As a general rule, the U.S. dollar is strong under two conditions. If the dollar is strong, either the economic outlook is exceptional for the United States alone, or the outlook is bad — possibly crisis-level bad — for the rest of the world (and potentially for the United States, too).

These conditional extremes — where the dollar is strong either in times of notable U.S. strength or notable global distress — create a phenomenon known as “the dollar smile.”

• On one side of the smile, the dollar is strong when investment capital is flowing heavily into the United States.

• On the other side of the smile, the dollar is strong when capital is fleeing risk assets and heading into safe havens like U.S. treasury bonds.

• In the middle of the smile — when the global economy is humming along — the value of the dollar generally declines. (This is what creates the lower portion of the smile.)

Why does the dollar generally behave like this?

In part because the U.S. dollar, as the world’s reserve currency, is the most important currency in the world. Global commodities are generally priced in dollars, and a majority of global trade transactions involve dollars (even when the U.S. is not involved).  

As the issuer of that all-important world reserve currency, the United States in some ways behaves like the banker in a game of Monopoly, or a financier helping the rest of the world make transactions. It is the implicit job of the world’s banker and financier to make sure plenty of currency and dollar-based credit is available for international transactions to take place.

And so, in normal times, America makes plenty of U.S. dollars available for the world to use in its transactions, and U.S. consumers further send large quantities of dollars into the world via the buying of imports. Meanwhile, various countries around the world do a lot of business in dollars, and then park their extra dollar assets in U.S. Treasuries. 

This activity, along with routine financial transactions that provide dollar-based credit for global trade, tend to weaken the dollar overall. All of these dollars going out, and circulating around, tend to increase the available supply of dollars, which causes the value of the dollar to fall on average.

Again, under normal conditions, this weakness is a feature of the system, not a bug. It lets the U.S. dollar perform like a lubricant that greases the wheels of world trade. If some other currency were the world reserve currency, it would behave in a similar way.

If the U.S. economy is exceptionally strong compared to the rest of the world, however, the dollar will tend to be strong, too — thus creating the left side of the smile — as international capital flows into, rather than out of, the United States.

The U.S. dollar was extremely strong in the latter half of the 1990s, for example, as first Asia and then Russia experienced financial crises while investors piled into a strong U.S. stock market.

The dollar was also tremendously strong in the early 1980s, as the U.S. emerged from recession and a new bull market developed, until an international agreement was struck in 1985 (the Plaza Accord) to push the value of the dollar lower.

When the dollar is weakening and drifting lower — the normal state of affairs at the bottom of the smile — the result is a kind of easy-money finance regime for emerging markets and commodity exporters.

As a rule, a weakening dollar means rising commodity prices, which in turn means larger profits for emerging-market economies and commodity exporters (and also for U.S. exporters and farmers).

The prospect of commodity-based profits then causes more investment capital to flow toward emerging markets and commodity producers. As this capital flows out of the United States, and into the rest of the world, it causes the dollar to weaken further in a virtuous cycle.

Ever since the Pfizer, Moderna, and AstraZeneca vaccines were announced, we have witnessed the dollar smile effect on steroids.

Prior to the vaccine announcements in November, the 2021 global economic outlook was still in doubt. But after the effectiveness of all three vaccines was confirmed, the prospect of a robust, vaccine-powered global recovery seemed assured.

That prospect, in turn, allowed capital to rush back into emerging-market assets and to further bid up commodity prices, causing the U.S. dollar to decline even faster as investor currency went out into the world (with dollars being sold to buy local stocks or bonds in various countries).

The speed at which the dollar has declined in recent days was a function of the whiplash created by the suddenness of the bullish vaccine shift. Immediately and out of the blue, in the space of a week or two, a trio of vaccine game changers meant the 2021 recovery outlook was suddenly better than investors could have hoped.

We should note that the dark side of the dollar smile — when the U.S. dollar spikes higher in a time of distress or outright crisis — is exactly what we saw in March 2020, when the full weight of the pandemic caused a market crash.

As risk assets sold off dramatically in March, and leveraged investors faced margin calls with wave after wave of forced selling, a flood of capital rushed for the safety of U.S. Treasury bonds, thus pushing up the price of the U.S. dollar (as U.S. Treasuries are denominated in dollars, which means buying treasuries is the same as buying dollars).

A crucial question at this moment is how long the U.S. dollar can continue to maintain its current downtrend — or to put it another way, how long the dollar can stay at the bottom of the smile. 

This matters because, as long as the dollar keeps weakening and drifting lower — or alternatively flatlining without rising much — commodity prices can keep on pushing higher, with emerging market assets looking increasingly attractive, too.

Some contrarians point to data that shows dollar index futures are at historically oversold levels, which increases the odds of a snapback rally.

If the trading community is extremely short the U.S. dollar — meaning they are betting in historic size on the dollar’s continued decline — that increases the odds the dollar could rally sharply at some point.

And yet, from another point of view, it is possible that dollar-bearish forex traders are like the sparrow on the hippo’s back compared to the larger forces at work.

The hippo in this metaphor — meaning the entity that matters far more than the sparrow — would be the world’s central banks and large investment institutions, who are still collectively sitting on a mountain of dollar-denominated assets.

If central banks are steadily selling off a portion of their dollar-denominated assets (like U.S. Treasuries) and reinvesting that capital in emerging-market equities or bonds, or commodity assets, or some other investment locale other than the United States, that steady selling pressure could create downward trend movement in the U.S. dollar that lasts for years.

Imagine, say, that the world’s central banks and institutions have 60% of their capital in U.S. dollar assets, and then decide to cut that overweighed portfolio amount back to 40%. A 40% weighting would still be a very significant dollar exposure weighting, just not as significant as before.

And yet, the divestment involved in the world collectively dropping its U.S. dollar holdings from 60% to 40% (just to give a plausible example) would amount to trillions upon trillions’ worth of dollar selling, spread out over a multi-year time period.

And why might that kind of divestment start happening now?

Because the prospect of a vaccine-powered recovery has put the dollar smile in a happy place for investors — with respect to emerging-market assets and commodities, that is — as 2021 rebound prospects look bullish for the world.

When it is all added together, we are looking at a potential virtuous cycle of dollar weakness.

In this cycle, an ongoing decline in the dollar helps emerging-market assets and energy and commodity prices rise, which in turn causes central banks and institutions the world over to sell more dollar assets in order to invest in commodity producers and emerging-market bonds — and their divestment then causes the dollar to fall even more.

If the dollar smile stays weak for a long while in this manner, investors will keep smiling, too.

Is hydrogen the fuel of the future? There are deep-pocketed players who believe so, and national governments are providing the carrot-and-stick incentives to potentially make it happen.

For hydrogen to take off in the 2020s, it will have to overcome a dark past. The Hindenburg disaster of 1937 was one of the most famous aviation accidents of all time, and hydrogen was the culprit. 

The Hindenburg was an 804-foot Zeppelin, also known as a German Airship. Zeppelins were cutting-edge technology in the 1930s — seen by many as the future of air travel — and the Hindenburg could cross oceans at speeds of up to 84 miles per hour.

The Hindenburg, in its second year of service, had already made multiple trips between Germany and the United States when it disastrously attempted to land at Naval Air Station Lakehurst in Manchester Township, New Jersey, on May 6, 1937.

Because of U.S. export restrictions on helium, the Hindenburg was filled with highly flammable hydrogen as a substitute. An apparent spark near a gas leak caused the hydrogen to catch fire, creating a catastrophic spectacle.

If you’re a classic rock fan, you may remember the Led Zeppelin I album cover showing a black-and-white photo of a burning airship; that was the Hindenburg as it sank in a ball of flame. The whole concept of airships for passenger travel sank with it.

Today, more than 80 years later, hydrogen is getting a real shot at redemption. It even has a role in the future of air travel, though zeppelins aren’t in the picture this time.

Airbus, the European aircraft giant, has announced plans to develop a commercially viable, zero-emission, hydrogen-powered airplane by 2025.

“Hydrogen is the most promising energy type to allow us to power aircraft and aviation with renewable energy,” Airbus engineer Glenn Llewellyn told Bloomberg. “Battery technology is not evolving at the pace required for us to achieve our ambition.”

Battery-powered planes are a nonstarter because the batteries are too heavy relative to the amount of energy they carry. Cars and buses can easily pull into charging stations, but you can’t recharge on a transatlantic flight.

Airbus turned to hydrogen after an exhaustive study of zero-emission alternatives. If they work out all the details — like how to transport and store the hydrogen safely — the production of hydrogen-powered aircraft could begin in the late 2020s, and the nearly $3 trillion aviation industry could be largely emission free by the late 2030s. 

The zero-emissions target is being pushed by governments with increasingly aggressive anti-pollution mandates. The U.K. government has said it will ban the sale of new gas and diesel vehicles by 2030, for example, and Japan is poised to require all new vehicles to be hybrid or electric by 2035.

Hydrogen has long been used for various industrial manufacturing processes. For the most part, though, industrial hydrogen is derived from fossil fuels, which means hundreds of tons per year in carbon emissions (a big no-no for governments committed to reaching carbon-free status by 2050).

The hydrogen of the future comes in two forms, green and blue.

• “Green” hydrogen uses renewable energy processes, like solar and wind, to generate hydrogen through water electrolysis (separating out the “H” in H₂O).

• “Blue” hydrogen is produced from natural gas in conjunction with carbon capture and storage. Even though a fossil fuel (natural gas) is used, the process is still considered carbon-free.

Blue hydrogen advocates point out how easy it could be for consumers to switch from gas-powered heat to hydrogen-powered heating solutions. In theory at least, it only requires a small modification to an existing natural-gas-powered boiler to make it work with hydrogen, and existing natural gas networks could still be used along with a carbon capture process.

Skeptics of hydrogen note that the stuff is still highly flammable, that hydrogen molecules are smaller than gas molecules (increasing the risk of leaks), and that most of this is still experimental. 

Still, the hydrogen train is rolling down the track — literally.

On Sept. 17, 2018, Germany unveiled the world’s first hydrogen-powered train, with the ultimate goal of replacing diesel-powered trains. Following the successful completion of an 18-month testing phase for the new hydrogen train technology, Germany began construction on the world’s first hydrogen train filling station in Bremervörde, Lower Saxony, in July 2020.  

The economics of hydrogen are still questionable, but that is where government muscle comes in.

A political commitment to the phasing-out of gas and diesel vehicles, coupled with ambitious “net zero” carbon emission targets over the next 20 to 30 years, are spurring governments to see hydrogen as the bridge to a zero-carbon future.

Bloomberg New Energy Finance estimates that, on a global basis, hydrogen will require $150 billion worth of government subsidies between now and 2030 in order to reach critical mass, with private-sector investment at many multiples of that (the subsidies are meant to prime the pump).

That sum is not a big stretch, however, given the increasing dominance of environmental issues (the Millennial generation, larger in size than the Baby Boomer generation, is particularly green-minded) and the new era of fiscal dominance we have entered (in which multi-trillion-dollar stimulus packages come with sequels). 

Possible investment plays related to hydrogen include Linde (NYSE: LIN), a U.K.-based industrial gas company; L’Air Liquide (AIQUY), a French industrial gas company; and Cummins (NYSE: CMI), a maker of specialized engines. There are also up-and-coming start-ups pushing the envelope for hydrogen-powered car technologies, particularly in China.

It’s still early days, but hydrogen is definitely an up-and-coming fuel to watch, and possibly invest in — as long as there aren’t more Hindenburgs.

In 1890s Britain, the bicycle represented a social and environmental breakthrough. Public enthusiasm for bicycles — and for the shares of publicly traded bicycle manufacturers — then fueled the Great British Bicycle Bubble of 1896.

The bubble inflated quickly, with share prices in British bicycle companies tripling in the space of months in 1896, even as the number of bicycle companies expanded more than five-fold.

But then a flood of low-cost American bikes invaded the market, and the mood soured. Enthusiasm and press hype sustained the mood a while longer — bicycles were the inevitable technology of the future, you see — but eventually the bubble popped.

By 1901 — five years after the bubble had first inflated — at least 40 publicly traded British bicycle companies had gone bankrupt. In the years that followed, at least another 60 went under or left the bicycle business. All told, more than 70% of the companies that had participated in the 1890s British bicycle boom wound up leaving the field or going bust.

Investors in the present day are no different than investors in the nineteenth century. The technology changes, but human nature stays the same.

Here at the tail end of 2020, we observe the full-fledged electric vehicle (EV) bubble now in play and can’t help but think of British bicycles. So much is the exactly the same:

• A technology that took multiple decades to reach critical mass.
• An awakening of the public consciousness as a result of key breakthroughs.
• A credible promise to transform the environment and society itself.
• Charismatic genius types pushing the utopian technology angle.
• Dozens of firms trading at valuations that make no sense.
• Investor faith rooted in stories and blue-sky possibilities, not math.
• The inevitable arrival of oversupply at increasingly cheap prices.
• The overwhelming likelihood of a stock market reckoning.

To be clear, the bicycle itself was a genuine breakthrough success story. The arrival of the modern-day bicycle really did transform the British landscape, much for the better.

The bicycle also set the stage for the motorcycle — more or less a bicycle with an internal combustion engine attached — which in turn begat the motor carriage, which then begat the Ford Model T and the modern automotive age.  

But the success is also kind of the point, really. It is par for the course for successful technologies to get way overhyped at their point of true breakthrough, and then to suck in massive amounts of investor capital, and then to destroy most of that capital as the boom goes bust.

William Blake once wrote: “The road of excess leads to the palace of wisdom; for we never know what is enough until we know what is more than enough.”

In addition to being poetic, Blake’s words might as well be a treatise on how the boom-and-bust cycle of technology investing works.

Great innovations require large amounts of capital to build out and deploy. Technology-minded investors, in their voluntary enthusiasm, perform a kind of public service in throwing their money at such innovations. Most of this capital winds up wasted or destroyed, but a small portion is transformative. It happens over and over. You can’t skip the excess, and thus you can’t skip the bust. That is what we got from Blake.  

Breakthrough innovations tend to take a long time. There is a tipping point where enthusiasm ramps up very quickly, and the new technology has the feel of an overnight sensation as it suddenly dominates the public consciousness. But that tipping point usually comes after decades of tinkering and adjustments.

The bicycle’s early ancestor was something called a “dandy horse,” a sort of bicycle with no pedals. The rider would straddle the dandy horse and push forward with his feet, Fred Flintstone style. The dandy horse was patented by German inventor named Baron Karl von Drais in Germany in 1818.

The dandy horse had a brief window of popularity, but it never really caught on. Over the next 40 to 50 years, inventors, entrepreneurs, and hobbyists continued to tinker with the concept of a wheeled riding machine. Some had three wheels, others four. But none of these cycles were ready for mass adoption.

In the 1860s, someone in Paris attached pedals and a rotary crank to the dandy horse, creating a crude prototype of the modern bicycle. This was a smart-enough innovation to spur a mini-boom in Europe and the United States, but again the enthusiasm petered out. Because of its stiff iron frame and the iron-and-wood wheels, the ride was extremely uncomfortable, and the bike was dubbed the “boneshaker” for that reason.  

In Britain, the bicycle’s design kept evolving, thanks to the interest of tinkerers and hobbyists. And finally, by the 1890s, the bicycle had morphed into a technology the public could embrace.

Key innovations included the chain-driven transmission, which reduced the size of the wheels without sacrificing power, and the invention of inflatable bike tires, which cushioned the bumpiness of the ride.

In this long arc of technology development — from 1818 to the 1890s — you may already notice the similarity to EVs, which have been around for a very long time. The first electric motor was developed in the 1830s, and the first commercially produced car (which flopped) arrived in 1884.

For 1890s Britain, the bicycle was a social and environmental breakthrough due to the heavy toll of pollution and the high cost of horse-drawn carriages.

The streets of London at that time were overflowing with horse manure. There were so many horse-drawn carriages — and thus so many manure-emitting horses — that people were afraid they would drown in the stuff, as we explained on Dec. 17 of last year.

When the bicycle exploded in popularity, thanks to a series of breakthrough innovations finally coming together, it was a genuine game changer. Finally, there was a way to transport people and goods with no ghastly pollution (horse manure) spewing out behind.

The bicycle also had a profound impact British society, as David Rubenstein wrote in his 1977 article, “Cycling in the 1890s”:

The Bicycle brought a new dimension to British social life in the 1890s. In a period marked by sharp changes in social attitudes, cycling provided not only a practical means of transport but a symbol of emancipation.

Advanced spirits were conscious of living in the fin de siecle decade, of passing from old ways to new in a number of important respects. Novelty was sought for its own sake. The result was the beginning of greater social freedom, above all for the middle classes to whom the bicycle was particularly precious.

Personal mobility, independent of railway timetables and stations, had previously been restricted to the minority who could afford a horse and carriage. Even carriages, however, had limitations in terms of flexibility and distance which the bicycle could easily overcome.

With its aid townsfolk could more easily reach the country and rural dwellers their nearby towns. As physical distance became less formidable, additional encouragement was given to demands for freedom from restrictions of the past…

All of this set the stage for the Great British Bicycle Bubble of 1896, which was kicked off by a massive speculative bet from a property dealer named Ernest Terah Hooley.

By 1896, bicycles were soaring in popularity with the British public. Those who couldn’t afford to buy one were renting by the week. There were 15 or 20 British bicycle companies at this point, but demand was overwhelming supply.

Ernest Terah Hooley smelled opportunity and had the guts to go big. He put together a hyper-aggressive leveraged buyout of a rubber tire maker, using bank funds to purchase a company called Pneumatic Tyre for 3 million pounds (an insane amount of money at the time).

Hooley’s purchase price represented a massive premium relative to revenue and profits, not unlike the nosebleed price-to-sales ratios in the EV space in 2020.

Hooley then changed the name to the Dunlop Pneumatic Tyre Company, spent a small fortune on marketing hype to bid up the company’s potential, and flipped it to another buyer for 5 million pounds.

Hooley’s brazen score set off a kind of bicycle gold-rush mentality among British investors and entrepreneurs. Within the space of months, the share prices of publicly traded British bicycle companies had tripled, and the total number of British bicycle companies rose by more than 400%.

With the dramatic expansion of production capacity, there was soon more than enough supply to meet demand. And yet, oddly, British bicycle manufacturers avoided cutting prices. The average price of a bicycle stayed stable, in what appeared to be a kind of gentleman’s collusion agreement.

And then the Americans came in.

The United States had the ability to ship and sell bicycles at about half the cost of British ones, likely due to greater scale of production.

When the American bikes started invading the British market, they were frowned upon at first. But the public soon enough realized they did the job fine and were easily a better deal at half the price. And so came the end of the Great British Bicycle Bubble, as competitive reality set in — along with a deluge of supply — and profit margins disappeared.

It took a while for the mood to sour, in part because the British press continued to focus on the bullish story aspects of the bicycle as a historic game-changing technology, the superior aspects of British bicycle craftsmanship over cheaper American versions, and so on.

But in the end, what mattered was the ramp-up of competition, the inevitable destruction of profit margins, and the unforgiving economics of supply and demand for an industry with far too many players.

In our view, the same exact things will matter for the electric vehicle space — where the competition is truly global, and affordable supply will soon enough be overwhelming. Perhaps, a few decades hence, a financial historian will look back to write about “the great Global EV Bubble of 2020.”

The National Defense Authorization Act (NDAA) is an annual bill, passed by Congress, that authorizes the U.S. defense budget. It is the primary means by which America funds its military.

For fiscal year 2021, the NDAA laid out a defense budget of just over $740 billion. That money is used for everything from paying soldiers to running military bases to maintaining the nuclear arsenal (and a whole lot more).

Because the NDAA is so important — America does not have a functional national defense without it — the bill passes every year without fail. The first NDAA bill was signed into law in 1961, and a new one has passed every year since.

On Dec. 1, President Trump threatened to veto the NDAA for fiscal year 2021 through a series of late-night tweets. (A presidential veto could block the bill’s passage.)

The Presidential Tweets demanded a repeal of an internet-related free speech protection law known as CDA Section 230, with text from the President as follows:

Section 230, which is a liability shielding gift from the U.S. to “Big Tech” (the only companies in America that have it – corporate welfare!), is a serious threat to our National Security & Election Integrity. Our Country can never be safe & secure if we allow it to stand…..

…..Therefore, if the very dangerous & unfair Section 230 is not completely terminated as part of the National Defense Authorization Act (NDAA), I will be forced to unequivocally VETO the Bill when sent to the very beautiful Resolute desk. Take back America NOW. Thank you!

A veto of the NDAA would be a huge deal to put it mildly. Without the NDAA, the national defense budget does not get funded.

From a national security perspective, the idea of shutting down the U.S. military is simply unthinkable. That is why the NDAA passes every single year, without fail, and has done so for fifty-plus years. You don’t mess with national defense.

If the President decided to actually veto the NDAA — which he could do by sending it back to Congress unsigned — it is a near certainty that the U.S. Congress would override the presidential veto by way of two-thirds majority vote. 

It is also possible the President could exercise what is known as a “pocket veto,” which cannot be overridden. With a pocket veto, the White House would simply take no action on the bill, neither signing it nor sending it back, until the window for passage expires. (It is called a “pocket veto” because the action is akin to the president putting the bill in his pocket, and keeping it there.)

It is possible President Trump could exercise a pocket veto if his demands are not met. But this course of action is extremely unlikely because again, if the NDAA does not pass, it would create an immediate national security crisis.

The odds are overwhelming that the NDAA will pass, the military will get its funding for 2021, and the president’s demand to repeal Section 230 will not be met.

Axios reports that, on Dec. 2, Republican Sen. Jim Inhofe was overheard telling President Trump loudly, via cellphone, that the NDAA bill would not meet either of his demands —  neither repealing Section 230, nor an earlier demand halting the renaming of military bases named after Confederate generals — implying the president would simply have to accept this.

“This is the only chance to get our bill passed,” Inhofe reportedly added.

Putting aside the tiny (but nonzero) chance of a national defense crisis if Trump decides to pocket veto the NDAA, it feels worthwhile to take a closer look at Section 230, an obscure section of a nearly 25-year-old law that has stirred the president’s ire and created headaches for big tech.

The first thing to know is that, contrary to the president’s assertion in his tweets, Section 230 applies to far more than just “Big Tech.” It touches thousands of companies, if not hundreds of thousands, from the largest tech giants all the way down to individual bloggers and local internet service providers.

In fact, Section 230 is considered by the Electronic Frontier Foundation (EFF) to be “the most important law protecting internet speech” and “one of the most valuable tools for protecting freedom of expression and innovation on the internet.”

Formally known as CDA 230, Section 230 is a part of the Communications Decency Act (CDA) of 1996.

In the mid-1990s, an effort was made to legislate speech issues around the internet. This gave birth to the CDA, which, according to the EFF, was originally intended to restrict free speech. But thanks to the efforts of the EFF and the early internet community, the anti-free speech provisions of the CDA were ultimately struck down by the U.S. Supreme Court, while Section 230 of the law remained.

The key passage in Section 230 reads as follows:

“No provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.”

The passage is a legal liability shield. It basically means that a host of third-party content cannot be sued for the nature of that content.

This means that, say, Google cannot be sued for objectionable third-party content in a YouTube video. It also means Facebook cannot be sued for objectionable content in Facebook posts, and that Amazon cannot be sued for objectionable content in product reviews.

But Section 230 extends far beyond the big platforms. It also protects internet service providers (ISPs), who might otherwise have legal risk for providing bandwidth to an objectionable website. It even protects individual bloggers who host their own sites, to the extent a third-party commenter might put something lawsuit-worthy in the comment section.

Last but not least, Section 230 protects third-party hosts from lawsuits related to the removal of content. If a website decides to remove third-party content that someone posted, for whatever reason, the third-party poster can get angry and complain. But they can’t sue.

The bottom line is that President Trump’s demand that Section 230 be “completely terminated” is not just unworkable, it is functionally impossible.

This is because, without Section 230, much of the internet would have to shut down — or restrict free speech dramatically — for fear of being sued into oblivion. The top-tier social media platforms would be at risk of facing hundreds of lawsuits per week, and countless smaller web-oriented businesses would be at risk of legal bankruptcy.

In Washington, Section 230 has stirred up anger on both sides of the aisle due to questions and frustrations relating to political speech. Republicans have said they feel censored by big tech social media platforms, whereas Democrats have accused Facebook of allowing hate speech and disinformation to flourish.  

If Section 230 were to actually be repealed, though, it wouldn’t make anyone happy. Public venues for free speech of any kind would simply disappear en masse. Google, Facebook, Twitter, Amazon, and many others would instantly face massive legal liability in the absence of Section 230’s protective umbrella, necessitating a drastic response. So would smaller social media sites, internet service providers all over the country, and any website that hosts unmonitored third-party comment sections, for that matter.

What the U.S. Congress really needs to do is reform Section 230 to deliver a more nuanced take on political speech. When it comes to the political speech angle, everyone is upset with the current configuration of things. Some parties feel censored, others feel that propaganda, disinformation, and hate speech are not being filtered strenuously enough, and the platforms themselves feel like they are caught in the middle of a brawl, with Republicans on one side and Democrats on the other.

As explained, the answer is not to repeal Section 230 outright. That simply won’t work. It would cause a stock market crash if it actually happened, as the sudden legal liability foisted on hundreds if not thousands of publicly traded companies (far more than just Big Tech) would create chaos.

The actual answer, though, is extremely tricky and challenging.

Reforming Section 230 in a logical way, while retaining the free speech platform protections that are vital, would require Congress to engage in an intelligent and informed debate over what the parameters of 21st century political speech should be, and then come to a nuanced, thoughtful, and bipartisan solution as to how reforms should be enacted.

We aren’t holding our breath.

Tesla’s valuation is spectacular nonsense. Tesla is in a bubble — one of the biggest bubbles of all time — and when the bubble pops, overleveraged bulls are going to get killed.

We have seen this over and over throughout history.

Later this week, we will revisit the Great British Bicycle Bubble of 1896. To give you a sneak preview, the Pollyanna optimism and disregard for basic math that drove a bubble in bicycle manufacturers — the original low-emission transport machines — is just as present today, 124 years later, in the wildly overdone hype surrounding the EV (electric vehicle) space. And Tesla is the grand Pooh-Bah of bubbles.

Tesla is also a classic example of how megabubbles work. First you get a whole bunch of investors excited about a story, preferably with the help of a skilled promoter. (Elon Musk happens to be one of the most skilled promoters in history.)

Then you create plausible narrative elements — projections of this or that business line — that stretch the math. And then you throw away the math altogether, and create elbow room for pure fantasy as Wall Street analysts chase the stock upward.

At that point, if it is well and truly a bubble, bullish sentiment will be so strong, and so story-driven, that the sheer impossibility of the math becomes irrelevant. At the same time, there will always be a Wall Street research firm making an asymmetric publicity bet with some new “bullish call” that pushes the stock target ever higher into the stratosphere.

The whole thing goes and goes until the maximum amount of hype and euphoria is priced in, with peak levels of investor capital sucked into the stock. Then momentum finally peters out, leaving gravity to take over. At this point, because the math was always nonsense, and the valuation had left the bounds of reality long ago, the stock goes splat — not unlike Yahoo after its addition to the S&P 500 index in 1999.

Again, this has happened over and over throughout history. It is like watching one of those horror movie sequels where you know exactly what will happen.

And with Tesla, you might very well have one of the purest bubbles of all time, in the sense of vaguely bullish sentiment that has gone global, on almost pure hype relative to the realm of the possible.

Are we short Tesla today? No. You don’t short a bottle rocket while it is still headed up. You wait until the arc of price trajectory no longer points to the sky and starts pointing toward the earth.

As of this writing, Tesla is still heading skyward. The market cap crossed $500 billion this week, with investors still piling in ahead of the December S&P 500 inclusion. As we noted on Nov. 18, the parallels to Yahoo entering the S&P 500 in 1999 are uncanny.

But there is another reason we bring up Tesla this week. The EV sales reports out of Europe are so bearish for Tesla, it is actually comical. When we saw how badly the Model 3 got trounced in October, we laughed out loud.

Tesla is, well and truly, not just one of the biggest bubbles ever, but one of the dumbest bubbles ever. Let us unpack the Europe situation to back that statement.

According to data from Bloomberg and Jato Dynamics, an automotive consultancy, the German auto giant Volkswagen had the No. 1 best-selling electric vehicle model in Europe for October 2020.

So was Tesla No. 2? Nope. That was Renault SA, a French auto giant. Was it No. 3? No. That was Hyundai. How about No. 4? Haha, no. That was Kia.

Already this news is not good. Tesla’s Model 3 was beat out by four competitors — not one, not two or three, but four! — in the most important electric vehicle market in the world.

But then you look at the October unit sales, and the numbers are jaw-dropping. Tesla got crushed:

• Volkswagen ID.3 hatchback: 10,475 units
• Renault SA Zoe: 9,800 units
• Hyundai Kona: 5,300 units
• Kia Niro: 3,900 units
• Tesla Model 3: 834 units

For October 2020 EV sales in Europe, Vollkswagen and Renault crushed it, while the Model 3 (Tesla’s EV flagship) didn’t even crack a thousand units.

Volkswagen, in fact, sold more than 12 times as many units of its top EV model as Tesla. Renault did roughly the same. Meanwhile Hyundai outsold Tesla more than six-fold and Kia more than four-fold.

All told, Tesla’s competitors sold more than 35 times as many units in comparison to the Model 3. Tesla’s percentage of European EV sales — looking at the top five sellers only — was less than 3%.

Now remember, in order for Tesla to justify its crazy-making market valuation of more than $550 billion, Tesla’s future EV sales would not only have to dominate the global market, they would have to slay competitors in the style of Conan the Barbarian.

To justify its current revenue and profit expectations, Tesla would have to own its competition the way Google owns search, or the way Microsoft Windows dominated PC operating systems in the 1990s.

And yet, in Europe — which is, again, the most important EV market in the world, due to its size, growth rate, and level of regulatory support — Tesla was not even competitive in October. Their Model 3 market share couldn’t even crack 3%.

So, why did Tesla get trounced? Likely because of a single five-letter word: Price.

For status-seeking showboats, owning a Tesla is a lifestyle statement. It is a way to tell people you have money (Teslas are expensive), while doing your part to help the planet.

But for most people, and especially in Europe, an EV is just a sensible vehicle choice. It is a means of getting from point A to point B, preferably at the lowest cost possible.

Electric car ownership has taken off in Europe in part because gasoline and diesel fuel have always been painfully expensive — far more so than in the United States — and in part because environmentally conscious European governments have pushed hard to favor EV ownership.

At the same time, European EV initiatives are growing more aggressive by the day. A case in point, as we wrote about here on Nov. 23, is the UK decision to ban sales of new gas and diesel cars by 2030.

As the EV market expands, the market share dominators will compete on cost, not sex appeal. Felipe Munoz, an auto analyst with Jato Dynamics, said as much to Bloomberg in explaining Volkswagen’s October sales jump.

“The reason why the [Volkswagen ID.3 hatchback] is a success could be down to its relatively affordable price,” Munoz said. He then suggested Volkswagen’s upcoming EV model, the ID.4, could be even more of a crossover hit.

The fact that established automakers can even compete with Tesla on price says something else important. It says that the performance characteristics of the Model 3 are not differentiated enough from the “good enough” EV models that other big players are already churning out.

Then, too, those good-enough competitor models are arguably improving by the day. And when local municipalities start looking into the purchase of self-driving electric car fleets, which could largely replace individual car ownership in dense urban centers, guess what their main criterion will likely be? Price.

What we are seeing here is the visible manifestation of something that was obvious all along:

• Tesla is not a software company. It is a car company, and a tiny one to boot (in actual volume terms). As Tesla attempts to scale, it will not only incur staggering capital expenditure costs — it will be hugely expensive to build out all that capacity — it will run into a brick wall of competitor volume.

• Auto industry competition has always been brutal, and profit margins have always been comparably tiny as a result. Tesla won’t change that. There is no magic technology bullet that justifies the choice of a Tesla over any other affordable EV. If there were, the Model 3 wouldn’t be getting crushed in the European EV market.

• In the auto industry, the only way to maintain high profit margins is to stick with high-end luxury vehicles, which are much more profitable to make, but also move in relatively tiny numbers. The market cap for Ferrari — the quintessential luxury-and-status car brand — is only $53 billion, because Ferrari’s volume is capped by the fact only rich people buy them. To justify a market cap above $550 billion, Tesla would need luxury-style profit margins with mass-market volume. Barring a patented technology breakthrough akin to a miracle, this is literally impossible.

• The mass-market electric vehicle space is going to be a low-margin, high-capex grind, just like the rest of the global auto industry, with giant competitors like Volkswagen, GM, Renault, Toyota, and others pouring tens of billions into the space. And the vast majority of EV units sold will ultimately compete on price — which means Tesla will never, ever, under any conceivable configuration, achieve the revenue or profit margins bulls now anticipate.

To get a sense of the incredibly tough competition Tesla faces, let’s return to Volkswagen for a moment. In 2019, Volkswagen announced a five-year research and development budget of 60 billion euros — or $72 billion at current exchange rates — devoted solely to electric vehicle sales.

We are already seeing the fruits of that investment, with Volkswagen’s ID.3 hatchback rising to the top of the European league tables. The ID.4 will likely be even more competitive — and with each iteration Volkswagen is likely to compete ruthlessly on the price and affordability factor.

And that is just one of Tesla’s deep-pocketed competitors. Just one! Nearly all of those deep pockets, if not every single one, will be striving to compete more on price and affordability than sex appeal — because price and affordability are the main factors when it comes to production volume (luxury-level profit margins are for niche players). 

We aren’t saying Tesla will go out of business. At some level the company could be a buy — though that level might be 60% lower or even 90% lower. We are in fact saying, as clearly as we can, that Tesla’s valuation relative to cold, hard competitive reality is one of the craziest things we have ever seen.

We still struggle to find the words. The bullish expectations now priced in for Tesla are akin to, say, a belief that Tiffany & Co. will somehow achieve the revenue footprint of McDonald’s, while still maintaining the margins of a high-end jeweler, because the CEO-founder is a magical genius with secret powers.

Mere weeks ahead of the big S&P 500 inclusion event — which we foresee being looked back on as a Yahoo style debacle that all parties will regret — the level of sheer, gravity-defying ridiculousness in the Tesla share price is somewhere between sublime and exquisite. It is a bubble for the ages.

On Nov. 20 we said the next U.S. Treasury Secretary would be pro-MMT, meaning, they would be a de facto believer in, and wielder of, Modern Monetary Theory.

And so it comes to pass. Janet Yellen, the incoming Biden administration’s pick for U.S. Treasury Secretary, is probably the most technocratically skilled and ideologically suited person on the planet for bringing about a new MMT era.

It is important to remember that Modern Monetary Theory (MMT) is not just a wild, crackpot notion.

In the world of economics — and increasingly the world of politics — a growing number of smart and influential people believe in the practices and conclusions of MMT, even if many prefer not to use the phrase out loud.

The nuts-and-bolts takeaway of MMT is that a government with monetary sovereignty can never go broke or run out of funds, because the funds are self-created. The government borrows in its own currency and can print new currency to pay off its debts.

Technically speaking, the logistical assertions of MMT are correct. When the U.S. Congress wants to, say, spend a trillion dollars, it just decides to spend the money. The U.S. Treasury can then issue government securities (bonds), which buyers then absorb.

But if nobody in the private sector wants to buy the newly issued government bonds, the central bank can just buy them itself, issuing currency to do so. In this sense, money is debt and debt is money. The whole thing is a closed loop, and MMT is correct to point out there is never a need for technical default.

MMT acknowledges that, if you print too much currency relative to how the economy is doing, you wind up with unhealthy inflation.

The inflation idea is central to the MMT premise: According to MMT, the only true barrier to how much a government can spend, or how big government deficits can safely be, is inflation. If you don’t have inflation, you are okay, and excess worries about deficit spending or the national debt are unnecessary.

The real point of MMT, as a school of thought and a way of shaping policy, is to help the labor side of the economy. MMT is not a neutral theory in the sense that it is just a description of how the monetary system works. The goal and focus of MMT, as a rule, is getting the government to do more and spend more, in various creative ways, to help raise wages and increase benefits, or to create wages where none existed before.

In some ways, MMT is a natural successor to Keynesian economic ideas. The core notion, once again, is that the government can do more — and should in fact do more — to help the economy in times of crisis, and particularly to help low-income workers and those who are struggling. 

This helps explain why, in our view, we are entering a kind of “new era” of MMT, which could also be described as neo-Keynesian economics on steroids.

The global pandemic has dramatically accelerated the hope and expectation of ongoing fiscal government help for struggling economies. That is what Keynesian economics, and ultimately what neo-Keynesian economics and MMT, is all about.

Then, too, some of the arguments are fairly compelling.

For example, without some form of sustained intervention between now and full rollout of a vaccine, there are credible estimates that 40% of all bars and restaurants in the United States could permanently close.

There are also numerous arguments that long-term unemployment effects — the cost of millions of Americans evicted and tens of millions of Americans unable to find work — could stretch out for years and leave deep economic scars.

Janet Yellen — the incoming Treasury Secretary nominee, who will almost certainly be confirmed by the Senate — has long specialized in labor economics, with a focus on what happens to middle-class and lower-income workers.

In a speech in 2013, when she was Vice Chair of the Federal Reserve, Yellen said the following:

These are not just statistics to me. We know that long-term unemployment is devastating to workers and their families. Longer spells of unemployment raise the risk of homelessness and have been a factor contributing to the foreclosure crisis. When you’re unemployed for six months or a year, it is hard to qualify for a lease, so even the option of relocating to find a job is often off the table. The toll is simply terrible on the mental and physical health of workers, on their marriages, and on their children.

Seven years later, in 2020 in the midst of a global pandemic, the risks of long-term unemployment are higher than ever. As a specialist in labor economics, a Treasury Secretary Yellen will be sharply focused on that area.

This means freeing up financial resources, and coming up with creative programs run jointly by the Treasury and the Federal Reserve, to move trillions in new spending into the U.S. economy, whether or not the legislative branch is on board.

We know what Yellen wants to do because she said it out loud.

Indeed, her open embrace of pro-labor, pro-MMT type policies — which means unrestrained deficit spending to help middle-class and low-income workers — are likely the main reason she was chosen to be the next Treasury Secretary in the first place.

“There is a glut of savings and a shortage of investment,” Yellen said in a central bank panel discussion on Nov. 16. “We have to have fiscal policy, structural policy other than just relying on central banks to achieve healthy growth,” she added. “At this point, they’re doing about all they can do.”

The other high-powered individual who believes central banks are “doing about all they can do” is Jerome Powell, the current Chairman of the Federal Reserve.

Under Powell, the Federal Reserve has not been shy in calling for more spending.

On Nov. 5, Powell said the initial CARES Act stimulus package was “absolutely essential in supporting the recovery that we’ve seen so far.” He also said that “further support is likely to be needed” and “fiscal policy can do what we can’t.”

In the normally restrained and polite tones of central-bank speak, and against a backdrop where the Fed lecturing Congress is usually frowned upon, Powell’s statements are the central-bank equivalent of shouting from the rooftops.

This means Treasury Secretary Yellen and Federal Reserve Chairman Powell will be on the same page. They both want to pump more funds into the U.S. economy, ideally as quickly as possible, to mitigate the potentially devastating effects of long-term unemployment.

And they will work together in figuring out how to do it, even if Congress is left out of the equation.

As Treasury Secretary, Janet Yellen will be particularly effective here because she is one of the most knowledgeable and connected insiders in all of economic history:

• Yellen headed the White House Council of Economic Advisers from 1997 to 1999. 

• She spent six years as President of the San Francisco Federal Reserve, one of the 12 regional Federal Reserve banks.

• She was the Federal Reserve vice chair (the No. 2 job) from 2010 to 2014 under Federal Reserve Chairman Benjamin S. Bernanke.

• She was the Chair of the Federal Reserve from 2014 to 2018 (with Powell, as a Federal Reserve governor, under her leadership during that time).

What all of that means is that possibly nobody — not one other person — knows as much about how to “work the system” as Janet Yellen does, in terms of the deep knowledge and experience she has gained at the nexus of politics, policy, and central banking over the past 25 years.

Having run the Federal Reserve for four years, and having served as the No. 2 for years before that — and having headed the CEA before that — Yellen will know the landscape like the back of her hand. She will not only be the first female Fed Chair and first Treasury Secretary, she will be the first person to have ever had the “big three” economic power jobs (CEA Chair, Fed Chair, and Treasury Secretary) all on the same resume.

That means Yellen will know exactly which levers to pull. And because she and Powell have the same mindset, and had already worked together for years, there will be no daylight between the Treasury and the Fed.

Yellen also has experience observing a divided government. Her years spent as vice chairman of the Fed came in the 2010 to 2014 period, when Democrats lost Congress and the Obama administration had to square off with anti-tax-and-spend policies.

All of this comes together against a backdrop where the Federal Reserve has already broken the rules of the Federal Reserve Act — through its unprecedented support for corporate bond markets — and nobody really cared. (Or at least, nobody with political power, anyway.)

Wall Street, meanwhile, is thrilled with the selection of Yellen as Treasury Secretary because, in her time running the Federal Reserve, markets did quite well.

This is a natural consequence of the fact that, when funds are pumped into the U.S. economy to try and help the labor force, Wall Street usually gets the first cut. Quantitative Easing (QE) did a lot more for share buybacks than it did for actual worker wages. If Yellen and Powell figure out how to unleash the fiscal taps in creative ways, a similar thing is likely to happen again.

This partly explains why, in our view, real inflation will be coming back in the next few years. Not the pretend stuff, but actual, full-on, wage-and-policy-driven inflation.

When that inflation wave (which could wash over the entire world) comes into contact with the biggest low-yield sovereign debt mountain in history — which is again global, with something like $18 trillion worth of debt sporting negative yields at last tally — the fireworks will be spectacular.

On Nov. 24 we asked, “When will Bitcoin have a meaningful correction?”

The very next day, a concerning piece of news triggered a correction-worthy sell-off into the Thanksgiving holiday (crypto markets never close).

But the Bitcoin correction then self-corrected, almost wholly reversing over the weekend that followed.

At the worst point of the correction — or perhaps call it a crypto flash-crash — Bitcoin in U.S. dollar terms (BTC/USD) was down close to 16% from its pre-Thanksgiving high.

But as of this writing on Monday, Nov. 30, BTC/USD has blasted its way to new all-time highs above $20,000.  

So, a meaningful correction? Hmm. An extremely quick one if so. Blink and you missed it.

As a point of note, Bitcoin is up more than 160% year-to-date and up close to five-fold from the March meltdown lows. It is also up more than 40% for the month of November alone. 

With upside performance like that, you are going to see some volatile downswings on occasion. They come with the territory.

Part of what happens is that, when a bull-market trend gets heavily extended, buyers will step back if they sense a flurry of sell orders hitting the market.

This can create a kind of air pocket where the price drops suddenly. The market may then find support where buy orders below the market are clustered.

If demand is still strong, volatile corrections tend to resolve quickly once buyers determine the selling pressure has eased. Their mood of patience can then flip back to urgency as the price starts to rise again. 

The drop also occurred mainly over the Thanksgiving holiday, which makes perfect sense. Though Bitcoin is a 24-hour market, there will be reduced trading volume, and thinner markets, when North American trading desks are closed.

Bitcoin had run so far, so fast, it would not have been surprising to see a correction with no news at all.

But there was in fact news this time, and it had the crypto community worried.

Brian Armstrong is the CEO of Coinbase, the most valuable North American crypto exchange (and a likely candidate to go public in the next six months). On Nov. 25, Armstrong Tweeted the following: 

Last week we heard rumors that the U.S. Treasury and Secretary Mnuchin were planning to rush out some new regulation regarding self-hosted crypto wallets before the end of his term. I’m concerned that this would have unintended side effects, and wanted to share those concerns…

You can read the Armstrong Tweet thread in its entirety here.

The gist is that the U.S. Treasury might try to force “Know Your Customer” (KYC) type identity disclosure rules on the users of individual crypto wallets. In the United States, KYC rules are largely in place for crypto exchanges, but not for self-hosted wallets or the user who holds their own keys.

Armstrong is right that forced disclosure rules for self-hosted crypto wallets would have a negative impact on the crypto space. They would create headaches for many crypto assets, and would act like a bottleneck for rapid crypto adoption. 

But some members of the crypto community feared that a regulatory violation of wallet privacy would pose an “existential threat” to Bitcoin, and that is not at all true. We can break this out into parts:

• The U.S. government will not be able to regulate self-hosted wallets easily. If they try, they will receive significant political pushback and could lose in court.

• While forced identity disclosure of self-hosted wallets would be problematic in many ways, it would not threaten Bitcoin — though it could well threaten other crypto assets.

• Bitcoin’s dominant use case is not privacy-based. While privacy is a helpful feature, Bitcoin could fulfill its mission and mandate even with no regulatory privacy at all.

To the first point, it is easy to forget that property rights are alive and well in the halls of the U.S. Congress. There are plenty of legislators who see the defense of property rights as an important aspect of government, and who will require extraordinary proof before signing off on privacy violations.

This does not mean self-hosted wallets will automatically be protected from privacy intrusions or forced identity disclosures. But it does mean that the U.S. government would have to go through a process of explaining itself before pushing intrusive rules through the system, in a manner consistent with other property and privacy norms.

For example, does the government have a right to know how many rare baseball cards you own or how many collectible cars? Can the government place onerous disclosure requirements on any type of asset, for any reason, in the vague name of financial transparency? Not necessarily — and not without a court fight that private-property advocates could win.

With that said, even if the U.S. Treasury pushes through identity disclosure rules for self-hosted wallets, this would not threaten Bitcoin in terms of its core use case. To understand why this is true, consider that the largest potential buyers of Bitcoin have no use for anonymity in the first place.

To the extent that Bitcoin becomes a store of value for corporations, pension funds, family offices, investors, and even central banks, anonymity does not make a difference at all.

Entities with the capacity to purchase Bitcoin in large amounts typically already have to disclose what they own, if not to the public then on some type of regulatory form, which means the whole self-hosted wallet question is moot.

This is true even for wealthy individual investors, who have a hundred different ways to shield their identity or create a veil of anonymity while still obeying legal disclosure rules. Think of the real estate property which is owned by an LLC, which is in turn owned by another LLC, which is managed by an offshore trust.

The bottom line is that there are so many ways to maintain the privacy veil, while still jumping through requisite legal hoops, that the buyers of Bitcoin with the capacity to hold large amounts will not be deterred. They were used to the legal disclosure cat-and-mouse game anyway. 

To be clear, it would not be a good thing if the U.S. government pushes through identity disclosure rules that impact self-hosted wallets. It would be a setback for the crypto asset space, and for private-property rights in general. And certain growing areas of the crypto industry, like the “Defi” decentralized finance movement, would likely be hurt.

But Bitcoin itself would be fine, because Bitcoin is not about privacy. It is about serving as a global consensus store of value, which gives the holder of Bitcoin the ability to opt out of a fiat-based system.

Think of Bitcoin as a sort of opt-out mechanism for monetary and fiscal policy.

If you don’t like how the U.S. government is handling its currency and debt mix — and you don’t like how Europe, Japan, or China are handling theirs, either — you can buy Bitcoin as a store of value instead.

Or, to put it another way, think of Bitcoin as a way to vote against central-bank management and to vote in favor of a global consensus algorithm instead.

If hundreds of millions of people and business entities, all around the world, mutually agree to store their savings in a digital asset of fixed quantity, with ease of access through an intermediary payments layer, then all who participate in that consensus can move a portion of their savings out of the fiat realm. That is the big idea here, and privacy has nothing to do with it. We are not belittling the value of privacy, or claiming that privacy as a feature has no importance. Instead we are pointing out that privacy is not a central feature of Bitcoin’s enduring appeal. The store-of-value dimension is.

Note, too, that the ability to invest in publicly traded company shares is highly useful, and valuable, even though no self-hosted wallet is available for, say, owning a stake in Google, Apple, or Netflix.

One could say that KYC rules are in place for all forms of corporate-share ownership, to the extent one can only own shares through a brokerage (which presumably keeps KYC data on file).

Is this ideal? Perhaps not. Is it an impediment to doing business? Not really, because the mountains of capital invested in publicly traded shares do not turn on a libertarian notion of privacy in the first place.

We do readily admit that the hidden goings-on of regulators have made us wary of large sections of the crypto space. More than two years ago, for example, we laid out our view to TradeSmith Decoder readers that so-called “privacy coins” — crypto assets specifically built to evade regulatory authority — were bugs looking for a windshield.

But again, that is not what Bitcoin is or does. Bitcoin is a non-replicable global consensus store of value network — a kind of “digital gold” with a higher level of user functionality than gold itself.

This is why, with each passing week, if not each passing day, you hear more and more bullish drum beats in the news, like this story from Nov. 28: The Guggenheim Funds Trust, which has $233 billion in assets under management, recently filed an amendment with the U.S. Securities and Exchange Commission (SEC) to invest up to 10% of the net asset value of its roughly $5 billion Macro Opportunities Fund in the Grayscale Bitcoin Trust (GBTC). Translation: Another half a billion that could be flowing into Bitcoin. This kind of thing is becoming old hat,  you see, because the biggest, smartest, most financially savvy institutional players in the world have done their due diligence on Bitcoin — and they get it.

Editor’s Note: One of the strangest things about the modern financial era is the dawn of negative interest rates. Who knew such a thing was even possible? And why do they exist in the first place? In today’s “best of” piece, originally published in May, we revisit the mechanics of negative interest rates and explain how they work. — JCL

Earlier this week we discussed the bond market’s ominous message, while emphasizing a forecast for negative U.S. interest rates.

Scott Minerd is talking about negative interest rates, too. This is notable because Minerd, the chief investment officer for Guggenheim Investments, oversees $270 billion worth of assets.

In a note published on May 10, Minerd said the following:

I see the yield on the 10-year Treasury note falling to 25 basis points or lower very soon, with a possibility that it will go negative in the intermediate term—our target is -50 basis points, and in certain circumstances it could go meaningfully lower. The long bond could ultimately reach around 25 basis points as the 10-year and 30-year area of the curve shifts down by over 100 basis points from where it is today.

As of this writing, the U.S. Treasury 10-year yield is 0.73%. If it shifts down “by over 100 basis points,” as Minerd anticipates, it will go below zero (and thus turn negative).

For investors, negative prices are yet another head-scratching feature of a weird and bizarre landscape.

Not too long ago, we discussed the possibility of negative oil prices in these pages, pointing out at the time that the futures had never done it, but less-than-zero could happen soon. The piece was published on a Friday; the front-month WTI contract went to negative $37.63 the following Monday.

Negative yields for U.S. Treasury bonds would be another world-historic first, though Europe and Japan arrived there some time ago. At one point in the fall of 2019, nearly $17 trillion worth of sovereign bonds, including a portion of corporate bonds, had negative yields attached.

Negative yields came to other parts of the world first, but not the United States, because Japan has been in a deflationary funk for decades, and Europe has long been headed in that direction.

The U.S., in contrast, is seen as a more dynamic place — but not for much longer, perhaps. 

In comparison to interest-rate yields, negative pricing for commodities is fairly straightforward. There is a lot of oil in the world, and oil producers can’t shut off the taps without major headaches; therefore, with too much oil around, producers had to pay purchasers to haul the stuff away.

Interest rates work sort of like that, but the whole setup is more abstract. A bond is not a physical commodity that takes up space, but debt still has commodity-like features in that the price of debt is governed by supply and demand.

When the price of a bond goes up, the interest rate goes down and vice versa. This is not a correlation, but an iron-clad relationship: The price paid for a bond determines the yield that is received.

For example, if you pay one dollar (par value) for an eight-cent annual coupon, your yield is exactly 8%; if you pay more than a dollar, you will still only get a dollar in principal back (plus the eight-cent annual coupon) when the bond matures; and if the amount you pay is high enough, your total yield winds up negative, meaning you lost some money on the deal.

Through this mechanism we can see how yields are entirely a function of prices paid. They call bonds “fixed income” because the coupon (eight cents, in our example) is always fixed, meaning it always stays the same.

Yield is thus determined by where you buy the bond in relation to par, either above or below. The more you pay above par ($1, in our example), the less return you get — and at a certain price, you lose money.

This leads to the next question: Why would purchasers ever buy bonds at a money-losing price? Buying something in order to lose half a percent, or whatever the negative yield is, seems about as logical as hitting one’s thumb with a hammer on purpose.

And yet there are logical reasons this happens.

First off note that, when it comes to government bonds, no person or committee decides to make the yield negative. Instead there is such a strong demand for the bonds that buyers keep bidding the price up, even after the yield hits zero and falls below.

As for why bonds still get bids when yielding less than zero, there are multiple possibilities for buyers’ rationale.

The first possibility is speculative price appreciation. If an investor buys sovereign bonds at a negative yield because he thinks the yield will go more negative still — meaning the bond moves higher in price — then he is simply looking to “buy low and sell high,” or rather “buy high and sell higher.”

Other investors, typically banks or large institutional investors, will buy negative-yielding bonds as a “least-bad alternative.”

By that meaning, these entities are forced by their charter or investment mandate to own some type of securities, or some mandated mix of stocks and bonds; if everything in their investment landscape looks terrible, buying bonds for a small fixed loss might be their “least bad” option.

Then, too, sometimes sovereign bonds see a rush of bids from safe-haven buying. When markets are in crisis, or there is otherwise a lot of turmoil, investors can rush into government bonds as a safe place to park their cash. If this happens in large enough volume, when yields were already low, the bond price can go negative and stay there.

It should go without saying by now, but negative-bond yields are a very bad sign for a nation’s economy, or the global economy on the whole when there is $10 to $20 trillion worth floating around. This phenomenon means the long-run outlook for economic growth is so poor, or so worrisome, or both, that investors can think of little better to do with their cash than pay a holding fee to keep it safe.

The final, and most frightening, reason for negative-bond yields is the presence of outright deflation. If prices nearly all across the board are contracting at, say, a 5% annual rate, then losing 1% or 2% on a fixed basis — for investors with no better option — might actually be a good deal.

In sum, negative-bond yields are a harbinger of looming deflation and nonexistent economic growth. In a world overloaded with debt, such conditions can be so dire they inspire a printing-press frenzy from the world’s central banks — but that is a topic for another day.

Bitcoin could be one of the greatest public investment opportunities in all of recorded history. That’s not hyperbole. We are serious about this — and we come to that view having studied Bitcoin intently for more than two years, and global markets overall for more than 20.

There are venture-capital opportunities and private-investment opportunities that can deliver multi-thousand-percent returns. But these opportunities are not public in the sense of being widely available and easily accessible for any investor at any account size.

Because every Bitcoin is divisible into 100 million Satoshis, you could purchase less than $5 worth if you wanted to. The headline price of Bitcoin is no barrier in this regard, and still wouldn’t matter even if Bitcoin reached $1 million per coin.

There are also stocks that can deliver multi-thousand-percent returns over the course of a decade or more — like Amazon.com, for example. But needless to say, to see that kind of price appreciation you have to get in very, very early, and “hundred-baggers” — investments that deliver a 100-fold gain, which translates to a 10,000% return — are incredibly rare.

And yet, even from current levels in the $8,000 to $10,000 range, Bitcoin looks like a ten-bagger. And it might even be a hundred-bagger.

Most investors still don’t understand why Bitcoin is such a compelling opportunity.

But little by little, more investors are starting to “get it.” And as the compelling nature of Bitcoin’s value proposition dawns on them, more investors could start accumulating Bitcoin, including institutional investors. This is how the price of BTC goes from $10,000 eventually to $100,000 — and from there possibly to $1 million and beyond.

Again, this possibility isn’t hype or silliness or fluff. It’s real.

And the possibility exists because Bitcoin has the potential to fulfill not just any “use case,” but one of the most profoundly valuable use-case propositions in all of human history.

Bitcoin is the purest form of “hard money” ever created.

Many investors are familiar with the concept of hard money. But they aren’t aware of the most accurate and profound definition (in our view) of what “hard money” truly is.

Here are some general examples of how “hard money” is used as a financial term:

• “Hard-money loans” are backed by real estate or tangible assets. If a business needs money badly, it can sometimes get a hard-money loan — typically in a private transaction, rather than with a bank — by pledging real estate or some other asset as collateral. In this instance, a “hard-money loan” refers to the fact that something real, some type of hard asset, is backing the loan.

• “Hard-money funding” represents a reliable and permanent income stream. If a nonprofit organization receives a grant, that is a one-time thing. But if the nonprofit has a regular stream of payments written into the funding organization’s budget, that is “hard-money funding” because it is perpetual and fixed.

• “Hard-money policy” represents currency backed by specie (typically gold or silver). In the age of the gold standard, which lasted from 1870 to 1914, international trade was facilitated by gold-backed exchange rates. Some financial historians consider it the most prosperous period in human history, in part due to widespread adherence to the gold standard. This period ended with the onset of World War I, when various nations abandoned fiscal discipline to pay for the war.

• “Hard-money coins” were gold coins tested for authenticity. In the 19th century, a common method of counterfeiting gold coins was to make a coin out of lead and paint it with a gold coating. Because lead is softer than gold, the receiver could literally bite the coin to judge its hardness. If the coin was too soft, it was probably made of lead beneath the gold coating. If deemed sufficiently hard, it was more likely to pass muster as the real thing.

All those definitions are logical and legitimate. But we would argue there is a better way to define the essence of what “hard money” is.

Our definition applies to gold as well as Bitcoin. It explains the attraction of both — and also explains why Bitcoin is “hard money” even more so than gold. Here it is:

“Hard money” is a medium of exchange that is literally hard to produce.

Ask yourself why gold is the current hard-money standard and not, say, copper or tin.

Gold is the world’s foremost monetary metal not just because it is stable, long-lasting, and attractive. There is far less gold in the earth’s crust, by volume, than there are quantities of the other base metals. As such, it takes far more work to pull gold out of the ground. There is just less of the stuff to be had per cubic ton of earth. This means producing more is hard, especially relative to the stock of gold that already exists.

There is a very big pile of gold in the world, thanks to above-ground gold stores that have been accumulating for thousands of years.

When gold gets dug up, it sticks around. Gold does not get used up like most commodities. This is important because the available quantity of gold in the world is very stable relative to the comparatively miniscule amounts of gold being dug up each year.

There is so much gold in the world that even if the gold miners go flat out, they will not be able to contribute more than, say, 2% a year or so to the world’s total gold reserves.

As such, gold is attractive as a monetary metal for two juxtaposed reasons: The general amount of gold available is very stable — it doesn’t swing around — and the new gold produced each year is a very small amount relative to global reserves.

That “small amount of production” part comes back to how “hard” it is to produce gold. Again, if gold were more like copper or tin, it would be a totally different story. The value of “hard money” in this sense relates to the fact that, any time a medium of exchange starts to increase in value, humans will find a way to make more of it.

Let us say, for hypothetical example, that the rare earth metal Ytterbium was declared to be money. Let us further say that Ytterbium was deemed extremely valuable as a medium of exchange.

What would happen next? Enterprising geologists and miners would go out and produce as much Ytterbium as they could.

If there was an opportunity to inflate the money supply with vast new quantities of Ytterbium, someone would seize it, because doing so would be highly profitable. 

The same applies to any form of money, and thus to any medium of exchange that is deemed to be money. If it’s easy to make more of the stuff, humans will figure out how via profit motive.

This is why the ancient forms of money — cattle, seashells, glass beads, and so on — all went by the wayside. The process for a failed form of money generally goes something like this:

• Hard-to-produce item X is dubbed a medium of exchange.
• Someone figures out how to produce large quantities of X.
• Unwieldy quantities of X enter the monetary system.
• The value of X is inflated away via oversupply.

Now think about our “hard money” definition — a medium of exchange that is hard to make or produce — in the context of fiat currency.

Fiat currency, as controlled by governments, is the literal opposite of hard money. It is the softest money in the entire world, in terms of the ease with which it gets created.

One of the things 2020 has shown us is how Jerome Powell, Chairman of the Federal Reserve, can literally call a press conference and create hundreds of billions of dollars, on the spot, on a Sunday night.

Now that is some non-hard money. For every central bank, it’s the same. Fiat money issued by governments can be created in mass amounts at the touch of a button. Central Bank Digital Currencies (CBDCs) will have the same characteristic, which is why they will never qualify as “hard money” either, and never function as reliable stores of value.

Getting back to Bitcoin: The reason Bitcoin is the purest form of “hard money” ever created is because the elasticity of Bitcoin is zero. This is a feature built directly into Bitcoin’s immutable mathematical programming. And eventually Bitcoin will become so “hard” to produce that the new amount of Bitcoins produced will be zero — forever.

Elasticity is a measure of how much supply or demand changes in response to price swings. Let’s say gold goes to $4,000 an ounce as a result of fiat currency printing, for example.

If that happens, the rate of gold miner production will expand. It won’t expand by a huge amount relative to the above-ground gold supply, but the supply of gold will still go up, at least a little bit, in response to upward price pressures.

But Bitcoin’s elasticity is zero because the rate of Bitcoin creation will never expand, no matter what the price does.

Even if Bitcoin shoots up to $50,000 or $100,000 per coin, the rate of creation for new coins will stay the same, and not budge one bit, because the whole structure is algorithmic and pre-determined.

Then, too, Bitcoin is designed so that the rate of production will steadily fall over time, and that rate of production will eventually hit zero. Once there are 21 million Bitcoins in the world, no more Bitcoins will be created, ever. The existing supply will be the defining amount for all time.

That is what makes Bitcoin a form of “hard money” that is even more pure than gold.

The hard-money properties we are describing make gold attractive as a long-term store of value.

Bitcoin has those same properties, but even moreso, with the added advantage of existing entirely in the digital world.

And because Bitcoin’s historical record is distributed via digital ledgers across servers all around the planet, Bitcoin is also as immutable and unchangeable as gold.

The one existential threat to Bitcoin is quantum computing, and the possibility that a quantum computer could somehow hack the blockchain. But this threat is on par with the threat of nano-scale 3D printers gaining the ability to assemble gold at the molecular level.

Both quantum computing and nano-molecular assembly are theoretical risks — one to Bitcoin and the other to gold — but neither are likely to happen within decades, if at all within our lifetimes.

And even as the quantum computing threat looms in the medium-term future, brilliant minds the world over are working on counterbalancing quantum cryptography solutions (which will be vital for protecting the world’s secrets, not to mention the world’s global financial transactions).

When quantum security exists, you can be sure it will be layered into the Bitcoin blockchain. There are already big brains thinking about it.

The upshot here is that, as the ultimate form of hard money, Bitcoin’s ultimate use case is serving as a store of value even more reliable and immutable than the store of value represented by gold.

Gold is valuable because the new supply in relation to existing supply — known as the “stock to flow ratio” — is reliably small.

Bitcoin has those same characteristics, with the added benefit of an elasticity of zero and a new supply rate that is both algorithmically fixed and heading to zero by design.

Some might ask, what about a new version of Bitcoin? Can’t somebody else just make a Bitcoin 2.0?

The answer there is no, or rather, anyone can make a hypothetical copy of Bitcoin, but nobody can make a true Bitcoin competitor. It is too late for that. This is because of network effects and the compound advantage of 10 years’ worth of head start on the store-of-value front. Consider the following:

• Bitcoin’s ultimate use case is serving as a digital store of value.
• Investors who buy Bitcoin long-term bolster this store-of-value case.
• The more Bitcoin is used as a store of value, the more its value increases.
• The bigger the network becomes, the stronger the network becomes.
• The higher Bitcoin’s value rises, the safer the network becomes.

What you have here is a flywheel where value begets value and strength begets strength. The more that investors perceive Bitcoin as a hard-money store of value, the more that additional investors will add funds based on the same perception, to the point where no other contender has a chance to compete.

At the same time, the bigger the network becomes, and the higher the value of Bitcoin rises, the more “mining power” is attracted to the Bitcoin mining and transaction network. This strengthens and safeguards the system yet further, making it even harder to break.

Bitcoin is digital gold. It has taken the “hard money” properties of gold, and made them even harder — and it has crossed the hurdles of global recognition and infrastructure, at a time when no other cryptocurrency comes close.

And now Bitcoin is poised to show its true worth in the aftermath of a post-pandemic world, with global debt levels exploding and fiat currency regimes heading for debt-induced meltdowns.

No other asset — anywhere, ever — has done anything remotely like this.

Before Bitcoin, only gold had served as a reliable and immutable store of value for the entire world. Bitcoin has taken that use case and gone digital with it.

In our view, that level of value-add to the world — acting as a store of value that is truly digital, truly trustable, and accessible to everyone — is potentially worth more than all the FANG stocks put together. We also suspect that, in due time, the world will figure this out.

Editor’s Note: When the end-of-year holidays roll around, we like to revisit an assortment of “best of” pieces taken from throughout the year. And what a year it has been. Given the degree to which 2020 has been mentally taxing for almost everyone, it seems fitting to revisit the topic of mental versus financial capital, and the reasons why both are equally important. — JCL

Investment success depends on two types of capital, financial and mental.

We are all familiar with financial capital. This is what goes in the brokerage account. Financial capital is what we use to buy and sell stocks, options, cryptocurrencies, or whatever it is.

Mental capital, though less well known, is just as important.

Without mental capital, financial capital is useless. The wise investor practices risk management not just with financial capital, but mental capital, too.

So, what is mental capital, exactly? There are different ways to define it. But three key areas of mental capital are emotional resilience, decision-making energy, and decision-making consistency.

Emotional resilience is about holding up well in times of stress. (Like right now.) The more emotional resilience you have, the better you can handle volatility and uncertainty.

There is a tongue-in-cheek saying, “blessed are the flexible, for they will not be bent out of shape.” Emotional resilience is the ability to be uncomfortable, or get pushed out of your comfort zone, and then spring back to positive form.

Decision-making energy, the second component of mental capital, is exactly what it sounds like. It is the amount of mental energy you have in reserve to make hard decisions, or to make a long series of decisions.

If you’ve ever had that feeling at the end of the day where you can’t decide what TV show to watch, let alone what to have for dinner, you know what it’s like for your reserves to be depleted.

In the field of neuropsychology there is a phenomenon known as “directed attention fatigue,” or DAF for short. DAF is a sense of mental tiredness that comes from fighting off distractions.

The harder you have to concentrate in order to pay attention, even as stimuli, emotions, and interruptions are flying all around, the more fatigued your mind becomes.

This also explains why mental capital gets depleted in high-volatility, high-stress environments. When anxiety levels are high, the distractions are internal. Your own brain, wired up by adrenaline, becomes an agent of self-distraction.

The distractions triggered by your own careening emotions then cause DAF — directed attention fatigue — as it gets harder and harder to maintain focus, and your ability to make decisions disappears.

This leads to the third component of mental capital, decision-making consistency.

Decision-making consistency is a measure of how well you follow your own rules.

Picture two investors using the same system to manage position risk. Both investors are committed to “always following the rules,” meaning, they fully intend to abide by the system.

If the first investor actually does this 100 times out of 100, their decision-making consistency is perfect. If the second investor does it half the time, but blows off the rule 50% of the time, their decision-making consistency is terrible (no better than a coin flip).

As with so many other things, it’s harder to be consistent in times of volatility and stress. The more that our emotions get tested, the harder it is to stay disciplined.

As a side note, this is where “stress eating” comes from: The temptation to indulge is constant, but under stress, the ability to resist is weakened.

It’s all connected: Emotional resilience makes it easier to preserve and replenish decision-making energy, which in turn enables decision-making consistency. And when mental or physical energy levels get depleted, the clarity and quality of decisions degrades, too.

So how do you preserve mental capital, or replenish reserves when mental capital is low?

The No. 1 thing is simple but profound: Be sure to get enough sleep.

Sleep has been described as “the Swiss Army knife of health” because physical rest is a key component of so many processes. When you sleep, your body heals and your mind cleans up, in terms of flushing out toxins while consolidating memories and digesting the lessons of the day.

It is often the case that, when mental capital is depleted — when emotions are raw, the mind is fuzzy, and decision-making capability is poor — physical rest is the most immediate remedy.

There are many other ways to build and replenish mental capital. In the broader sense, it’s a topic that could fill a thousand books, but a good first step in these wild times is simply remembering that mental capital is important.

If you find yourself feeling irritated or anxious, get a change of scenery and a good night’s sleep. You might be surprised what a difference it can make.

And if you aren’t doing so already, try to spend as much time thinking about mental capital — your own psychological health and well-being, and capacity for good decision-making — as you do thinking about financial capital (the stuff in the brokerage account).

You just might find yourself on a smoother investing path, with more success, less internal stress, and a heightened quality of life as a result.