The Special Purpose Acquisition Company, or SPAC for short, had a supernova kind of year in 2020.

The after-effects could be felt, in a bullish way, well into 2021, as hundreds of billions of dollars’ worth of SPAC-driven merger and acquisition (M&A) activity waits to be unleashed.

In 2020, the total amount of capital flowing into SPAC deals smashed all previous records, besting the prior record year (which was 2019) by nearly 10-to-1.

Alternately known as “Blank-Check Deals” or “Backwards IPOs,” the SPAC, as an investment vehicle, has a comparable feel to the joint-stock offerings of the 1720 South Seas bubble.

In 1720, the year that a speculative frenzy surrounded the South Sea Company, there was so much investor froth and fervor afoot that fly-by-night operations sprang up left and right to take advantage, offering a wide array of exotic and bizarre schemes.

The SPAC has two basic forms, with a different nickname for each.

As a “Blank-Check Deal,” the SPAC is a way to raise money for an unknown acquisition target.

In this manner, investors give the SPAC manager carte blanche to buy something, typically within the next two years, and fund the SPAC with hundreds of millions of dollars (or billions of dollars) to do so.

One could call it pig-in-a-poke investing, except the poke has no pig in it. There is nothing there until an acquisition is made. The idea is that the SPAC manager is wise enough, or experienced or connected enough, to make a deal that investors will make money on.

The second form of SPAC, “the backwards IPO,” is a means of going public without really going public.

When a young company (or even a brand new company) comes to the market via SPAC, they skip the normal initial public offering (IPO) process.

Instead of going public the hard way (with an IPO), to do a SPAC, the hot new company does a reverse merger with a sleepy public company that is already exchange-listed, and takes over the existing listing before changing the symbol and the name.

Going public through the SPAC route has multiple advantages:

• It is often faster than a typical IPO process.
• It can generate huge (yet opaque) profits for the SPAC manager.
• It lets the company sidestep rigorous IPO disclosures.

But there is another loophole advantage for SPACs that is larger than all other advantages combined.

It is such a jaw-dropping loophole, in fact, one wonders why the Securities and Exchange Commission (SEC) has allowed it to exist.

With an IPO, there is a strict “quiet period” prior to the official launch. Also with an IPO, corporate executives are not allowed to talk up future prospects of the company in an unproven way.

You aren’t allowed to aggressively “hype” an IPO, in other words. There are limits on what company executives can say and do. For the most part, respectable Wall Street analysts are supposed to make the sales pitch for them, with a rigorous prospectus outlining the risks.

With the SPAC, there is none of that. If you are doing a SPAC, you can say whatever you want.

You can make wild future projections about revenue years into the future, go on hundreds of YouTube channels, podcasts, and investor message boards, and hype to your heart’s content. 

The “hype free-for-all” angle, in our view — meaning the ability to promote with abandon, and no holds barred — is probably the biggest reason that SPACs exploded in popularity in 2020. Here are a few examples of what we mean:

• Fisker, an electric vehicle (EV) company in the mold of Tesla, did a SPAC worth $3 billion. In raising the funds, the founder projected $13 billion revenue by 2025 (up from zero in 2020), as based on reservations for a vehicle it plans to sell in 2022 (which doesn’t exist yet).

• Chamath Palihapitiya, a noted and outspoken venture capitalist, aggressively pitched a SPAC acquisition of Opendoor, a robo-buyer of homes sight unseen. In a CNBC appearance, Palihapitiya confidently predicted Opendoor’s revenue would more than double by 2023. The shares of the SPAC rose 35% in a day.

• After Nikola, another EV company in the mold of Tesla, said it was going public via SPAC in March 2020, the company’s founder did interviews with countless podcasters and YouTubers, boldly predicting the company would soon be making billions in revenue. Nikola’s shares peaked at $80 and finished the year at $15.26, a more than 80% decline.

According to Bloomberg, the first-ever SPAC deal goes back to 1993.

But the SPAC concept never took off in the 1990s, perhaps because investors were too skeptical, or asset managers were gun-shy of trying something so brazen, or both. 

In the first decade of the 2000s, the peak SPAC year was 2007 — also the height of a private equity bubble and housing bubble — where SPACs saw $7 billion worth of deals.

That sounds like a rounding error now, but it was eye-brow raising at the time. Then the global financial crisis killed off speculative activity for a while, and SPAC deals went dormant until 2019 — at which point they exploded, and then in 2020 went supernova.

In 2019, according to research firm Dealogic, there were $13.5 billion worth of SPAC deals. In 2020, there were at least $131 billion worth of such transactions, nearly 10 times the 2019 amount.

Why the SPAC supernova? Because the SPAC is the perfect vehicle for a hyper-speculative environment.

When investors are willing to throw money at anything, almost anyone with a strong enough pedigree, or plain old celebrity name recognition, can cash in with a SPAC offering.

And boy, is everyone trying. Some notable SPAC deals include a famous Major League Baseball manager (Billy Beane, the subject of the book-turned-movie Moneyball); a former astronaut (Scott Kelly); a former NBA all-star (Shaquille O’Neal); and a former Republican Speaker of the House (Paul Ryan).

So on the one hand you have celebrities and hedge fund managers turning fame or reputation (or both) into a chance to print money — by way of being handed other people’s money in a SPAC wrapper — with a promise to make some acquisition that will be truly great (again, with nobody knowing what it is).

And on the other hand, you have high-flying companies of the sexy technology variety — electric vehicles, self-driving, and forms of futuristic tech — with founders and hype-men able to paint visions of billions flying in through the window, taking their message directly to small investors via YouTube channels and podcasts and message boards. (Boy oh boy, are there message boards.)

It is not hard to see how all of this ends. The technology changes but people stay the same.

We are now witnessing one of the most brazen mania-driven money grabs in all of history, right up there with the South Seas bubble, Holland’s Tulip Mania, the 1929 boom, and any other mania one would care to name.

The one possible exception would be Japan’s late-1980s boom — but if real estate sees enough of a frenzy, maybe we’ll eclipse that one, too.

All of this sounds like a warning that “the end is coming.” And it may well be. But we can’t say when with any kind of confidence, because there is plenty of liquidity still available to keep the party going.

Because the typical SPAC has a time limit for making an acquisition with the cash it has raised, we can expect a flood of cash to power a new wave of M&A activity in 2021.

According to estimates from Goldman Sachs and Bank of America, the SPAC M&A wave could be $300 billion to $400 billion in the coming year.  And then, too, behind that wave, you have private equity fund managers sitting on as much as $1.6 trillion worth of dry powder not yet deployed into deals.  

That tells us the SPAC supernova — and the epic market mania we are now all living through, on par with the great all-time manias all through the ages — probably isn’t over yet.

Editor’s Note: The markets and the TradeSmith offices are closed for the Martin Luther King, Jr., holiday, so today we’re sharing a guest editorial from our friend Jeff Brown at The Bleeding Edge that we thought was particularly insightful. We hope you enjoy these predictions for 2021; we’ll be back tomorrow with our own thoughts on the market and the year to come.

Each year, I make predictions about what I see coming in the different areas of technology that I follow. Regular readers are familiar with many of these exciting tech trends: 5G networks, biotechnology, artificial intelligence, and much more.

As investors, we want to have these important topics on our radar. Each of these technologies offers incredible investment opportunities that we don’t want to miss.

And we have a lot to look forward to in the coming year…

1. Self-Driving Cars

The development of artificial intelligence (AI) is one of the most important trends we follow in my research. AI assists in many other different areas of technology. And one key area I’m watching is autonomous vehicles.

We saw incredible progress in this space during 2020. And now, 2021 will be the year that fully autonomous technology is deployed. It won’t be worldwide. It won’t even be nationwide. But we’ll start to see companies like Tesla demonstrate fully functional self-driving cars that can operate in almost any conditions – in bad weather, on city streets, on gravel roads, and so on.

And that leads me to my next prediction…

2. Waymo

Waymo is Google’s self-driving technology division. And I predict we will see the first major licensing deal between Waymo and an automotive manufacturer in 2021.

A lot of people believe that Waymo wants to become a carmaker. But that’s nonsense. That’s a resource-intensive business with low margins. Google has no interest in being an automotive manufacturer. Its master plan is really to license its self-driving technology so that it can be used by existing carmakers.

So one day soon, we’ll walk into an auto dealership. We’ll see a new car or truck on display in the showroom. And it will have a sign: “Self-driving technology from Waymo.”

Or perhaps it will be a ride-hailing company like Uber or Lyft. They’ll simply license Waymo’s technology and embed it in their cars. Or perhaps it will be a new entrant that specializes in grocery delivery in autonomous vehicles. You simply plop the groceries in the self-driving car, and it heads off to somebody’s front door.

That’s what’s coming down the line. And I predict the first licensing deal will be sometime in the next 12 months.

3. Robotics

I have one more prediction involving a different kind of AI…

One of the biggest breakthroughs of last year involved AI as it applies to computer vision and the ability for a robot to grip an object. This has been a huge bottleneck for manufacturing robots.

Right now, even the best robots are still not as fast or as efficient as a human when it comes to picking or sorting objects. And the reason is that these robots still aren’t great at “understanding” how best to grip different objects.

Is this object slippery? Is it delicate? Do I have to hold this object a particular way? These are things that humans know instinctively. But manufacturing robots still have a tough time.

Right now, it takes about 29 seconds for a robotic arm to “look” at an object and “decide” the best way to get it from Point A to Point B without damaging it.

But a team of researchers out of U.C. Berkeley is solving this problem. The team used a form of AI called deep neural networks to train a robotic arm on the optimal way to move objects around without damaging them.

And get this. After training, it didn’t take the robot 29 seconds to “decide” how best to move an object. It took just 80 milliseconds. That’s an incredible 350x improvement.

This was really the last piece of the puzzle. I predict we will start to see this technology deployed in manufacturing plants, logistics facilities, warehouses, and even laboratories in 2021.

4. 3D Printing

Continuing with the theme of manufacturing, next I want to discuss another important technology: 3D printing (more formally known as additive manufacturing).

Already, 34% of all global installations of additive manufacturing equipment are happening in the U.S. And it’s easy to see why. Additive manufacturing wastes fewer materials, it is much faster, and it’s done at a fraction of the cost.

For example, a company that needed to create molds to produce a propeller for a large air compressor saved $147,000 per mold casting by using 3D printing. And additive manufacturing saved 8 to 11 months on delivery of the mold castings.

And this is having an impact on a lot of different industries.

In fact, it may sound crazy, but I predict the first 3D-printed rocket will go into orbit sometime in the next 12 months.

There’s already a company called Relativity Space. It can 3D-print an entire rocket – including the engine – in 60 days. It can take up to a year to build a rocket using traditional methods.

So yes, I predict a 3D-printed rocket will go into orbit in 2021.

And finally… my last prediction for 2021 may be my most important one…

5. IPOs

We are going to see record levels of capital raised from initial public offerings (IPOs) in 2021. Last year, there were 489 IPOs that raised a combined $154 billion.

But I predict that 2021 will surpass even those incredible numbers.

As I’ve written about before, there’s a backlog of IPOs right now. There are so many exciting technology companies that have been staying private for years. All this pressure has been building, and now the cork on the champagne bottle has finally popped.

And this flood of IPOs is great news for investors. Investing early can provide some of the best profits available.

But there’s one big problem…

Lately, these IPOs are listed at a certain price, but when they open for trading, the share price leaps to incredible valuations.

I recently saw this dynamic firsthand when I recommended an exciting artificial intelligence company to readers of my Exponential Tech Investor service when it went public in December.

The stock was priced around $42. But when it started trading, the stock immediately jumped above $100. Investors never had a chance to invest at a reasonable valuation.

And this is happening everywhere. Airbnb, AbCellera, Snowflake… these are all recently public companies. But each time, when the stock began trading, it soared past the original IPO price. Sometimes it starts trading two or three times higher than the original listing price.

At these levels, I can’t recommend any of these companies. The valuations are simply too high.

So what is the solution?

The most obvious answer is to buy shares before the IPO. But pre-IPO shares are typically reserved for large institutional investors. Retail investors have been locked out.

But there is a way to do things a little differently. There is a way to invest in pre-IPO companies from your brokerage account. It’s with something I call a “pre-IPO code.” And it’s open to all investors, accredited or not.

These “pre-IPO code” companies enable investors to essentially get shares in companies before their IPOs.

And no, this is not any type of private deal. The opportunity has been building over recent years, and there are now hundreds of these pre-IPO code companies trading right now.

If anyone wants to find out the full story on this exciting opportunity, there’s good news. I recently hosted my Pre-IPO Code event, where I shared all the details.

And I’m making the replay available for just a short time. If you want to learn more about this unique opportunity, go right here to watch for free.

Regards, Jeff Brown
Editor, The Bleeding Edge

Speculative areas of the market are not just red hot, they are white hot.

Initial Public Offerings (IPOs), a barometer of speculative froth, are on fire. In the past few days alone:

• Petco Health and Wellness (WOOF) jumped more than 63% on their first day of trading.
• Poshmark (POSH) saw its share price more than double on the first day.
• Affirm Holdings (AFRM) nearly doubled on day one, then continued to rise.

And of course, two big-name IPOs from December, Airbnb (ABNB) and DoorDash (DASH), saw a first-day double and a near-double, respectively.

But frenzied IPOs are only the beginning. In the first full week of trading for 2021, penny stocks (companies with share prices less than a dollar) accounted for more than 20% of overall volume. That is mind-boggling.

At the same time, trading volume in December was higher at broker-operated venues (where trading apps like Robinhood send their orders to be executed) than at the actual Nasdaq or New York Stock Exchange.

This is in keeping with estimates that a whopping 10 million new retail trading accounts were opened in 2020, and that individual retail traders accounted for 25% of total volume on the busiest days of 2020.

We explained the roots of this phenomenon six months ago on July 13, “How Silicon Valley Engineered a Retail Trading Mania.”

To quickly recap, the speculative cocktail of commission-free trading, highly addictive online trading platforms (OTPs) like Robinhood, a mass-distribution of $1,200 stimulus checks, an ability to pump stock trading ideas through social media and online communication channels, and a “bored in lockdown” incentive to play around with stocks all came together to fuel a neutron bomb of speculative frenzy.

And the craziness seems to be getting crazier, as evidenced by a recent tweet from Elon Musk — now the richest man in the world, on paper anyway — which helped a stock gain more than 6,300% over the course of three trading days completely by accident.

The Musk tweet was only two words — “Use Signal” — and was almost certainly a reference to switching from the Facebook-owned WhatsApp messaging service to an alternative messaging app called Signal, because Signal is believed to have better privacy protections than WhatsApp.

But the online community saw Musk’s “Use Signal” as a chance to pump the shares of Signal Advance (SIGL), a penny stock trading below 60 cents.

The trading volume in SIGL then exploded, purely because of the Musk tweet mix-up — although many who were buying surely knew it was a case of mistaken identity, but didn’t care. As of the Jan. 14 market close, SIGL remained up more than 2,300%.

For those who still believe in the efficient market hypothesis, it would be interesting to hear an explanation for the Signal episode (which is ongoing).

But nor is that the craziest part. Aggressive retail traders are not only fully aware of their newfound powers, but they are actively using them to conduct bull raids in defiance of fundamental logic.

To give a quick bit of background, the greatest trading book of all time is Reminiscences of a Stock Operator, published in 1923.

Through the voice of a pseudonym, the book describes the tales, exploits, and lessons learned of the legendary speculator Jesse Livermore, a man who made and lost multiple fortunes in his speculating career (including a reported gain of $100 million or more in the 1929 stock market crash).

Near the end of Reminiscences, the book describes classic methods of manipulating a stock, for the purpose of helping a pool of buyers either accumulate a large block of shares at a low price or sell a large block of shares at a high price.

Part of that old art — which is basically illegal now — was conducting bull raids and bear raids, which were concerted efforts to drive the price of a stock (or a commodity) much higher or lower.

What has happened today, nearly 100 years later, is that what’s old has become new again through the use of online message boards.

Retail traders in the “Wall Street Bets” community on Reddit, a popular message board site, have taken it upon themselves not to look for stocks with good fundamentals and bullish prospects, but to pick a name of their own choosing and make it go higher through sheer force of will.

These so-called “meme stocks” — which get that designation because the online community creates an endless stream of internet memes pushing the bull case — get a bullish boost not through fundamental arguments, but through the clearly telegraphed message that “we in the community are going to buy the heck out of this thing.”

It is like the old bull raids of Jesse Livermore’s day. Except, rather than being conducted by a pool of wealthy insiders and market operators, you have a bunch of Robinhood traders on message boards, sending out a kind of bull raid Bat Signal through a proliferation of meme posts.

While this has been going on for a while now, the most spectacular success to date was logged this week in the stock of GameStop (GME), a beaten-down retailer that most of (professional) Wall Street expects to fail.

The business model of GME is so 1990s that it hurts: They let customers rent physical video game cartridges from physical locations, like a kind of Blockbuster Video for gaming consoles.

Nearly everything about the GME business model, from the brick-and-mortar stores, to the physical game cartridges, to the challenge of surviving a pandemic, smells like an extinction event, with the death of Blockbuster Video as a kind of template.

As a result of this gloomy outlook, GME had the second-highest “short” float of any publicly traded stock, meaning that short sellers were making highly aggressive bets that the company would fail.

The shorts had been fighting a losing war against GME at least since August, when the share price steadily began to rise.

But a few weeks ago, an army of Reddit-savvy retail traders decided to make GME their next high-profile bull raid target, figuring they could trigger a massive “short squeeze,” the term for what happens when a tsunami of long-side buying power forces the shorts to buy their shares back at much higher prices.

And the campaign worked, with a vengeance.

After a few weeks of beating the drum for a bull raid on GME, the company announced new additions to its board of directors that included the e-commerce genius Ryan Cohen, a co-founder of Chewy (CHWY).

That bullish news was enough to send GME shares rocketing higher, to the tune of more than 100% gains in two trading days, on trading volume in the vicinity of 125 million shares.

That was enough to catch Jim Cramer’s attention, who said on his Mad Money TV show:

“Right now, if you go to those sites… they’re mostly populated by younger readers and participants who are plainly, openly plotting to blow up the shorts — in this case by buying GameStop at any price and bidding the stock up, up and up to crush the shorts so they have to cover… It’s incredible to watch. I think they’re succeeding beyond their wildest dreams.”

In some respects, the investment community has never seen anything like this, ever. While bull raids were common a century ago, not even in Jesse Livermore’s day were such raids conducted out in the open, brazenly, in defiance of logic and common sense.

It isn’t even “this stock is going to be the next Tesla.” Instead, it has morphed into, “This stock will go up because we say so.”

One is reminded of the famous quote widely attributed to political operative Karl Rove, in the immediate aftermath of the Iraq War, in 2004:

“We’re an empire now, and when we act, we create our own reality. And while you’re studying that reality — judiciously, as you will — we’ll act again, creating other new realities, which you can study too, and that’s how things will sort out. We’re history’s actors…and you, all of you, will be left to just study what we do’.”

New IPOs doubling left and right, penny stocks flying, meme stocks being launched like rockets at will, coordinators of bull raid campaigns openly boasting of their power — how long can all of this last?

Not forever, that’s for sure. But we also can’t know when it ends. Consider, for example, the fact that last year’s distribution of $1,200 stimulus checks provided the initial dose of rocket fuel for the Robinhood-enabled retail trading mania — and another round of $2,000 checks is likely coming soon.

Goldman Sachs thinks a new commodity supercycle could be underway. We think they might be right.

If they are in fact right — which is easily possible — base metals like copper, along with other commodity staples widely used in construction, vehicles, and home appliances, could be looking at price gains that stretch out over a decade, or even multiple decades.

A recent Goldman Sachs research report, published in November 2020, laid out the case for a “structural bull market” in commodities, with “similar structural forces to those which drove commodities in the 2000s.”

To understand Goldman’s argument, we need to dial back the clock 15 years or so.

In the mid-2000s, China looked ascendant, and a great deal of excitement surrounded the BRIC countries — Brazil, Russia, India, and China.

Emerging markets were center stage back then, so much so that many believed “The Emerging Markets Century” was at hand.

In 2007, a book of the same name — The Emerging Markets Century — was published by Antoine van Agtmael, the policy consultant who originally coined “Emerging Markets” as an investing term.

With China driving demand trends, and other fast-growing emerging markets seeming to follow suit, commodities were believed to be in a BRIC-driven supercycle.

Institutional demand for commodities as an investment class was also high in the mid-2000s — the logic being that, if commodity prices were going to rise for decades, institutional portfolios should have exposure to them.

This logic contributed to a five-fold rise in copper over the course of the 2000s, and the West Texas Intermediate crude oil price running up to $133 per barrel in 2008.

But the commodity supercycle was stopped cold by the global financial crisis of 2008, and so were emerging market equities, which took more than a decade to regain their late-2007 highs.

(Ironically, The Emerging Markets Century was published just in time for a ten-year struggle.)

In the initial supercycle of the 2000s, the BRIC countries — and other emerging markets, too — were expected to see a virtuous circle of rising consumer demand, bullish investor sentiment, and robust local growth.

Picture billions of new capitalists clamoring for washing machines, air conditioners, and cars as they joined the ranks of the global middle class, even as cities were built out with 21st century infrastructure.

The emerging market dream stalled out, though, and the years that followed the financial crisis were a total bust for commodities, with bellwether commodity indexes and ETFs losing more than half their value in the 2010s.

Now, though, the whole world is in stimulus mode, the global economy is anticipating a vaccine-powered recovery, and the U.S. dollar could be headed into a multi-year downtrend.

All of that favors a new commodity supercycle getting underway, and possibly lasting longer this time.

The basic idea behind a commodity supercycle is that global demand for commodities shifts upward in a fundamental, structural type of way, with the elevated demand trend so strong that it takes decades for production to catch up.

There are five potential drivers for seeing that kind of structural demand shift in the years to come: Green energy initiatives; FDR-style infrastructure projects; reworked home spaces in a post-pandemic world; urban center renewal; and emerging market growth. To briefly cover each:

• Green energy initiatives, along the lines of ramping up renewable energy sources, phasing out internal combustion engines, retro-fitting buildings for energy efficiency, and moving toward net-zero carbon emissions, could require trillions of dollars of spending over the next few decades — much of it oriented toward green energy projects that will utilize base metals and other commodity staples.

• FDR-style infrastructure projects, of the kind President Franklin Roosevelt used to create jobs in the Great Depression, could be popular all over the world in the coming decades, especially given that rich, industrial countries like the U.S. and Germany are in dire need of long-term infrastructure repairs. An overhaul of roads, bridges, power stations, transportation networks, and more could be a powerful source of demand for raw materials.

• For knowledge workers and those whose jobs enable it, the transition to work from home (WFH) is not going away, with millions of workers likely to adopt WFH conditions either permanently or part-time (one or two days per week) after the pandemic. This shift is spurring a deep rethink of home-based needs, with an emphasis on more square footage (to make room for that home office), more home-based amenities, more green appliances, and so on. This means lots of construction and plenty of new gadgets, bullish for copper and other raw materials.

• As cities see a transition away from office buildings and corporate real estate, an opportunity will arise to transform urban centers and make them more livable. That means more outdoor dining, more green buildings, more mixed-use residential space, more reclamation of parking spaces (with fewer cars coming in) — and lots of construction to make it happen, once again driving a structural demand for raw materials.

• Emerging markets were largely ignored and left in the cold for the decade following the global financial crisis. Investors’ attention was instead fixated on big tech and opportunities within the United States. Now, though, the U.S. dollar may have registered a long-term peak, and emerging-market assets look highly attractive relative to overvalued U.S. equities — especially if a structural bull market in commodities is increasing their revenues and profits, creating a virtuous cycle of more direct investment and more local growth. The build-out of domestic consumer demand — those “three billion new capitalists” making their way toward middle-class status — could then further drive raw materials demand.

The other two factors favoring a commodity supercycle outlook are the twilight of the U.S. dollar as the world’s reserve currency — it won’t crash or go to zero, but it seems hardly possible the dollar will continue to hold a 60% market share of central bank reserves — and the incredibly overvalued nature of U.S. equity names, particularly technology names.

If emerging markets can catch the twin tailwinds of a weakening dollar and rising commodity prices —  both of which act like stimulus for their commodity-oriented economies — we could see a virtuous circle in which more demand for commodities translates into more demand for  emerging-market assets, which in turn causes the dollar to weaken further as investor capital flows out of the U.S., with the weaker dollar then boosting commodities further and strengthening the cycle even more.

As the institutional world starts taking Bitcoin seriously, new questions are emerging.

For instance:

• Will Bitcoin replace the U.S. dollar?
• Will it push aside major fiat currency competitors?
• Could Bitcoin usher in a fiat-free world?

In our view, the answer is “no” three times over.

The destiny of Bitcoin is not to replace or dominate fiat currencies. It is to offer a global store of value, and to put a check on the governments that issue fiat currencies.

One of Bitcoin’s most important features — if not the most crucial feature of all — is permanent scarcity. The Bitcoin supply is immutably fixed. Once a certain number of Bitcoins are mined (approximately 21 million), there will never be any more.

In contrast, with fiat currencies, the supply is not at all fixed. Instead, it is the opposite: The fiat currency supply can be expanded at will. This is a feature, not a bug. Expansion of the currency supply is sometimes a helpful thing.

Imagine a scenario, for example, where a major natural disaster overtakes the United States, and hundreds of billions of dollars in emergency spending is needed to address the crisis.

With a fiat currency system, Congress can simply issue new debt and send out the funds. That is, in fact, what happened in response to the coronavirus crisis. Congress decided to spend the money, and immediately did so.

That useful ability — the ability to respond quickly in a crisis — is a function of a system with an expandable fiat currency supply.

There are situations where, if no new funds are immediately available, the likely outcome is some form of economic collapse.

An ability to expand the currency supply is like a line of credit in this regard. A business that has an emergency line of credit, only to be used in serious situations, is better off than a business with no such access to credit.

If a business takes a terrible hit — because of, say, a sharp but temporary downturn in customer traffic — then a line of credit can get that business through the rough period and help it survive to the other side. Absent that line of credit, the business is at risk of failing.

(We are seeing this reality play out for millions of businesses in real time: Those businesses with access to credit lifelines are able to weather the worst of the pandemic, while those that lack such access are more likely to close.)

So fiat currencies, in a way, provide a kind of credit lifeline for an economy that needs one. The alternative to having this lifeline can be extreme economic pain, or even a shock-induced deflationary collapse. It is good, not bad, to have a government with flexibility to respond to emergency events. 

An economy that is rapidly growing may also need an expanding currency supply in order to support the expansion. That is because a shortage of currency, relative to the optimal amount needed to support business activity, can act as a constraint on growth.

In theory, the total amount of a currency in circulation doesn’t matter, as long as the currency is divisible into small enough units. This theory would argue that, if an economy is growing rapidly as the currency supply stays the same, the adjustment should come through prices. An economy that has grown larger, with a currency supply that has stayed the same, should see wages and prices that are lower.

The problem is that, in the real world, wages and prices tend to be “sticky.” It is not easy to adjust the average price level of goods and services on a whim. It is particularly hard to adjust wages downward.

Imagine an employer saying: “The currency has gotten stronger over the past 12 months, so everyone is getting a reverse raise. Your take-home pay will be reduced by 10%.” Human psychology doesn’t work that way — it is hard to adjust prices downward.

This means that, when there is not enough currency available for a growing economy, the tendency is simply for the availability of loans to be suboptimal, and the rate of new job growth to be limited.

And so the psychological inability of businesses to reduce wages and prices easily or quickly means that, as an economy grows, it is healthy, overall, for the supply of currency to grow alongside the economy at a reasonable and logical rate. You need an expandable currency supply to make that happen. 

If a currency has a fixed supply, all adjustments have to come through price. In the context of a national economy, wages and prices do not change quickly or easily. This creates a mismatch that causes big problems, or restrains growth, if the supply of currency is out of whack with what makes sense.

“But hold on,” you say. “What about the tendency of governments to abuse their fiat currency privileges?

“What about the fact that governments tend to abuse their lines of credit by borrowing too much, and that expanding supplies of fiat currency tend to expand too fast (and never seem to shrink)?’

Those are, indeed, serious problems. And that is why Bitcoin provides such an elegant solution — not as a means of replacing fiat currency, but as a way to keep government policies in check.

Because the Bitcoin supply is fixed, all upward shifts in demand have to be met with upward adjustments in price. And because the total supply of Bitcoin will never exceed 21 million, the Bitcoin supply can never be debased by printing-press activity.

Those features make Bitcoin an attractive place to store savings — especially if currencies around the world are being debased by unwise government policies.

If a fiat currency is depreciating in value because its respective government is printing too much of it, Bitcoin will see its value rise sharply in relation to that currency (because the supply of one is expanding, while the supply of the other stays fixed).

This relationship allows investors and savers to vote with their feet. If they don’t like how their home currency is being treated, they can hotfoot it into Bitcoin (by moving a larger portion of their savings into Bitcoin). Bitcoin, in this manner, becomes a means of peaceful protest against undesirable government policies.

Again, the useful feature here is not replacing the fiat currency in question, but rather putting a check on it.

No sovereign government with the ability to issue its own currency will voluntarily give up that right — and nor should it. As we have explained, it is useful having the ability to spend at will in the event of a national emergency, and it is also helpful to have a slowly expanding currency supply that matches the natural rate of economic growth (because human nature does not do well with downward wage adjustments).

But sovereign governments, quite obviously, have what one might call a “discipline problem” — and Bitcoin can help with that problem by acting as a viable alternative when governments get it wrong and abuse their fiat currency privileges.

Imagine a world where sovereign governments are forced to use their fiat powers wisely, because they know that if they don’t, the nation’s savers will transfer more assets into Bitcoin.

In this world, sovereign governments can maintain access to the positive side of fiat currency issuance. They can issue more currency as needed to help the economy in emergencies, and they can grow the currency supply in accordance with growth (which is a healthy thing to do).

As Bitcoin finds success as a global store of value, it will not exactly underpin a new kind of gold standard  — governments are not going back to that — but it will, in fact, be a readily available savings mechanism that investors can shift a greater portion of their savings into at will.

In this sense, one could think of Bitcoin like the famous “bond vigilantes” of old.

The bond vigilantes were a sort of mythical group who were expected to sell U.S. treasury bonds, and drive up U.S. interest rates in doing so, if government policies were too loose.

In homage to the bond vigilantes, James Carville, a political adviser to U.S. President Bill Clinton, once said:

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

The bond vigilantes are more or less gone now, lost to the sands of time. But Bitcoin can take up that role, in a sense, by acting as a check on the impulses of all national governments and all fiat currency regimes.

In this manner, the juxtaposition of Bitcoin’s supply being fixed — and the fiat currency supply being expandable — is an excellent thing. You want the fiat supply to have an expandable property, as long as that property is not abused. And Bitcoin as a liquid alternative will be there at the ready when politicians get abusive (as they inevitably will at times).

In another sense, Bitcoin has the potential to become a kind of “digital gold standard” for the entire world.

That does not mean national governments will affix their fiat currencies to some limited quantity. They won’t. But it does mean Bitcoin could become a price benchmark more immutable than the fluctuating value of things as priced in, say, dollars or euros or yen or renminbi.

Along with acting as a fixed supply alternative to local fiat arrangements, Bitcoin could become an iron yardstick as opposed to the rubber yardstick we now have in the U.S. dollar — a price benchmark to rule them all.

The nature and function of Bitcoin makes it the ideal vehicle to do this, while allowing governments to continue managing their currency and debt mix locally (with Bitcoin a check on their worst impulses).

The U.S. money supply is divided into three categories — M1, M2, and M3 — with each category progressively less “liquid” in terms of how quickly it can be accessed and spent.

The M1 category includes physical cash and coins, demand deposit bank accounts (the type from which cash can be withdrawn any time), and other liquid forms of money like travelers’ checks and negotiable order of withdrawal (NOW) accounts.

If you want the most elegant case for why inflation is a risk in 2021, it might just be the trajectory of M1 over the course of the past year, as shown below via a chart from the Federal Reserve Bank of St. Louis (FRED).

The chart shows M1 dating back to 1996, and tells a story in three acts:

• Prior to the global financial crisis of 2008, the rise in M1 was fairly tame compared to what came next. A pick-up occurred in the early 2000s, but it hardly registered relative to what followed.

• After the 2008 crisis, M1 started to rise aggressively, heading up and to the right for more than a decade, as the Federal Reserve maintained various quantitative easing (QE) programs.

• In 2020, as a result of pandemic-fighting measures both monetary and fiscal, M1 went vertical. Instead of moving up and to the right as before, it seemed to simply move straight up. 

The portion of M1 that sits in bank accounts (demand deposits) can be used by the banks to make new loans and can also be spent by consumers.

When lending and spending picks up in line with a vaccine-powered recovery, the thinking is that all of this liquidity will contribute to inflation (prices for goods and services starting to rise).

Last week, the bond market started to take the prospect of inflation seriously. Ten-year inflation expectations are now above 2% for the first time in two-plus years (since late 2018), and the yield on the U.S. 10-year treasury note is above 1% for the first time since March 2020.

In our view, it was no coincidence inflation expectations surged immediately after Democrats won both Senate seats in the Jan. 5 Georgia special election.

As we explained a few days ago, unified legislative control increases the odds of big spending initiatives — and multiple new rounds of fiscal help, including large stimulus checks — getting pushed through.

With the above said, even though inflation expectations and the 10-year nominal yield are both rising, the real yield has gone more negative than ever.

The real yield is the nominal yield minus inflation. So, for example, if you own a bond that pays 1%, and inflation is 2%, you come out with a loss because inflation eats up your gains. And if inflation expectations are rising faster than interest rates, negative real yields can become even more negative.

That is exactly what we are seeing, as the FRED chart shows below. The black line is the zero level where the real yield (the nominal yield minus inflation expectations) turns negative.

Even with nominal interest rates rising now, the real yield on the 10-year has not been this negative in decades (because inflation expectations are rising faster).

From a Federal Reserve perspective, negative real yields are a feature and not a bug. That is because, when real yields are negative, it means the debt burden is being inflated away. This is a helpful thing when government debt levels are set to explode.

The interesting question is what happens next.

Interest rates can theoretically rise as long as inflation expectations rise faster, with inflation continuing to erode the debt burden. But if interest rates rise too far, too fast, it could mean trouble for stock market valuations (which are supported by low interest rates), or even threaten the economic recovery.

The Federal Reserve will have to pull off an extra tricky balancing act moving forward.

On the one hand, the Fed will want inflation to run a little bit hot (above 2%) as the U.S. economy recovers, and a modest rise in long-term interest rates can comfortably go along with that.

But if inflation starts to get too hot, or interest rates start to spike as investors flee the bond market, the Fed could be forced to take new emergency actions. The four-way interplay here — between interest rates, inflation expectations, stock market sentiment, and the recovery outlook — will be important to watch in the year ahead.

A little over a month ago, on Dec. 8, 2020, TradeSmith Decoder went long a sizable basket of oil and gas stocks in the model portfolio.

Price action was flashing a green light — always a requirement for new positions — and our bullishness was rooted in the beaten-down profile of energy stock valuations; the demand-boosting prospects of a vaccine-powered recovery; the outlook for a weakening U.S. dollar (which could help lift the oil price); and the rising prospect of inflation in the coming year. 

And then, last week, Saudi Arabia gave us a gift.

Seemingly out of nowhere, in the aftermath of the Jan. 5 OPEC-Plus meeting, the Saudis announced a unilateral, million-barrel-a-day production cut, set to last for at least two months.

The response to the cut was electrifying. The West Texas Intermediate crude oil price, which had already responded bullishly to the official meeting, jumped more than 5%, to close at a 10-month high, after the Saudis revealed the surprise news.

The surge sent the oil price above $50 per barrel for the first time since the dark days of the pandemic and sent a variety of oil and gas stocks rocketing higher. Multiple names in our basket were up 5% to 10%.

“We gave the oil industry a wonderful present and a wonderful surprise,” said Saudi Energy Minister Prince Abdulaziz bin Salman.

The price cut was the brainchild of Crown Prince Mohammed bin Salman, the half-brother of the Energy Minister, and de facto ruler of the Saudi Kingdom, who goes by the initials MBS.

Energy analysts considered the move to be classic MBS: Bold and brash with a taste for drama, though not necessarily thought through in the longer term.

Saudi Arabia, as the leader of OPEC, is playing a complicated game with at least four opponents in mind: Russia; oil-trading hedge funds; the U.S. shale industry; and the novel coronavirus.

OPEC-Plus is composed of OPEC, led by Saudi Arabia, and an additional producer group led by Russia (hence the “Plus”), with 23 members total in the expanded group.

Saudi Arabia and Russia have a “frenemy” (friend yet enemy) type relationship. They do not like each other much, but they fear and despise the U.S. shale industry even more.

After getting into a short-lived price war last year, Saudi Arabia and Russia mended fences in response to the dire threat posed by the pandemic. With global oil demand hammered by the pandemic (nobody traveling anywhere), OPEC-Plus cut oil production by 9.7 million barrels per day, with plans to add it back slowly as the global economy healed.

By end-of-year 2020, Saudi Arabia and Russia were again at odds. The Saudis were inclined to keep production reined in, just in case new lockdowns were imposed and the pandemic grew worse with the vaccine rollout going slower than expected.

Russia, on the other hand, was more worried about competition from the U.S. shale industry and preferred to accelerate a return to full output while betting on recovery.

The result, as revealed at the Jan. 5 OPEC-Plus meeting, was something of a bullish compromise for the oil outlook. The group had agreed to keep oil output flat, rather than raise it by 500,000 barrels per day as Russia preferred.

And then, after the official meeting, Saudi Arabia sprang a bullish trap for the hedge funds that had been shorting long-dated oil contracts. The Saudis announced that, unilaterally and of their own accord, they would be cutting the million extra barrels.

Russia and Kazakhstan were allowed a tiny increase of 75,000 barrels per day each, likely as a form of concession to the Russians. The Saudis suggested they would cut an additional amount to offset the Russia and Kazakhstan amounts, too.

The Saudi Energy Minister stressed the decision was made by MBS himself. “We are the guardian of this industry,” he added.

The Saudi production cut can be seen as a combination insurance play, short squeeze, and shale gamble, all rolled into one. The net result is that it’s a big positive for U.S. energy stocks.

The production cut was an insurance play because Saudi Arabia, and most of the producers in the traditional OPEC group, are still worried about demand risks created by the pandemic. If new lockdowns are imposed, or if the vaccine-powered recovery is delayed by the slowness of getting shots into arms, the Saudi cut will provide something of a buffer against that.

The production cut was also a deliberate bit of gamesmanship, meant to short squeeze oil-bearish hedge fund managers who were caught leaning the wrong way. MBS kept his plans quiet to deliberately catch these players unaware.

There is a popular, long-dated, WTI oil-futures spread that energy-focused hedge funds like to trade, known as “Dec-Red-Dec” because it juxtaposes the December oil futures contract and the December contract of the following year. (“Red” refers to a contract that is an additional year out.)

When the cut was announced, the spread jumped to a 12-month high, forcing a painful round of short covering, which further boosted long-dated oil prices.

Then, too, the Saudi production cut was a gamble because the risk exists of U.S. shale producers filling in the gap. Were U.S. shale producers to ramp up production immediately in response to the higher oil price, both Saudi Arabia and Russia could lose market share as the profits from a higher price go to a despised competitor.

The shale gamble looks like it will pay off, though, because U.S. oil and gas producers seem more focused on paying down debt and solidifying dividends than trying to immediately ramp up production with oil prices back above $50 per barrel.

If Saudi Arabia has played its cards right, and the vaccine-powered recovery continues to unfold, the oil price could continue to march higher over the course of 2021 as resurgent demand couples with an ongoing fall in the U.S. dollar.

The ideal combination, and the thing the Saudis are hoping for, is to see a renewed wave of optimism kick in just as their multi-month cuts expire, helping lift the oil price back into the $60 to $70 range. That combo would, in turn, be very bullish for energy stocks.

Brexit, as you likely know, is shorthand for “British exit,” in reference to the United Kingdom parting ways with the European Union (E.U.) after a 47-year relationship. Brexit was made real through a U.K. referendum vote whose results shocked the world — few expected it would happen — in the summer of 2016.

For four long years, in an excruciating process that often felt like drilling a tooth without novocaine, the U.K. and Europe struggled to “get Brexit done” (a campaign slogan wielded by U.K. Prime Minister Boris Johnson, known as BoJo in the British press).

On Dec. 24, 2020 — Christmas Eve — Brexit finally got done. The actual details of Brexit amounted to 1,246 pages of customs requirements and red tape. But it was finally over, and BoJo announced to the world with glee that the U.K. would finally, at long last, be completing its split with the European Union.

The Johnson government wanted to give the impression that Brexit was wrapped up and over, having finally come to a deal. The reality is closer to the opposite, due to all the negotiating still left to be done.

With the initial part done, the truth of Brexit is captured in an old Winston Churchill quote:

“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

The shape of the deal offers unique benefits for each side.

The E.U., for instance, will have the chance to “take back control” (to use another BoJo campaign phrase) of Europe-related banking activity and financial services, with activity now concentrated in London dispersing to the continental finance hubs of Paris, Frankfurt, and Amsterdam.

The E.U. will also have an easier time making policy and coming to important decisions, as the U.K. had long been the member most likely to kick up a fuss and go its own way.

Then, too, the E.U. could wind up with two new members before the end of the decade — Scotland and Northern Ireland — with an independent Scotland joining the E.U. directly, and Northern Ireland joining by default after returning to Ireland (which is already an E.U. member). 

On the U.K. side, there will be more “regulatory freedom” (yet another BoJo slogan), though it will also come with an explosion of new customs requirements and onerous red tape.

The E.U. will remain the U.K.’s nearest and largest trading partner, and it will carry most of the weight in the relationship by dint of being six to seven times larger, economically speaking. The U.K. will no longer have open access to European markets, hence the explosion of new customs requirements and red tape issues that are already causing headaches at British ports.

“Many truckers are still warning of chaos as they struggle to adjust to the new paperwork required by Britain’s departure from the European Union,” Bloomberg reports. “Drivers are being held up for hours because they lack the right documents, they say.”

In exchange for jammed-up trade lanes and piles of new paperwork, the U.K. is being paid in sovereignty, meaning that U.K. citizens will now have the ability to feel more sovereign than before. This feeling of sovereignty is not tangible without a translation to some kind of policy advantage, but for many who voted for Brexit, the feeling alone seems worth a large economic cost.

Prior to Brexit, the U.K. had a unique deal with the E.U. that was astonishingly favorable, so much so it could only have been an accident of history.

As an E.U. member, the U.K. had two stellar advantages that were even more incredible when combined in one package. As an E.U. member, it was easy for London to remain the cultural and financial center of not just the U.K. but the entire European continent, automatically making it one of the top three finance hubs in the world.

The other potent advantage the U.K. enjoyed was full and unfettered access to E.U. markets, coupled with the U.K.’s ability to keep its own currency (the British pound) and run its own monetary policy.

Both of those advantages meant significant economic gains for the U.K. When put together in combination, the net upside was spectacular. It is hard to describe how lucrative it can be to run the financing for a body of countries nearly seven times your size, with full trading access to all of their economies, while retaining the ability to adjust your own monetary policy as you see fit.

But such forms of membership advantage, as powerful as they are, do not translate well to politically charged referendum campaigns, which helps explain why the more “accessible” feeling of sovereignty, though not actually attached to a net upside, won the day.

The down-to-the-wire Brexit negotiations also seemed fishy, in two different senses of the word, based on the areas it emphasized versus those it neglected completely.

Sharp disagreements around fishing rights in U.K. waters, for example, were one of the most contentious parts of the deal, even though fishing as a revenue source represents less than one-half of 1% of U.K. economic activity.

At the same time various forms of services, which make up roughly 80% of the U.K. economy, were not really addressed, and financial services in particular — a massive earnings source for the U.K. — were left to be addressed later, too.

As such the deal felt fishy in the descriptive sense of the term — meaning something that is dubious or suspect — in that it focused aggressively on an area of the economy that is practically a rounding error in GDP terms, while ignoring the elephant in the room in terms of financial access.

The U.K. and the E.U. have agreed to work out much of the services part later, and they want to have a “memorandum of understanding” for financial services access within the first few months of 2021.

This is like negotiating an employment agreement that emphasizes reimbursement for office supplies, while leaving the matter of salary and bonus compensation to be handled at a later time. It doesn’t really make sense — unless the driving goal was simply to “get Brexit done” before a deadline, leaving the real work still ahead.

All in all, the Brexit deal seems quite bullish for Europe, in our view, in part because of what the U.K. is giving up that the E.U. will be able to count as a gain.

To the extent that E.U.-related banking and finance activity migrates away from London, and toward the financial centers of Paris, Frankfurt, and Amsterdam, the E.U. economy will be strengthened; and if Scotland and Northern Ireland cross over to the E.U., its economic heft and clout will be strengthened further.

The U.K., meanwhile, will have the ability to go its own way on negotiating trade deals — but it has paid a significantly heavy price, not just in terms of new red tape and customs headaches with European trade, but also in regard to heavyweight players like China and the United States.

Then, too, as the U.K. slogs its way through ongoing rounds of Brexit negotiations on matters unresolved, the Johnson government will also have to deal with increasing feelings of frustration and resentment in Scotland, where an independence streak is already strong.

When Scotland held an independence referendum on Sept. 18, 2014, the measure was voted down by a margin of 55.3% “no” to 44.7% “yes.”

But the proposal then involved Scotland going its own way as an independent country, because the U.K. was part of the E.U. at the time. When another referendum comes up, which seems only a matter of time, Scots will have the added cushion of knowing they’ll be able to join the E.U. immediately.

And if the U.K.’s economic waters are rough these next few years, Northern Ireland sentiment will move in the same direction: Merging with Ireland, already an E.U. member, would make Northern Ireland a part of a much larger whole.

As these and other realities sink in, BoJo is going to have his work cut out for him. The overall outlook for Europe, at least, looks more bullish now than before.

The U.S. dollar could start to lose its world reserve currency status in the 2020s. Not all at once, and not overnight, but steadily over a period of years.

In fact, the process may have already begun, which would partly explain the dollar’s powerful downtrend from March 2020 onward.

At the moment, the dollar is still a world reserve currency without peer. It has the largest share of global currency reserves by far, indicating central banks around the world have a strong preference for dollars.

According to data from the International Monetary Fund (IMF), the U.S. dollar had a 61.3% share of currency reserves in the second quarter of 2020.

That was more than triple the share of the No. 2 world currency, the euro, which came in at just 20.3% of reserves. The Japanese yen, at No. 3, was just 5.7%. 

Central banks hold currency reserves as a form of insurance and a means of trade. For instance, if a country does a fair amount of business with the United States, it may want to have U.S. dollars on hand as a form of backstop for its own local currency.

The insurance aspect comes in handy because, if the local economy and the local currency get knocked around, the dollars can be used in a pinch. This is the main function of reserve currencies: To provide a measure of safety to countries that do business in currencies other than their own, and thus subject themselves to risk factors beyond their own borders.

A country with heavy dollar reserves may also routinely collect dollars in exchange for the goods that it exports. Those dollars might be held onto for safekeeping and parked in U.S. treasury bonds (which are like dollars in a longer-term form).

Then, too, the U.S. dollar is so popular, it is commonly used in trade transactions that have nothing to do with America at all. This is an offshoot of the dollar’s common acceptance. If two countries with little-known currencies want to do business with each other, the U.S. dollar — like a trusted and popular middleman — is a natural third-party choice for pricing the transaction.

The dollar’s popularity as described also helps explain why global commodities are generally priced in dollars. For decades it has been the most efficient thing to just quote prices and run transactions in the currency everyone is most familiar with.

This is why, with a greater than 60% share of reserves worldwide — and a comparable level of use in trade transactions — the dollar can punch so far above its weight in terms of global economic involvement.

When adjusted for purchasing power, America’s share of economic output, as a single-country percentage of the global economy, has been in the range of 16% to 17% for the past five years, according to Statista data.

The extra weight for America’s currency, in terms of the U.S. dollar being more than 60% of currency reserves, is a function of who holds dollars and who uses dollars, and why.

With that brief refresher, we can cover basic reasons why the dollar will be so vulnerable in the 2020s, and what it means to say the dollar’s world reserve currency status will fade.

Some of the pressures the dollar will face in the 2020s are as follows:

• Greater isolationism on the part of the United States will mean less trade with the rest of the world. That will reduce the flow of dollars outward, and the total number of dollar transactions, which in turn will reduce the global appetite for dollar-denominated assets.

• The popularity of the euro, the world’s No. 2 reserve currency, is set to increase as countries like Russia and China deliberately try to move away from the dollar-based pricing standard. Both Russia and China are wary of American power, and jointly they are trying to use the euro more often for energy transactions (e.g., Russia selling oil and gas in euros and China buying it in euros). A greater use of the euro in trade transactions will reduce dollar demand.

• The acceleration of technologies like 3D printing, and an increasing shift toward robotics and virtualization, means the total amount of cross-border trade is likely to decline in coming years. Put another way, countries will trade less “stuff” with each other when more stuff is made at home. That will reduce the need for the dollar as a transactional go-between.

• The rise of cryptocurrency solutions and instant-settlement payment rails reduces the need for a trusted third-party currency as a go-between for transactions. In the past, a trade transaction between two countries could take days to settle, increasing the currency risk of the transaction. In the transactions of tomorrow, conversion from one currency to another can be instant or very close to instant — again reducing the need for a third-party world reserve currency.

• As hard assets become “tokenized” and made liquid via blockchain technologies, it becomes easier to store wealth in hard assets rather than fiat currency or government securities. Imagine a cryptocurrency-tokenized version of Canadian timberland, for example, as such that one could put money into timberland (or take it out) with a surprising degree of liquidity. As various forms of tokenized hard-asset alternatives become more popular, the demand for dollars will fall.

• As issuer of the world’s reserve currency, the United States can take advantage of its so-called “exorbitant privilege” by printing and spending a lot of new dollars. With U.S. treasury yields below the rate of inflation, this is a lousy deal for all the countries in the world that are sitting on dollars, or earning negative returns after inflation on low-yield treasury bonds. The more that the U.S. abuses its privileges, in light of the other factors, the more that global demand for dollar-denominated assets — as something to sit with and hold onto — will fall.

None of this is a forecast for the death of the dollar, or for the dollar’s total demise as a popular vehicle in global trade transactions. A change that drastic is not necessary in order for the dollar’s value to fall, by a large amount, over a multi-year period.

This is because the dollar has such a high starting point to fall from. When an asset or a currency is said to be heavily “overweight” in global portfolios, all that is needed is a modest amount of selling — or a sustained shift back toward a “normal” weight — for the value of that asset to potentially fall by a lot.

Remember that the U.S. dollar, as of the second-quarter 2020 tally, comprises more than 61% of global currency reserves. This means that, for every 100 units of cash and government securities that a central bank holds in its reserve accounts, on average more than 61 of those units are U.S. dollar related. (U.S. treasury bonds count in this category, because treasury bonds are directly convertible into dollars.)

Given that state of affairs, imagine what would happen if the dollar’s share of global reserves was cut by a third, falling from, say, just above 61% to somewhere around 40% of reserves.

If that happened, the dollar would still punch far above its weight relative to America’s economic output, and it could still be the most popular reserve currency. But the journey from more than 61% of reserves down to 40% of reserves — as the total number of dollar-based transactions declined — would require a whole lot of dollar-asset selling, on the order of multiple trillions of dollars, over a multi-year period.

And now we get to the heart of the matter as to why the U.S. dollar outlook is historically bearish, quite possibly for the rest of the decade. It is not about an Armageddon call, or an expectation of fiat currency collapse, or even a negative outlook on America’s long-term economic prospects.

Instead, it is more about the transition from a world where a single world reserve currency dominates to an outsized degree, to a world where such dominance is no longer so necessary.

As the world gets a little more comfortable using euros as an alternative commodity-pricing mechanism; storing wealth in Bitcoin; running cross-border transactions less often because ever-more goods and services originate at home; and handling a higher volume of peer-to-peer transactions instantly through blockchain-based settlement systems and payment rails, there will be simply less need for a middle-man transactional vehicle (like the U.S. dollar) that greases the wheels of world trade.

This transition could matter a great deal to traders and investors, even those who never trade currencies or think about them at all.

That is because dollar-based prices are so dominant as a pricing mechanism in today’s world, a sharp long-run decline in the value of the dollar (because central banks are selling off dollar reserves, rather than adding to them) could have a dramatic long-run impact on stock prices, hard asset prices, and more.

Given this state of affairs, a persistent and somewhat extreme one-time journey for the U.S. dollar — going from super-dominant world reserve currency to something still popular, but far less dominant — could be one of those deep, tidal, macro-level influences that impact the price of nearly all other assets for years on end.

And to that end, a falling dollar is bullish for hard assets, and potentially bullish for stock prices, too — at least in nominal terms — because so many things remain priced in dollars, and as a rule, when the value of a currency falls, the value of an asset priced in that currency tends to rise as a natural form of adjustment. If there is a greater supply of dollars available today versus yesterday, those less-valued dollars will buy less of a given asset, and so the dollar-based price of that asset, all other things being equal, goes up.

Adjustments like this tend to happen automatically; if they didn’t, the value of scarce assets (like, say, Google shares) would automatically drop as the value of the pricing currency dropped, and that would not make sense. (If the dollar crashed and saw a 30% decline overnight, would it make sense for the tech juggernauts to also have a 30% off sale, or for gold and oil to have a 30% off sale, just because the dollar was down that much? No — their prices would adjust higher instead.)

The deep and persistent nature of the shifts we are describing — including a major, one-time shift away from the dollar’s multi-decade dominance as the world’s reserve currency — also help explain why we can be deep-conviction dollar bears in terms of expecting the USD downtrend to be long-lasting, playing out not over a period of weeks or months, but years on end (and maybe the rest of the decade). As this trend plays out, it makes sense to expect nominal price appreciation — and in some cases spectacular price appreciation — across a wide range of assets, as much of the stuff that is priced in dollars sees the rubber yardstick of fiat currency value get stretched. In result, a great many excellent trading opportunities should present themselves (indeed this is already happening) along the way.

On Dec. 17, we wrote to you with the following headline: “The Stars are Aligning for Inflation’s Grand Return — and Bitcoin’s Dominance as an Inflation Hedge.”

Bitcoin was trading around $23,000 at that time. A few weeks later, it is up more than 52% (pushing $35,000 as we write this note).

Perhaps needless to say, the TradeSmith Decoder portfolio had a spectacular finish to an already excellent year. We anticipate 2021 could be even better — because of that whole inflation thing.

On Dec. 17 we said:

So, yes. Inflation is coming. Big inflation. Expectations are the first factor. A falling U.S. dollar is the second factor. Rising commodity prices will be the third factor, an overly stimulated top half of the economy clamoring for supply-chain goods in short supply will be a fourth, real upward momentum in wages and labor costs a fifth, mushrooming deficits a sixth, on and on.

All of that remains true. And now we can add another Godzilla-sized inflation driver: Political regime change in Washington.

In the aftermath of the 2020 presidential election, it looked like America would have a divided government. Democrats would control the White House and the U.S. House of Representatives, and Republicans would maintain their hold on the U.S. Senate (with Mitch McConnell wielding the gavel).

That isn’t the forecast anymore. As of Jan. 20, U.S. Senator Chuck Schumer will likely get the gavel. Republicans seemingly have lost control of the Senate. If that happens, the Democrats will have unified legislative control in Washington, for the next two years at minimum.

What does this do to our inflation thesis? It pours kerosene on the fire. The implications of this political regime change in Washington — and that is what it amounts to — are almost breathtaking.

First, we’ll do a quick recap of what just happened.

For those who aren’t caught up on the firehose of political events, the state of Georgia held a special election on Jan.5. In that election, two U.S. Senate seats were up for grabs.

Because Georgia is historically a conservative state, Republicans were expected to win both seats. Instead, they may have lost them both.

In one of the two Georgia contests, Democratic candidate Raphael Warnock has already been declared the victor. Warnock will be the first African American to represent Georgia in the U.S. Senate.

In the other contest, Democratic candidate Jon Ossoff has a statewide lead of more than 17,000 votes as of this writing, with remaining ballots expected to lean heavily Democratic.

Neither Republican candidate has conceded as of now — but realistically speaking, it is over. Warnock has won and Ossoff’s odds of victory exceed 95%.

This means the U.S. Senate will be split 50-50, which in turn means the White House breaks the tie. By constitutional law, the U.S. Vice President is also President of the Senate. Vice President-elect Kamala Harris will thus cast the deciding vote in the event of a 50-50 split, and Democratic Sen. Chuck Schumer will replace Republican Mitch McConnell as majority leader.

Why is this development inflationary? Let us count the ways.

The biggest reason is because Democrats are aggressively pro-stimulus, and majority control of the U.S. Senate will allow them to authorize more stimulus through a process known as budget reconciliation.

Legislation passed by way of budget reconciliation — a process created in 1974 — cannot be filibustered. This means that, on many items relating to the budget and to spending (like stimulus), Republicans will not be able to block passage if the Democrats can get to 50 votes.

As we explained in our Nov. 2 primer on the difference between monetary policy and fiscal policy:

With fiscal policy, the government can simply hand out money, and let people spend it however they want. Alternatively, the government can use fiscal policy to buy things itself, injecting currency into the system through direct transactions with private-sector businesses.

Either way, the core of fiscal policy is not about lending or borrowing. It is about the “helicopter drop,” in the sense that the government goes out and drops money from helicopters on people.

That kind of “helicopter drop” spending power, if wielded with force, is about as inflationary as it gets.

As you ponder the implications of that, recall that Vice President-elect Harris, when she was still Sen. Harris, along with Senators Bernie Sanders and Ed Markey, introduced a bill in May 2020 proposing recurring payments of $2,000 per month to American households earning less than $120,000 per year.

And then reflect on the fact that, with political regime change in the U.S. Senate, Democrats will control all the committee chairs. We are likely to see Sen. Sanders in charge of the U.S. Senate Budget Committee.

Unified legislative control — encompassing the White House, the House of Representatives, and the U.S. Senate — also means Democrats will have an easier time getting major recovery initiatives passed, along the lines of the massive public works programs introduced by U.S. President Franklin Delano Roosevelt (FDR) in the 1930s.

Then, too, senate control means Democrats will not only control the committee chairs, but they will decide which bills are brought to the floor. That, too, will have a major impact, increasing the odds of significant legislative changes in areas relating to worker protections, minimum wage levels, and other pro-labor initiatives.

With a 50-50 split, the Democrats’ senate majority will be as narrow as it gets. For some of the Biden administration’s goals, they will still have to reach across the aisle for Republican support. But they won’t have to reach very far, and there are numerous Republican senators who will be willing to embrace a pro-infrastructure, pro-worker stance if designed in the right way.

To simplify what is going to happen next, think about this: The beating heart of the Biden administration agenda will be figuring out how to stimulate the bottom half of the economy, and how to get fiscal help to low-income Americans and blue-collar workers.

That agenda will be inflationary by design, in part because the Federal Reserve and the U.S. Treasury will want to generate a certain amount of “good” inflation on purpose.

Remember that policy makers are more afraid of deflation than a little bit of “good” inflation, because runaway deflation can lead to an economic death spiral akin to what we saw in the early 1930s. As a result of this mindset, the Fed and Treasury are likely to be comfortable targeting a “good” dose of inflation, in the realm of 2% to 3%.

The challenge, though, will be keeping “good” inflation from turning into galloping inflation as worker wages rise, labor costs rise, fiscal spending initiatives expand, and the pro-stimulus “helicopter drops” keep coming. 

The other big reason why political regime change is inflationary is because of what it will do to investor psychology and expectations.

Stock market investors, on the whole, are financially conservative as a group. As a general rule, investors like to see restrained spending, limited budgets, and low inflation.

This makes sense when you consider investors’ natural self-interest. The most favorable configuration for asset prices is arguably a combination of loose monetary policy and tight fiscal policy, meaning a central bank that keeps interest rates low and a government that doesn’t spend too much.

Because of their natural orientation, investors are likely to process political regime change in Washington, and the prospect of pro-labor, pro-spending Democratic control, as a kind of low-grade inflationary panic attack.

As a result of this, exploding deficit fears will intensify. Declining dollar fears will intensify. And a hunger for hard assets will intensify.

Those fears will be stoked by political language: Senate Republicans, having lost control of the legislature, will be shouting early and often about fiscal ruin.

And at the same time, the fiscal ruin narrative will be fed by the data. Deficits and debt loads really are likely to go vertical in the next few years, even as the Federal Reserve is forced to buy more and more of the U.S. Treasury market (because foreign buyers will be absent).

And efforts to stir up “good inflation” by stimulating the lower half the economy will actually work — showing up in the data, too — because when you put money directly into people’s hands, they spend it.

Policy judgements aside, we see historic levels of trading and investing opportunity in this development. The return of inflation, after an incredibly long absence, was already set to be a very big deal.

As a result of political regime change in Washington — and Democrats getting unified legislative control — all of the inflation drivers get stronger, even as psychological expectations (investors fearing inflation in advance) create a powerful tailwind for commodities and hard assets.

The stage now looks set for another wild — and wildly profitable — trading and investing year ahead.