Weekly Market Update by Retirement Lifestyle Advocates

          As we have often discussed here, the US Dollar and every other currency in the world are fiat currencies; they are currencies by decree and backed only by ‘the full faith and credit of the government that issues them”.

            When looking at any world fiat currency, the question is not IF the currency has been devalued, the question is HOW MUCH the currency has been devalued.  This is the inflation part of the economic cycle that precedes the deflation part of the economic cycle.

            As currencies are devalued, at least initially, asset prices are inflated.  When you think about this, it makes perfect sense.  If currency devaluation causes the price of groceries to move higher, doesn’t it follow that any other asset priced in US Dollars would also nominally appreciate in value?

            While boom and bust cycles have always existed in stock and real estate markets because of the human emotions of fear and greed, these cycles have been greatly exaggerated under the fiat currency system. 

            Since fiat currencies are loaned into existence in the fractionalized banking system, the more borrowing that takes place, the more currency that is created.  When interest rates are held to an artificially low level for a period of time, more currency is created and a price bubble forms. 

            As currency is created, it has to go somewhere and historically speaking excess currency has found its way to the stock market and the real estate market, often eventually creating a price bubble.  A price bubble cannot exist without easy credit and low interest rates.  In other words, easy credit is price bubble fuel.

            More recently, after the financial crisis, when the Fed cut interest rates to zero but the desired result of more borrowing to create more currency was not achieved.  If you’re wondering why, it’s because Americans, collectively, had no more capacity to take on debt.  If you can’t afford the payment on the new loan, it really doesn’t matter what the loan interest rate is.

            So, the Fed took unprecedented action.  The central bank began a program of quantitative easing which simply means currency creation.  From 2010 to 2020, the Fed created about $2 trillion in new currency via quantitative easing.

            Then, in 2020, COVID hit.  In response, the government rolled out massive stimulus programs funded by more currency creation by the Federal Reserve.

            The Fed created $5 trillion from thin air as observed from the Fed’s balance sheet below.  The Fed’s balance sheet is a proxy for the amount of currency the Fed has created from thin air.

            Notice from 2020 to 2022, the Federal Reserve created about $5 trillion in new currency from thin air.

            Compare the Fed’s balance sheet to this price chart of the S&P 500.  This is a weekly price chart of the S&P 500 from 2019 through 2022.  Notice that about the time the Fed began quantitative easing a.k.a. currency creation and the Fed’s balance sheet expanded, stock prices began to rise as well.

            There are numerous historical examples of this.  Here are a few: 

            In April of 1989, the fed Funds rates was 9.84%.  Just four years later, then Federal Reserve Chair, Alan Greenspan and his cohorts at the Fed had reduced interest rates by more than 6%, to 3.71% .

            The result was a tech stock bubble from the mid 1990’s that topped in 2000 before the bust happened. 

            The Fed’s response to the bust was more of the same.  By December of 2003, interest rates had been reduced to .98%.  The predictable outcome was another stock market bubble and a real estate bubble.  Both the stock market and the real estate market experienced a bust that bottomed in 2009.

            The Fed’s response, this time under the leadership of Ben Bernanke, was more of the same.  Interest rates were reduced to effectively 0% in early 2009, but this time the reduction in interest rates didn’t work. 

            Why?

            American citizens and businesses already had too much debt.  It didn’t matter what the interest rate on the new loan was; they couldn’t afford the payment.

            The Fed then took unprecedented action.  The central bank embarked on a program of quantitative easing a.k.a. currency creation.  This radical policy was justified by stating it was ‘temporary’ and would only continue until the US economy grew its way out of the debt problem.

            Trouble is, as we’ve discussed, today’s currency is debt.  Currency creation adds to debt levels.  It doesn’t solve the problem, it only masks the problem temporarily.  Case in point, world debt levels stood at about $100 trillion total at about the time quantitative easing first began.  Today, worldwide debt levels total more than $300 trillion.

            The next bust figures to be a real doozy as this level of unpayable debt is purged from the financial system.

            The Great Depression was a painful deflationary period caused by debt excesses.  As debt was purged from the system, the price of stocks and real estate fell, and cash gained purchasing power.

            You may be wondering why we haven’t yet experienced an environment like the Great Depression since debt levels today are significantly higher now when measured as a percentage of the economy than at the onset of the Great Depression.

            The answer is remarkably simple.

            At the onset of the Great Depression, the currency system was a gold-exchange based system.  The US Dollar was backed by gold, at least loosely.  In 1913, the US Dollar was 100% backed by gold.  By 1914, the Fed had changed the money rules to have the US Dollar only 40% backed by gold, allowing for an increase in the currency supply of 250%.

            However, because there was still a limit on the amount of currency that could be created, debt levels could not reach the levels that we see today.

            That, as you now know, is not the case today.  The Fed, over the last 110+ years, has continued to change the money rules so that now the central bank can create currency as they see fit.

            Think about the progression of these money rules for a moment.  The US Dollar has gone from being gold, to being fully backed by gold, to being partially backed by gold, to being loaned into existence so currency levels could be increased by reducing interest rates, to now being printed from thin air.

            Due to these money rule changes, boom-and-bust cycles are now baked into the economy.  At some point though, when currency creation no longer works or is ceased to prevent the destruction of the currency, the mother of all deflationary climates will become a harsh reality.  When that happens, owning cash assets or safe money assets will be vitally important.

            Here's the rub: We don’t know when this deflationary period will emerge. Here’s what I can tell you: every day that passes, we are one day closer to that inevitable outcome.

            Here’s what else is undoubtedly a reality: when the next bust occurs, the Federal Reserve will attempt to utilize the only tool the central bank has left in its toolbox – currency creation.

            Will the Fed succeed in reflating the bubble as they have each time up until this point?

            I have my doubts, but as economic historian, Egon von Greyerz says, forecasting is a mug’s game.  

            My own go-to analogy is that the ‘what’ is easier to predict than the ‘when.’

            So what should you do?

            I’d suggest having some inflation hedge assets in your portfolio as well as assets that will retain purchasing power when the deflationary reset hits.

          This week’s RLA radio program features an interview I conducted with Mr. Markl Jeftovic, publisher of The Bitcoin Capitalist.

          Mark and I discuss the current state of the US economy and investing markets.  We also discuss the growing role of cryptocurrencies in the financial system.

            The radio program is posted on this site. You can listen now by clicking on the "Podcast" tab at the top of this page.  The weekly Headline Roundup newscast is also posted there.  If you haven’t yet done so, check out the free resources available on the website.

“The difference between stupidity and genius is that genius has its limits.”

                                                                        -Albert Einstein