurants, concerts, hotels, airlines, etc.) and spent more on goods. It’s pretty clear in the inflation data.

Source: Tony Sagami

In barely more than a year we reversed a shift that unfolded over decades. 

Of course it’s not going smoothly!

Second, it would be nice to know more specifically what is in all these containers. 

I suspect a big part of it emanates from housing construction growth. 

Building materials are bulky and consume a lot of shipping capacity relative to their value. 

New homes, once occupied, also spark many other purchases: furniture, lawnmowers, garden hoses, etc.

If I’m right on that, then a break in the housing boom might have a swift effect on the supply chain problems. 

But right now there is no sign of such, in part because the policies driving it aren’t changing. 

Which brings us to my next big point.

Running It Hot

Traditionally, the Federal Reserve prevents the economy from overheating by taking away the punchbowl, as the old saying goes. 

That skill set seems to have atrophied from disuse. 

Understandably so, too. 

We have seen nothing you could reasonably call “overheating” since the 1990s. 

Surging first-half 2021 growth simply recovered the prior year’s decline, more or less, and now seems to be ending.

So the current generation of Fed leaders and staff has spent years looking for ways to fill the punchbowl. 

They have long talked of letting the economy “run hot,” tolerating higher inflation for some extended period that would balance out years of lower inflation.

If that’s your perspective, then the idea this post-COVID period would bring only “transitory” inflation was likely disappointing. 

Look at Jim Bianco’s chart above, and you’ll see it has been many years since core CPI stayed above 2.5% for very long, and it’s often been well below. 

These last few months, while sharply higher, are still nowhere near restoring long-term “normal” inflation.

In my view even 2% inflation is too much. 

Some officials at least claim to be concerned about current levels. 

But as an institution, the Fed doesn’t seem to think the party is out of hand. 

They are certainly doing nothing to stop it.

Yet the supply-chain inflation Bianco describes is partly a result of the Fed’s actions since early 2020. 

Their initial dramatic moves were appropriate. We were in an unprecedented situation that could have destabilized the banking system. 

That risk passed pretty quickly, leaving a garden-variety recession they could have addressed without the drama. 

Yet their crisis programs and policies are still in place today. 


I see two reasons.

First, they’re using new tools (like loan guarantees) because the old tools don’t work anymore. 

Debt loads, both public and private, are so gigantic that injecting more money no longer has the stimulative effect it once did. 

Lacy Hunt says declining velocity is key to this. 

They can create liquidity but they can’t force banks to lend, or businesses and consumers to borrow. 

Here’s Lacy in the most recent Hoisington quarterly.

“As velocity declines, each dollar of money produces less GDP. 

The drop in velocity to lower levels indicates that monetary policy becomes increasingly asymmetric in its capabilities. 

While tightening operations are effective, Fed actions to support the economy are largely counterproductive even when they are novel in scope and massive in size. 

Benefits can accrue but their impact on economic growth has proved to be extremely minimal.

The Fed is able to increase money supply growth but the ongoing decline in velocity means that the new liquidity is trapped in the financial markets rather than advancing the standard of living by moving into the real economy.”

In other words, the Fed can still take away the punchbowl but is unable to refill it. 

They don’t want to take it away because they have this fantasy it will eventually work. 

So they are keeping short-term rates at zero and buying $120 billion in bonds every month, along with assorted other programs. 

You can see what it’s done to their balance sheet.

Source: Reuters

That $120 billion monthly bond buy goes $80 billion to Treasury securities and $40 billion to mortgage-backed securities. 

This is a giant rate subsidy to the federal government’s borrowing as well as home buyers. 

No surprise, both have been adding leverage. 

And as noted, the latter group is probably aggravating the supply chain problem.

All this monetary stimulus had some effect, of course, but the latest growth forecasts suggest it is already dissipating. 

The Fed did so much, so fast, it produced a self-limiting recovery in which supply-chain inflation caps potential growth.

That’s not good, but we have another culprit.

Bipartisan Failure

In March 2020, with COVID-19 spreading in the US, no one really knew what to expect. 

Just as the Fed was right to aggressively protect the financial system, the federal government acted correctly to help the millions who lost jobs and income. 

But details matter, and time is showing the stimulus programs were poorly designed and often counterproductive.

Let’s start with the core problem: They got the goal wrong. 

The target shouldn’t have been to stimulate the entire economy, but to maintain the status quo for affected individuals. 

At the time we (wrongly) thought a few weeks of inactivity would suffice. 

The goal should have been to replace the lost income and only the lost income, for the people who actually lost it.

But as a practical matter, that was apparently too hard. 

So instead we pushed them into an unemployment insurance system unprepared for the task and added a flat $300 weekly supplement that was more than some people needed and not enough for others. 

Then we also sent checks to almost everyone (excluding the highest income groups) whether they needed them or not. 

Then we did it again in late 2020, and again in 2021.

Note, this was a bipartisan policy failure. 

The first two COVID relief bills, totaling over $3 trillion, passed a Democratic House and Republican Senate. President Trump signed both. 

President Biden and a Democratic House and Senate added $1.9 trillion more. Everyone’s fingerprints are on this.

But whoever you blame, this money had a giant effect on consumer spending. 

Not all of it was bad. If the government is going to kill people’s jobs, it can at least help them buy groceries. 

The problem is that large amounts went not to basic needs but to discretionary luxuries, some of which are on those ships the ports can’t unload fast enough.

Easy Money

I have been trying to explain for years the subtle difference between QE (Quantitative Easing) and outright money printing (MMT). 

Essentially, the Fed does not buy government debt directly from the government. 

They go into the open market and buy it from people/institutions that originally bought that paper at Treasury’s auctions.

Typically, the money the Fed uses to buy that debt goes back on the Fed’s balance sheet as excess bank reserves. 

You can zoom in on the chart below and see what looks like a flat line up until about 2009 is actually composed of very tiny bumps. 

A small amount of “excess reserves” was normal. 

Then they started QE in 2009 and the amounts exploded. 

They began slowly tapering down in 2018 until the amounts jumped again from the COVID QE.

Again, in theory, banks could lend this money. 

That is not happening. 

It is ending up in margin accounts and other products, directly or indirectly boosting the stock market. 

That easy money policy coupled with extremely low interest rates is boosting home prices, exacerbating wealth and income disparity.

Source: FRED

Low interest rates are of limited help to first-time homebuyers when the average price goes from $380,000 to $420,000 in a little over a year. 

This is what happens when government, in this case the Federal Reserve, meddles in the market, albeit with good intentions. 

Now, if you already own a house that’s rising in value, you are not upset. 

But if you are trying to buy one the Fed is making it harder on you. 

It’s a corollary to financial repression.

An intended consequence? 

As many as 25% of homes are now being bought by yield-seeking funds that will rent them. 

When bonds no longer even keep up with inflation, investors look for other ways to get yield. 

And residential real estate offers not just yield but depreciation. 

That would not be possible or even necessary if Treasuries were 2½%.

Source: FRED

So where is the inflation coming from if it is not directly from QE? 

It is coming from the $6 trillion in high-powered Fed money plus fiscal stimulus spending. 

That money did not end up on the Federal Reserve balance sheet; it went directly into consumers and some businesses. 

The stimulus programs are the real helicopter money that Ben Bernanke mentioned almost 20 years ago.

For the record, I agree with Lacy Hunt. 

We will eventually go back to a slow-growth, disinflationary environment. 

I think real GDP will likely average 1% for the rest of this decade because of the debt burden. 

But in the meantime, until the stimulus and supply chain issues work out, until we figure out how to entice potential employees back to work, we’re going to have to deal with uncomfortably high inflation.

This from Grant Williams’ recent Things That Make You Go Hmmm:

Not only that, but recent comments by Fed officials suggest the Fed is trying to gently convince their adoring public that inflation may actually turn out to be “a little stronger than they forecast for a little longer than they forecast.” 


As you can tell, this is a vast problem with many moving parts. 

It has other elements I haven’t mentioned today, too. 

Like, for instance, low interest rates and quantitative easing can’t solve supply chain issues, microchip shortages, or changes in the labor market.

Together, the federal government and the Federal Reserve have put us all in a jam with no good alternatives. 

Yet we do have options. 

They aren’t great but would let us avoid the worst. 

I’ll describe them for you next week.

New York and Dallas

I had planned to be in New York next week, but circumstances changed. 

I will be in NYC beginning November 7 for a packed week of meetings and for my friend David Bahnsen’s launch party of his new book There Is No Free Lunch. It is going to be a powerful book. 

Then on to Dallas/Granbury for Thanksgiving.

I mentioned Jim Bianco’s powerful Twitter thread, which I quoted and made sure all those who follow me had a chance to read. 

Frankly, you should follow me on Twitter as much for the links I provide as well as my own commentary.

Halloween in my neighborhood, which has lots of kids, is interesting. 

This is a golf community so the parents and kids go from house to house by golf carts, often fabulously decorated. It is really quite fun. 

I think Halloween is Shane’s favorite holiday, and she really enjoys all the kids. 

She even gets me into the spirit, so to speak.

I have been busy with all sorts of things, and got undermined as my internet went down for a few days. 

We now have backup hotspots and it looks like I might even be able to get more reliable fiber-optic soon.

It’s time to hit the send button so let me wish you a great week and the start of a wonderful holiday season.

Your convinced the Fed has made a monetary policy mistake analyst,


John Mauldin
Co-Founder, Mauldin Economics