Controlling the Curve

By John Mauldin

If time is money, then interest rates are the price of time. The most important interest rates in the world are for US Treasury securities. This is why I’ve long said it makes no sense for a committee to set those rates. 

The markets could do just fine without that help, thank you. 

But the Federal Reserve’s Open Market Committee arbitrarily decides the overnight Federal Funds rate. And lately, it doesn’t stop there.

Like the proverbial frog in a boiling pot, we are slowly being conditioned to accept this as normal. 

The warm water feels good at first. 

We think we can hop out in time. It’s not clear we can. And it’s not just the Fed. 

Central banks all over the world are turning the heat up on the various currency pots.

Today I want to discuss an arcane-sounding but incredibly important term you need to know: Yield Curve Control. 

Several central banks are already using it and I see a strong possibility the Fed will join them. 

But first we must again consider the Gripping Hand.

Brief Update on the COVID-19 Gripping Hand

Currently, we see good news. Cases, hospitalizations, and deaths are falling across the developed world, with a few exceptions. 

This is partially because a large number of people have already had the virus (usually mild cases), we are vaccinating the most vulnerable people at a better rate, and we are continuing to social distance and use masks.

I am sure that everybody wants this trend to continue. However, it is too early to give the all-clear signal, as the UK variant (B117) has spread throughout the United States and much of the developed world. It is a race between vaccine-induced herd immunity and the growing rate of B117 infections. 

The South African and Brazilian variants are in the US, but in smaller numbers (so far).

The bad news is that Israel and some other countries that have been extraordinarily successful in vaccinating their people are still seeing significant outbreaks. 

From what I’ve read, we should know in the next few weeks if we will face another round of outbreaks. So the best advice is get your vaccine, continue to social distance and stay safe, and hope for the best.

Now on to yield curve control.

Blunt Instruments

The Federal Reserve System has two mandates from Congress: maximum employment and price stability. It has rarely achieved both at once and certainly isn’t doing so now.

(Quick note on jobs: Interest rates are not the appropriate tool for promoting employment. Fiscal policy is. Today’s jobs report was ugly. Most of the very mild growth came in public education, with just 6,000 jobs in the private sector. Another 406,000 people dropped out of the labor force, keeping the unemployment rate artificially low. The broader U-6 rate is over 11%, which is more real-world. Low interest rates aren’t helping businesses hire employees. The Fed really can’t help boost employment. Preaching over.)

However, these twin goals are vague enough to let the Fed’s board and staff think they’re succeeding at times. This is the source of many problems. Thinking you are in control of something when you are actually not can be quite dangerous.

For such a powerful institution, the Fed is still surprisingly limited. It can’t force banks to lend, nor can it force people or businesses to borrow. It can highly encourage these things, though, and has many ways to do so. Most of them involve short-term liquidity and interest rates—the so-called “short end” of the yield curve.

What is the yield curve, you may ask? It’s simply a chart of how interest rates rise or fall by the loan’s length, or maturity. A “normal” yield curve looks something like this:

Source: Investopedia

To put some numbers to this, here are the actual yields for the last four days (through Thursday) for the various Treasury maturities. Note that interest rates out to two years are only 11 basis points or less. The curve doesn’t “steepen,” if we can call it that, until after the five-year point.

Source: GuruFocus

This is the actual graph of the above data from Thursday from 

The 10-year yield is now at 1.18% as of Friday morning.

Source: GuruFocus

The key point to notice is that above the 10-year point, today’s yields exceed those of February 2020, one year ago. That means the Fed may be losing control of the longer end of the yield curve. Investors in long-term bonds are losing money because as yields rise the value of the bonds falls. Those who bought TLT, the 20+-year iShares Treasury ETF, are now down more than 5% for the year.

Going back to the basics, interest rates typically rise with maturity because longer terms mean more risk for the lender. The Fed has little control over those factors, but it can anchor the left (short-term) end of that curve wherever it wants. The rest of the curve will then respond, getting flatter, steeper, or assuming other shapes. It can even invert, and frequently does so just ahead of recessions.

Since the Fed’s tools work mostly on the short end of the yield curve, it has limited ability to influence long-term interest rates. Quantitative easing is one way around this limitation. In QE, the Fed uses excess bank reserves (and there are a lot of them) to buy long-term Treasury and agency securities. This applies downward pressure on those points of the yield curve. Stopping those purchases or liquidating its holdings pushes that part of the curve back up.

QE is useful but cumbersome. Moreover, market forces can reduce its effectiveness. The Fed is a big buyer but it’s not the only buyer A more direct method is outright “yield curve control” or YCC I am beginning to hear this term from people I consider very knowledgeable. They are generally not happy with the prospect. My suggestion is you get used to the possibility because it will affect the way your bond investing works... and not in a good way.

Under YCC, the Fed would announce it wants, say, the 10-year Treasury yield (or some other target) to be x% and then use its unlimited buying power to purchase as many bonds as necessary to achieve this. In theory, the knowledge the Fed will do this would prevent others from demanding higher yields, and the Fed wouldn’t actually have to do much. The threat alone would achieve the goal.

This isn’t a new idea. The Fed actually employed YCC during World War II. But it has consequences that aren’t always predictable and may not be good. We can get an idea by looking at other central banks who are already doing it.

Zero Bound

I noted above the Fed’s vague dual mandate. One example is the way Fed officials interpret “price stability” to mean “2% inflation target.” That’s not stability. Indeed, it is the opposite of stability. But in their twisted thinking, a little inflation helps.

(And now, they have twisted their thinking further to make 2% average inflation the target. So let’s say that inflation rates for a period of time were about 1.5%, which is more or less what we’ve had for the last few years, so they would be willing to tolerate a 3% inflation rate for a year so they can get a 2% average over whatever period of time they wish, without telling us what that period of time is. It goes without saying that if a 2% inflation rate is not price stability, then there is no way in hell you could consider 3% inflation “stable.”)

But generating inflation isn’t necessarily easy. Japan is the prime modern-day example. Inflation there plunged after its economic bubble collapsed in the early 1990s. The Bank of Japan responded by dropping interest rates toward zero, with little effect. Within a few years the country was in outright deflation. That made it all but impossible for the BOJ to push real interest rates any lower. Over the next decade or so they pulled out every tool in the toolbox and invented a few new ones. None of them helped much, except maybe in preventing an even worse collapse.

In 2016 the BOJ added YCC to its ongoing QE and other programs. Ten-year Japanese Government Bond yields were fixed in a narrow band around 0%. The BOJ said it would buy JGB securities in whatever amount necessary to maintain that band.

Source: New York Federal Reserve Bank

You can see the targeted JGB yield stayed at zero (± about 20 basis points) once the YCC policy took hold. It’s still there now, and the BOJ hasn’t had to enforce this policy because traders haven’t seriously challenged it. Could they? Maybe, but the BOJ is now buying practically every bond the Japanese government issues. 

And they issue a lot of them. What used to be one of the most liquid markets in the world is now moribund. If the Bank of Japan doesn’t show up to the bond market, there is no trading. There are days when the Japanese government bond markets literally have no trades. This is truly a world gone mad.

Nevertheless, the pandemic inspired other central banks to consider Japan’s methods. In March 2020, the Reserve Bank of Australia set a 0.25% “target” for 3-year Australian Government Bonds, later lowering it to 0.1%. This is another form of YCC. And now the European Central Bank is doing something similar, though with different mechanics.

The goal in all these cases isn’t so much to generate inflation, but to prevent or at least minimize deflation. Generating growth is hard when prices are falling because buyers are being rewarded to wait. Fear of the virus and government responses to it are profoundly deflationary.

“A Nasty Repricing Event”

YCC has another feature, though, one that makes it attractive to fiscal policymakers as well as central bankers. Government spending, and debt issuance to finance it, rise even in normal recessions. This one has put it on steroids in many countries. That’s a lot easier to manage if your central bank is pledging to buy all the bonds you issue at very attractive rates. Since many of the bonds are already at negative rates (which, if you are government, has to be considered attractive), there is very little if any financial constraint on government spending.

(Sidebar: Italy is on like it’s 29th different government over the last 40 years, and it looks like “Whatever It Takes” Super Mario Draghi will become the next prime minister. My bet is that he can talk his old friend Christine Lagarde into buying more Italian bonds at ridiculous prices. Europe is indeed the land of Yield Curve Control.)

This week the Congressional Budget Office updated its economic projections. Their scenarios are always a bit rosy but this one was even more so. They are basically saying the pandemic is over, at least economically. From their summary:

Over the course of the coming year, vaccination is expected to greatly reduce the number of new cases of COVID-19, the disease caused by the coronavirus. As a result, the extent of social distancing is expected to decline. In its new economic forecast, which covers the period from 2021 to 2031, the Congressional Budget Office therefore projects that the economic expansion that began in mid-2020 will continue. Specifically, real (inflation-adjusted) gross domestic product (GDP) is projected to return to its pre-pandemic level in mid-2021 and to surpass its potential (that is, its maximum sustainable) level in early 2025. In CBO’s projections, the unemployment rate gradually declines through 2026, and the number of people employed returns to its pre-pandemic level in 2024.

They are also predicting large deficits for 2021.

I sincerely hope this GDP projection is right. Nothing would thrill me more than for vaccinations to bring COVID-19 cases down from crisis to nuisance level by the end of this year. I think this is possible, but not probable. 

We have way too many unanswered questions about how well the vaccines work and what impact the variants will have. We’ll learn more over the coming weeks and months, but we just don’t know yet.

But set that aside for a minute. The US economy and the federal budget didn’t look great even before COVID-19 came along. 

Excess debt, which is mostly the result of monetary policy, has capped economic growth while demographics and entitlement spending have the budget on an unsustainable path.

Here again is the chart I occasionally share of CBO’s tax and spending projections. There is no good way out of this.

As I have noted with chagrin, even Republicans are no longer fiscally conservative. They wouldn’t have cut spending to any meaningful degree if they were now in control, and might have increased it. As it is, Democrats control the White House and (tenuously) Congress, and they would raise spending even without the pandemic. Now they will raise it even more

I think it is highly likely that President Biden gets at least $1 trillion or more for his COVID-19 relief package. Further, I think there may be some real bipartisan support for a $1 trillion infrastructure program, which we actually need. I would go further and create a new federal “infrastructure bank” that would issue GNMA-like bonds to finance revenue-generating infrastructure programs like electricity and water which can generate their own repayment plans. Then use the federal government infrastructure program for things that don’t have income tied to them like bridges and roads. It would double our bang for the buck and upgrade our woefully inferior infrastructure.

But I digress. In any scenario, Treasury issuance is going to grow considerably in the 2020s. We are already at a $2 trillion deficit without any pandemic relief or infrastructure spending. Who will buy that debt? Or, more to the point, how high will long-term yields need to go to draw out enough buyers? Anything above 2% or so would raise debt service costs to problematic levels. But that would likely happen if the virus fades and we get the kind of snap-back recovery CBO expects. (Count me dubious. I think the massive debt is going to be a drag on growth and this will be a slower recovery than the one in the 2010s.)

As rates rise and federal financing becomes more expensive, I see a significant probability the Fed will impose some kind of YCC policy on Treasury yields. They will essentially be monetizing the debt, though they’ll come up with ways to “sterilize” their purchases. And I fear, like the BOJ, a policy that starts out as temporary will become semi-permanent.

My friends Karen Harris and Austin Kimson at Bain’s Macro Trends Group pointed out some of the risks in a recent report.

While yield curve control has undeniable benefits (from the perspective of central banks), the strategy also carries several meaningful risks. Among these is the fact that it distorts market pricing for all risk assets. [Emphasis mine] Arguably, this is a feature and not a bug, but, like all exercises in price control, one cost of the policy could be the misallocation of resources. In the case of sovereign bonds, the mispricing problem could leak into all other risk assets. The price controls will eventually have to end (presumably), at which point the clash between reality and asset prices could produce a nasty repricing event. This is the stuff of which financial crises are made.

Yield curve controls also greatly increase the incentives for governments to borrow, with potentially inflationary consequences. It is often said that the bond market vigilantes are the only real check on government spending; yield curve controls effectively silence these market players. In extremis, the central bank could finance the central government in all but name, as has effectively happened in many developed economies (including the US and UK) over the last year. As we noted in a previous article, the unique circumstances of 2020 broke the traditional link between central bank-facilitated deficit spending and inflation, but that relationship will likely return to normal faster than politicians and the citizenry rediscover their interest in frugality.

And with Janet Yellen and Jerome Powell both in the mix now, I can’t imagine how this ends well. US Treasury yields are the benchmark for all kinds of other financial asset prices. If they aren’t floating freely, the entire global economy is basically one giant price control. 

The result, as Bain says, will be widespread resource misallocation and asset mispricing. 

And eventually a “repricing event” that will make the recent GameStop fiasco look like a child’s tea party.

White Papers, Where Do You Hide, and Finding Income

I’m still working on getting that vaccine, hopefully this next week. Meanwhile I visited the dentist, a very good one I know here in Puerto Rico, but it was still a visit to the dentist. I had a painful evening when the analgesic wore off.

Next week’s letter will have a link to a new white paper I am just finishing. It outlines with some rather definitive specificity my views on investment portfolio construction, the difference between absolute and relative return strategies, strategies you might want to consider and places to find income in a zero-yield world. Believe it or not, mid-single digits and higher are out there if you know where to look. Which of course, my team does. I am more convinced than ever that passive index investing is going to end in tears.

And with that (plus a suggestion you follow me on Twitter), I will hit the send button and wish you a good week! Stay safe and in touch with your friends.

Your old dog learning new tricks analyst,

John Mauldin
Co-Founder, Mauldin Economics

Investor anxiety mounts over prospect of stock market ‘bubble’

Veteran managers warn over exuberance as stock valuations and other signals flash red

Katie Martin in London

Analysts worry that speculators using apps like Robin Hood are contributing to a market in which companies like Tesla have soaring valuations and bitcoin is racing to new highs © FT montage; Bloomberg

Screaming stock rallies and wild speculation by have-a-go amateur investors are stirring concerns among market veterans over a bubble to rival anything seen in the past century.

After a dramatic rebound from the coronavirus crash last March, benchmark equity indices have toppled a series of record highs in the early days of 2021. 

Bitcoin, the most speculative bet of them all, has raced to new extremes. Popular stocks like Tesla continue to defy efforts at sober valuation. 

Baupost Group founder Seth Klarman has warned that investors are under the misplaced impression that risk in markets “has simply vanished”, likening them to frogs being slowly brought to the boil. 

GMO co-founder Jeremy Grantham has described the rally since 2009 as an “epic bubble” characterised by “extreme overvaluation".

Fund managers are on alert for a pullback. “Timing the end of this frothiness is hard. It can go on longer than you think. I don’t see a huge move lower . . . But we have become more cautious,” said David Older, head of equities at Carmignac.

But with markets floating on an unprecedented wave of monetary and fiscal support, bond yields nailed near historic lows and investors — both institutional and retail — sitting on piles of excess cash, outlandish patterns in stock markets could persist for some time.

In a note in mid-January, analysts at Absolute Strategy Research produced a checklist of bubble indicators, setting the current rally in US “growth” stocks in the same context as the boom and bust in Japanese equities in the 1980s, the more abrupt rise and fall of dotcom stocks in the late 1990s and the long round trip in commodities stocks in the opening decade of the 2000s.

Common features include low interest rates, stock valuations that tower over earnings, runaway retail trading, and rapid accelerations in equity gains. On all these points, current market conditions look alarming. 

ASR points out that more than 10 per cent of stocks in the US blue-chip S&P 500 benchmark are 40 per cent or more above their averages of the past 200 days — a phenomenon seen only four times in the past 35 years.

“Clients are increasingly worried,” said Ian Hartnett, co-founder of ASR. But, he added, rallies could just be getting started, if interest rates remain low, and fund managers feel pressure to hop on the bandwagon. 

“There is career risk in the fear of missing out,” he said. 

“People find a way to rationalise every bubble. They have to explain to a chief investment officer, or to an investment committee, why they have gone long here.”

Some point to the explosion in trading by inexperienced amateurs as a particular concern. These investors, seen as flighty “weak hands” by professional fund managers, intolerant of losses and quick to exit bets, have been on the ascendancy as lockdown boredom encouraged them to the commission-free trading offered by start-ups like Robinhood.

In the US, Americans were turning to stocks as “the casinos are closed [and] a lot of sports are shut down,” said Mr Older at Carmignac. 

Much of their investment is, he noted, focused on “hyper growth” stocks such as electric vehicle makers. “There is no valuation ceiling for these companies,” he said.

But even given all these warning signs, investors are not staging any rush to the exits. 

In part, that is because the surge in retail trading may be less troubling than it looks. 

Unlike previous high-profile episodes of retail trading exuberance, analysts and fund managers suspect that the current bout may be more robust and less likely to saddle households with huge losses.

“It’s important to remember how retail investors are financing these purchases,” said Salman Baig, multi-asset investment manager at Unigestion in Geneva, drawing a contrast to events such as China’s 2015 bubble, where a rise in margin finance sent stocks soaring before a brutal crash.

“Now, household savings are high,” he added. “People have built up cash balances . . . It does not feel to us like a bubble. Rather, there are some expensive stocks where there could be a meaningful correction.”

Optimists also stress that professional investors are not demonstrating the same gung-ho attitude to risk-taking: instead, they continue to take precautions against the risk of a market setback. 

The Vix volatility index, a reflection of hedging against sharp moves in US stock markets, stands at more than 23 points, compared with a long-run average just below 20. At the start of last year, it was at 14 points.

“The fact that people are still nervous enough about future volatility suggests people are not all in,” said Andrew Sheets, chief cross-asset strategist at Morgan Stanley.

Echoes with previous precursors to market shake-outs are strong. 

But barring a near-unimaginable withdrawal of support from central banks, or a burst of inflation that seriously jolts the bond markets, many investors agree it is hard to imagine what could trigger a large reversal in risky assets.

“I don’t think the bubble bugles are acknowledging why stocks are so expensive,” said Michael Kelly, head of multi-asset investment at PineBridge Investments. “In 2021, markets are going up because earnings are going up and excess liquidity is still surging. 

We are in a structural growth in capital because of the rising savings rate and, on top of that, quantitative easing. 

We’ve never ever had that before.” 

It will take at least a decade for this to unwind, he believes.

Suck It, Wall Street

In a blowout comedy for the ages, finance pirates take it up the clacker

Matt Taibbi

In the fall of 2008, America’s wealthiest companies were in a pickle. 

Short-selling hedge funds, smelling blood as the global economy cratered, loaded up with bets against finance stocks, pouring downward pressure on teetering, hyper-leveraged firms like Morgan Stanley and Citigroup. 

The free-market purists at the banks begged the government to stop the music, and when the S.E.C. complied with a ban on financial short sales, conventional wisdom let out a cheer. 

"This will absolutely make a difference," economist Peter Cardillo told CNN. "Now, if there is any good news, shorts will have to cover.”

At the time, poor beleaguered banks were victims, while hedge funds betting them down as the economy circled the drain were seen as antisocial monsters. 

“They are like looters after a hurricane,” seethed Andrew Cuomo, then-Attorney General of New York State, who “promised to intensify investigations into short selling abuses.” 

Senator John McCain, in the home stretch of his eventual landslide loss to Barack Obama, added that S.E.C. chairman Christopher Cox had “betrayed the public’s trust” by allowing “speculators and hedge funds” to “turn our markets into a casino.” 

Fast forward thirteen years. 

The day-trading followers of a two-million-subscriber Reddit forum called “wallstreetbets” somewhat randomly decide to keep short-sellers from laying waste to a brick-and-mortar retail video game company called GameStop, betting it up in defiance of the Street. 

Worth just $6 four months ago, the stock went from $18.36 on the afternoon of the Capitol riot, to $43.03 on the 21st two weeks later, to $147.98 this past Tuesday the 26th, to an incredible $347.51 at the close of the next day, January 27th. 

The rally sent crushing losses at short-selling hedge funds like Melvin Capital, which was forced to close out its position at a cost of nearly $3 billion. 

Just like 2008, down-bettors got smashed, only this time, there were no quotes from economists celebrating the “good news” that shorts had to cover. 

Instead, polite society was united in its horror at the spectacle of amateur gamblers doing to hotshot finance professionals what those market pros routinely do to everyone else. 

If you’ve ever seen Animal House, you understand the sentiment.

The press conveyed panic and moral disgust. 

“I didn’t realize it was this cultlike,” said short-seller Andrew Left of Citron Research, without irony denouncing the campaign against firms like his as “just a get rich quick scheme.” 

Massachusetts Secretary of State Bill Galvin said the Redditor campaign had “no basis in reality,” while Dr. Michael Burry, the hedge funder whose bets against subprime mortgages were lionized in “The Big Short,” called the amateur squeeze “unnatural, insane, and dangerous.”

The episode prompted calls to regulate Reddit and, finally, halt action on the disputed stocks. As I write this, word has come out that platforms like Robinhood and TD Ameritrade are curbing trading in GameStop and several other companies, including Nokia and AMC Entertainment holdings.

Meaning: just like 2008, trading was shut down to save the hides of erstwhile high priests of “creative destruction.” 

Also just like 2008, there are calls for the government to investigate the people deemed responsible for unapproved market losses. 

The acting head of the SEC said the agency was “monitoring” the situation, while the former head of its office of Internet enforcement, John Stark, said, “I can’t imagine there isn’t an open investigation and probably a formal order to find out who’s on these message boards.” Georgetown finance professor James Angel lamented, “it’s going to be hard for the SEC to find blatant manipulation,” but they “owe it to look.” The Washington Post elaborated:

To establish manipulation that runs afoul of securities laws, Angel said regulators would need to prove traders engaged in “an intentional act to push a price away from its fundamental value to seek a profit.” In market parlance, this is typically known as a pump-and-dump scheme…

Even Nancy Pelosi, when asked about “manipulation” and “what’s going on on Wall Street right now,” said “we’ll all be reviewing it,” as if it were the business of congress to worry about a bunch of day traders cashing in for once. 

The only thing “dangerous” about a gang of Reddit investors blowing up hedge funds is that some of us reading about it might die of laughter. That bit about investigating this as a “pump and dump scheme” to push prices away from their “fundamental value” is particularly hilarious. 

What does the Washington Post think the entire stock market is, in the bailout age?

America’s banks just had maybe their best year ever, raking in $125 billion in underwriting fees at a time when the rest of the country is dealing with record unemployment, thanks entirely to massive Federal Reserve intervention that turned a crash into a boom. 

Who thinks the “fundamental value” of most stocks would be this high, absent the Fed’s Atlas-like support in the last year?

For context, Goldman, Sachs posted revenues of $44.56 billion in 2020, its best year since 2009, a.k.a. the last year Wall Street cashed in on a bailout. 

Back then, the shortcut back to giganto-bonuses was underwriting fees for financial companies raising money to purge themselves of TARP debt. 

This time it’s underwriting fees for bond issues and IPOs. 

The subtext of both bailouts was that anyone who owned or underwrote financial assets got richer, while everyone else got the proverbial high hat. 

It’s no accident that income inequality dramatically accelerated after the last bailouts, and that the only people to see net gains in wealth since 2008 have been the richest 20% of Americans, a pattern almost certain to continue. 

The constant in the bailout years has been a battery of artificial stimulants sent through the financial sector, from the TARP to years of zero-interest-rate policies (ZIRP) to outright interventions like the multiple trillion-dollar rounds of Quantitative Easing. 

All that froth allowed finance companies to suck out hundreds of billions in fees, encouraged lunatic risk-taking in every direction and rampages of private equity takeovers, and kept a vast stable of functionally dead companies alive on cheap credit.

Those so-called “zombie companies” make up roughly 30% of all corporations in America now, and they racked up over a trillion dollars in new debt since the pandemic alone. 

While policymakers may have stabilized the economy with the bailouts, they may also “inadvertently be directing the flow of capital to unproductive firms,” as Bloomberg euphemistically put it back in November.

In other words, it was all well and good for investment banks and executives of phoney-baloney companies to gorge themselves on funhouse profits on a funhouse economy, but when amateurs decided to funnel just a bit of this clown show into their own pockets, finance pros wailed like the grave of Adam Smith had been danced upon. 

The worst was Morgan Stanley CEO James Gorman, who issued a somber warning that those behind the recent market frenzy are “in for a very rude awakening,” adding, “I don’t know if it is going to happen tomorrow, next week or in a month, but it will happen.”

This is the same James Gorman whose company just saw its 2020 fourth-quarter profits go up 51% versus the year before, with total revenues up 16% to $48.2 billion, matching almost exactly the 16% rise in the stock market last year. 

If you’re going to rake in $33 million as Gorman did last year captaining a firm that just siphoned off billions in essentially risk-free profits underwriting a never-ending bailout, should you really be worrying about someone else getting a “rude awakening”? 

There are 19 million people collecting unemployment who might be reading those profit numbers. Does this man know how to spell “pitchfork”?

GameStop has prompted more pearl-clutching than any news story in recent memory. 

Expert after gave-faced expert has marched on TV to tell Reddit traders that markets are complicated, this isn’t a game, and they wouldn’t be doing this, if they really understood how things work.

“I’m not sure everybody fully understands what’s happening here,” was the melancholy comment on CNBC of Wall Street’s famed fluffer-in-chief, Andrew Ross Sorkin. 

The author of Too Big to Fail added in pedagogic tones that while this “stick it to the man moment” might feel good, betting up the value of GameStop above Delta Airlines just isn’t right, because “there are no fundamentals here”:


How much does Sorkin think his exalted Delta Airlines would be worth now, if the Fed hadn’t stopped its death plunge last March? 

How much would any of the airlines be worth in the Covid age, with their fleets of mothballed jets? 

What a joke!

Furthermore, everybody “understands” what happened with GameStop. 

Unlike some other Wall Street stories, this one isn’t complicated. 

The entire tale, in a nutshell, goes like this. One group of gamblers announced, “Fuck you!” 

Another group announced back: “No, fuck YOU!”

That’s it. 

Or, as one market analyst put it to me this morning, 

“A bunch of guys made a bet, got killed, then doubled and tripled down and got killed even more.”

Regarding improprieties, leaving aside that the Redditors were doing exactly what billion-dollar hedge funds do every day — colluding to move a stock for fun and profit — the notion that this should be the subject of a federal investigation is preposterous.

Is it completely outside the realm of possibility that the GME fiasco isn’t just day traders giving the finger to Wall Street, that “major players” are behind the stock’s movement, in an illegal manipulation scheme? 

No. Probably it’s not that, but it could be, just as some of the usual suspects may have piled on the long side once the frenzy started. 

But if there’s anything to investigate here, the obvious place to start is with the hedge funds and their brokers. 

While it isn’t a complicated story, some of the awesome humor of GameStop is in the mechanics.

Unlike betting on a stock to go up (i.e. betting “long”), where you can only lose as much as you invest, the losses in shorting can be infinite. 

This adds a potential extra layer of Schadenfreude to the plight of the happy hedge fund pirate who might have borrowed gazillions of GameStop shares at five or ten hoping to tank the firm, only to go in pucker mode as Internet hordes drive the cost of the trade to ten, twenty, fifty times their original investment.

Short-sellers bet by borrowing shares from so-called prime brokers (Goldman, Sachs and JP Morgan Chase are among the biggest), selling them, and waiting for the price to drop, at which point they buy them back on the open market at the lower price and return them. 

The commonly understood rub is that prime brokers don’t always really procure those original borrowed shares, and often give out more “locates” than they should, putting more shares in circulation than actually exist (as in this case). 

GameStop is exposing this systematic plundering of firms using phantom shares and locates, by groups of actors who now have the gall to complain that they’re the victims of a “get rich quick” scheme. 

Short-sellers are not inherently antisocial. 

They can be beneficial to society, instrumental in rooting out corruption and waste in whole sectors like the subprime industry, or in single companies like Enron. 

Moreover, the wiping out of such funds isn’t necessarily to be cheered. Sorkin correctly notes that many hedge funds invest on behalf of entities like pension funds, though maybe they shouldn’t, given their high cost and relatively mediocre performance, as I’ve noted before.

However, that’s the point. The degree to which even the beneficial functions of short-sellers are cheered or not is dependent upon whose corruption they’re uncovering. 

Let the record show that when the S.E.C. imposed a ban on shorts of financial stocks in 2008, they routed short-sellers who were dead right about the insolubility of America’s banking sector. 

The state prevented their correct judgment about companies like Wachovia and Washington Mutual, whose stocks kept plunging even after the ban and went bust soon after. 

The shorts were right about all the other banks, too. 

The Inspector General of the TARP, Neil Barofsky, eventually told the Financial Crisis Inquiry Commission that 12 of the 13 biggest banks were on the brink of failure when they got saved — by the short ban, by emergency overnight grants of commercial bank licenses to companies that weren’t commercial banks, by the bailouts, by the subsequent avalanche of underwriting fees, and most of all, by the lies about all of the above.

The home of James “rude awakening” Gorman, Morgan Stanley, got its bank holding company license (and the lifesaving Fed credit lines that came with it) late on a Sunday night in September, 2008, because the firm couldn’t have opened its doors without it the next Monday morning. 

They’d have been blown to bits, by “fundamentals.” 

Instead, they got rescued, given a forever pass to keep feeding at the neck of society while claiming, falsely, to be not-failures and not-welfare recipients, better somehow than the “dumb money” they think should be theirs alone to manage. 

The rank selectivity of this makes any moral argument against the GameStop revolt moot. 

There’s no legitimate cause here, just an assertion of exclusive rights to plunder, which will doubtless be exercised now in the form of bans, investigations, and increased barriers to market entry. 

Probably also, in the political spirit of our times, there will some form of speech crackdown on platforms like Reddit, to protect us from the mob.

About that: there are many making hay of a description found on a Subreddit, to the effect that wallstreetbets is “like 4Chan found a Bloomberg terminal.” 

A columnist at the Guardian, settling into the rhetorical line sure to find acceptance among the wine-and-MSNBC crowd, admitted to finding the rampaging-id dynamic on 4chan funny as a young person, but strange now to “witness a brief and regretful adolescent occupation re-emerge as a prominent cultural force.” 

The author wanted to admit to laughing at this “intentionally senseless” behavior, but ultimately decried the “transgressive attitudes” of the Redditors.

This is where society will ultimately come down, of course, uniting to denounce $GME as financial Trumpism, even though it actually comes closer to being an updated and superior version of Occupy Wall Street. 

It’s likely not any evil manipulation scheme, but ordinary people acting — out of self-interest, but also out of sheer enthusiasm for one of the best reasons to do just about anything, because you can — on a few simple, powerful observations. 

They’ve seen first that our markets are basically fake, set up to artificially accelerate the wealth divide, and not in their favor. 

Secondly they see that the stock market, like the ballot box, remains one of the only places where sheer numbers still matter more than capital or connections. 

And they’re piling on, and it’s delicious, not so much because they’re right, but because the people running for cover are so wrong, and still can’t admit it.

Buy the ticket, take the ride, nitwits. 

If you earned anything, it’s this. 

This is why it’s such a joke to see Wall Street mouthpieces like Squawk Box co-host. 

Unsound Banking: Why Most of the World's Banks Are Headed for Collapse

by Doug Casey


You’re likely thinking that a discussion of "sound banking" will be a bit boring. 

Well, banking should be boring. 

And we’re sure officials at central banks all over the world today—many of whom have trouble sleeping—wish it were.

This brief article will explain why the world’s banking system is unsound, and what differentiates a sound from an unsound bank. 

I suspect not one person in 1,000 actually understands the difference. 

As a result, the world’s economy is now based upon unsound banks dealing in unsound currencies. 

Both have degenerated considerably from their origins.

Modern banking emerged from the goldsmithing trade of the Middle Ages. 

Being a goldsmith required a working inventory of precious metal, and managing that inventory profitably required expertise in buying and selling metal and storing it securely. 

Those capacities segued easily into the business of lending and borrowing gold, which is to say the business of lending and borrowing money.

Most people today are only dimly aware that until the early 1930s, gold coins were used in everyday commerce by the general public. 

In addition, gold backed most national currencies at a fixed rate of convertibility. Banks were just another business—nothing special. 

They were distinguished from other enterprises only by the fact they stored, lent, and borrowed gold coins, not as a sideline but as a primary business. 

Bankers had become goldsmiths without the hammers.

Bank deposits, until quite recently, fell strictly into two classes, depending on the preference of the depositor and the terms offered by banks: time deposits, and demand deposits. 

Although the distinction between them has been lost in recent years, respecting the difference is a critical element of sound banking practice.

Time Deposits. With a time deposit—a savings account, in essence—a customer contracts to leave his money with the banker for a specified period. 

In return, he receives a specified fee (interest) for his risk, for his inconvenience, and as consideration for allowing the banker the use of the depositor’s money. 

The banker, secure in knowing he has a specific amount of gold for a specific amount of time, is able to lend it; he’ll do so at an interest rate high enough to cover expenses (including the interest promised to the depositor), fund a loan-loss reserve, and if all goes according to plan, make a profit.

A time deposit entails a commitment by both parties. 

The depositor is locked in until the due date. 

How could a sound banker promise to give a time depositor his money back on demand and without penalty when he’s planning to lend it out?

In the business of accepting time deposits, a banker is a dealer in credit, acting as an intermediary between lenders and borrowers. 

To avoid loss, bankers customarily preferred to lend on productive assets, whose earnings offered assurance that the borrower could cover the interest as it came due. 

And they were willing to lend only a fraction of the value of a pledged asset, to ensure a margin of safety for the principal. 

And only for a limited time—such as against the harvest of a crop or the sale of an inventory. 

And finally, only to people of known good character—the first line of defense against fraud. 

Long-term loans were the province of bond syndicators.

That’s time deposits. 

Demand deposits were a completely different matter.

Demand Deposits. 

Demand deposits were so called because, unlike time deposits, they were payable to the customer on demand. 

These are the basis of checking accounts. 

The banker doesn’t pay interest on the money, because he supposedly never has the use of it; to the contrary, he necessarily charged the depositor a fee for:

1. Assuming the responsibility of keeping the money safe, available for immediate withdrawal, and

2. Administering the transfer of the money if the depositor so chooses by either writing a check or passing along a warehouse receipt that represents the gold on deposit.

An honest banker should no more lend out demand deposit money than Allied Van and Storage should lend out the furniture you’ve paid it to store. 

The warehouse receipts for gold were called banknotes. 

When a government issued them, they were called currency. 

Gold bullion, gold coinage, banknotes, and currency together constituted the society’s supply of transaction media. 

But its amount was strictly limited by the amount of gold actually available to people.

Sound principles of banking are identical to sound principles of warehousing any kind of merchandise, whether it’s autos, potatoes, or books. 

Or money. 

There’s nothing mysterious about sound banking. 

But banking all over the world has been fundamentally unsound since government-sponsored central banks came to dominate the financial system.

Central banks are a linchpin of today’s world financial system. 

By purchasing government debt, banks can allow the state—for a while—to finance its activities without taxation. 

On the surface, this appears to be a "free lunch." 

But it’s actually quite pernicious and is the engine of currency debasement.

Central banks may seem like a permanent part of the cosmic landscape, but in fact they are a recent invention. 

The US Federal Reserve, for instance, didn’t exist before 1913.

Unsound Banking

Fraud can creep into any business. 

A banker, seeing other people’s gold sitting idle in his vault, might think, "What is the point of taking gold out of the ground from a mine, only to put it back into the ground in a vault?" 

People are writing checks against it and using his banknotes. 

But the gold itself seldom moves. 

A restless banker might conclude that, even though it might be a fraud on depositors (depending on exactly what the bank has promised them), he could easily create lots more banknotes and lend them out, and keep 100% of the interest for himself.

Left solely to their own devices, some bankers would try that. 

But most would be careful not to go too far, since the game would end abruptly if any doubt emerged about the bank’s ability to hand over gold on demand. 

The arrival of central banks eased that fear by introducing a lender of last resort. 

Because the central bank is always standing by with credit, bankers are free to make promises they know they might not be able to keep on their own.

How Banking Works Today

In the past, when a bank created too much currency out of nothing, people eventually would notice, and a "bank run" would materialize. 

But when a central bank authorizes all banks to do the same thing, that’s less likely—unless it becomes known that an individual bank has made some really foolish loans.

Central banks were originally justified—especially the creation of the Federal Reserve in the US—as a device for economic stability. 

The occasional chastisement of imprudent bankers and their foolish customers was an excuse to get government into the banking business. 

As has happened in so many cases, an occasional and local problem was "solved" by making it systemic and housing it in a national institution. 

It’s loosely analogous to the way the government handles the problem of forest fires: extinguishing them quickly provides an immediate and visible benefit. 

But the delayed and forgotten consequence of doing so is that it allows decades of deadwood to accumulate. 

Now when a fire starts, it can be a once-in-a-century conflagration.

Banking all over the world now operates on a "fractional reserve" system. 

In our earlier example, our sound banker kept a 100% reserve against demand deposits: he held one ounce of gold in his vault for every one-ounce banknote he issued. 

And he could only lend the proceeds of time deposits, not demand deposits. 

A "fractional reserve" system can’t work in a free market; it has to be legislated. 

And it can’t work where banknotes are redeemable in a commodity, such as gold; the banknotes have to be "legal tender" or strictly paper money that can be created by fiat.

The fractional reserve system is why banking is more profitable than normal businesses. 

In any industry, rich average returns attract competition, which reduces returns. 

A banker can lend out a dollar, which a businessman might use to buy a widget. 

When that seller of the widget re-deposits the dollar, a banker can lend it out at interest again. 

The good news for the banker is that his earnings are compounded several times over. 

The bad news is that, because of the pyramided leverage, a default can cascade. 

In each country, the central bank periodically changes the percentage reserve (theoretically, from 100% down to 0% of deposits) that banks must keep with it, according to how the bureaucrats in charge perceive the state of the economy

In any event, in the US (and actually most everywhere in the world), protection against runs on banks isn’t provided by sound practices, but by laws. 

In 1934, to restore confidence in commercial banks, the US government instituted the Federal Deposit Insurance Corporation (FDIC) deposit insurance in the amount of $2,500 per depositor per bank, eventually raising coverage to today’s $250,000. 

In Europe, €100,000 is the amount guaranteed by the state.

FDIC insurance covers about $9.3 trillion of deposits, but the institution has assets of only $25 billion. 

That's less than one cent on the dollar.

I’ll be surprised if the FDIC doesn’t go bust and need to be recapitalized by the government. 

That money—many billions—will likely be created out of thin air by selling Treasury debt to the Fed.

The fractional reserve banking system, with all of its unfortunate attributes, is critical to the world’s financial system as it is currently structured. 

You can plan your life around the fact the world’s governments and central banks will do everything they can to maintain confidence in the financial system. 

To do so, they must prevent a deflation at all costs. 

And to do that, they will continue printing up more dollars, pounds, euros, yen, and what-have-you.

Editor’s Note: As spending skyrockets, governments around the world continue to finance it by money printing and debasing their currencies.

That’s why precious metals like gold and silver are going to play a much bigger role in the future of finance.

As central banks destroy paper currencies, it could cause a panic into gold and kick off an enormous bull market.

Biden’s Grand Opening

With an economic rescue plan that is both ambitious and well targeted, US President Joe Biden and his team have demonstrated a clear understanding of the scale and range of action that the current situation requires. A broader reconstruction plan can and must come later; but crisis management remains the order of the day.

James K. Galbraith

AUSTIN – In the space of less than three months, events have conspired to transform the American political scene. 

First, the COVID-19 pandemic defeated Donald Trump – not because public sentiment in this deeply polarized country changed, but rather because the virus forced open the gates of ballot access. 

Owing to a vast upsurge of early voting and mail-in ballots, the 2020 election’s turnout surpassed that of 2016 by 20 million votes, and featured a greater share of the electorate than any US presidential election since 1900.

With an economic rescue plan that is both ambitious and well targeted, US President Joe Biden and his team have demonstrated a clear understanding of the scale and range of action that the current situation requires. A broader reconstruction plan can and must come later; but crisis management remains the order of the day.

Second, thanks to ten years of local organizing by voting-rights activists led by Stacey Abrams, Georgia replaced both of its Republican senators with Democrats in the January 5 runoff elections, thus handing narrow control of the US Senate to President Joe Biden’s Democratic Party.

Finally, Trump and some of his fellow Republicans incited a rabble to ransack the US Capitol. That catastrophic political miscalculation resulted in the death of five people (including a police officer), Trump’s second impeachment, and the lasting disgrace of the defeated president’s most aggressive would-be successors, Senators Josh Hawley of Missouri and Ted Cruz of Texas.

The moment was ripe for Biden to tell the country about his own economic plans. And when he spoke, it was with focus, precision, and a clear sense of the scale and range of action that the situation requires.

Biden has proposed a rescue plan that will advance a number of urgent objectives at once. 

His first priority is public health, a long-neglected issue that can be met in part by creating community vaccination centers and medical clinics, and by training and employing at least 100,000 new public-health workers in the basics of epidemic control. 

Essential elements of this plan will reach into low-income and minority communities, as well as into prisons and jails.

A second goal of the Biden plan is income support, which will take the form of extra cash for households below a certain threshold, extended and expanded unemployment insurance, emergency paid leave, grants to renters and small businesses, and tax credits for childcare costs.

Third, the Biden plan aims to stabilize federalism with some $350 billion in support for state and local governments whose tax bases have imploded. Such funding is urgently needed to keep teachers, firefighters, police, and other essential public servants on the job – as is the additional $20 billion that would go to keep public transit operating through the crisis.

Finally, the Biden plan has a fair-play element, proposing a long-overdue increase of the federal minimum wage to $15 per hour, which would raise wages for some 30% of all American workers.

Biden has correctly billed his plan an “American Rescue Plan,” rather than as a “recovery” or “stimulus” program. If successful, the package will stem the pandemic, stave off a variety of social calamities, and prevent the collapse of state and local government services. 

Economic reconstruction is important; but it is a separate objective that can be advanced in a second package. Biden has made sure to acknowledge this point: once the rescue plan has been implemented, the reconstruction can begin, with an emphasis on infrastructure, energy, and climate policy.

Among other things, this second phase can be used to put America’s advanced sectors back to work in the service of public purpose and social need.

This sequencing is crucial, because these sectors will not simply revive and return to their previous positions in the economy. 

Now that the pandemic has upended aerospace, commercial and retail construction, the energy sector, and much else, a wide array of skills and resources will need to be reallocated. A second-phase economic program can guide the way.

Most important, Biden’s plan made no mention of Wall Street shibboleths about budget deficits or the national debt. 

It does not propose merely temporary measures that will be reversed later, nor does it appeal to economic forecasts to cover a gap between the program’s outlays and results. 

Given the orthodox cast of Biden’s economic team, this is especially encouraging to see. Having committed to an ambitious agenda at the outset, it will be somewhat more difficult for his people to backslide later on.

Still, three things that are missing from the Biden package will need to be taken up in due course. 

First, neither the public-health programs nor the infrastructure, energy, and climate initiatives will provide enough jobs to offset the losses in America’s vast services sector. 

Following the inevitable decline of office and retail work and the disappearance of a wide range of in-person services that could not survive the pandemic, middle-class Americans have retreated into their suburban homes. 

It is already clear that, sooner or later, a guaranteed public or non-profit jobs program will need to be put on the table.

Second, in order to return to viability, many services and small businesses will need to move to new ownership and cost-sharing arrangements, which can best be achieved through cooperative structures with appropriate local oversight and financing. 

And similar arrangements will be needed to sustain the work of artists, actors, musicians, and writers. 

As in the New Deal, America’s creative people need (and deserve) support that the commercial economy will not be able to provide.

Lastly, once the immediate crisis has passed, emergency measures to defer rent, mortgages, health bills, and student loans will need to be submitted to a system that can write down, cancel, or settle unpayable debts in a fair and orderly fashion.

These later steps presuppose the earlier ones. But following a magnificent inauguration, we are already seeing the first rays of coherent, qualified, dedicated, and serious leadership. Biden is certainly capable of meeting the emergency at hand, and he has already seized the moment. 

The country now must demand that Congress approve his program immediately.

James K. Galbraith, a former Executive Director of the Joint Economic Committee, is Professor of Government and Chair in Government/Business Relations at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin. He is the author of Inequality: What Everyone Needs to Know and Welcome to the Poisoned Chalice: The Destruction of Greece and the Future of Europe.