The Number Zero and Bitcoin

Satoshi gave the world Bitcoin, a true “something for nothing.” His discovery of absolute scarcity for money is an unstoppable idea that is changing the world tremendously, just like its digital ancestor: the number zero.

Zero is Special

“In the history of culture the discovery of zero will always stand out as one of the greatest single achievements of the human race.” — Tobias Danzig, Number: The Language of Science

Many believe that Bitcoin is “just one of thousands of cryptoassets”—this is true in the same way that the number zero is just one of an infinite series of numbers. In reality, Bitcoin is special, and so is zero: each is an invention which led to a discovery that fundamentally reshaped its overarching system—for Bitcoin, that system is money, and for zero, it is mathematics. Since money and math are mankind’s two universal languages, both Bitcoin and zero are critical constructs for civilization.

For most of history, mankind had no concept of zero: an understanding of it is not innate to us—a symbol for it had to be invented and continuously taught to successive generations. Zero is an abstract conception and is not discernible in the physical world—no one goes shopping for zero apples. To better understand this, we will walk down a winding path covering more than 4,000 years of human history that led to zero becoming part of the empirical bedrock of modernity.

Numerals, which are symbols for numbers, are the greatest abstractions ever invented by mankind: virtually everything we interact with is best grasped in numerical, quantifiable, or digital form. Math, the language of numerals, originally developed from a practical desire to count things—whether it was the amount of fish in the daily catch or the days since the last full moon. Many ancient civilizations developed rudimentary numeral systems: in 2000 BCE, the Babylonians, who failed to conceptualize zero, used two symbols in different arrangements to create unique numerals between 1 and 60:

Babylonian cuneiform was a relatively inefficient numeral system — notice how many more written strokes are necessary for each number symbol — and calculation using it was even more cumbersome.

Vestiges of the base-60 Babylonian cuneiform system still exist today: there are 60 seconds in a minute, 60 minutes in an hour, and 6 sets of 60 degrees in a circle. But this ancient system lacked a zero, which severely limited its usefulness. Ancient Greeks and Mayans developed their own numeral systems, each of which contained rough conceptions of zero. However, the first explicit and arithmetic use of zero came from ancient Indian and Cambodian cultures. They created a system with nine number symbols and a small dot used to mark the absence of a number—the original zero. This numeral system would eventually evolve into the one we use today:

The first known written zero: from the Bakhshali manuscript which contains pages dating back to the 3rd and 4th centuries AD.

Inscription K-127 bears the earliest zero ever discovered—dated from the 7th century, it was discovered in the 19th century in Cambodia.

In the 7th century, the Indian mathematician Brahmagupta developed terms for zero in addition, subtraction, multiplication, and division (although he struggled a bit with the latter, as would thinkers for centuries to come). As the discipline of mathematics matured in India, it was passed through trade networks eastward into China and westward into Islamic and Arabic cultures. It was this western advance of zero which ultimately led to the inception of the Hindu-Arabic numeral system—the most common means of symbolic number representation in the world today:

The Economization of Math

When zero reached Europe roughly 300 years later in the High Middle Ages, it was met with strong ideological resistance. Facing opposition from users of the well-established Roman numeral system, zero struggled to gain ground in Europe. People at the time were able to get by without zero, but (little did they know) performing computation without zero was horribly inefficient. An apt analogy to keep in mind arises here: both math and money are possible without zero and Bitcoin, respectively—however both are tremendously more wasteful systems without these core elements. Consider the difficulty of doing arithmetic in Roman numerals:

If you thought you were bad at arithmetic using numbers, just try doing it with letters.

Calculation performed using the Hindu-Arabic system is significantly more straightforward than with Roman numerals—and energy-efficient systems have a tendency to win out in the long run, as we saw when the steam engine outcompeted animal-sourced power or when capitalism prevailed over socialism (another important point to remember for Bitcoin later). This example just shows the pains of addition—multiplication and division were even more painstaking. As Amir D. Aczel described it in his book Finding Zero:

Roman numeral inefficiency would not be tolerated for long in a world enriching itself through commerce. With trade networks proliferating and productivity escalating in tandem, growing prospects of wealth creation incentivized merchants to become increasingly competitive, pushing them to always search for an edge over others. Computation and record-keeping with a zero-based numeral system was qualitatively easier, quantitatively faster, and less prone to error. Despite Europe’s resistance, this new numeral system simply could not be ignored: like its distant progeny Bitcoin would later be, zero was an unstoppable idea whose time had come:

Functions of Zero

Zero’s first function is as a placeholder in our numeric system: for instance, notice the “0” in the number “1,104” in the equation above, which indicates the absence of value in the tens place. Without zero acting as a symbol of absence at this order of magnitude in “1,104,” the number could not be represented unambiguously (without zero, is it “1,104” or “114”?). Lacking zero detracted from a numeral system’s capacity to maintain constancy of meaning as it scales. Inclusion of zero enables other digits to take on new meaning according to their position relative to it. In this way, zero lets us perform calculation with less effort—whether its pen strokes in a ledger, finger presses on a calculator, or mental gymnastics. Zero is a symbol for emptiness, which can be a highly useful quality—as Lao Tzu said:

More philosophically, zero is emblematic of the void, as Aczel describes it:

“…the void is everywhere and it moves around; it can stand for one truth when you write a number a certain way — no tens, for example — and another kind of truth in another case, say when you have no thousands in a number!”

Drawing analogies to the functions of money: zero is the “store of value” on which higher order of magnitude numerals can scale; this is the reason we always prefer to see another zero at the end of our bank account or Bitcoin balance. In the same way a sound economic store of value leads to increased savings, which undergirds investment and productivity growth, so too does a sound mathematical placeholder of value give us a numeral system capable of containing more meaning in less space, and supporting calculations in less time: both of which also foster productivity growth. Just as money is the medium through which capital is continuously cycled into places of optimal economic employment, zero gives other digits the ability to cycle—to be used again and again with different meanings for different purposes.

Zero’s second function is as a number in its own right: it is the midpoint between any positive number and its negative counterpart (like +2 and -2). Before the concept of zero, negative numbers were not used, as there was no conception of “nothing” as a number, much less “less than nothing.” Brahmagupta inverted the positive number line to create negative numbers and placed zero at the center, thus rounding out the numeral system we use today. Although negative numbers were written about in earlier times, like the Han Dynasty in China (206 BCE to 220 BCE), their use wasn’t formalized before Brahmagupta, since they required the concept of zero to be properly defined and aligned. In a visual sense, negative numbers are a reflection of positive numbers cast across zero:

Zero is the center of gravity for our entire numeral system, just as money is central to any economic system.

Interestingly, negative numbers were originally used to signify debts—well before the invention of double-entry accounting, which opted for debits and credits (partly to avoid the use of negative numbers). In this way, zero is the “medium of exchange” between the positive and negative domains of numbers—it is only possible to pass into, or out of, either territory by way of zero. By going below zero and conceptualizing negative numbers, many new and unusual (yet extremely useful) mathematical constructs come into being including imaginary numbers, complex numbers, fractals, and advanced astrophysical equations. In the same way the economic medium of exchange, money, leads to the acceleration of trade and innovation, so too does the mathematical medium of exchange, zero, lead to enhanced informational exchange, and its associated development of civilizational advances:

The Mandlebrot Set: one of the most famous examples of a fractal, a mind-bending mathematical structure formed with complex numbers that models the geometry of nature and its intrinsic complexity. One of the best known examples of mathematical beauty, this fractal exhibits infinite depth, breadth, and non-repeating self-similarity. Zero is a necessary prerequisite to such fractal modeling.

Zero’s third function is as a facilitator for fractions or ratios. For instance, the ancient Egyptians, whose numeral system lacked a zero, had an extremely cumbersome way of handling fractions: instead of thinking of 3/4 as a ratio of three to four (as we do today), they saw it as the sum of 1/2 and 1/4. The vast majority of Egyptian fractions were written as a sum of numbers as 1/n, where n is the counting number—these were called unit fractions. Without zero, long chains of unit fractions were necessary to handle larger and more complicated ratios (many of us remember the pain of converting fractions from our school days). With zero, we can easily convert fractions to decimal form (like 1/2 to 0.5), which obsoletes the need for complicated conversions when dealing with fractions. This is the “unit of account” function of zero. Prices expressed in money are just exchange ratios converted into a money-denominated price decimal: instead of saying “this house costs eleven cars” we say, “this house costs $440,000,” which is equal to the price of eleven $40,000 cars. Money gives us the ability to better handle exchange ratios in the same way zero gives us the ability to better handle numeric ratios.

Numbers are the ultimate level of objective abstraction: for example, the number 3 stands for the idea of “threeness” — a quality that can be ascribed to anything in the universe that comes in treble form. Equally, 9 stands for the quality of “nineness” shared by anything that is composed of nine parts. Numerals and math greatly enhanced interpersonal exchange of knowledge (which can be embodied in goods or services), as people can communicate about almost anything in the common language of numeracy. Money, then, is just the mathematized measure of capital available in the marketplace: it is the least common denominator among all economic goods and is necessarily the most liquid asset with the least mutable supply. It is used as a measuring system for the constantly shifting valuations of capital (this is why gold became money—it is the monetary metal with a supply that is most difficult to change). Ratios of money to capital (aka prices) are among the most important in the world, and ratios are a foundational element of being:

“In the beginning, there was the ratio, and the ratio was with God, and the ratio was God.” — John 1:1*

*(A more “rational” translation of Jesus’s beloved disciple John: the Greek word for ratio was λόγος (logos), which is also the term for word.)

An ability to more efficiently handle ratios directly contributed to mankind’s later development of rationality, a logic-based way of thinking at the root of major social movements such as the Renaissance, the Reformation, and the Enlightenment. To truly grasp the strange logic of zero, we must start with its point of origin—the philosophy from which it was born.

Philosophy of Zero

“In the earliest age of the gods, existence was born from non-existence.” — The Rig Veda

Zero arose from the bizarre logic of the ancient East. Interestingly, the Buddha himself was a known mathematician — in early books about him, like the Lalita Vistara, he is said to be excellent in numeracy (a skill he uses to woo a certain princess). In Buddhism, the logical character of the phenomenological world is more complex than true or false:

Or not true,

Or both true and not true,

Or neither true nor not true.

This is the Lord Buddha’s teaching.”

This is the Tetralemma (or the four corners of the catuskoti): the key to understanding the seeming strangeness of this ancient Eastern logic is the concept of Shunya, a Hindi word meaning zero: it is derived from the Buddhist philosophical concept of Śūnyatā (or Shunyata). The ultimate goal of meditation is the attainment of enlightenment, or an ideal state of nirvana, which is equivalent to emptying oneself entirely of thought, desire, and worldly attachment. Achievement of this absolute emptiness is the state of being in Shunyata: a philosophical concept closely related to the void—as the Buddhist writer Thich Nhat Hanh describes it:

“The first door of liberation is emptiness, Shunyata

Emptiness always means empty of something

Emptiness is the Middle Way between existent and nonexistent

Reality goes beyond notions of being and nonbeing

True emptiness is called “wondrous being,” because it goes beyond existence and nonexistence

The concentration on Emptiness is a way of staying in touch with life as it is, but it has to be practiced and not just talked about.”

Or, as a Buddhist monk of ancient Wats temple in Southeast Asia described the meditative experience of the void:

A direct experience of emptiness is achievable through meditation. In a true meditative state, the Shunyata and the number zero are one and the same. Emptiness is the conduit between existence and nonexistence, in the same way zero is the door from positive to negative numbers: each being a perfect reflection of the other. Zero arose in the ancient East as the epitome of this deeply philosophical and experiential concept of absolute emptiness. Empirically, today we now know that meditation benefits the brain in many ways. It seems too, that its contribution to the discovery of zero helped forge an idea that benefits mankind’s collective intelligence — our global hive-mind.

Despite being discovered in a spiritual state, zero is a profoundly practical concept: perhaps it is best understood as a fusion of philosophy and pragmatism. By traversing across zero into the territory of negative numbers, we encounter the imaginary numbers, which have a base unit of the square root of -1, denoted by the letter i. The number i is paradoxical: consider the equations x² + 1 = 0 and x³ + 1 = 0, the only possible answers are positive square root of -1 (i) and negative square root of -1 (-i or i³), respectively. Visualizing these real and imaginary domains, we find a rotational axis centered on zero with orientations reminiscent of the tetralemma: one true (1), one not true (i), one both true and not true (-1 or ), and one neither true nor not true (-i or i³):

Zero is the fulcrum between real and imaginary number planes.

Going through the gateway of zero into the realms of negative and imaginary numbers provides a more continuous form of logic when compared to the discrete either-or logic, commonly accredited to Aristotle and his followers. This framework is less “black and white” than the binary Aristotelean logic system, which was based on true or false, and provides many gradations of logicality; a more accurate map to the many “shades of grey” we find in nature. Continuous logic is insinuated throughout the world: for instance, someone may say “she wasn’t unattractive,” meaning that her appeal was ambivalent, somewhere between attractive and unattractive. This perspective is often more realistic than a binary assessment of attractive or not attractive.

Importantly, zero gave us the concept of infinity: which was notably absent from the minds of ancient Greek logicians. The rotations around zero through the real and imaginary number axes can be mathematically scaled up into a three-dimensional model called the Riemann Sphere. In this structure, zero and infinity are geometric reflections of one another and can transpose themselves in a flash of mathematical permutation. Always at the opposite pole of this three-dimensional, mathematical interpretation of the tetralemma, we find zero’s twin—infinity:

Scaling the real and imaginary number planes into the third dimension, we discover zero’s twin: infinity.

The twin polarities of zero and infinity are akin to yin and yang — as Charles Seife, author of Zero: Biography of a Dangerous Idea, describes them:

In Eastern philosophy, the kinship of zero and infinity made sense: only in a state of absolute nothingness can possibility become infinite. Buddhist logic insists that everything is endlessly intertwined: a vast causal network in which all is inexorably interlinked, such that no single thing can truly be considered independent — as having its own isolated, non-interdependent essence. In this view, interrelation is the sole source of substantiation. Fundamental to their teachings, this truth is what Buddhists call dependent co-origination, meaning that all things depend on one another. The only exception to this truth is nirvana: liberation from the endless cycles of reincarnation. In Buddhism, the only pathway to nirvana is through pure emptiness:

Nirvana, the ultimate spiritual goal in Buddhism, is attained by entering the void in meditation—this is where zero was discovered.

Some ancient Buddhist texts state: “the truly absolute and the truly free must be nothingness.” In this sense, the invention of zero was special; it can be considered the discovery of absolute nothingness, a latent quality of reality that was not previously presupposed in philosophy or systems of knowledge like mathematics. Its discovery would prove to be an emancipating force for mankind, in that zero is foundational to the mathematized, software-enabled reality of convenience we inhabit today.

Zero was liberation discovered deep in meditation, a remnant of truth found in close proximity to nirvana — a place where one encounters universal, unbounded, and infinite awareness: God’s kingdom within us. To buddhists, zero was a whisper from the universe, from dharma, from God (words always fail us in the domain of divinity). Paradoxically, zero would ultimately shatter the institution which built its power structure by monopolizing access to God. In finding footing in the void, mankind uncovered the deepest, soundest substrate on which to build modern society: zero would prove to be a critical piece of infrastructure that led to the interconnection of the world via telecommunications, which ushered in the gold standard and the digital age (Bitcoin’s two key inceptors) many years later.

Blazing a path forward: the twin conceptions of zero and infinity would ignite the Renaissance, the Reformation, and the Enlightenment — all movements that mitigated the power of The Catholic Church as the dominant institution in the world and paved the way for the industrialized nation-state.

Power of The Church Falls to Zero

The universe of the ancient Greeks was founded on the philosophical tenets of Pythagoras, Aristotle, and Ptolemy. Central to their conception of the cosmos was the precept that there is no void, no nothingness, no zero. Greeks, who had inherited their numbers from the geometry-loving Egyptians, made little distinction between shape and number. Even today, when we square a number (x²), this is equivalent to converting a line into a square and calculating its area. Pythagoreans were mystified by this connection between shapes and numbers, which explains why they didn’t conceive of zero as a number: after all, what shape could represent nothingness? Ancient Greeks believed numbers had to be visible to be real, whereas the ancient Indians perceived numbers as an intrinsic part of a latent, invisible reality separate from mankind’s conception of them.

The symbol of the Pythagorean cult was the pentagram (a five-pointed star); this sacred shape contained within it the key to their view of the universe—the golden ratio. Considered to be the “most beautiful number,” the golden ratio is achieved by dividing a line such that the ratio of the small part to the large part is the same as the ratio of the large part to the whole. Such proportionality was found to be not only aesthetically pleasing, but also naturally occurring in a variety of forms including nautilus shells, pineapples, and (centuries later) the double-helix of DNA. Beauty this objectively pure was considered to be a window into the transcendent; a soul-sustaining quality. The golden ratio became widely used in art, music, and architecture:

A simple sequence of calculations converges on the golden ratio, the “beautiful number” bountiful in nature. Beauty of this caliber heavily influenced many domains including architecture (as seen in the design of The Parthenon here).

The golden ratio was also found in musical harmonics: when plucking a string instrument from its specified segments, musicians could create the perfect fifth, a dual resonance of notes said to be the most evocative musical relationship. Discordant tritones, on the other hand, were derided as the “devil in music.” Such harmony of music was considered to be one and the same with that of mathematics and the universe—in the Pythagorean finite view of the cosmos (later called the Aristotelean celestial spheres model), movements of planets and other heavenly bodies generated a symphonic “harmony of the spheres”—a celestial music that suffused the cosmic depths. From the perspective of Pythagoreans, “all was number,” meaning ratios ruled the universe. The golden ratio’s seemingly supernatural connection to aesthetics, life, and the universe became a central tenet of Western Civilization and, later, The Catholic Church (aka The Church).

Zero posed a major threat to the conception of a finite universe. Dividing by zero is devastating to the framework of logic, and thus threatened the perfect order and integrity of a Pythagorean worldview. This was a serious problem for The Church which, after the fall of the Roman Empire, appeared as the dominant institution in Europe. To substantiate its dominion in the world, The Church proffered itself as the gatekeeper to heaven. Anyone who crossed The Church in any way could find themselves eternally barred from the holy gates. The Church’s claim to absolute sovereignty was critically dependent on the Pythagorean model, as the dominant institution over Earth—which was in their view the center of the universe—necessarily held dominion in God’s universe. Standing as a symbol for both the void and the infinite, zero was heretical to The Church. Centuries later, a similar dynamic would unfold in the discovery of absolute scarcity for money, which is dissident to the dominion of The Fed—the false church of modernity.

Ancient Greeks clung tightly to a worldview that did not tolerate zero or the infinite: rejection of these crucial concepts proved to be their biggest failure, as it prevented the discovery of calculus—the mathematical machinery on which much of the physical sciences and, thus, the modern world are constructed. Core to their (flawed) belief system was the concept of the “indivisible atom,” the elementary particle which could not be subdivided ad infinitum. In their minds, there was no way beyond the micro barrier of the atomic surface. In the same vein, they considered the universe a “macrocosmic atom” that was strictly bound by an outermost sphere of stars winking down towards the cosmic core—Earth. As above, so below: with nothing conceived to be above this stellar sphere and nothing below the atomic surface, there was no infinity and no void:

A finite universe with Earth at the center was the central tenet of ancient Greek philosophy and, later, of The Catholic Church’s institutional dominion over the world.

Aristotle (with later refinements by Ptolemy) would interpret this finite universe philosophically and, in doing so, form the ideological foundation for God’s existence and The Church’s power on Earth. In the Aristotelean conception of the universe, the force moving the stars, which drove the motion of all elements below, was the prime mover: God. This cascade of cosmic force from on high downward into the movements of mankind was considered the officially accepted interpretation of divine will. As Christianity swept through the West, The Church relied upon the explanatory power of this Aristotelean philosophy as proof of God’s existence in their proselytizing efforts. Objecting to the Aristotelean doctrine was soon considered an objection to the existence of God and the power of The Church.

Infinity was unavoidably actualized by the same Aristotelean logic which sought to deny it. By the 13th century, some bishops began calling assemblies to question the Aristotelean doctrines that went against the omnipotence of God: for example, the notion that “God can not move the heavens in a straight line, because that would leave behind a vacuum.” If the heavens moved linearly, then what was left in their wake? Through what substance were they moving? This implied either the existence of the void (the vacuum), or that God was not truly omnipotent as he could not move the heavens. Suddenly, Aristotelean philosophy started to break under its own weight, thereby eroding the premise of The Church’s power. Although The Church would cling to Aristotle’s views for a few more centuries—it fought heresy by forbidding certain books and burning certain Protestants alive—zero marked the beginning of the end for this domineering and oppressive institution.

An infinite universe meant there were, at least, a vast multitude of planets, many of which likely had their own populations and churches. Earth was no longer the center of the universe, so why should The Church have universal dominion? In a grand ideological shift that foreshadowed the invention of Bitcoin centuries later, zero became the idea that broke The Church’s grip on humanity, just as absolute scarcity of money is breaking The Fed’s stranglehold on the world today. In an echo of history, us moderns can once again hear the discovery of nothing beginning to change everything.

Zero was the smooth stone slung into the face of Goliath, a death-stroke to the dominion of The Church; felled by an unstoppable idea, this oppressive institution’s fall from grace would make way for the rise of the nation-state—the dominant institutional model in modernity.

Zero: An Ideological Juggernaut

Indoctrinated in The Church’s dogma, Christianity initially refused to accept zero, as it was linked to a primal fear of the void. Zero’s inexorable connection to nothingness and chaos made it a fearsome concept in the eyes of most Christians at the time. But zero’s capacity to support honest weights and measures, a core Biblical concept, would prove more important than the countermeasures of The Church (and the invention of zero would later lead to the invention of the most infallible of weights and measures, the most honest money in history—Bitcoin). In a world being built on trade, merchants needed zero for its superior arithmetic utility. As Pierre-Simon Laplace said:

“…[zero is] a profound and important idea which appears so simple to us now that we ignore its true merit. But its very simplicity and the great ease which it lent to all computations put our arithmetic in the first rank of useful inventions.”

In the 13th century, academics like the renowned Italian mathematician Fibonacci began championing zero in their work, helping the Hindu-Arabic system gain credibility in Europe. As trade began to flourish and generate unprecedented levels of wealth in the world, math moved from purely practical applications to ever more abstracted functions. As Alfred North Whitehead said:

The point about zero is that we do not need to use it in the operations of daily life. No one goes out to buy zero fish. It is in a way the most civilized of all the cardinals, and its use is only forced on us by the needs of cultivated modes of thought.”

As our thinking became more sophisticated, so too did our demands on math. Tools like the abacus relied upon a set of sliding stones to help us keep track of amounts and perform calculation. An abacus was like an ancient calculator, and as the use of zero became popularized in Europe, competitions were held between users of the abacus (the abacists) and of the newly arrived Hindu-Arabic numeral system (the algorists) to see who could solve complex calculations faster. With training, algorists could readily outpace abacists in computation. Contests like these led to the demise of the abacus as a useful tool, however it still left a lasting mark on our language: the words calculate, calculus, and calcium are all derived from the Latin word for pebble—calculus.

The algorists competing against the abacists: contests like these empirically proved the supremacy of a zero-based numeral system over others, even when aided by ancient mathematical tools like the abacus.

Before the Hindu-Arabic numerals, money counters had to use the abacus or a counting board to keep track of value flows. Germans called the counting board a Rechenbank, which is why moneylenders came to be known as banks. Not only did banks use counting boards, but they also used tally sticks to keep track of lending activities: the monetary value of a loan was written on the side of a stick, and it was split into two pieces, with the lender keeping the larger piece, known as the stock—which is where we get the term stockholder:

An ancient loan tracking device called a tally stick: the lender kept the larger portion, the stock, and became a stockholder in the bank that made the loan.

Despite its superior utility for business, governments despised zero. In 1299, Florence banned the Hindu-Arabic numeral system. As with many profound innovations, zero faced vehement resistance from entrenched power structures that were threatened by its existence. Carrying on lawlessly, Italian merchants continued to use the zero-based numeral system, and even began using it to transmit encrypted messages. Zero was essential to these early encryption systems—which is why the word cipher, which originally meant zero, came to mean “secret code.” The criticality of zero to ancient encryption systems is yet another aspect of its contribution to Bitcoin’s ancestral heritage.

At the beginning of the Renaissance, the threat zero would soon pose to the power of The Church was not obvious. By then, zero had been adapted as an artistic tool to create the vanishing point: an acute place of infinite nothingness used in many paintings that sparked the great Renaissance in the visual arts. Drawings and paintings prior to the vanishing point appear flat and lifeless: their imagery was mostly two-dimensional and unrealistic. Even the best artists couldn’t capture realism without the use of zero:

Pre-Renaissance art: still better than a banana duct taped to a canvas.

With the concept of zero, artists could create a zero-dimension point in their work that was “infinitely far” from the viewer, and into which all objects in the painting visually collapsed. As objects appear to recede from the viewer into the distance, they become ever-more compressed into the “dimensionlessness” of the vanishing point, before finally disappearing. Just as it does today, art had a strong influence on people’s perceptions. Eventually, Nicholas of Cusa, a cardinal of The Church declared, “Terra non est centra mundi,” which meant “the Earth is not the center of the universe.” This declaration would later lead to Copernicus proving heliocentrism—the spark that ignited The Reformation and, later, the Age of Enlightenment:

By adding the vanishing point (a visual conception of zero) to drawings and paintings, art gained the realistic qualities of depth, breadth, and spatial proportion.

A dangerous, heretical, and revolutionary idea had been planted by zero and its visual incarnation, the vanishing point. At this point of infinite distance, the concept of zero was captured visually, and space was made infinite—as Seife describes it:

“It was no coincidence that zero and infinity are linked in the vanishing point. Just as multiplying by zero causes the number line to collapse into a point, the vanishing point has caused most of the universe to sit in a tiny dot. This is a singularity, a concept that became very important later in the history of science—but at this early stage, mathematicians knew little more than the artists about the properties of zero.”

The purpose of the artist is to the mythologize the present: this is evident in much of the consumerist “trash art” produced in our current fiat-currency-fueled world. Renaissance artists (who were often also mathematicians, true Renaissance men) worked assiduously in line with this purpose as the vanishing point became an increasingly popular element of art in lockstep with zero’s proliferation across the world. Indeed, art accelerated the propulsion of zero across the mindscape of mankind.

Modernity: The Age of Ones and Zeros

Eventually, zero became the cornerstone of calculus: an innovative system of mathematics that enabled people to contend with ever-smaller units approaching zero, but cunningly avoided the logic-trap of having to divide by zero. This new system gave mankind myriad new ways to comprehend and grasp his surroundings. Diverse disciplines such as chemistry, engineering, and physics all depend on calculus to fulfill their functions in the world today:

Calculus enables us to make symphonic arrangements of matter in precise accordance with our imaginations; this mathematical study of continuous change is fundamental to all physical sciences.

Zero serves as the source-waters of many technological breakthroughs—some of which would flow together into the most important invention in history: Bitcoin. Zero punched a hole and created a vacuum in the framework of mathematics and shattered Aristotelean philosophy, on which the power of The Church was premised. Today, Bitcoin is punching a hole and creating a vacuum in the market for money; it is killing Keynesian economics—which is the propagandistic power-base of the nation-state (along with its apparatus of theft: the central bank).

In modernity, zero has become a celebrated tool in our mathematical arsenal. As the binary numerical system now forms the foundation of modern computer programming, zero was essential to the development of digital tools like the personal computer, the internet, and Bitcoin. Amazingly, all modern miracles made possible by digital technologies can be traced back to the invention of a figure for numeric nothingness by an ancient Indian mathematician: Brahmagupta gave the world a real “something for nothing,” a generosity Satoshi would emulate several centuries later. As Aczel says:

A composition of countless zeroes and ones, binary code led to the proliferation and standardization of communications protocols including those embodied in the internet protocol suite. As people freely experimented with these new tools, they organized themselves around the most useful protocols like http, TCP/IP, etc. Ossification of digital communication standards provided the substrate upon which new societal utilities—like email, ride sharing, and mobile computing—were built. Latest (and arguably the greatest) among these digital innovations is the uninflatable, unconfiscatable, and unstoppable money called Bitcoin.

A common misconception of Bitcoin is that it is just one of thousands of cryptoassets in the world today. One may be forgiven for this misunderstanding, as our world today is home to many national currencies. But all these currencies began as warehouse receipts for the same type of thing—namely, monetary metal (usually gold). Today, national currencies are not redeemable for gold, and are instead liquid equity units in a pyramid scheme called fiat currency: a hierarchy of thievery built on top of the freely selected money of the world (gold) which their issuers (central banks) hoard to manipulate its price, insulate their inferior fiat currencies from competitive threats, and perpetually extract wealth from those lower down the pyramid.

Given this confusion, many mistakenly believe that Bitcoin could be disrupted by any one of the thousands of alternative cryptoassets in the marketplace today. This is understandable, as the reasons that make Bitcoin different are not part of common parlance and are relatively difficult to understand. Even Ray Dalio, the greatest hedge fund manager in history, said that he believes Bitcoin could be disrupted by a competitor in the same way that iPhone disrupted Blackberry. However, disruption of Bitcoin is extremely unlikely: Bitcoin is a path-dependent, one-time invention; its critical breakthrough is the discovery of absolute scarcity—a monetary property never before (and never again) achievable by mankind.

Like the invention of zero, which led to the discovery of “nothing as something” in mathematics and other domains, Bitcoin is the catalyst of a worldwide paradigmatic phase change (which some have started calling The Great Awakening). What numeral is to number, and zero is to the void for mathematics, Bitcoin is to absolute scarcity for money: each is a symbol that allows mankind to apprehend a latent reality (in the case of money, time). More than just a new monetary technology, Bitcoin is an entirely new economic paradigm: an uncompromisable base money protocol for a global, digital, non-state economy. To better understand the profundity of this, we first need to understand the nature of path-dependence.

The Path-Dependence of Bitcoin

Path-dependence is the sensitivity of an outcome to the order of events that led to it. In the broadest sense, it means history has inertia:

Path-dependence entails that the sequence of events matters as much as the events themselves: as a simple example, you get a dramatically different result if you shower and then dry yourself off versus if you dry yourself off first and then shower. Path-dependence is especially prevalent in complex systems due to their high interconnectivity and numerous (often unforeseeable) interdependencies. Once started down a particular pathway, breaking away from its sociopolitical inertia can become impossible—for instance, imagine if the world tried to standardize to a different size electrical outlet: consumers, manufacturers, and suppliers would all resist this costly change unless there was a gigantic prospective gain. To coordinate this shift in standardization would require either a dramatically more efficient technology (a pull method—by which people stand to benefit) or an imposing organization to force the change (a push method—in which people would be forced to change in the face of some threat). Path-dependence is why occurrences in the sociopolitical domain often influence developments in the technical; US citizens saw path-dependent pushback firsthand when their government made a failed attempt to switch to the metric system back in the 1970s.

Bitcoin was launched into the world as a one of a kind technology: a non-state digital money that is issued on a perfectly fixed, diminishing, and predictable schedule. It was strategically released into the wild (into an online group of cryptographers) at a time when no comparative technology existed. Bitcoin’s organic adoption path and mining network expansion are a non-repeatable sequence of events. As a thought experiment, consider that if a “New Bitcoin” was launched today, it would exhibit weak chain security early on, as its mining network and hash rate would have to start from scratch. Today, in a world that is aware of Bitcoin, this “New Bitcoin” with comparatively weak chain security would inevitably be attacked—whether these were incumbent projects seeking to defend their head start, international banking cartels, or even nation-states:

Bitcoin’s head start in hash rate is seemingly insurmountable.

Path-dependence protects Bitcoin from disruption, as the organic sequence of events which led to its release and assimilation into the marketplace cannot be replicated. Further, Bitcoin’s money supply is absolutely scarce; a totally unique and one-time discovery for money. Even if “New Bitcoin” was released with an absolutely scarce money supply, its holders would be incentivized to hold the money with the greatest liquidity, network effects, and chain security. This would cause them to dump “New Bitcoin” for the original Bitcoin. More realistically, instead of launching “New Bitcoin,” those seeking to compete with Bitcoin would take a social contract attack-vector by initiating a hard fork. An attempt like this was already made with the “Bitcoin Cash” fork, which tried to increase block sizes to (ostensibly) improve its utility for payments. This chain fork was an abject failure and a real world reinforcement of the importance of Bitcoin’s path-dependent emergence:

Bitcoin Cash is considering a rebrand to Bitcoin Crash.

Continuing our thought experiment: even if “New Bitcoin” featured a diminishing money supply (in other words, a deflationary monetary policy), how would its rate of money supply decay (deflation) be determined? By what mechanism would its beneficiaries be selected? As market participants (nodes and miners) jockeyed for position to maximize their accrual of economic benefit from the deflationary monetary policy, forks would ensue that would diminish the liquidity, network effects, and chain security for “New Bitcoin,” causing everyone to eventually pile back into the original Bitcoin—just like they did in the wake of Bitcoin Cash’s failure.

Path-dependence ensures that those who try to game Bitcoin get burned. Reinforced by four-sided network effects, it makes Bitcoin’s first-mover advantage seemingly insurmountable. The idea of absolute monetary scarcity goes against the wishes of entrenched power structures like The Fed: like zero, once an idea whose time has come is released into the world, it is nearly impossible to put the proverbial genie back in the bottle. After all, unstoppable ideas are independent lifeforms:

Finite and Infinite Games

Macroeconomics is essentially the set of games played globally to satisfy the demands of mankind (which are infinite) within the bounds of his time (which is strictly finite). In these games, scores are tracked in monetary terms. Using lingo from the groundbreaking book Finite and Infinite Games, there are two types of economic games: unfree (or centrally planned) markets are theatrical, meaning that they are performed in accordance with a predetermined script that often entails dutifulness and disregard for humanity. The atrocities committed in Soviet Russia are exemplary of the consequences of a theatrical economic system. On the other hand, free markets are dramatic, meaning that they are enacted in the present according to consensual and adaptable boundaries. Software development is a good example of a dramatic market, as entrepreneurs are free to adopt the rules, tools, and protocols that best serve customers. Simply: theatrical games are governed by imposed rules (based on tyranny), whereas rulesets for dramatic games are voluntarily adopted (based on individual sovereignty).

From a moral perspective, sovereignty is always superior to tyranny. And from a practical perspective, tyrannies are less energy-efficient than free markets because they require tyrants to expend resources enforcing compliance with their imposed rulesets and protecting their turf. Voluntary games (free market capitalism) outcompete involuntary games (centrally planned socialism) as they do not accrue these enforcement and protection costs: hence the reason capitalism (freedom) outcompetes socialism (slavery) in the long run. Since interpersonal interdependency is at the heart of the comparative advantage and division of labor dynamics that drive the value proposition of cooperation and competition, we can say that money is an infinite game: meaning that its purpose is not to win, but rather to continue to play. After all, if one player had all the money, the game would end (like the game of Monopoly).

In this sense, Bitcoin’s terminal money supply growth (inflation) rate of absolute zero is the ultimate monetary Schelling point a game-theoretic focal point that people tend to choose in an adversarial game. In game theory, a game is any situation where there can be winners or losers, a strategy is a decision-making process, and a Schelling point is the default strategy for games in which the players cannot fully trust one another (like money):

Among many spheres of competing interpersonal interests, scarcity is the Schelling point of money.

Economic actors are incentivized to choose the money that best holds its value across time, is most widely accepted, and most clearly conveys market pricing information. All three of these qualities are rooted in scarcity: resistance to inflation ensures that money retains its value and ability to accurately price capital across time, which leads to its use as an exchange medium. For these reasons, holding the scarcest money is the most energy-efficient strategy a player can employ, which makes the absolute scarcity of Bitcoin an irrefutable Schelling point—a singular, unshakable motif in games played for money.

A distant digital descendent of zero, the invention of Bitcoin represents the discovery of absolute scarcity for money: an idea as equally unstoppable.

Similar to the discovery of absolute nothingness symbolized by zero, the discovery of absolutely scarce money symbolized by Bitcoin is special. Gold became money because out of the monetary metals it had the most inelastic (or relatively scarce) money supply: meaning that no matter how much time was allocated towards gold production, its supply increased the least. Since its supply increased the slowest and most predictable rate, gold was favored for storing value and pricing things—which encouraged people to voluntarily adopt it, thus making it the dominant money on the free market. Before Bitcoin, gold was the world’s monetary Schelling point, because it made trade easier in a manner that minimized the need to trust other players. Like its digital ancestor zero, Bitcoin is an invention that radically enhances exchange efficiency by purifying informational transmissions: for zero, this meant instilling more meaning per proximate digit, for Bitcoin, this means generating more salience per price signal. In the game of money, the objective has always been to hold the most relatively scarce monetary metal (gold); now, the goal is to occupy the most territory on the absolutely scarce monetary network called Bitcoin.

A New Epoch for Money

Historically, precious metals were the best monetary technologies in terms of money’s five critical traits:

  1. divisibility,
  2. durability,
  3. portability,
  4. recognizability, and
  5. scarcity.

Among the monetary metals, gold was relatively the most scarce, and therefore it outcompeted others in the marketplace as it was a more sound store of value. In the ascension of gold as money, it was as if free market dynamics were trying to zero-in on a sufficiently divisible, durable, portable, and recognizable monetary technology that was also absolutely scarce (strong arguments for this may be found by studying the Eurodollar system). Free markets are distributed computing systems that zero-in on the most useful prices and technologies based on the prevailing demands of people and the available supplies of capital: they constantly assimilate all of mankind’s intersubjective perspectives on the world within the bounds of objective reality to produce our best approximations of truth. In this context, verifiable scarcity is the best proxy for the truthfulness of money: assurance that it will not be debased over time.

As a (pre-Bitcoin) thought experiment, had a “new gold” been discovered in the Earth’s crust, assuming it was mostly distributed evenly across the Earth’s surface and was exactly comparable to gold in terms of these five monetary traits (with the exception that it was more scarce), free market dynamics would have led to its selection as money, as it would be that much closer to absolute scarcity, making it a better means of storing value and propagating price signals. Seen this way, gold as a monetary technology was the closest the free market could come to absolutely scarce money before it was discovered in its only possible form—digital. The supply of any physical thing can only be limited by the time necessary to procure it: if we could flip a switch and force everyone on Earth to make their sole occupation gold mining, the supply of gold would soon soar. Unlike Bitcoin, no physical form of money could possibly guarantee a permanently fixed supply—so far as we know, absolute scarcity can only be digital.

Digitization is advantageous across all five traits of money. Since Bitcoin is just information, relative to other monetary technologies, we can say: its

  1. divisibility is supreme, as information can be infinitely subdivided and recombined at near-zero cost (like numbers); its
  2. durability is supreme, as information does not decompose (books can outlast empires); its
  3. portability is supreme, as information can move at the speed of light (thanks to telecommunications); and its
  4. recognizability is supreme, as information is the most objectively discernible substance in the universe (like the written word). Finally, and most critically, since Bitcoin algorithmically and thermodynamically enforces an absolutely scarce money supply, we can say that its
  5. scarcity is infinite (as scarce as time, the substance money is intended to tokenize in the first place). Taken in combination, these traits make absolutely scarce digital money seemingly indomitable in the marketplace.

In the same way that the number zero enables our numeric system to scale and more easily perform calculation, so too does money give an economy the ability to socially scale by simplifying trade and economic calculation. Said simply: scarcity is essential to the utility of money, and a zero-growth terminal money supply represents “perfect” scarcity — which makes Bitcoin as near a “perfect” monetary technology as mankind has ever had. Absolute scarcity is a monumental monetary breakthrough. Since money is valued according to reflexivity, meaning that investor perceptions of its future exchangeability influence its present valuation, Bitcoin’s perfectly predictable and finite future supply underpins an unprecedented rate of expansion in market capitalization:

Bitcoin is truly unique: a perfectly scarce and predictably supplied money.

In summary: the invention of Bitcoin represents the discovery of absolute scarcity, or absolute irreproducibility, which occurred due to a particular sequence of idiosyncratic events that cannot be reproduced. Any attempt to introduce an absolutely scarce or diminishing supplied money into the world would likely collapse into Bitcoin (as we saw with the Bitcoin Cash fork). Absolute scarcity is a one-time discovery, just like heliocentrism or any other major scientific paradigm shift. In a world where Bitcoin already exists, a successful launch via a proof-of-work system is no longer possible due to path-dependence; yet another reason why Bitcoin cannot be replicated or disrupted by another cryptoasset using this consensus mechanism. At this point, it seems absolute scarcity for money is truly a one-time discovery that cannot “disrupted” any more than the concept of zero can be disrupted.

A true “Bitcoin killer” would necessitate an entirely new consensus mechanism and distribution model; with an implementation overseen by an unprecedentedly organized group of human beings: nothing to date has been conceived that could even come close to satisfying these requirements. In the same way that there has only ever been one analog gold, there is likely to only ever be one digital gold. For the same quantifiable reasons a zero-based numeral system became a dominant mathematical protocol, and capitalism outcompetes socialism, the absolute scarcity of Bitcoin’s supply will continue outcompeting all other monetary protocols in its path to global dominance.

Numbers are the fundamental abstractions which rule our world. Zero is the vanishing point of the mathematical landscape. In the realm of interpersonal competition and cooperation, money is the dominant abstraction which governs our behavior. Money arises naturally as the most tradable thing within a society—this includes exchanges with others and with our future selves. Scarcity is the trait of money that allows it to hold value across time, enabling us to trade it with our future selves for the foregone opportunity costs (the things we could have otherwise traded money for had we not decided to hold it). Scarce money accrues value as our productivity grows. For these reasons, the most scarce technology which otherwise exhibits sufficient monetary traits (divisibility, durability, recognizability, portability) tends to become money. Said simply: the most relatively scarce money wins. In this sense, what zero is to math, absolute scarcity is to money. It is an astonishing discovery, a window into the void, just like its predecessor zero:

Actual footage of Bitcoin devouring fiat currencies.

Fiat Currency Always Falls to Zero

Zero has proven itself as the capstone of our numeral system by making it scalable, invertible, and easily convertible. In time, Bitcoin will prove itself as the most important network in the global economic system by increasing social scalability, causing an inversion of economic power, and converting culture into a realignment with Natural Law. Bitcoin will allow sovereignty to once again inhere at the individual level, instead of being usurped at the institutional level as it is today—all thanks to its special forebear, zero:

Central planning in the market for money (aka monetary socialism) is dying. This tyrannical financial hierarchy has increased worldwide wealth disparities, funded perpetual warfare, and plundered entire commonwealths to “bail out” failing institutions. A reversion to the free market for money is the only way to heal the devastation it has wrought over the past 100+ years. Unlike central bankers, who are fallible human beings that give into political pressure to pillage value from people by printing money, Bitcoin’s monetary policy does not bend for anyone: it gives zero fucks. And in a world where central banks can “just add zeros” to steal your wealth, people’s only hope is a “zero fucks” money that cannot be confiscated, inflated, or stopped:

Central banks literally “just add zeros” to steal vast swathes of societal wealth.

Bitcoin was specifically designed as a countermeasure to “expansionary monetary policies” (aka wealth confiscation via inflation) by central bankers. Bitcoin is a true zero-to-one invention, an innovation that profoundly changes society instead of just introducing an incremental advancement. Bitcoin is ushering in a new paradigm for money, nation-states, and energy-efficiency. Most importantly, it promises to break the cycle of criminality in which governments continuously privatize gains (via seigniorage) and socialize losses (via inflation). Time and time again, excessive inflation has torn societies apart, yet the lessons of history remain unlearned—once again, here we are:

Thank you internet for all the hilarious yet meaningful memes.

The Zero Hour

How much longer will monetary socialism remain an extant economic model? The countdown has already begun: Ten. Nine. Eight. Seven. Six. Five. Four. Three. Two. One. Liftoff. Rocket technicians always wait for zero before ignition; countdowns always finalize at the zero hour. Oil price wars erupting in Eurasia, a global pandemic, an unprecedented expansionary monetary policy response, and another quadrennial Bitcoin inflation-rate halving: 2020 is quickly becoming the zero hour for Bitcoin.

Inflation rate and societal wellbeing are inversely related: the more reliably value can be stored across time, the more trust can be cultivated among market participants. When a money’s roots to economic reality are severed—as happened when the peg to gold was broken and fiat currency was born—its supply inevitably trends towards infinity (hyperinflation) and the functioning of its underlying society deteriorates towards zero (economic collapse). An unstoppable free market alternative, Bitcoin is anchored to economic reality (through proof-of-work energy expenditure) and has an inflation rate predestined for zero, meaning that a society operating on a Bitcoin standard would stand to gain in virtually infinite ways. When Bitcoin’s inflation rate finally reaches zero in the mid 22nd century, the measure of its soundness as a store of value (the stock-to-flow ratio) will become infinite; people that realize this and adopt it early will benefit disproportionately from the resultant mass wealth transfer.

Zero and infinity are reciprocal: 1/∞ = 0 and 1/0 = ∞. In the same way, a society’s wellbeing shrinks towards zero the more closely the inflation rate approaches infinity (through the hyperinflation of fiat currency). Conversely, societal wellbeing can, in theory, be expanded towards infinity the more closely the inflation rate approaches zero (through the absolute scarcity of Bitcoin). Remember: The Fed is now doing whatever it takes to make sure there is “infinite cash” in the banking system, meaning that its value will eventually fall to zero:

Market value of money always converges to its marginal cost of production: “Infinite cash” means dollars will inevitably become as valuable as the paper on which they are printed.

Zero arose in the world as an unstoppable idea because its time had come; it broke the dominion of The Church and put an end to its monopolization over access to knowledge and the gates to heaven. The resultant movement—The Separation of Church and State—reinvigorated self-sovereignty in the world, setting the individual firmly as the cornerstone of the state. Rising from The Church’s ashes came a nation-state model founded on sound property rights, rule of law, and free market money (aka hard money). With this new age came an unprecedented boom in scientific advancement, wealth creation, and worldwide wellbeing. In the same way, Bitcoin and its underlying discovery of absolute scarcity for money is an idea whose time has come. Bitcoin is shattering the siege of central banks on our financial sovereignty; it is invoking a new movement—The Separation of Money and State—as its revolutionary banner; and it is restoring Natural Law in a world ravaged by a mega-wealth-parasite—The Fed.

Only unstoppable ideas can break otherwise immovable institutions: zero brought The Church to its knees and Bitcoin is bringing the false church of The Fed into the sunlight of its long-awaited judgement day.

Both zero and Bitcoin are emblematic of the void, a realm of pure potentiality from which all things spring forth into being — the nothingness from which everything effervesces, and into which all possibility finally collapses. Zero and Bitcoin are unstoppable ideas gifted to mankind; gestures made in the spirit of “something for nothing.” In a world run by central banks with zero accountability, a cabal that uses the specious prospects of “infinite cash” to promise us everything (thereby introducing the specter of hyperinflation), nothingness may prove to be the greatest gift we could ever receive…

Thank you Brahmagupta and Satoshi Nakamoto for your generosity.

America’s Make-or-Break Week

The bills are now coming due for big companies and millions of laid-off workers. Decisions made in the next few days will shape how coronavirus impacts the economy

Congress has passed a $2 trillion rescue plan but before those funds start to flow, American companies from the owner of a single liquor store in Boston to corporate giants like Macy’s Inc., must decide what to do about April’s bills: Which obligations do they pay and which can they put off? How many employees can they afford to keep on the payroll? Can they get a break on rent?

The decisions they make this week could shape how deeply the economy is damaged by the coronavirus pandemic.

“Rent is due. Utilities are due. Credit card bills are due April 1,” said Hadley Douglas, who has laid off two workers from her liquor business, The Urban Grape. “The deadline is looming large and it is petrifying.” She said her landlord turned down a request to temporarily pay half the rent but said to keep in touch as it was focusing first on smaller, harder hit businesses.

Millions of Americans are suddenly out of work and many businesses have already closed under orders from state and local governments to close to prevent the spread of the virus. A record 3.28 million Americans filed for unemployment benefits in the week ended March 21.

The U.S. restaurant industry has lost $25 billion in sales since March 1, according to a survey of 5,000 owners by the National Restaurant Association. Nearly 50,000 stores of major U.S. retail chains have closed, according to the companies.

An estimated $20 billion in monthly retail real estate loans are due as early as this week, according to Marcus & Millichap, a commercial real-estate services and consulting firm. Many retailers and restaurants have said they are not going to pay their April rents, which in turn poses a threat to the $3 trillion commercial mortgage market.

Economic activity in the U.S. and other developed countries could be lowered by a quarter, the Organization for Economic Cooperation and Development said Friday.

Companies of all sizes are feeling the squeeze, especially retailers and restaurants that have closed their doors during the outbreak. Nike Inc. is asking to pay half its rents. TJ Maxx is delaying payments to its suppliers. Victoria’s Secret and Men’s Wearhouse have furloughed thousands of workers. Cheesecake Factory Inc. closed 27 of the company’s locations and furloughed 41,000 hourly workers, nearly 90% of its total staff.

Tyson Evans, a 23-year-old line cook for Cheesecake Factory in Indianapolis, Indiana, said he and fellow workers were stunned to learn about the furloughs. He said they believed the company would continue to employ them despite a drop in business. He is now filing for unemployment.

“We keep this company going,” said Mr. Evans, who is currently living with his parents and worried about paying bills including his phone, grocery and prescriptions. He has started an online petition to urge the chain to keep paying furloughed workers.

Denise Burger, a 64-year-old Cheesecake Factory server in Escondido, Calif., said she was counting on the 36 hours of work the company had scheduled for her before the furloughs came down. Ms. Burger said she’s been contacting her mortgage and credit card companies to try and postpone payments.

“This pandemic has put much stress and strain on me,” said Ms. Burger, who is single and has worked for the company for six years in a job she loved.

California-based Cheesecake Factory said it would continue to provide health insurance for employees until June 1, and provide them a daily meal from their restaurants that remain open for take-out orders.

Cheesecake Factory has notified landlords that it won’t pay April rent. “Due to these extraordinary events, I am asking for your patience and, frankly, your help,” wrote Chief Executive David Overton.

Owners of independent and small restaurant chains have also asked their landlords for rent relief, with mixed responses. Some say landlords are offering them deferments of several months, whereas others haven’t gotten much help yet.

“Landlords, if they are overly greedy, they could be losing us,” said Andy Howard, chief executive of Huey Magoo’s Restaurants, who is pleading for a break on rents for his Orlando, Fla., chicken tenders chain.

Residential and commercial landlords say they have been flooded with requests from individuals and businesses saying they will struggle to pay their rent for April and beyond.

“I feel like I’m running triage in a retail hospital out of my apartment,” said Ami Ziff, director of national retail for Time Equities Inc., which owns 122 retail centers, including shopping centers, malls and street-front retail locations in 25 states.

Mortgage firms are bracing for a wave of missed payments starting April 1 as borrowers lose their jobs. Fannie Mae and Freddie Mac say they will offer deferrals on home mortgages and postpone foreclosures. Auto dealers say consumers are calling to put off their April lease or loan payments.

Guy Hillel, 47 years old, got laid off from his job as a food and beverage manager at a Times Square hotel earlier this month after the property closed due to the outbreak. He is eligible for $504 a week in unemployment benefits, a fraction of what he was earning.

Mr. Hillel, who has a wife and two children, says it isn’t enough to cover the family’s expenses. He has called credit-card companies to negotiate payment extensions, and tried unsuccessfully to delay his monthly car loan for his family’s Volkswagen Tiguan sport-utility vehicle.

“It’s extremely stressful,” Mr. Hillel said. “It’s crazy: I’m more exhausted now than I was before when I had a job.”

Mr. Hillel estimates his family will receive some stimulus money, but not the full amount awarded to couples.

The federal economic stimulus program passed last week will provide direct payments to Americans as well as loans to large and small companies. The bill includes $350 billion to help small businesses keep people on their payrolls.

For employees, it increases current unemployment benefits by $600 a week for four months. It also provides one-time checks of $1,200 to Americans with adjusted gross income up to $75,000 for individuals and $150,000 for married couples; individuals and couples are eligible for an additional $500 per child.

Treasury Secretary Steven Mnuchin said the Trump administration aims to send out direct payments to individuals in three weeks and that banks should be able to originate same-day loans for small businesses in as little as a week.

Many business owners and individuals said they have little in the way of cash reserves or savings for bills that come due in the next few days. Some wonder whether the aid will be enough.

The Small Business Administration said the stimulus bill provides “small businesses with the resources they need to get them through this unprecedented time.”

America’s large, marquee retailers are also struggling.

Macy’s Chief Executive Jeff Gennette told suppliers last week that while he had hoped to reopen stores by April 1, that was highly unlikely. “While our digital business and call centers remain open, we have lost the majority of our sales,” Mr. Gennette wrote in a letter reviewed by The Wall Street Journal.

Macy’s has suspended its dividend and drawn down its credit line to bolster its cash. It has reduced pay for executives. It’s also canceling some orders and has doubled the amount of time it gives itself to pay suppliers, to 120 days. Nevertheless, Mr. Gennette wrote in the letter, the retailer may need to begin furloughing some of its 130,000 employees.

Nike has offered to pay 50% rent on its 384 closed U.S. stores, landlords say, and when the stores reopen, a percentage of sales in lieu of any rent for 12 months. Nike executives said they will continue to pay workers while the stores are shut.

“We are currently honoring all existing contracts with our landlords. In collaboration with our real estate partners, we provided a proposal looking at near and long term approaches that we believe will help ensure both parties remain viable business partners through this unprecedented time,” a Nike spokeswoman said.

Tapestry Inc., the parent of Coach and Kate Spade, extended U.S. and European store closures through April 10, but is continuing to pay store workers. “What will be important as we come out the other end is to have a committed team of people,” said Chief Executive Jide Zeitlin.

Mr. Zeitlin said the company is in negotiations with landlords about rent forgiveness and is looking at other expenses to cut aside from labor.

T.J. Maxx and Ross Stores Inc. have canceled orders through mid-June and are delaying payments to suppliers, according to people familiar with the situation. A T.J. Maxx spokeswoman declined to comment. A spokeswoman for Ross Stores didn’t respond to a request for comment.

Financial pressures are particularly intense for small business owners; In a typical community, about half of small businesses had less than two weeks of cash liquidity, according to a 2019 report by the JPMorgan Chase Institute.

Pennsylvania deemed auto repair an essential business, which allowed Tom Bemiller, the chief executive of The Aureus Group, to keep open his three repair shops in the Philadelphia area. Revenue is down 35% this month, he said.

“Customer after customer is telling us I am not going to get my car fixed until this blows over,” said Mr. Bemiller.

Mr. Bemiller said his priority is to pay his 25 employees and his suppliers. His bank is working to determine whether it can retool the terms of his company’s $450,000 loan to allow for interest-only payments and has increased its credit line by $50,000, enough to cover two weeks of payroll. Pennsylvania is letting him delay certain sales tax payments; American Express Co. has agreed to waive fees and interest if he delays his $270,000 corporate credit card bill for one month.

“Right now everything is on the table because we are in survival mode,” Mr. Bemiller said. “We are reaching out to all vendors and creditors and asking for help and trying to delay payments as much as possible.”

Mr. Bemiller has reduced his own salary. He hopes to defer payments on his mortgage, student loans, credit card bills and other expenses, but hasn’t had time to work on that yet because he’s been singularly focused on the business, which provides all of his family’s income.

At Envision Travel Holdings Inc., a travel agency with 11 offices, revenue has fallen by two-thirds in the past month and is expected to drop to near zero in the next month or so. The Las Vegas company, which normally has 40 employees and 25 independent contractors, has laid off four workers and cut hours by 20%.

All but one of Envision’s landlords has agreed to reduce rents, cutting payments to about $15,000 from $38,000, with missed payments tacked on to the end of the lease. The travel company put a hold on its 401(k) retirement savings plan and, for now, dropped its 50% contribution to the employee dental plan. “We are analyzing every expense, line by line,” owner Thomas Carlsen said.

The universal advice we are giving tenants is don’t pay your rent and see what happens,” said Derek Wolman, partner at law firm Davidoff Hutcher & Citron LLP, which often represents bars, restaurants and hotels in lease negotiations. He said this is especially true in New York state, where there is pending legislation that would give 90 days of rent forgiveness to residential and commercial tenants who suffered financially as a result of Covid-19.

In Detroit, Bedrock, a developer and property owner created by billionaire Dan Gilbert, is offering free rent to more than 100 small businesses and restaurants from April to June. “Hopefully, they sense we’re in it to help them,” said Matt Cullen, chief executive of Bedrock. On Monday, Michigan ordered all non-essential businesses to close.

Smaller landlords who don’t have enough reserves to tide them through a prolonged pause in rent collection say they are in a precarious state.

Why is the landlord the first line in bailing them out?,” said Corey Bialow, a small property owner. He owns a stake in 12 properties in different states including New Jersey and Massachusetts. He said he will be on the hook for additional costs beyond mortgages such as real estate taxes, maintenance and insurance and will have to dip into his savings to pay for these. “I’m personally on the hook.”

Coyote Hole Ciderworks, a three-year-old cider producer in Lake Anna, Va., saw an 80% drop in revenue after it was forced to shutter most of its operations.

Coyote typically employs seven workers most of the year and fifteen or more in the summer. Now, just co-owner Laura Denkers and one employee remain on the payroll; Her husband, Chris, has stopped taking a salary so the company can continue paying health insurance premiums. The Denkers’ 10-year-old twin sons have cystic fibrosis, which makes keeping health coverage crucial.

The couple began applying for a $60,000 disaster loan from the SBA on March 20. They said all the information they put into the system was lost when the SBA revamped the disaster loan application process because of technical difficulties.

The small company has secured a 90-day reprieve on mortgage payments from its bank; Mr. Denkers plans to pay the minimum allowed on his corporate credit card and is trying to defer payments on equipment loans and other bills. “The next three weeks is the real crunch time when we need an influx of money,” he said.

Jodi Rodriguez, until recently director of retail and sales for Ovenly, a New York City-based wholesale and retail bakery that laid off all of its 72 employees, filed for unemployment March 18.

She wrote a letter to the landlord of the building she’s lived in for eleven years, asking for a temporary discount on the rent on her New York apartment. Ms. Rodriguez owns a rental property in Florida, but the tenant is a make-up artist who isn’t currently working. “I’m unsure whether she is going to pay or not,” Ms. Rodriquez.

“The hardest part right now is health insurance,” said Ms. Rodriguez, noting that coverage through Ovenly ends March 31.

Even businesses that have had gains are facing uncertainty. Ms. Douglas, the Boston liquor store owner, said in-store sales are up 130% over what she had budgeted, more than offsetting the collapse of her catering and event business. She’s keeping a close eye on cash flow and expenses, worried that she, her husband or one of their employees might get sick, that worker illnesses could disrupt her supply chain or that the state could order liquor stores to close.

Ms. Douglas is a member of a local business group in Boston’s South End neighborhood that recently surveyed more than 100 small firms. Most of the owners reported revenue is down by 90% or more in March, with monthly losses totaling about $8.5 million for the 72 businesses that provided specific figures.

“Every order we put in is nerve-wracking because we are so worried about getting stuck with product we can’t sell,” she added. “We are open today but that doesn’t mean we will be open next week.”

Covid-19 has exposed our financial fragility

An orgy of borrowing, speculation and euphoria has left the markets on the verge of catastrophe

Financial markets have experienced the fastest ever crash over the past few weeks. Even during the dotcom bust and the Lehman crisis, stocks did not fall this quickly. In less than a month, we have seen major indices fall almost 30%, and stocks in sectors such as oil and travel down by 80%. We are experiencing terrifying daily declines not seen since the 1929 stock market crash that preceded the Great Depression.

We are at a watershed moment: the coronavirus Covid-19 is a catalyst fast bringing many long simmering problems to the boil. It is exposing the creaking financial systems around us and it will change the way economies function. Economic and financial pundits, however, have been focusing almost exclusively on the short-term effects of coronavirus and so are missing the much bigger themes at play.

Epidemiologists tell us that when it comes to the virus, we are looking at a once in a century event. It is highly contagious and highly lethal. Experts are not comparing Covid-19 to SARS or Swine Flu, but to the Spanish influenza of 1918 that killed between 50 and 100 million people worldwide.

We do not have good data on what the stock market did during the 1918 flu, but we do know that it led to a severe recession. The connection between influenza and recessions is well documented. Going as far back as the Russian flu in 1889-90, the Spanish flu in 1918, the Asian flu in 1957-58 and the Hong Kong flu of 1968-69 — they all led to recessions. This one will be no different.

But this recession will not only be driven by the economic loss of able-bodied workers, it will be helped along too by the steps political leaders take to avoid the spread of the coronavirus. In medicine, the immune system’s response can often be worse than the disease. When the body goes into septic shock, the immune system overreacts, releasing what doctors refer to as a cytokine flood, which can reduce blood to vital organs and lead to death. Sepsis is common and kills more than 10 million people a year. Today, the political reaction to Covid-19 is causing something akin to a septic shock to the global economy.

The recession is likely to be very sharp and but brief. Recessions are self-regulating. De-stocking of shelves and warehouses leads to re-stocking. Collapsing low interest rates and oil prices eventually spur spending and borrowing. Government spending and central bank easing eventually feed through to the real economy. While there will be massive panic and bankruptcies today, there is little doubt that markets will be better in a year, and certainly will be in two to three years,

But the structural changes to how our economy operates, however, will be felt for decades to come. And this is in large part because we didn’t learn the lessons of the last crash.

Over the years since the 2008 crisis, central banks have been trying to stamp out every single small fire that flares up (the European crisis in 2011-12, the Chinese slowdown in 2015-16, the slowdown last year); but suppressing volatility and risk only creates bigger fires. Risk is like energy and cannot be destroyed. It can only be transformed.

Forest fires are a useful analogy. California has infrequent, devastating forest fires; the Mexican state of Baja California has many small frequent fires and almost no major catastrophic fires. Both states have a similar climate and vegetation, yet they have vastly different outcomes. That’s because when there are very few small fires, underbrush grows, vegetation increases and creates greater kindling for the next fire. Suppressing small risks only makes them emerge eventually as very big ones.

In politics and economics, massive change events tend to happen not in orderly sequences, but in sudden spasms, like the Arab Spring, or the collapse of the Eastern Bloc. Watching events unfold is often like watching sand grains pile slowly on top of one another until a final, random grain causes the entire pile to collapse. People knew the Arab countries were fragile and that the Eastern Bloc might eventually fall, but predicting which grain of sand would do it precipitate either was impossible.

Physicists call these transitions critical thresholds. Critical thresholds are everywhere in nature. Water at moderate temperatures is disorganised and free-flowing, yet at a given critical value, it has an abrupt transition to a solid. It’s the same with the sandpile: one grain too many can trigger collapse — but which one?

In 1987 Per Bak, Chao Tang, and Kurt Wiesenfeld found that while sandpiles may be individually unpredictable, they all behave the same way. The critical finding of their experiments was that the distribution of sand avalanches obeys a mathematical power law: The frequency of avalanches is inversely proportional to their size. Much like forest fires, the less frequent they are, the more catastrophic they are.

It’s the same with financial markets and the economy. We will experience years of quiet, interrupted by sudden avalanche. Years of slowly adding grains of sand can end abruptly — to our great surprise. Today in financial markets, many unsustainable trends have been building, and the coronavirus is merely the grain of sand that has tipped the sandpile.

It would be controversial to say that the stock market reaction to the coronavirus would not have been very big had we not been in the middle of an orgy of borrowing, speculation and euphoria. Of course, stocks would have fallen with coronavirus headlines, but it is unlikely they would have crashed the way they did without those exacerbating factors. Furthermore, without enormous underlying imbalances of high corporate debt, the prospect of poor sales would not have driven so many stocks to the verge of collapse.

This aspect of the current crisis has so far gone unreported. But not unmentioned. A few weeks before the crash, Charlie Munger, vice chairman of Berkshire Hathaway and Warren Buffett’s longtime business partner, issued a dire warning, “I think there are lots of troubles coming,” he said at the Los Angeles-based Daily Journal annual shareholders meeting. “There’s too much wretched excess.”

Speculative euphoria was at record highs. As Sir John Templeton once said, “Bull markets are born in pessimism, grow on skepticism, mature on optimism and die on euphoria.” Investors were all on the same side of the boat, and it capsized, as happens in market crashes.

  • Investors were buying a record amount of call options, or bets on stock prices rising further. According to SentimenTrader, by early February, “We’ve never seen this level of speculation before. Not even close.”
  • Asset managers were betting in record quantities on stock futures, which are instruments to bet on underlying indices. Positioning in S&P futures hit a new high as of February 11.
  • Hedge fund borrowing to buy stocks was at a 24-month high. They were highly confident markets would keep rising.


QF Research@ResearchQf

Asset Manager positioning in S&P futures hit a new high as of February 11 in both net contracts and value. S&P futures comprises the bulk of equity futures positioning by these funds.

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It was not a coincidence that there was such euphoria. Retail brokerages had announced over the past few months that they were eliminating all commissions on trading activity. Buying and selling stocks was suddenly “free”. It was like pouring truckloads of kerosene on a blaze. At Charles Schwab, daily average trading revenue exploded 74% after the change.

In scenes reminiscent of the dotcom boom, stocks were doubling overnight. Virgin Galactic Holdings, with no revenue, was worth over $6 billion dollars. Tesla, which has never made money selling cars, had a market capitalisation greater than any other car manufacturer. Its stock price quadrupled in less than three months. The market was so stretched that it would have crashed due to its own absurdity — with or without coronavirus.

The source of this “free” trading came from high frequency trading firms that are supposed to act as market makers, executing buys and sells for clients. Except that they are not really disinterested middlemen; they are running their own trading strategies to make money off retail investors. They execute the order flow of so called mom and pop investors and profit from these “dumb money” retail traders, in the words of Reuters.

The brokerages which sell retail orders receive hundreds of millions of dollars in return from the market makers. This means that, essentially the market makers are bribing the brokerages to profit from retail traders. For example, E*Trade received $188 million for selling its customer order flow last year, while TD Ameritrade made $135 million in the fourth quarter alone. The market makers are willing to pay so much because they almost never lose money — they trade fast and know where the market is going.

As Warren Buffet once said, “As they say in poker, ‘If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.’” Retail is the patsy.

Ken Griffin is the owner of Citadel Securities the biggest market-making firm, and his business is so profitable that he has gone on one of the greatest property buying sprees of all time. In 2015 Griffin paid $60 million for multiple condo units in Miami. He paid a U.S.-record $239.96 million penthouse in New York City, a $122 million mansion in London, and over $250 million in Palm Beach properties. Market making against “dumb money” is a fabulous business.

As the mania deflated in late February, though, mom and pop were abandoned. As the crash started, market makers pulled back and provided less liquidity. Retail investors were left high and dry. It is no wonder prices fell so quickly.

The high frequency market makers have since been pleading for more capital, and rumors swirl that many are experiencing financial difficulties. The illusion of benign market makers looking after retail investors has vanished.

There are echoes here of the old problems from the Lehman crisis; but they have mutated into different forms. During the Lehman crisis, mortgage bonds were pooled together, and insurance companies and pension funds bought them. Today, retail investors have been buying popular funds known as Exchange Traded Funds (ETFs). These are easy to trade and cheap, but they have a fundamental problem. While ETFs have simple tickers like HYG, JNK, LQD that the average retail broker can trade on their screen, they are really holding hundreds of individual bonds inside of them that the investor is unaware of. These bonds are not easy to trade at a moment’s notice and are highly illiquid. But while the ETFs rose slowly and steadily, and investors poured more money in, lulled by a false sense of security.

While the ETF shares trade daily by the second, the underlying bonds are not easy to trade on their own. In the old days, insurers and pension funds bought these bonds, put them away in a drawer and never traded them. Today, though, investors expect instant liquidity from an illiquid investment. Liquidity mismatches are as old as banking itself (deposits and cash are highly liquid, while mortgages and loans are often completely illiquid); the problems of ETFs have been known all along, and the outcome has been inevitable.

As the coronavirus panic spread, the ETFs started trading at big discounts to the underlying value of the baskets of bonds. Markets are broken, and the gap is a sign of how illiquid the underlying holdings really are.

But these ETFs should never have been allowed in the first place. In the words of Christopher Wood, an investment strategist at Jefferies, “they commoditise equity and bond investing in an insidious way which ultimately creates a dangerous illusion of liquidity. True, ETFs are cheap. But so is fast food.”

While ETFs may appear technical and unrelated to the broader problems in markets, they share the same underlying problem. We have had the illusion of safety and liquidity for some time, and it is the coronavirus that has exposed the gaping holes in financial markets.

The coronavirus won’t kill companies. But it will expose their bloated, overleveraged balance sheets. Corporate debt in companies has never been higher and has now reached a record 47% of GDP.

Rather than encouraging moderation, central bankers and policy makers have been reloading the all you can eat buffet and persuading everyone to come back for third and fourth plates. The European Central Bank and the Bank of Japan have been buying corporate bonds, and central banks have kept funding at zero rates, which has encouraged a massive increase in indebtedness over the past decade.

Central bankers have long promoted high corporate leverage because they see it as a way to stimulate demand. Even now, many economists see no problems on the horizon. In the New York Times, Nicolas Veron, a senior fellow at the Peterson Institute for International Economics in Washington, was openly mocking anyone advocating prudence, “The prophets of doom who thought that more debt was more risk have generally been wrong for the last 12 years.” Like most central bankers for the past decade, he argued, “More debt has enabled more growth, and even if you have a bit more volatility, it’s still net positive for the economy.”

But while debt has encouraged growth, it has also introduced much greater financial fragility, and so the growth is fundamentally unsound. We are now finding out that less debt, rather than lower rates is better for financial stability.


The global economy has gone mad


According to FactSet, 17% of the world’s 45,000 public companies haven’t generated enough cash to cover interest costs for at least the past three years. Debt has been used to finance more debt in a Ponzi fashion. The Bank for International Settlements looked at similar economic measures globally and found that the proportion of zombie companies — companies that earn too little even to make interest payments on their debt, and survive only by issuing new debt — is now higher than 12%, up from 4% in the mid 1990s.

Entire industries are zombies. The most indebted and bankruptcy prone industry has been the shale oil industry. In the last five years, over 200 oil producers filed for bankruptcy. We will see dozens if not hundreds more bankruptcies in the coming year. They were all moribund with oil at $50 dollars; they’re now guaranteed to go bust with oil at $30.

Only now, belatedly, are groups like the IMF waking up to the scale of the problem. In a recent report they warned that central banks have encouraged companies to pursue “financial risk-taking” and gorging on debt. “Corporate leverage can also amplify shocks, as corporate deleveraging could lead to depressed investment and higher unemployment, and corporate defaults could trigger losses and curb lending by banks,” the IMF wrote.

According to the IMF, a downturn only half as bad as 2008 would put $19 trillion of debt—nearly 40% of the corporate borrowing in major countries—at risk of default. The economic consequences would be horrific.

Corporate debt has doubled in the decade since the financial crisis, non-financial companies now owe a record $9.6 trillion in the United States. Globally, companies have issued $13 trillion in bonds. Much of the debt is Chinese, and their companies will struggle to repay any of it given the lockdown and the breakdown in supply chains.

We have not even begun to see the full extent of the corporate bond market meltdown. One little discussed problem is that a large proportion of the debt is “junk”, i.e. lowly rated. An astonishing $3.6 trillion in bonds are rated “BBB”, which is only one rating above junk. These borderline bonds account for 54% of investment-grade corporate bonds, up from 30% in 2008. When recessions happen, these will be downgraded and fall into junk category. Many funds that cannot own junk bonds will become forced sellers. We will see an absolute carnage of forced selling when the downgrades happen. Again, the illusion of safety and liquidity will be exposed by the coronavirus.

The average family is encouraged to save money for a rainy day, in case they are fired, or they face hardship. Saving some money is considered prudent. It’s quite different for business. Companies pocket the profits in the good years and ask Uncle Sam to bail them out in the bad years. Heads shareholders win, tails the taxpayer loses.

Industry can’t be blamed for not expecting an act of God or force majeure, but in the past 30 years we have seen two Gulf Wars, 9/11, SARS, MERS, Swine Flu, the Great Financial Crisis, etc. Saving for a rainy day should only be expected in cyclically sensitive industries.

But rather than do that, companies have been engaging in a rather more reckless strategy: borrowing to buyback shares. This may boost their Return on Equity (ROE), but it is not remotely prudent and makes their companies highly vulnerable. Borrowing to prop up their own shares means they have less on hand when hard times come.

According to Barons, “Stock buybacks within the S&P 500 index totaled an estimated $729 billion in 2019, down from a record $806 billion in 2018.”

And then along came coronavirus.

Of those industries that are now seeking a bailout, none has saved for a rainy day. Boeing, the poster boy of financial engineering and little real engineering, bought back over $100 billion worth of stock over the past few years. Today it is asking the government for a backstop to its borrowing.

According to Bloomberg, since 2010, the big US airlines have spent 96% of their free cash flow on stock buybacks. Today, they’re asking US taxpayers for $25 billion.

Airline CEOs have been handsomely paid while not saving for a rainy day. Delta Airline’s CEO Ed Bastian made the most, earning nearly $15 million in total compensation. American CEO Doug Parker $12 million, while United CEO Oscar Munoz earned total compensation last year of $10.5 million.


Corporate buyback culture is financial engineering not value creation


The cruise liners were little different. Over the past decade, Carnival Cruises paid $9.2 billion dollars in dividends to its billionaire owners and bought back $6.7 billion of shares. Royal Caribbean, which is a smaller company, paid out $2.7 billion in dividends and $1.6 billion in buybacks. And the smallest cruise liner Norwegian Cruise Line spent $1.3 billion on share buybacks.

For years, the cruise lines have triumphally proclaimed massive dividends and buybacks. For example, Carnival proudly announced in 2018. “In just three years, we have doubled our quarterly dividend and invested $3.5 billion in Carnival stock.”

Cruise lines have no real claim to any bailout. They pay no taxes due to a legal loophole, and all their vessels fly the flags of Liberia, Panama and the Marshall Islands. Furthermore, their owners tend to be billionaires with more than enough financial wherewithal to recapitalise their own businesses. Their shareholders are not among the 1%. They’re among the 0.01% of richest people in the world. In the worst-case scenario, the US has a highly efficient bankruptcy process. Bondholders of today become shareholders of tomorrow, and the companies can have a fresh start. Bondholders would only be more than happy to own the equity of these companies.

Banks, too, will inevitably be asking for bailouts before this is over. Banks have among the most aggressive stock buyback programs of any industry, with some repurchasing a staggering 10% of their outstanding shares annually. The eight biggest banks have announced they will suspend their share buybacks for the next two quarters due to the COVID-19 pandemic on the global economy. In 2019, the top eight banks bought back $108 billion of their own stock.

If any good can come of the current crisis, perhaps it is exposing the irresponsibility of share buybacks and lack of prudence of most companies.

Monetary policy was one of the mechanisms employed in response to the last crisis, in the hope its effects would trickle down to the unwashed masses. Central banks bought vast amounts of treasuries and mortgage bonds to tighten financial spreads for banks and borrowers, but none of it went directly to households. It was all intermediated by the financial system and those who had access to capital.

The absurdity of the policy was perfectly illustrated recently in Europe. The European Central Bank has been busy buying bonds, and recently it bought bonds from LVMH, the luxury conglomerate owned by the world’s richest man Bernard Jean Étienne Arnault. The bonds had a negative yield, meaning that the ECB was paying LVMH to borrow. LVMH used the ECBs money to buy Tiffany.

If rates are now so low that billionaires are being paid to borrow, monetary policy has reached the limits of its usefulness.

Investors own stocks because their bond portfolios have acted like a hedge. Whenever stocks have fallen, bonds have gone up. In every downturn since the 1980s, central banks have cut rates, but most government bonds now have close to zero yields.

Extremely low interest rates and high valuations mean that any small change in interest rates will make portfolios much more volatile. If interest rates were to rise even slightly, they would vaporise many bond and stock portfolios. The margin of safety in bonds and stocks has diminished rapidly as rates have approached zero.

The world is now upside down. Many investors now buy stocks for current income and buy bonds to trade given how volatile they have become. Things cannot hold.

What do high frequency market making, share buybacks and high corporate debt have in common? They are supposedly tools to make trading, growth and returns on capital more efficient and cheaper, yet they have made the system more fragile and less resilient. Perhaps returns on capital and cheapness of market orders and ETFs are less important than stability and anti-fragility, i.e. designing systems that are robust in the face of stress.

We have seen the fragility in supply chains in the recent crisis.When the coronavirus struck in China, suddenly companies everywhere found out that outsourcing all their manufacturing and even medicines and face masks to China might be a problem.

Manufacturing has become less robust, more fragile, even if the returns on capital are better for those companies that outsource everything to China in pursuit of share buybacks.

The lessons of history are instructive. Although planting a single, genetically uniform crop might be more efficient and increase yields in the short run, low genetic diversity increases the risk of losing it all if a new pest is introduced or rainfall levels drop.


Have we been played by China?


The Irish Potato Famine is one such cautionary tale of the danger of monocultures, or only growing one crop. The potato first arrived in Ireland in 1588, and by the 1800s, the Irish had used it to solve the problem of feeding a growing population. They planted the “lumper” potato variety. All of these potatoes were genetically identical to one another, and it was vulnerable to the pathogen Phytophthora infestans. Because Ireland was so dependent on the potato, one in eight Irish people died of starvation in three years during the Irish potato famine of the 1840s.

The lessons from nature are dire. In the 1920s, the Gros Michel banana was almost wiped out by a fungus known as Fusarium cubense, and banana shortages became a growing problem. The widespread planting of a single corn variety contributed to the loss of over a billion dollars worth of corn in 1970, when a fungus hit the US crop. In the 1980s, dependence upon a single type of grapevine root forced California grape growers to replant approximately two million acres of vines when the pest phylloxera attacked.

Today, China is manufacturing’s monoculture.

Against this dangerous backdrop of volatility and uncertainty, the coronavirus will now achieve the impossible. For the past few years, two ideas have floated around on the political fringes of the Left, but they have been dead on arrival. No one has seriously thought they might become government policy. Today, the Left and Right in the United States and Europe are embracing them.

Andrew Yang, a former tech executive from New York, ran a quixotic, obscure presidential campaign in the United States based on the idea that every citizen should receive a Universal Basic Income (UBI). He advocated a “Freedom Dividend”. This would be a form of universal basic income that would provide a monthly stipend of $1,000 for all Americans between the ages of 18 and 64.

Today, Trump, Pelosi, Romney and others are fully backing Yang’s idea. Respected think tanks such Brookings and Chatham House have advocated UBI. But once it is implemented, there will be no going back. Handouts will start small and grow.

The other big idea has come from Stephanie Kelton, who advised Bernie Sanders and advocates for Modern Monetary Theory (MMT). Kelton argues that in any country with its own currency, budget deficits don’t matter unless they cause inflation. The government can pay for what it needs by simply printing more money — no reason to borrow by issuing bonds. Helicopter money.


Could free cash fix the economy?


Her ideas were widely criticised across the Left and Right, ranging from Paul Krugman to Warren Buffett to Federal Reserve Chairman Jay Powell.

Yet today, the two ideas have come together. There are no atheists in foxholes. Even libertarians on Twitter are now calling for government intervention. Investors and politicians of all stripes are calling for UBI financed by MMT money issuing.

This is an epochal turning point, a great reset. The coronavirus is the grain of sand that will cause the avalanche.

For once the taboo of printing money to pay citizens is broken, we can never go back. Governments will spend money with few constraints, aided by central banks. It’s a strategy that has not worked well in emerging markets, and it did not work well in the 1970s — which has conveniently been forgotten.

Undoubtedly, the government must compensate citizens from mandatory curfews and quarantines. The short-term impacts of the lockdowns must be mitigated, but temporary policies must not become permanent political expedients.

That’s why the danger is not today or even a year from now, it’s five to ten years away, when the crisis has past, along with the reason for UBI and monetary easing. What politican will be disciplined enough to stop spending? What central banker will raise rates when it is unpopular to do so?

Today we are reaping the whirlwind of the last financial crisis. Rather than pursue lower leverage, less debt and more robust institutions and more responsible corporate behaviour, investors and companies instead learned that they would be bailed out in a crisis.

Central banks became enamored of their own success as fire fighters, and they have busily been trying to put out fires by

  • encouraging reckless behaviour,
  • prizing low volatility above a robust financial system,
  • viewing “risk management” as preferring no financial corrections ever.

They should accept that sometimes putting out every single fire creates greater conflagrations. They should be humbler about the extent and limits of their power.

It looks like they’re about to learn the hard way.

Will Central Bank Liquidity Be the Next Recession Catalyst? (w/ Danielle DiMartino Booth)

As 2018 drew to a close, global central bank liquidity flipped from net positive to net negative for the first time in a decade. Danielle DiMartino Booth joined Real Vision to explain her thesis that share buybacks have created positive momentum in US equity markets that until only recently have moved away from historically low volatility. The question is, can that volatility be contained as liquidity withdraws? Filmed on November 14, 2018 in New York.


DANIELLE DIMARTINO BOOTH: Hello, I am Danielle DiMartino Booth.
Happy to be back on Real Vision.
Since the last time I was on, I have founded a new company called Quill Intelligence.
We produce a daily newsletter called The Daily Feather and it’s already garnered a cult following.
Rolled out right after Memorial Day, and we are looking to truly launch a research revolution
that is based on my many years inside the Federal Reserve when I did research on behalf
of President Richard Fisher of the Dallas Fed that was unbiased and had absolutely no
agenda and wasn’t trying to sell anything.
And believe it or not, investors really enjoy that.
They appreciate that.
So how did we get here?
Well, it started on August 11, 1987, and unlike Jerome Powell, who had no days in office before
he was greeted with a crashing stock market, Alan Greenspan had a few months as chairman
of the Federal Reserve before he was greeted with the crash of 1987 when stocks fell 23%
in one day, which hasn’t been matched since then.
We might find out in the coming years what it feels like.
But in the days and the months that followed, Alan Greenspan did something extraordinary
that set up where we are today and where we’re headed.
He actually leaked information to bond trading desks ahead of Fed moves to inject liquidity
into the system.
This was fully sanctioned, and he had the New York markets– open markets desk as his
compadre to do this.
And that was when in the current era of monetary policy-making, moral hazard was introduced
into the system.
So following 1987, every other hiccup in the markets, whether it was the tequila crisis
in Mexico with the peso, whether it was the Orange County bankruptcy, a few years later,
we had long-term capital management blow up– famously, obviously, Jimmy Cayne refused to
write the check to bail out that big academic run hedge fund– but every single time there
was a liquidity event in the markets, the Fed would come riding to the rescue.
So fast forward, I’m going to bring Jay Powell back into this discussion.
Fast forward to the fall of 2012, what did we learn on January 5, 2018.
Well, we had the transcripts released.
We actually got to hear Jay Powell in Jay Powell’s words– because he’s a very quiet
man– we got to hear what Jay Powell thought about this era of unprecedented moral hazard
and how it had woven its way into investors’ psyches.
And he basically said, I’m reluctant to vote for this final round of quantitative easing.
It has become habitforming to investors, and by all appearances, we are blowing a fixed
income duration bubble across the credit spectrum.
I just got goose bumps, because look at where we are today.
Look at where risk lies today.
But the point is, every single time the Fed had to pull out extraordinary measures, it
had to pull them out for longer than the prior episode.
When the internet bubble crashed in 2000, we had to take interest rates even lower.
We had to keep them even lower for a more protracted period of time.
And that served to blow the housing bubble up.
Obviously, there were many other players, credit rating agencies, investment banks,
crooked mortgage brokers, delusional home buyers, but the Fed was right there keeping
money cheap, lower for longer.
In the current episode, call it the past decade, we took one step beyond– one step further
into the abyss of this grand experiment by keeping money lower for longer and engaging
in quantitative easing.
There’s a name for it.
It was designed in 2007.
It’s called the Bernanke Doctrine.
But Bernanke took a few people into a quiet room in Jackson Hole, a few of his closest
advisors– which is questionable on an ethical level itself– and they laid out the fact
that the Fed would have to get to the zero bound first– that was a critical step one–
before it could then launch into quantitative easing.
It was designed in private, and the game plan was laid out for what was to come.
So what is quantitative easing, and how does the current era of lower for longer differ
from its prior episodes.
So we haven’t– I still have pronoun challenges as a former Fed insider– how did the Fed
conceive quantitative easing?
They basically wanted to synthetically produce interest rates that were lower than what they
could get them to on a numeric level, the zero bound as we called it.
So in order to do that, they decided to go out into the open market and purchase securities.
In fact, inside the Fed, they never called it quantitative easing.
They called it large-scale asset purchases, because that’s what people inside the Fed.
Do they put big fancy labels on things so that people are confused and don’t know what
the hell they’re doing.
So these large-scale purchases were rolled out slowly, one wave after another.
It started with the United States.
It started with Ben Bernanke, but it was as contagious as the clap.
I mean, it went global.
It went viral.
It went everywhere.
And eventually, we had obviously the Bank of Japan.
We had the Bank of England.
We had the European Central Bank.
We had the People’s Bank of China.
One of the biggest quantitative easing programs in existence was very quietly undertaken in
So at the end of 2018, at the end of this year, which is very close to us, for the first
time in a decade, we will go net negative.
We will flip on a global basis to quantitative tightening.
To explain the– to explain how dramatic this is consider the furor of the Federal Reserve
letting Lehman Brothers fail and within the blink of an eye rescuing AIG, $85 billion
By the end of 2017, global quantitative easing was running at a $2.12 trillion annual run
It was as if we were bailing out AIG every single month and then some.
And then started 2018.
By October, the European Central Bank had tapered its purchase program, its QE program.
It had tapered it down to 15 billion euros per month.
On December 31, excuse me, that goes away.
January 1, 2019, the European Central Bank will stop expanding the size of its balance
sheet, and globally, we will for the first time, once again, go net negative on liquidity.
And the implications have already been– they’ve already been gleaned by the markets, right.
Deutsche Bank has already observed that 89% of asset classes worldwide are– they’re sporting
negative returns for 2018.
You can’t make this stuff up.
So the world has already figured out what negative liquidity feels like, what the drought
could feel like.
US equity investors maybe not so much.
We’ve had something else going on here in this country this year called share buybacks.
So what differentiates the United States from the R.O.W.– from the rest of the world.
Why has it been so awesome to be a US stock investor in 2018.
Well, I’m afraid I’m going to be a broken record here, because it is one word– and,
boy, does this get– it just gets people so mad.
Because they want to talk about fundamentals and earnings, and in a monopoly society
, mind
you, we have just a few great big companies that are making everything and collecting
all the profits.
I digress.
But what makes the United States the place to be, the it girl for investors?
It’s liquidity.
Liquidity is global.
Liquidity is fungible.
Liquidity is agnostic.
But liquidity also has a home or had a home here in the United States in 2018.
The tax bill that was rolled out, according to JP Morgan, brought an additional $300 billion
in share buyback power into the equity markets.
That’s on top of last year’s $550 billion or so.
So estimates suggests that we’ll get to the $850 billion dollar mark by the end of this
Maybe GEs buybacks don’t have the same bang that they once did.
Maybe apples don’t either.
That might be heresy.
But the fact is, we had something the rest of the world didn’t, and we benefited greatly
from it.
Because the mother’s milk of markets was still flowing through the United States in 2018,
unlike our international counterparts.
So that’s what made this one heck of a year.
So here we sit at the precipice of what we believe to be the next rate hike at the Fed’s
December meeting.
We’re looking to go to 2.5% on the Fed funds rate.
But we know from what Jay Powell has told us that that is still three rate hikes shy
of what he considers to be neutral– a neutral fed funds rate where that it’s the Goldilocks
Where the economy is not overheating or slowing down, he considers to be 3%.
Unfortunately, his predecessor, Janet Yellen, is on record as having implemented the slowest,
most prolonged, most painstakingly painful tightening in US history under her leadership.
In other words, Janet left Jay with a lot of work to be done with not so much time,
as the economy was heading into, as we know, June 2019 will mark the longest expansion
in US history.
It’s really hard to tighten into an expansion that’s lasted as long as it has, but that’s
exactly what Jay Powell inherited.
It was interesting that most in the media when Jay Powell’s name was rolled out said
he’s a Yellen clone.
This is it.
We’re in good shape.
This guy is going to be our next best friend.
He’s the market’s BFF.
And what did Jay Powell say after his first day in office when the Dow was down by four
Let me think.
He said nothing.
And what did he say at the end of February as the risk parity trade unraveled in bloody
I’ll borrow from another Real Vision guest, Christopher Cole, Artemis Capital out of Austin,
Texas, good friend.
And the way he explains it is very simple.
The world was basically betting– there was a crowded trade that was betting that volatility
would never rear its ugly head approximately forever.
So into this comes the beginning of the liquidity withdrawal, which the markets didn’t like
one bit.

Into this steps somebody who’s not a Yellen clone who’s going to tighten monetary policy,
who’s going to be tougher, who’s not going to say a peep when markets get upset.
So what we saw was the resurrection of the long dead volatility in the month of February.
And this is typically how cycles end, by the way.
It’s just– they’ve never been this protracted.
We’ve never had a year on record like we had in 2017 when the VIX, the Volatility Index
on the Standard and Poor’s 500, when the VIX was south of 10 for 50 some odd days in 2017
wiping, I mean, any other year in history– there’d been one or two or three days, but
the VIX was south of 10.
And it was always assigned to run for the exits, but not in 2017– not when you have
$2.12 trillion of quantitative easing flowing through the capital markets worldwide, which
creates this great reflation trade.

When only one country’s manufacturing sector was contracting– that was South Africa–
the rest of the world was booming, floating on the sea of liquidity.
Again, once that became– once that started to be extracted from the markets come February,
once Jay Powell said a whole lot of nothing in reaction to the stock market’s hissy fit,
then people got really upset.
You ended up having an exchange traded fund shut down that was based on this short volatility
The stock market felt that the worst had come to past.
An exchange traded fund, ironically enough, named XIV, the opposite of the VIX had to
shut down.
So was this the reserve, breaking the buck, money fund moment after Lehman fell.
Could we all breathe a sigh of relief and walk away and say, boy, thank god February’s
only 28 months.
Can we get back to the market going up again?
Please and thank you.
Well, companies got back to the business of buying back their shares, and the tax bill
was passed.
And you have this gigantic surge of fiscal stimulus and liquidity going into this economy.
What could possibly go wrong?
Well, not a whole heck of a lot– not until the liquidity once again started to run dry.
What happened on October the 1st?
What two things happened on October the 1st– actually, October the 5th?
October the 1st, the ECB reduced its taper to $15 billion a month from 30.
So one more– one more whisk away of liquidity.
On October the 5th, according to Goldman Sachs, 86% percent of companies in the S&P 500 were
in buyout blackout.
It was too close to earnings.
It was this two week period around when companies report earnings that they typically are not
in the market buying back their shares.
So this double whammy of this liquidity being pulled out of the markets, lo and behold,
set off– I won’t use that word storm– in the markets.
There was a big sell off.
It was not related to being short volatility.
However, there’s something called the smart money flows index.
And it basically gauges– you can look it up on your Bloomberg SMFI Go.
It basically gauges institutional investors who trade in the first 30 minutes and the
last 30 minutes of trading every day.
We all know that the last hour of trading the stock market is the most important.
Well, this index peaked in January.
And after this unwind of this risk parity, short volatility, trade happened.
A lot of people came running back into the market, especially corporate America.
The smart money stayed out.
Smart money was at the lowest level since 1996 in October.
It never came back.
It never put its trust back into what it was looking at.
And lo and behold, it was not the unwind of a trade in October.
It was managers selling their biggest holdings.
It was managers taking their profits.
There are moments in every cycle.
I remember in 1999 some sell side strategist analysts came out and said price line’s going
to $1,000, baby.
And these moments stick in your mind.
And every day when you’re turning on bubble vision and they’ve got a little countdown
to a trillion dollars for Apple or Amazon, that was kind of my moment.
That was my moment in the current cycle.
And sure enough, Amazon managed to trim $200 billion of market capitalization off in the space of a few days, because it disappointed on its earnings.
And what we saw in October was the beginning of the end da, da, da of the passive investing trend in this country.
I’ll share something on a personal investing level.
When you spend nearly a decade inside the Federal Reserve, you get a little bit freaked
out about how the sausage is made.
You get a little bitter about basically monkeying with price discovery, unfettered price discovery.
I was raised as a young whippersnapper on a trading floor up here in New York, and I
learned about bid, ask, spread, price discovery.
That was how the world was supposed to work.
Don’t fight the Fed is the antithesis of price discovery.
Don’t fight the Fed has turned into a passive investing revolution, this great renaissance
where investors can pat themselves on the shoulder and they can say, wow, I am paying
0.25%. Look at my low fees.
Well, what October taught investors, passive investors was that momentum that is awesome–
I mean, great, momentum is wonderful– when these huge market capitalization stocks are
going up, the fangs.
But it works the same way in reverse.
So at Quill, we ran a little analysis that showed that the S&P 500 was down 10%, and
then these mega caps were down 12% in October.
So I think the rude awakening that so many investors have– 45% of equity funds right
now are in some passive strategy.
So let’s say almost half of US equity investors have a rude awakening, because they’re going
to find out that you can actually lose more in capital than you save in fees.
And they’re not going to like it.
They’re not going to like it one bit.
But that is what don’t fight the Fed fostered.
There was no reason to study a company’s fundamentals, as long as liquidity was flowing through the
All you had to do was buy the market, whatever that market was.
And it ended up feeding into a lot of the unintended consequences that we have.
The fact that you have the death of innovation in America– if you’re a big company and you’re
doing well, you used to stick around for your own initial public offering.
That’s no longer the case.
And it ties back to don’t fight the Fed.
If I’ve got a trillion dollar market cap and I see any form of competition in front of
me, what do I do?
I just buy it and get bigger, because you know what?
I can bet the farm.
I can use– just like Americans use their home equity to cash out during the housing
boom years, corporations can use their stock equity right now.
It’s fat.
It’s happy.
It’s expensive.
But they use that.
They’re borrowing against their net worth effectively to buy any competition that gets in their way.
And then we wonder why the people in the beltway in Washington DC are all a twitter.
Well, maybe somebody should have reined in the Fed and made them stop this lunacy a long
time ago before we had actual macroeconomic consequences that are going to take down the
baby boomers, by the way.
So where is the economy headed in 2019?
So my good friend, David Rosenberg, he was one of the few people to along with me get
derided in 2005 for calling the housing bubble what it was.
I learned something as we’ve become friends over the years, and that is that there’s one
critical sector that flags a slowing economy and that is housing.
Housing leads economies into recession.
Housing leads economies into recovery.
So the beauty of housing is it’s unbroken.
It leads economies into recoveries.
It leads economies into recession.
It’s got a nice sidekick called autos, and it is another uber cyclical industry that
also flags when we’re getting to turning points, when we’re getting to economic inflection
points. And what we know is that the delta matters.
The change matters.
I get a kick out of a lot of the punditry that says, you know what?
Back in 1981, and I only had a 16% mortgage.
And I just get a kick out of them, because I just– I sit there at the television making
a triangle sign going it’s the delta, you moron.
It’s the starting point that matters.
It’s the fact that mortgages were 3%, and now they’re over 5%.
The tightening that the Fed has undertaken is starting to bite.
Starting points matter, especially when it comes to housing, especially when it comes
to anything cyclical.
So if you start off with a 3% handle on the mortgage and you end up with this 200 basis
point move that we’ve seen and now we’ve got mortgage rates that are at seven year highs
and they’re north of 5% for 30 year– 30 year conforming mortgages, it makes a huge difference.
Housing prices have been going up very fast– had, I need to use my verbs correctly.
Housing prices had been going up.
All of the increase in average monthly mortgage payments in 2017 was due to home price appreciation–
homes becoming prohibitively expensive, intuitive enough.
In 2018, it has been a pure mortgage rate story.
If you can imagine, as low as mortgage rates are today, the average monthly mortgage payment has increased by 20% this year.
That is enough to stop a housing market in its tracks, and that’s exactly what it’s done.
The danger that I see– the real danger that I see that the game changer that housing can
be is if we have sustained declines in stocks, if this takes the wind out of the baby boomer
generation, if their IRAs and 401Ks are depleted– and God knows what’s going to happen to their
bond holdings, which they should be watching much more closely– if this happens, there
is a logical place that baby boomers are going to turn to look for liquidity.
It’s like the L word.
I just– I carry the liquidity banner everywhere I go.
Baby boomers will look for liquidity.
And if there’s one message I’d like to convey, it’s that hollowing out an entire generation
of first time homebuyers, the millennials putting off setting up house and home for
a decade is going to have real true ramifications for the boomers.
They’re going to look to sell their homes, and they’re going to realize that there is
a yawning gap, a vacuum underneath them.
Because the first time homebuyer a millennial who should have bought their first home 10 years ago and didn’t and waited 10 years, they’re in their first home now.
They’re not doing what they were supposed to have done.
They’re not moving up to their middle home in the buying cycle of life.
They’re not moving up to that move up.
And who is going to buy baby boomers homes?
It’s the move up crowd that can afford to trade up to the McMansion.
But they’re not there.
They’re absent.
So as badly as baby boomers are going to need the liquidity from that home equity that they
have to fund their retirement, it’s not going to be there.
We’re going to see more dramatic home price declines than anybody’s anticipating, because
of this demographic divide.
Thank you, Federal Reserve.
I think investors have been engaging signposts in trying to figure out which direction the
wind is blowing.
I think investors have had their eye on the wrong target.
They’ve been watching stock market volatility.
They’ve had their eagle eye trained on the VIX index.
I’m not watching the VIX index.
I’m not.
Because nothing becomes unglued– or as Chris Cole explained to me, February was just a
flirtation with the unwind of this massive risk parity trade.
We don’t find out what unhinged looks like until we see volatility in the bond market.
That is where the gogo juice is.
If you’re not following the MOVE index, put it on your radar– M-O-V-E.
Get rid of the VIX, follow the move.
Because it’s the credit markets where damage can truly be done.
Going into the last crisis, we had $170 trillion of debt globally.
Today, we have over $250 trillion of debt.
A lot of it’s toxic.
I am watching more closely than anything.
I’ve done more writing over the past year.
I was in front of the Wall Street Journal.
I was in front of Bloomberg.
Even though I write for Bloomberg, I was in front of everybody in writing about triple
B rated investment grade bonds.
You must put investment grade in quotes.
That is what I’m following the most closely.
General Electric, I will remind you, was a triple B rated company.
Its bonds traded like junk.
This is the sector that has grown to be a $3 billion monster– $3 billion.
Think about that.
Where’s the parallel?
Oh, I don’t know.
Subprime mortgages circa 2007 peaked out at $3.2 trillion dollars.
The triple B segment of the investment grade bond market is now $3 trillion.
It is larger than every other investment grade rated bond combined.
Morgan Stanley did a recent analysis.
I’ve gotta agree with it.
They think that we will see a third– a third of this $3 trillion downgraded.
They call them fallen angels.
And I think we will see angels falling from the firmament in this next downturn, because credit rating agencies have actually done something remarkably similar to what they
did during the last run up, during the last credit boom.
Their analysts, believe it or not– I mean, I hate to convey such shock– but their analysts
have been strong armed by management that’s paid by the companies they rate to maintain
their investment grade ratings.
Because if they’re not maintained, then big institutions fiduciarily cannot hold these
And so they have bent.
And who will pay?
That would be grandma and grandpa, because their local neighborhood broker has told them that it is an investment grade bond fund and you’re going to be just fine.
There is something worse.
There is the leverage loan market, and this came right out of the mouth of one of the
high yield strategists at a credit rating from a few years ago.
Remember, this the next time somebody tells you about the virtues of leverage loans in
a rising rate environment, again, capital losses– capital losses.
Leverage loans are basically issued by companies that cannot access the junk bond market. They are junkier than junk.
So what do they do?
They go off to their friendly neighborhood investment banker, and they syndicate a big
junkie loan.
That market is bigger than the high yield bond market.
That’s another benchmark that we’ve seen in 2018.
Follow leverage loans.
Follow investment grade.
There’s a reason investment grade has been so much bloodier than high yield.
It’s with good reason.
So if you don’t have an account at Merrill Lynch, let’s say, maybe you should get one.
Open a money market fund.
Get access to weekly fund flow reports, because they tend to be– the first signal that you’ll
ee is funds flowing in and out of any given asset class.
And they’re what I follow the most closely to see where investment grade, where any asset class for that matter is headed.
I think the most difficult question to answer in today’s environment is where do you put your money?
How do you protect yourself?
Again, this is a vestige of being a Fed insider for as long as I would– excuse me, for as
long as I was– and what we learn in downturns is the hard lessons of correlations.
And unfortunately, asset classes tend to move in tandem when price discovery has been eradicated, when central banks prolong the business cycle artificially.
So there really are so few places to hide, but I may as well share where I’m hiding.
I have a lot of money in cash.
It pays a lot these days.
It actually pays more than inflation, so that’s technically a lot.
And it’s an option for the first time.
In my investing career, cash is an option for the first time.
And believe it or not, I own a lot of short dated municipal bonds.
I like to say that there is no such thing as a Prexit.
We weren’t able to get rid of Puerto Rico.
It was against the Constitution.
But by the same token, we have a lot, a lot of states and municipalities that will have–
they’ve got growing mushroom clouds over them, Chicago, Illinois, New Jersey, California.
We will have municipal bonds that go belly up, and we will have serious pension crises
in the years to come.
But that being said, there are a lot of well-run states and municipalities.
So I have found myself a great manager who doesn’t buy funds at all.
Individual bonds that you do your true due diligence on– it’s one of the last standing
asset classes where you can truly do your homework and find out if you are going to
get paid back your principal.
Capital losses, preserve your money.
So I’m in very few places.
I own a gold fund.
Because if we’ve learned one thing from lower for longer and from overly intrusive central
banks, it’s that there’s exactly one asset class on planet Earth that is negatively correlated
to pretty much everything else when the peanut butter hits the fan.
And that’s gold.
Am I a gold bug?
Are we going back on the gold standard?
No, we’re not.
It’s not practical.
But that being said, if you want to hedge your portfolio, it’s a really good place to
But if there’s one irony I will leave you with, it’s Janet Yellen.
This is a woman who said that we’ll never have another financial crisis in our lifetimes.
She attributes this to the fact that the banking system in the United States is cleaner than
it once was, recapitalized, kumbaya, cue the birds and the butterflies.
Just have them fly on screen.
Does anybody– can somebody tell her where the capital markets are?
Can somebody tell her where the growth has happened?
And once she appreciates that and the fact that under her leadership the Fed prolonged
an economic cycle beyond where it should have been and prevented companies from defaulting
that should have defaulted, that her second statement that this is going to be a plain
vanilla, shallow, not bad recession, it’s just going to be another walk in the park
what we have coming up.
Well, we’ve got to clean up the last cycle, which we never did clean up because QE prevented
And we’ve got to do the next cycle that’s even bigger.
So will it be plain vanilla?
Will it be short and shallow?
I don’t think so.
But I am happy that Janet Yellen is on the record saying that we would have a kind recession,
and that we would never have another financial crisis.

Fed Intervenes With $45.55 Billion Weekend Repo, But Overall Liquidity Ticks Down

The Federal Reserve Bank of New York executed a $45.55 billion weekend liquidity operation Friday, which resulted in led overall temporary central bank liquidity to tick lower.

The Fed added the money to financial markets via what’s called a repurchase agreement operation, or repo, that expires on Monday. It took in $28.2 billion in Treasurys, $1 billion in agencies and $16.35 billion in mortgage bonds from eligible banks, known as primary dealers.

With $48.78 billion in outstanding repos maturing Friday, overall temporary liquidity provided by the Fed via repo transactions ebbed $3.2 billion to $170.5 billion.

Fed repo interventions take in Treasurys, agency and mortgage bonds from the dealers, in what is effectively a short-term loan of central-bank cash, collateralized by the bonds. Primary dealers are limited in the amount of liquidity they can take in exchange for their securities, and they pay interest to the central bank to get the funds.

The Repo Market, Explained
The repo market shook the financial world in September when an unexpected rate spike choked short-term lending, spurring the Federal Reserve to intervene. WSJ explains how this critical, but murky part of the financial system works, and why some banks say the crunch could have been prevented. Illustration: Jacob Reynolds for The Wall Street Journal

Fed money-market interventions are aimed at keeping the federal-funds rate within the central bank’s 1.5%-to-1.75% target range. The interventions also limit but not eliminate the volatility in other money-market rates. The Fed controls the fed-funds rate to influence the overall cost of borrowing in the U.S. economy as part of its efforts to achieve the job and inflation goals set for it by Congress.

Facebook’s Libra Must Be Stopped

After years of disregarding privacy, exploiting user data, and failing to control its platform, Facebook has now unveiled a cryptocurrency and payment system that could take down the entire global economy. Governments must intervene before a company that “moves fast and breaks things” ends up breaking everything.

NEW YORK – Facebook has just unveiled its latest bid for world domination: Libra, a cryptocurrency designed to function as private money anywhere on the planet. In preparing the venture, Facebook CEO Mark Zuckerberg has been in negotiations with central banks, regulators, and 27 partner companies, each of which will contribute at least $10 million. For fear of raising safety concerns, Facebook has avoided working directly with any commercial banks.
Zuckerberg seems to understand that technological innovation alone will not ensure Libra’s success. He also needs a commitment from governments to enforce the web of contractual relations underpinning the currency, and to endorse the use of their own currencies as collateral. Should Libra ever face a run, central banks would be obliged to provide liquidity.

The question is whether governments understand the risks to financial stability that such a system would entail. The idea of a private, frictionless payment system with 2.6 billion active users may sound attractive. But as every banker and monetary policymaker knows, payment systems require a level of liquidity backstopping that no private entity can provide.

Unlike states, private parties must operate within their means, and cannot unilaterally impose financial obligations on others as needed. That means they cannot rescue themselves; they must be bailed out by states, or be permitted to fail. Moreover, even when it comes to states, currency pegs offer only an illusion of safety. Plenty of countries have had to break such pegs, always while insisting that “this time is different.”

What sets Facebook apart from other issuers of “private money” is its size, global reach, and willingness to “move fast and break things.” It is easy to imagine a scenario in which rescuing Libra could require more liquidity than any one state could provide. Recall Ireland after the 2008 financial crisis. When the government announced that it would assume the private banking sector’s liabilities, the country plunged into a sovereign debt crisis. Next to a behemoth like Facebook, many nation-states could end up looking a lot like Ireland.

Facebook is barreling ahead as if Libra was just another private enterprise. But like many other financial intermediaries before it, the company is promising something that it cannot possibly deliver on its own: the protection of the currency’s value. Libra, we are told, will be pegged to a basket of currencies (fiat money issued by governments), and convertible on demand and at any cost. But this guarantee rests on an illusion, because neither Facebook nor any other private party involved will have access to unlimited stores of the pegged currencies.

To understand what happens when regulators sit on their hands while financial innovators create put options, consider the debacle with money market funds in September 2008. Investors in MMFs were promised that they could treat their holdings like a bank account, meaning they could withdraw as much money as they put in whenever they wanted. But when Lehman Brothers collapsed, MMF investors all tried to cash out at the same time, whereupon it became clear that many funds could not deliver. To forestall a widespread run on all MMFs and the banks that backed them, the US Federal Reserve stepped in to offer liquidity support. A run on Libra would require support on a much larger scale, as well as close coordination among all central banks affected by it.

Given these massive risks, governments must step in and stop Libra before it launches next year. Otherwise, as Maxine Waters, the Chairwoman of the US House Committee on Financial Services, has warned, governments may as well start drafting their own living wills. In the parlance of finance and banking, a “living will” is a written plan that banks provide to regulators describing how they will unwind themselves in the event of insolvency. In the case of a government, a living will would have to explain how the relevant authorities would respond to Libra breaking its peg and triggering a global run.

Obviously, this raises a number of pertinent questions. Would governments vow, like former Fed chairman Ben Bernanke in September 2008, followed by European Central Bank President Mario Draghi in July 2012, to do “whatever it takes” to ensure the currency’s survival? Would they even have the capacity to do so, let alone coordinate their actions – and share losses – with all the other countries involved? Would governments be able to seize control of the system if it proves incapable of sustaining itself?

Silence in response to Facebook’s announcement this week is tantamount to endorsing its dangerous new venture. Governments must not allow private, profit-seeking parties to put the entire global financial system at risk. If banks are “too big to fail,” then states definitely are. If governments fail to protect us from Facebook’s latest act of hubris, we will all pay the price for it.

Trump May Kill the Global Recovery

In a sharp departure from this time last year, the global economy is now being buffeted by growing concerns over US President Donald Trump’s trade war, fragile emerging markets, a slowdown in Europe, and other risks. It is safe to say that the period of low volatility and synchronized global growth is behind us.

.. In 2017, the world economy was undergoing a synchronized expansion, with growth accelerating in both advanced economies and emerging markets. Moreover, despite stronger growth, inflation was tame – if not falling – even in economies like the United States, where goods and labor markets were tightening.
.. Stronger growth with inflation still below target allowed unconventional monetary policies either to remain in full force, as in the eurozone and Japan, or to be rolled back very gradually
.. Markets gave US President Donald Trump the benefit of the doubt during his first year in office; and investors celebrated his tax cuts and deregulatory policies. Many commentators even argued that the decade of the “new mediocre” and “secular stagnation” was giving way to a new “goldilocks” phase of steady, stronger growth.
.. Though the world economy is still experiencing a lukewarm expansion, growth is no longer synchronized. Economic growth in the eurozone, the United Kingdom, Japan, and a number of fragile emerging markets is slowing.
.. while the US and Chinese economies are still expanding, the former is being driven by unsustainable fiscal stimulus.
..with the US economy near full employment, fiscal-stimulus policies, together with rising oil and commodity prices, are stoking domestic inflation.
.. the US Federal Reserve must raise interest rates faster than expected, while also unwinding its balance sheet.
.. the prospect of higher inflation has led even the European Central Bank to consider gradually ending unconventional monetary policies, implying less monetary accommodation at the global level. The combination of a stronger dollar, higher interest rates, and less liquidity does not bode well for emerging markets.
..  Despite strong corporate earnings – which have been goosed by the US tax cuts – US and global equity markets have drifted sideways in recent months.
.. The danger now is that a negative feedback loop between economies and markets will take hold. The slowdown in some economies could lead to even tighter financial conditions in equity, bond, and credit markets, which could further limit growth.
.. Since 2010, economic slowdowns, risk-off episodes, and market corrections have heightened the risks of stag-deflation (slow growth and low inflation); but major central banks came to the rescue with unconventional monetary policies as both growth and inflation were falling.
.. These risks include the negative supply shock that could come from a trade war; higher oil prices, owing to politically motivated supply constraints; and inflationary domestic policies in the US.
.. this time the Fed and other central banks are starting or continuing to tighten monetary policies, and, with inflation rising, cannot come to the markets’ rescue this time.
Another big difference in 2018 is that Trump’s policies are creating further uncertainty. In addition to
  • launching a trade war, Trump is also
  • actively undermining the global economic and geostrategic order that the US created after World War II.

.. the Trump administration’s modest growth-boosting policies are already behind us, the effects of policies that could hamper growth have yet to be fully felt. Trump’s favored fiscal and trade policies will crowd out private investment, reduce foreign direct investment in the US, and produce larger external deficits.

  • His draconian  will diminish the supply of labor needed to support an aging society.
  • His environmental policies will make it harder for the US to compete in the green economy of the future.
  • And his bullying of the private sector will make firms hesitant to hire or invest in the US.

.. Even if the US economy exceeds potential growth over the next year, the effects of fiscal stimulus will fade by the second half of 2019, and the Fed will overshoot its long-term equilibrium policy rate as it tries to control inflation; thus,

achieving a soft landing will become harder.

.. By then, and with protectionism rising, frothy global markets will probably have become even bumpier, owing to the serious risk of a growth stall – or even a downturn – in 2020.

.. With the era of low volatility now behind us, it would seem that the current risk-off era is here to stay.