MicroStrategy, a Nasdaq-listed company with a roughly $1.5 billion market cap, is the first publicly traded entity to embrace Bitcoin as a corporate treasury asset. But it won’t be the last.

As of Sept. 15, 2020, MicroStrategy (MSTR) revealed it had purchased 38,250 Bitcoins at an aggregate price of $425 million, including fees and expenses.

MicroStrategy had originally purchased $250 million worth of Bitcoin in August 2020, and then added $175 million more.

“This investment reflects our belief that Bitcoin, as the world’s most widely adopted cryptocurrency, is a dependable store of value and an attractive investment asset with more long-term appreciation potential than holding cash,” said Michael Saylor, MicroStrategy’s founder and CEO, in August.

“We find the global acceptance, brand recognition, ecosystem vitality, network dominance, architectural resilience, technical utility, and community ethos of bitcoin to be persuasive evidence of its superiority as an asset class for those seeking a long-term store of value,” Saylor added.

That might sound familiar. We’ve said much the same for years now, and pounded the table for Bitcoin’s long-term investment case at its low point below $3,200 in December 2018.

Saylor is used to being ahead of the curve on technology.

In the 1980s, Saylor attended the Massachusetts Institute of Technology (MIT) on a U.S. Air Force scholarship, earning multiple degrees in aeronautics and astronautics (with a specialty in spaceship design), as well as science, technology, and society (the history of science).

Saylor founded MicroStrategy in the late 1980s, while still in his 20s, and took the company public in 1998; by his own reckoning he is the longest-serving CEO in the enterprise software industry.

Given that background, Saylor is uniquely equipped to understand the intersection of technology and society, and the nature of technological revolutions.

In a recent interview, Saylor described Bitcoin as “a hive of cybernetic hornets doing the bidding of Mother Nature, protected by a wall of encrypted energy.”

In Saylor’s view, Bitcoin is “dematerialized gold,” but it is also much more than that, because the global Bitcoin community makes it a kind of living technological entity.

While the core of Bitcoin and the sanctity of the ledger remain the same – immutable and unchanging – the outer layers of Bitcoin continue to evolve through community innovation, making it stronger, safer, and increasingly useful over time.

MicroStrategy, as a U.S.-listed, publicly traded company, took a big step in deciding to make Bitcoin its primary corporate treasury asset.

For publicly traded companies, corporate treasury assets are usually kept as bland and boring as possible, tending toward a mix of cash, government securities, and high-grade corporate bonds.

The idea behind corporate treasury conservatism is that a publicly traded company is not in business as a money manager. When investors buy the company’s shares, they want undiluted exposure to the company’s product line and business model, not an embedded investment portfolio.

There are exceptions to the rule, and companies where the investment portfolio is a major draw. Berkshire Hathaway is the most famous example of this. But as a general rule, corporate treasury departments are supposed to be boring.

As he described it in a Real Vision interview with Raoul Pal, Saylor discovered Bitcoin as a result of the pandemic.

After the pandemic hit, Saylor saw the extreme things the U.S. government did as a form of policy response, and the way U.S. Treasuries seemed destined to lose money after inflation, and could not, in good conscience, keep MicroStrategy’s corporate treasury holdings in dollar-denominated assets.

This led Saylor to ask himself a question: What is the best way to preserve value over time? If the goal was to maintain, say, $100 million worth of purchasing power for at least 100 years, transferring it to someone in the year 2120, what would be the best way to do it?

After looking at all the various options — stocks, bonds, gold, real estate — Saylor decided that Bitcoin was the most logical store of value imaginable. In the long run, even gold sees annual supply expansion year after year; it is only Bitcoin that has absolute scarcity and a dilution factor of zero.

“If you go out more than a decade, all the noise drops away and stuff becomes real clear,” Saylor said.

It will take time before, say, the majority of corporate treasury departments in the S&P 500 embrace Bitcoin as a balance sheet asset. But on a longer-term timeframe, the decision seems inevitable.

As of 2020, the U.S. dollar and U.S. Treasury bonds are still seen as the bedrock of the global financial system and the lowest-risk assets imaginable from a corporate treasury perspective.

This view may not hold, however, if inflation pressures return alongside currency debasement fears and persistent negative real yields.

To a significant degree, the corporate treasurers of U.S.-listed public companies are guided by social convention. In the eyes of their peers, sitting in dollar-denominated assets is the respectable thing to do. That may not be the case when U.S. dollars and Treasuries are seen as eroding at the margins like sand.

At the same time, it may seem increasingly bizarre for corporate treasury departments not to own Bitcoin, at least in some modest percentage amount, once the crypto reaches a sentiment tipping point.

Consider a scenario where the U.S. dollar is consistently losing 5% per annum in real-world purchasing power, with Treasury bond yields near zero.

If the main body of corporate treasury assets is losing 3 to 5%, year in and year out, putting 2% of assets into Bitcoin as an inflation hedge could become a no-brainer, with the inherent risk of loss from inflation (3 to 5%) being greater than the hedge.

When S&P 500 corporate treasury departments embrace the logic of, say, putting 2% of assets into Bitcoin, it should be well on its way to a 10X return from current levels, if not headed far beyond.

Say you have an investment choice between two gold mining companies. They are similar except for a single variable, the average production cost per ounce.

One miner produces gold at an average production cost of $900 per ounce; the other does so at $1,800 per ounce. Which miner is the better investment, in terms of 12-month price appreciation?

It’s actually a trick question. The answer depends on the price of gold, the price action history for both companies, and what is happening in the precious metals investment cycle.

Say, for example, that gold is at $2,000 and on the way to $2,400 at the time of making the choice.

In a gold price transition from $2,000 to $2,400, the profit margin per ounce for the low-cost miner will increase by roughly 36%. At the same time, the profit margin for the high cost miner will increase by 200%.

By the time gold is at $2,000 per ounce, the price of the low-cost miner will have already risen a significant amount. Between $2,000 and $2,400, the low-cost miner’s share price could comfortably rise by another 30-40% in proportion to its further profit margin expansion.

Whereas the high-cost miner, which had been underwater until the gold price crossed the $1,800 per ounce threshold, could see its profit margins triple between $2,000 and $2,400 — and see its share price double in that time frame.

The interesting takeaway is that, at a certain point in the cycle, gold miners with strong fundamentals could have a modest amount of share price upside left — because they have already gone up a lot —  whereas gold miners with weaker fundamentals could have far more upside left, on the order of 400% more, because their margin expansion doesn’t kick into gear until gold breaks a late ceiling.

And so, in terms of the question, “Is it better to invest in a low-cost miner ($900 per ounce) or a high-cost one ($1,800 per ounce),” the answer is dependent on price-action history (which has already gone up, and which has not moved as much yet) along with the journey of the gold price itself, and the overall state of the precious metals cycle.

To put it broadly, what matters here is situational analysis and not fundamentals alone.

Poker players are well familiar with the situational analysis concept. The fundamentals of an individual company are like the strength of the players’ hole cards in a poker hand (the two cards the player is dealt before the flop) in Texas Hold ’Em.

The key thing is that no poker hand is ever played in a vacuum. The cards in one hand are only the start. There is always a surrounding situation, and sometimes the total situational impact makes a weaker hand better than a strong one.

For example, say you are playing deep stack No Limit Hold ’Em, and you are involved in a hand with four other people before the flop is dealt. Which would you rather have in that situation: Pocket kings first to act, or nine-ten suited last to act?

In this situation, nine-ten suited last to act is the more desirable holding, by far, because of the circumstances and the positioning in the hand.

In many cases, the pocket kings will be beaten by a concealed drawing hand, but the player holding the kings will have a hard time throwing them away (because the kings look so attractive). The player holding kings will also be “flying blind” to the extent they are first to act (with four other players acting behind the first player with each new card that is dealt).

At the same time, nine-ten suited last to act will be easy to throw away in most circumstances — and will completely miss most flops — but could turn into a hugely profitable hand with the right board flop (e.g., a board that delivers two pair, or a combination flush draw and open-ended straight draw).

At the same time, because the nine-ten suited hand is last to act — a key part of the situation as we described it — the player will have maximum information at each decision point. They will be able to see how all four opponents behave, and what their decisions are, before making their own decision in each round.

This makes nine-ten suited a better hand than pocket kings in the situation described, because it will be far less prone to unwieldy large losses — if the hand does not connect, it is thrown away — whereas if the hand catches the right card combination, it can generate a very large return (by winning a giant pot with a straight or flush, or bluffing opponents out on the strength of a strong draw).

The applicable poker lesson, applied to investing, is once again the value of situational analysis: Looking at the total picture, rather than just the cards alone (or the fundamentals of the company alone).

The fundamentals of an individual publicly traded company, when considered for investment, are like the strength of the cards one holds in a Texas Hold ’Em hand before the flop. The cards are never played in a vacuum; there is always a situational context. It is the same with investment opportunities.

Situational analysis also helps explain why it is dangerous to weight the fundamentals of a company above and beyond anything else. In poker, this is known as playing your cards but not the table, or playing your hand but not your opponents. It is not the way to go.

If consumers are wildly enthusiastic about a product, for example, but wild enthusiasm is already factored into the share price valuation, there is no edge to be found by investing on the basis of consumer sentiment.

This is one of the deep problems with, say, the narrow view of company fundamentals pushed by a majority of Wall Street analysts. It is never the company story in a vacuum that matters, because nobody ever invests in a vacuum. It is always the story in relation to situational context at a given point in time.

To what extent does the company’s valuation already reflect excitement for the product? To what extent have likely investors in this company already bought? What catalyst exists that could change the picture in a manner that is not priced in? These are crucial questions to ask.

For example, as shown with our gold miner example earlier, the lower-cost miner might be a better company in absolute terms, or at an early point in the cycle, but a higher-cost miner could be a far better investment, in terms of 12-month price appreciation, later in the cycle.

In the end, it makes perfect sense that weak fundamentals are sometimes better than strong ones, just as a weak poker hand is better than a strong one, because fundamentals and situational context matter together, side by side. It is never just one or the other. It is always the net combination of both.

Sometimes situational context subtracts from the value of an intrinsically stronger hand — as with pocket kings in a lousy situation — while adding to the value of an intrinsically weaker hand, as with nine-ten suited in a fantastic situation.  The pathway to maximizing reward versus risk thus with understanding the bigger picture.

It is true that most investors are not well-versed in taking in the bigger picture, which is exactly what situational analysis requires.

This is probably related to the reasons why new poker players are not good at looking beyond the hole cards in their hand, and considering situational factors like the nature of their opponents, their positioning in the hand, and the relative size of chip stacks on the table.

We’ve received some interesting questions about the election, and about TradeSmith Decoder as a service. We’ll answer a few of those today.

As a quick note regarding questions, the mailbag is always open: You can reach us via [email protected]. We always enjoy hearing from readers — and if your question is a common one, we may answer it directly in a future TradeSmith Daily.

Q. Some think “gridlock” is bullish for markets, as it has been in the past. Why do you disagree?

Gridlock — a scenario where Washington can’t make policy and can’t pass bills — has historically been seen as positive. In the past, Wall Street has preferred a gridlocked Washington to an engaged one.

But the key difference is the macro backdrop.

When the economy is functioning on normal terms, Wall Street prefers that Washington stay out of the way. To the extent that new legislation stifles commerce, no news is good news.

In past years it has been the central bank, not Congress, that has done the heavy lifting in terms of helping markets with monetary policy.

If the Chairman of the Federal Reserve can lift the stock market by cutting interest rates, or introducing a new QE program, then Wall Street won’t much care what Republicans and Democrats are doing.

But the logic of gridlock changes when a crisis hits. Think about natural disasters, like hurricanes and floods. If FEMA, the Federal Emergency Management Agency, did not exist, the country would want to create it. 

Then, too, when monetary policy maxes itself out, fiscal policy — action from Congress — is what’s left.

The Federal Reserve is set up to help Wall Street, not Main Street. The Fed can’t send checks to people or keep mom-and-pop stores and small-time landlords from going bankrupt.

If the country is faced with a tidal wave of evictions and bankruptcies, coupled with millions of business closures, it is fiscal response that can make a difference.

Remember the horrible advice that U.S. Treasury Secretary Andrew Mellon reportedly gave to Herbert Hoover early in the Great Depression: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. Purge the rottenness out of the system.”

We now know that Mellon’s instinct — “liquidate” everything — was a recipe for economic collapse, because a lot of the severe financial distress in a macro-driven crisis is not “rottenness” at all, but rather hard-working people caught out by forces beyond their control.

The mechanism for alleviating these crises is no longer the central bank, but Congress, which holds the power of the purse. Wall Street understands this. Investors on the whole believe it, and CEOs do, too.

To put it another way, gridlock in a time of crisis is bearish because the threat of deflationary collapse is bearish, and gridlock means a lack of fiscal safety net.

Consumers trust banks because of FDIC insurance. If not for FDIC insurance, we would see fewer banks and a lot more bank runs.

If the availability of emergency fiscal policy is FDIC insurance for the economy on the whole, then gridlock is like suspension or cancellation of that policy. That makes Wall Street nervous.

Q. Won’t we mostly have gridlock anyway, if Democrats control the House of Representatives?

It’s true the House of Representatives is not in play in this election. There is a theoretical chance it could flip from Democrat to Republican, but the odds are very low.

Still, though, we don’t include the House in various gridlock scenarios because, in many cases, the House is willing to do business, even with Republican leadership.

It’s important to define the basic terms. Functional government does not mean legislation passes smoothly or easily. It means a better-than-even chance of passing anything at all.

Consensus is still a hard slog, and even with party unity you don’t always get it. Republicans tried to dismantle the Affordable Care Act in 2018 — while controlling the White House, the Senate, and the House of Representatives before it flipped — and still failed.

So consensus doesn’t mean instant passage. It just means passage is feasible. Gridlock, on the other hand, means that passage is virtually impossible. It puts the odds at slim-to-none.

A Democrat-led House of Representatives is not a gridlock factor by this measure because there are a significant number of moderate Democrats in the House. These moderates hail from districts that are more purple than blue, meaning they are incentivized to act in a non-partisan fashion. That, in turn, means a consensus can be wrangled out, at least in theory. 

The Senate, meanwhile, is much more combative. It is the place where bills go to die — as declared by its own leadership.

In 2019, majority leader Mitch McConnell said “Let me be clear: I will be the Grim Reaper in the Senate” with respect to anti-free-market legislation. If Dems retake the Senate, and have to face a Trump White House, they will feel the same about anti-labor or anti-environment legislation and will launch dozens of investigations alongside. That is where you see gridlock.

Q. What happens if state or local governments are denied access to credit?

This is a fascinating question. We honestly don’t know, because it has never happened in modern times.

In 2019, we wrote about pension-related crisis scenarios where various states could become insolvent. California, Illinois, and others have long had the financial equivalent of a ticking time bomb in their pension portfolios.

Now, thanks to COVID-19, the threat of state-level crisis has accelerated and expanded. The pandemic has been catastrophic for state budgets, in terms of ratcheting up costs and reducing all manner of tax revenues at the same time (property tax, sales tax, state income tax).

Our general conclusion in 2019 was that, due to the ticking time bomb in pension fund obligations, a multi-trillion bailout was inevitable. And we came to that conclusion, mind you, multiple months prior to COVID-19.

So, this is one more trend that the pandemic has accelerated. Multi-trillion bailouts for the various states are impossible to avoid at this point.

But what if the federal government just says no, or gridlock prevents a state bailout from happening?

Then the situation might be comparable to Greece. If you recall the European debt crisis that peaked in 2012 or so, Greece was the focal point.

The Greek economy was in shambles — crushed by a gigantic debt load — and deep-pocketed EU members, led by Germany, did not want to help with Greek debts, and it was touch-and-go as to whether Greece would stay in the EU.

If the federal government decided to, say, treat California the way the EU treated Greece in 2012, you could see a genuine secession movement take hold.

There could also be a banding together of states with broken budgets due to convergent long-term interests, and some kind of ultimatum to the tune of: “If you don’t want to help us now, we see no obligation to keep sending you transfer payments.”

So, ultimately, if the United States is to stay the United States, the states will get a multi-trillion-dollar bail-out. They are going to need one, perhaps sooner rather than later, and the nation will support it rather than vote against it, because otherwise we are talking about a dissolution of the union.

The really hairy question is how long a resolution would take. The European debt crisis, which dragged on for about two years, from 2010-2012, was relentlessly grinding and horrible. It was like pulling teeth or getting a cavity drilled without Novocaine, for what felt like an interminable period of time.

How will municipal bond markets respond to all this? It depends entirely on local specifics. But in states going through a COVID-accelerated budget crisis, one can forecast an elevated period of volatility that could last for years, as the specifics of state level bailouts get worked out.

Q. How will gold and silver respond to the various scenarios?

The ultimate outlook for precious metals is wildly bullish. The question is what happens between here and there. This, too, is a factor that depends on the path of fiscal policy, and what happens to the federal government.

The United States has a mountain of debt. So, too, does the world. This mountain of debt threatens to topple over and crush all that lies beneath it. If the U.S. economy experiences a deflationary collapse, a debt mountain, built up over decades, will be the culprit. 

For a sovereign government, there are only two ways out of a situation like this. You either inflate the debt away — which ultimately means printing currency to pay off obligations — or you find some kind of growth miracle, a way to grow the economy at such a rapid rate that productive income expands at a fast enough rate to comfortably service the existing debt.

The rapid-growth angle is a pipe dream. It isn’t a realistic hope. That means the powers that be will have to inflate the debt away, which means resorting to the printing press, and the United States, thanks to the size of its obligations, will have to print more than anyone else.

As mentioned, this is wildly bullish for precious metals, Bitcoin, and all manner of inflation assets that can benefit from a decline of faith in the U.S. dollar and the general erosion of fiat currency.

But as with the inevitability of government-funded state bailouts, it isn’t just the destination, but the path from here to there that matters.

In terms of currency printing, the Federal Reserve can’t do enough by itself. The real spender, the mega-spender, has to be Congress, which still holds the power of the purse. When Congress decides to spend trillions, and keep spending trillions, that is when you will see things really take off.

This is why a timing component still exists for precious metals investments. We are extremely long-term bullish on the precious metals space. But we are also aware that, sometimes, the government can take its sweet time in reaching a conclusion, even when delay is foolhardy or dangerous.

Q. It sounds like things could get crazy. Should I go to cash, or what?

If you’re not prepared for turbulence, going to cash is certainly an option. Keith Kaplan, our CEO, has said that cash is a better alternative than going into this election unprepared. (That’s one of the reasons we created the election webinar.)

But cash isn’t necessarily the best option, if you are willing to prepare and take action. The post-election scenario will generate major upside opportunities — not just major risks — and staying in cash is a form of risk all by itself.

If inflation picks up, even as money market funds yield close to zero, staying in cash could mean a steady loss of purchasing power. And if various paper assets continue their uptrends, or go further into “melt-up” mode, the cash-bound investor may not know when to get back in, or how to get back in.

Being stuck on the sidelines as historic opportunities are generated, and various areas of the market rise sharply while your cash feels worthless can be a painful proposition indeed.

It’s totally understandable to fear volatility, because most investors are not ready for it. And frankly, in our view most research services aren’t ready for it either.

The typical long-only, stock-based research service is built for bull markets and calm environments, where the only real question is which stock to buy.

TradeSmith Decoder, the research service we run, is completely different. We have long been prepared for this moment.

When markets get volatile, that is when real traders thrive. And when extreme “macro” factors start to dominate the landscape — stuff like inflation, debt crises, geopolitics, and societal unrest — that is when a deep knowledge of financial history, and a deep versatility in terms of trading instruments, both long and short, starts to really matter.

So in terms of what you should do: If you don’t want to sit in cash, you should consider subscribing to TradeSmith Decoder. We’ve been anticipating this market sea change for a very long time (which is why we called many aspects in advance, prior to the pandemic, in our Deadly Decade Survival Guide in 2019).

TradeSmith Decoder provides daily commentary to subscribers. It provides real-time trading signals via daily broadcasts. And it provides position sizing in a closely tracked model portfolio.

If you don’t want to sit in cash and watch your purchasing power erode, you need trading capability, and guidance from someone who is deeply seasoned and deeply familiar with the type of market environment we are heading into now. That is what TradeSmith Decoder was built for. It is the culmination of 20 years of skill and experience, distilled into a product that will keep you informed, every single trading day.

Q. Are readers told WHEN to buy and sell with TradeSmith Decoder?

Yes, they are. And this is one of the most important aspects.

Analyzing markets is one thing. Keeping track of markets on a day-in and day-out basis is another.

Knowing when to buy or sell — when to add to a position, when to take partial profits, when to move quickly — is crucial for success. There can be weeks or months at a time when no action is required on a position. And then, within the space of a day or two, action can be vital.

We track hundreds of instruments, every single day, including a watchlist of potential trades we are prepared to enter. We also track all of our positions, every single day, monitoring the price action not just for new positions, but for opportunities to add to existing positions, or to take profits on a position, or to exit a position entirely.

Due to the sheer number of information streams involved, it is impossible to track that amount of data without a streamlined system for managing all that information complexity.

Fortunately, TradeSmith Decoder has such a system — which was built and perfected over the course of 20 years — and we use it not just to give general guidelines, but to tell subscribers EXACTLY what we are buying and selling, with real-time instructions down to the day.

Q. Do you need a cryptocurrency account to use TradeSmith Decoder?

You don’t need cryptocurrency access to benefit from TradeSmith Decoder. It certainly doesn’t hurt, as we are active in cryptocurrencies.

But there are various stock- and ETF-based alternatives to direct cryptocurrency exposure — we have told subscribers about them — and more will be on the way.

We have so many opportunities in Decoder that cryptocurrency is only one aspect. At the moment, the majority of positions in the Decoder portfolio are equities and ETFs (and that will normally be the case).

Q. What are the benefits of Decoder’s “go anywhere” approach? Why not just stick with stocks?

Look, stocks are great in a multi-year bull market.

There are long stretches of time where stocks seem to rise and rise, and all the major indexes drift gently upward, and investors don’t have to worry about “macro” factors like interest rates, inflation, geopolitical conflicts, or currency volatility.

In periods like those, stocks are all you need. But the periods don’t last.

At certain points in the cycle, the market is like a calm ocean — small waves, plenty of sunshine, and a gentle breeze that is perfect for sailing. In those times, long-only investing is the way to go.

But at other points in the cycle, the market is like a storm-wracked ocean. In those periods you have giant waves, – the kind that can easily swamp or drown an unprepared vessel – with thunder and lightning and full-force gales.

We are headed into the second type of market environment — the one with high volatility, big waves, and stormy skies. This is partly just a natural aspect of cycles.

Markets generally were quiet and calm for about a decade, from 2009-2019. That period will be looked back on as a golden age for stocks.

But moving forward, we will see the opposite conditions, for years — because that is how cycles go. For whatever reason, a new decade seems to reverse the trends of the previous decade.

Then, too, we are now at the tail end of a bigger cycle, a long-term debt cycle, that began in 1980 and is coming to a climax in 2020. For roughly 40 years, leverage and debt in the system was built up from a low base. Now we are set to see that 40 years of leverage and debt build-up go into reverse.

In terms of “go anywhere” capability, this means that some of the very best opportunities of the next few years will not be in stocks at all.

The best opportunities of the new decade could be in currencies, which are about to explode in volatility; or cryptocurrencies, which are seeing a historic rise to prominence; or in commodities, which will see 1970s-style price appreciation as the U.S. dollar declines.

To be sure, we expect TradeSmith Decoder to do very well in equities, ETFs, and options, in the coming years. (We also have the ability to go short as well as long, which is crucial.) But our “go anywhere” capability, and the chance to exploit major opportunities not just in stocks, but in currencies, commodities, and cryptocurrencies, will be more valuable than ever in the macro-dominant world that lies ahead.

We’ll have the ability to make explosive gains in years where the stock market was flat or even down. How many traditional investors will be able to look forward to that? Not many.

The markets of today are the same as markets not just hundreds of years ago, but thousands of years ago. This is possible because human nature has not changed. The technology is different, but human nature is the same.

The basic mechanisms of financial markets — regarding things like credit and lending, speculation, government intervention, and even quantitative easing — are also ancient. The first known instance of quantitative easing (QE) is ancient, too.

We explained this week how  an all-consuming Supreme Court battle threatens to delay vital fiscal support, both before the election and after. The market is also beginning to process its fear of a “chaos” outcome, which has even greater potential to jam up the fiscal pipes completely.

This is frightening because the U.S. economy is still in dire need of help, and everyone knows it.

• “Seven in 10 Americans (70%) say they would support the government sending an additional economic impact payment,” a new poll from Gallup and Franklin Templeton reported this month.

• “Fed Pleads Anew for Stimulus, and Markets Start to Give Up Hope,” reads a Sept. 23 Bloomberg headline. “The power of fiscal policy is really unequaled by anything else,” said Federal Reserve Chairman Jerome Powell to lawmakers on Tuesday.

• “Top CEOs call for ‘major’ coronavirus stimulus to keep economy from backsliding,” the Washington Post reports. The CEOs cited include the heads of Apple, JPMorgan Chase, and Chevron, all of whom expect turbulent conditions through 2022.

At a certain point, monetary policy reaches a point of maximum effectiveness.

Beyond that point, if the outlook is still dire, fiscal help — direct from the government — is required to bridge the gap. This reality can be severely problematic if Congress can’t get its act together.

In the fourth quarter of 2008, the stock market went through a severe period of extended turbulence, in part, because Congress couldn’t agree whether to fund the Troubled Asset Relief Program (TARP).

Between the month-end close for August 2008 and the one for February 2009, the S&P 500 fell more than 40%. Congressional dithering contributed to much of that.

We now appear to be revisiting a jammed-up-Congress scenario not just because of Supreme Court issues, but rising concern over post-election-day issues. The newest fear point for markets is the possibility that, in the midst of ballot chaos, state legislatures could cut short the sorting process and assign their electors by force.

This would lead to a flood of court challenges and legal maneuvers, which would completely paralyze the halls of Congress.  

But getting back to the first known instance of Quantitative Easing, it is important to remember that, while all of this chaos may feel new, it isn’t new to history.

In fact, with much of what is going on today, we’re reminded of the Roman Financial Crisis of 33 A.D.

What happened in 33 A.D., almost two full millennia ago, demonstrates all the mechanics of a modern financial crisis, with a knock-down, drag-out political crisis thrown into the mix, too.

Adding to the irony, the Roman version even involved a backstabbing Senate — and finished out with three years of zero-interest-rate policy, by way of a kind of QE bailout for the One Percent.

It really is the same game! 

To give a shortened rundown of what happened:

Tiberius, the second Roman emperor, was an accomplished Roman general who more or less hated politics. Because the intrigue of Rome revolted him, Tiberius banished himself to the island of Capri, while still retaining emperor status.

With Tiberius physically removed from Rome, the stage was set for a power grab. Sejanus, the head of the Praetorian Guard, decided he could amass power for himself.

With enough intrigue to fill a Netflix show — including murders and betrayals — Sejanus established himself at the center of power in Rome, bolstered by a web of relationships in the Roman Senate.

Tiberius, physically removed in Capri, played it cool for a while, but then decided to politically ambush Sejanus. In a scene reminiscent of the movie Goodfellas, Sejanus thought he was heading to a coronation of sorts, but instead wound up imprisoned and executed.

With Sejanus executed and rebranded as a traitor, the desire arose to punish the followers and enablers of Sejanus among the Roman elites. This was accomplished by dusting off an old law, one that had been on the books for decades but that had long fallen out of use.

Nearly 70 years prior, Julius Caesar had passed a law requiring that active money lenders (creditors) keep a certain percentage of their capital invested in Italian land. The idea was to make sure that creditors had strong ties to Rome (through land ownership), with the land also functioning as a kind of de facto bank collateral.

Fast forward to 33 A.D., and many of Sejanus’ wealthy allies were engaged in speculative lending without meeting the particulars of the land ownership requirement (which everyone had more or less forgotten about).  

The Roman Senate also wanted to re-implement the land ownership requirement because Romans were spending too much on imports, and too much gold and silver was flowing out of Rome.

By forcing creditors to put some of their capital back into Roman land, this would, in theory, calm down overly speculative markets and help keep more gold and silver at home. So the reimplementation of Caesar’s creditor land law wasn’t just a revenge play, it was a kind of ad hoc monetary policy.

When the land-owning law was brought back on the books, a great many Roman elites were sued in the courts on the charge of lending without sufficient land ownership.

The courts were quickly overwhelmed by all these lawsuits — it appeared that hundreds of Roman senators were in violation — forcing Tiberius to implement an 18-month grace period for creditors to get their land-ownership affairs in order. 

This led to a deflationary credit crisis, which was more or less a market structure event. It worked like this:

• Creditors called in most of their loans, if not all of their land, in order to free up money to buy Italian land, to come into compliance with the re-enacted law.

• Debtors, who had their loans suddenly called in, were forced to sell their land, in order to free up money to pay off the loans.

• Land sales by debtors created a glut in the Roman real estate market. Lots of land for sale.

• Creditors, meanwhile, had an 18-month grace period, and could see that the price of land was falling. So they stepped back from the market and held off on land purchases.

• Land prices then collapsed due to unmatched debtor sales — and because land ownership was the linchpin of the Roman state, this led to a deflationary economic bust.

So there is intrigue in the halls of power, and a shift in government policy directly impacts asset values, and from there, the “market structure” of the series of events that followed led to economic collapse.

Sound familiar? The exact same thing happens in modern times.

So how did the Roman financial crisis end? Fortunately for Rome, Tiberius was rich, and the Roman Treasury had plenty of cash in its coffers.

And so, in order to solve the crisis, Tiberius gave 100 million sestertii — a gargantuan sum of money in those days — to a special class of Roman banks.

The banks then lent that money to Roman elites at zero interest, on a three-year term, against land-based collateral representing twice the loan value.

To put it another way, Rome had a liquidity crisis, and Tiberius solved the crisis with a combination of fiscal support and quantitative easing (via zero-interest-rate monetary policy).

Because the land price collapse was market-structure driven — it was caused by a lack of liquidity, not an actual downturn in the Roman economy — Tiberius was able to solve the liquidity problem with de facto quantitative easing, taking credit risks onto his own balance sheet (which was also the government’s balance sheet).

Fast forward nearly 2,000 years, and the game looks much the same.

The scary part about the U.S. government’s inability to act, at this dark juncture in 2020, is the way it resembles both 2008 (in terms of the gap between the TARP proposal and congressional funding) and the Roman Financial Crisis of 33 A.D. (with the markets waiting for Uncle Sam, a modern day Tiberius, to pony up another round of liquidity assistance). 

Financial history can be bizarre and fascinating and strange. In times like these, when government policy dominates market outcomes, knowledge of financial history can also be the difference between surviving and thriving in markets and getting crushed.

You may remember Theranos, the blood-testing startup run by Elizabeth Holmes. Theranos was a fraud, but the company reached a multi-billion-dollar valuation by suckering some of the most powerful people in Silicon Valley and Washington, D.C.

Theranos had an “all-star” board of directors that was almost cartoonish in its weight and stature. At various points along the way, the Theranos board included two former U.S. Secretaries of Defense; a former U.S. Secretary of State; two former U.S. senators; a former chairman and CEO of Wells Fargo; and a former head of the Centers for Disease Control and Prevention (CDC).

All of those people were completely conned, lending their reputations and gravitas to a pretend technology that never existed. They were far from the only ones to get fooled.

Near the peak of her celebrity, Elizabeth Holmes appeared on the covers of Inc., Fortune, and Forbes, glowingly profiled as an up-and-coming billionaire set to transform the health care sector. For every cover, Holmes wore a black turtleneck, like her professed idol Steve Jobs.

To keep the mystique intact, Holmes carefully cultivated an eccentric Jobs-like image. She routinely wore all-black clothing, leaving her hair deliberately unkempt, and speaking in an odd baritone that, according to at least one former professor, was much deeper than her normal voice.

In retrospect, it appears Holmes believed in her prototype. But she let the hype get ahead of the technology, and then had to play catch-up. When the prototype failed to actually work, she was stuck. At a certain point, Theranos decided to continue on with deception, in the hope of pulling off a miracle, rather than admitting there wasn’t any there there (because the prototype never actually worked).

Holmes and Theranos were exposed by a Wall Street Journal reporter named John Carreyrou. His reporting ultimately became a book — Bad Blood: Secrets and Lies in a Silicon Valley Startup — that received critical acclaim and multiple business book awards.

A Hollywood movie based on the Carreyrou book, with the actress Jennifer Lawrence starring as Holmes, is still in the works. As for the real Elizabeth Holmes, she is set to go to trial in March 2021, and could potentially be facing a 20-year prison sentence.

We were reminded of Theranos by the fraudulent goings-on at Nikola (NKLA), an electric vehicle startup that recently saw its stock price plunge after the founder and chairman resigned.

In some ways, the Theranos fraud was much bigger, and much worse, than Nikola’s. As part of its deception pattern, Theranos provided faulty blood test results under false pretenses to an estimated 176,000 consumers.

And yet, the peak valuation for Theranos was around $10 billion, a level achieved in 2013-2014. That valuation was achieved as a private company, backed by sophisticated investors. 

Nikola, on the other hand, reached a peak valuation of almost $37 billion on June 9, five days after going public via reverse merger with a Special Acquisition Vehicle, or SPAC.

As of this writing, NKLA shares are down roughly 70% from their June peak. And yet, not unlike the Robinhood favorite Hertz (HTZ) — a stock that still trades, but whose value is probably zero — it is entirely possible Nikola’s true value is zero.

Nikola reminds us of Theranos, in part, because of the caliber and reputation of those who got fooled. That group includes Mary Barra, the CEO of General Motors, who has been recognized for being sharp and competent.

On Sept. 8, General Motors announced a “strategic partnership” with Nikola to jointly produce an electric/hydrogen pick-up truck. The idea was that Nikola would provide the core technology and appeal, while GM would provide the platform and distribution.

It sounded like a smart idea. Investors loved the team-up, and the share price of both companies surged.

But then Hindenburg Research, a short-selling research firm, published a skeptical report on Nikola, accusing the company of conducting an “intricate fraud.” (This is another point of comparison to Theranos, with Hindenburg Research playing a gumshoe role similar to Carreyrou.)

The truth about Nikola turned out to be ugly, to the point of being ridiculous. Within days, Nikola’s founder was forced to resign, causing Nikola’s share price to tank. Bloomberg columnist Tim O’ Brien provided a brutal bullet summary of the report findings:

• Trevor Milton, Nikola’s 39-year-old founder, made dozens of false statements over the years that helped him parlay what appear to be some very tall tales about Nikola’s technology, production, and performance into a $20 billion stock market valuation.

• Turning inexpensive hydrogen into auto fuel is key to Nikola’s success, and Milton has routinely said that he succeeded at cutting the cost of hydrogen by about 81% compared with his peers and was already producing it. Neither of those things were true, apparently.

• Milton appointed his brother, Travis, as “Director of Hydrogen Production/Infrastructure” at the company. Hindenburg said Travis’ “prior experience looks to have largely consisted of pouring concrete driveways and doing subcontractor work on home renovations in Hawaii.”

• Milton claims Nikola designs all its truck components itself but it appears “to simply be buying or licensing them from third parties.”

• Milton once staged a promotional video of a Nikola truck cruising along a highway when, in fact, “Nikola had the truck towed to the top of a hill on a remote stretch of road and simply filmed it rolling down the hill.”

• Nikola appeared to have padded orders for its products, and some of its early corporate backers cashed out chunks of their stakes in the company, along with Milton himself, after Nikola went public in June.

Wow. That is quite the list.

The mentality of Trevor Milton, the now-disgraced founder of Nikola, bears striking resemblance to that of Elizabeth Holmes.

Here is another visionary, it seems, who had a prototype that almost worked — but not quite — and so he fudged to make up the difference. And then fudged some more, and yet more, as the con grew ever bigger.

But here is the amusing thing, or perhaps the alarming thing: As of this writing — with the fraud exposed and the founder out — NKLA still has a market cap of $10.8 billion. Trevor Milton, as shamed as he might feel right now, is still a multi-billionaire.

One wonders if Elizabeth Holmes is following the Nikola story. If so, she is probably kicking herself.

If only Holmes had run the Theranos scam six years later, with reverse-merger SPAC options and an army of Robinhood superfans to rely on, she might never have been caught.

Or better yet, she might have had the chance to cash out as a billionaire even after being caught, with Robinhood fans holding onto their Theranos shares — and keeping the valuation in the $10-billion-plus range — even after the tech was revealed to be hype and hot air.

A U.S. Senate battle royale over who gets to fill a U.S. Supreme Court seat is bearish for markets. That is a key reason why bearish feeling has intensified this week, with asset prices dropping across the board.

The cause-and-effect mechanism here is not direct, but indirect. It has to do with fiscal support.

The real U.S. economy – meaning Main Street rather than Wall Street – is still in danger of collapse due to ongoing pandemic fallout.

In the early months of the pandemic, we avoided economic devastation via trillions in fiscal support. It was not just the Federal Reserve that kept things together, but the Federal Reserve acting in concert with Congress providing direct-to-consumer “helicopter money” – think stimulus checks, the Paycheck Protection Program (or PPP), and topped-up unemployment benefits – that kept the economy afloat.

But now those funds are running dry, and the real economy is far from healed. Metaphorically speaking, Main Street is still in intensive care, and still in need of life support. But to the extent Congress is consumed by a no-holds-barred political battle, the odds of vital fiscal support are reduced.

The fiscal taps have been shut off for weeks now, with severe economic pain points starting to materialize as a result. A knock-down, drag-out Supreme Court fight means the taps could stay shut off until the election, and even, potentially, the months afterward).

This lack of fiscal support puts Main Street in grave danger, which endangers the stock market, too. If the real economy collapses, white collar workers get laid off, too. If that happens, 401(k) accounts stop getting auto-funded, and passive investment flows go into reverse. No bull market could survive that, let alone a precarious retail mania fueled by call-option buying. 

With regard to economic impacts, the upcoming presidential election offers the greatest policy divergence since 1980. Depending on who wins control of the White House – and not just the White House, but the Senate — the outlook for various parts of the market will diverge wildly.

Various volatility instruments, like CBOE Volatility Index (VIX) futures contracts, were already pricing the 2020 presidential election as one of the biggest event risks in market history.

The closeness of the 2020 election, and a sideshow drama with China, only add to investor worries at this point. And so, with the battle royale for a Supreme Court seat now underway — and both parties threatening extreme measures — we are getting an advance preview of what the election could mean.

For the stock market, and markets in general, the concerns are still economic and monetary, rather than legislative. Markets did not swoon this week in reaction to the prospect of conservative or liberal court rulings.

Instead, as mentioned, the problem is fiscal support, or rather, an ongoing lack of fiscal support due to an all-consuming focus on Supreme Court issues in Washington.

Perhaps you recall December 2018, when the Dow Jones Industrial Average had its worst month in 70 years. That violent market move was a message to Fed Chairman Powell.

By late 2018, Powell had assumed it was safe for the Federal Reserve to move away from easy monetary conditions, and to start the transition back to normalcy in terms of monetary policy.

Investors panicked over this prospect, causing a dizzying market drop. December 2018 was a mini-meltdown because investors feared premature tightening from the Fed would be catastrophic.

Powell, not being a fool, immediately reversed his stance as a result of the market drop, and put the Federal Reserve back on a dovish footing. The stock market then did a bullish U-turn, and booked stellar gains for 2019.

But now, in 2020, the market needs to grab the attention of Congress, not the Federal Reserve, because, in the “monetary plus fiscal” equation, the monetary side is already maxed out.

That is to say, the Federal Reserve is already at maximum dove levels. They have provided so much liquidity and so much backstop support for credit markets, there is little more they can do.

And yet – this is very important to understand – the Fed cannot help the real economy directly, and the real economy is still at death’s door.

Powell himself knows this, which is why his prepared congressional testimony for Sept. 22 includes the statement that small and medium-sized businesses may need “direct fiscal support.” Translation: The Fed has done what it can. Uncle Sam has to do the rest, which means another helicopter drop.

The United States is still deep in the throes of a painful recession, bordering on a depression, far worse than anything investors have seen in their lifetimes (barring the handful of 100-year-olds who remember the 1930s).

Then, too, for tens of millions of Americans, their Great Depression is now. The economic reality of Main Street, for at least a third of the population if not more, is 1930s-level distress, right down to eviction notices, boarded-up businesses, and long lines for food banks.

The distress point is easy to miss because, at this very moment, U.S. household net worth just hit an all-time high. How is this possible?

Because trillions of dollars in fiscal stimulus and central bank support, coupled with an online trading mania, have created record-busting levels of paper-asset inflation. The real economy is not the stock market and vice versa.

Not only did the Federal Reserve do a huge amount this spring, the U.S. government swooped in with trillions as noted. In the second quarter of 2020, U.S. government debt rose at a pace of 59% annualized! That is a tremendous amount of money. A lot of it helped people pay rent and buy food with businesses shuttered and jobs vaporized. But a lot of those funds also went straight to Wall Street.

Why is this super-important to understand right now? Because, again, the U.S. economy, far from being “on the road to recovery,” is still wholly dependent on fiscal support. Monetary policy can’t help.

The Federal Reserve can’t get money to Main Street, nor keep tens of millions of Americans from being evicted for lack of ability to pay rent, or millions more businesses from shuttering. Only the U.S. government can do that, with another round of fiscal help.

Without additional help from the U.S. government, the real economy is likely to collapse. This is just an observation based on the numbers. When one considers the number of small and medium-sized businesses still facing permanent closure, and the number of Americans facing food insecurity or a loss of the roof over their heads, the data is staggering.

And this helps explain why Wall Street is succumbing to bearish fear, and a Supreme Court battle royale has a direct and bearish impact on the stock market.

It goes like this:

• The thing that saved the U.S. economy in 2020 was not the Federal Reserve alone, but Federal Reserve actions combined with historic spending from the U.S. government. It was not just monetary policy, in other words, but monetary policy plus fiscal policy, with the fiscal part equating to government spending of the “helicopter money” variety, sending checks directly to households and businesses.

• As long as the U.S. government remains committed to propping up Main Street and the real economy, Wall Street gets a free ride – and paper assets can do well – because the firehose of fiscal stimulus, in conjunction with near-zero interest rates, means Wall Street gets a huge paper-asset boost.

• But if the U.S. government stops providing aid to Main Street – if the fiscal taps suddenly go dry while the real economy is still on life support – there is a real risk of follow-on deflationary collapse. The service sector, including food, travel, retail, and other key pillars of the real economy, have been hit so hard by the pandemic that, if the government stops helping, a tsunami of bankruptcies, evictions, and commercial loan defaults will follow.

• When Republicans and Democrats are engaged in fierce partisan battles, the odds for future stimulus – for ongoing fiscal support – tend to decline, because nobody can agree on terms and political leaders are consumed by the fight at hand. This means that, as the parties hold the equivalent of an Ultimate Fighting Championship cage match for who will fill (or won’t fill) a vacant Supreme Court seat, they forget to pay attention to the real economy, which is in real danger of imploding.

We are now in crunch-time conditions for keeping the real economy afloat. Bankruptcies, evictions, domino-chain business failures, and empty food cupboards are a harsh reality materializing right here, right now, across the nation as you read this.

And yet a deal for additional fiscal stimulus (help for a suffering real economy) is nowhere in sight, and the odds of an extended Supreme Court fight – which could consume the attention of Congress even after the election – means that additional rounds of fiscal help for a collapsing real economy could be off the table for months.

Wall Street genuinely fears that outcome, and rightly so, because if the Main Street economy collapses, the party being thrown on Wall Street cannot continue.

Without that ongoing fiscal boost, consumer spending dries up, small and medium-sized businesses start to go bust at an alarming rate – in a way we haven’t seen yet, because the initial rounds of stimulus prevented that – and Wall Street loses its “free rider” status because there aren’t any funds to free ride upon if the fiscal taps are shut.

Making matters worse, it is not just the nations’ small and medium-sized businesses that are in trouble now, but the banks.

Why the banks? Because the banks are facing a massive wave of commercial loan defaults. We have already seen the major banks set aside record levels of loan loss provisions, to the tune of tens of billions per quarter.

If the banks are setting aside record levels of loan loss provisions, they are hunkering down and preparing to take a major hit. And that means the banks are not lending to anyone except those with pristine credit, meaning the strongest businesses and the most financially stable individuals.

That, in turn, means the bottom 90% of the economy is being cut off from access to loans and credit, because the banks aren’t providing it. To wit, if your credit is pristine you are fine; if it isn’t, and you or your business needs to borrow funds, too bad.

This leaves most of the country, and most of the real economy, gasping for air.

And so, if you take away all manner of fiscal support – or rather, if you let the multi-trillion fiscal support pool provided months ago run dry – you get economic implosion.

To use another metaphor, getting the U.S. economy all the way through the pandemic is like crossing an economic desert. Conditions in that desert are so inhospitable to economic life that an emergency water supply is needed. That emergency water supply is fiscal support.

If the economy runs out of water (fiscal support) too early, it dies of thirst, because the banks aren’t lending, the profits aren’t flowing, and the landlords are in trouble just like the tenants. 

But Washington isn’t seeing this because the headline numbers look superficially positive – e.g., record levels of household wealth based on paper-asset inflation – and because crisis avoidance via the last rounds of stimulus created a sense of complacency, and because Republicans and Democrats are now too busy fighting over a Supreme Court seat.

As a result of this fiscal lack, the outlook for severe loan defaults and impairment of bank balance sheets becomes much darker.

The bottom line is that politicians in Washington simply do not understand the profound vulnerability of the U.S. economy right now. But the market is starting to get it.

Politicians do not understand the stark reality that, while the first round of fiscal support did a good job of keeping the real economy from collapsing, a second round is now needed, not because the U.S. economic engine is broken, but because banks have shut the lending window, and the devastating impacts of the pandemic are still in play.

In 2019, we said that the 2020s, as a decade, would look like a combination of the 1920s and the 1930s. Unfortunately, we are seeing what that means, as the 1930s aspect of the equation hits home.

Then, too, the impact of the 2020 election will only intensify many of the trends we are seeing now. The difficulty lies in knowing which trends will be intensified, because it depends on who wins, not just at the presidential level, but the Senate level, too.

It will be the most important election since 1980, and possibly the most important election in our lifetimes, in terms of divergent policy extremes and direct market impacts.

In 2015, Harvard professor Graham T. Allison argued that the United States and China could be at war within a decade.

Five years later — and with five years left to go — Allison’s prediction is slowly coming true. We aren’t there yet, but the story is unfolding in a warlike direction. Military conflict between the United States and China is conceivable by 2025, if not before then. 

Here and now, in 2020, U.S.-China tensions are approaching a boiling point. Regardless of who wins the 2020 election, and which party controls the U.S. senate, these tensions are here to stay.

To understand why the U.S. and China are headed toward conflict — and why Professor Allison’s “Thucydides Trap” theory could be correct — we can look to recent headlines.

On Sept. 18, the Trump administration announced a major escalation in an increasingly chilly U.S.-China technology stand-off. TikTok and WeChat were on a list to be immediately banned in the United States and removed from app stores for U.S. consumers.

An outright ban of this scope — TikTok is reportedly used by 100 million Americans — would have been unprecedented, and would have risked equally unprecedented retaliation from China (like a ban of Apple or Microsoft, perhaps).

The TikTok and WeChat ban, originally set to begin one minute from midnight on Sept. 20, was temporarily postponed on news of a pending deal. While the terms are not yet finalized, Oracle looks set to acquire 12.5% of TikTok, and Walmart 7.5%.

The idea is that Oracle will provide cloud services for the data collected on TikTok’s 100 million or so American users, and Walmart will provide an e-commerce and product fulfillment angle.

There is also a strange and unclear proposal from the White House asking that Bytedance, TikTok’s parent company, provide billions of dollars for an American history education initiative.

The point here, at least superficially, is to ensure TikTok is majority-owned by American interests, with a U.S. headquarters and U.S.-controlled servers.

While Bytedance will continue to own 80% of TikTok, the Oracle-Walmart stakes technically fulfill the majority owner requirement because U.S. shareholders own 40% of Bytedance, bringing the total to 52%.

All of the above assumes the Oracle-Walmart deal actually goes through (it is still being finalized as of this writing).

If the deal does not go through, for whatever reason, then the TikTok and WeChat ban that was announced on Sept. 18, then postponed, will likely be enacted. At that point, China could do something drastic with respect to American companies doing business in mainland China — Apple most immediately comes to mind — and at that point, billions of dollars in revenue, if not tens of billions projected out to future years, will be under threat.

The drama seems a bit much for a smartphone app mostly used for lip-syncing songs and making 20-second videos of teenagers acting silly.

But it makes sense because, just as screaming fights between a married couple are typically not about the superficial topic at hand — the real trouble is deeper and unspoken — so it is with the U.S. and China.

The U.S. has reacted with fear and suspicion to the TikTok app because, for all its silliness, TikTok is the first overseas technology to make real inroads into the habits – and smartphones – of 100 million Americans.

When it comes to tech, the United States is used to being the conquering imperialist. Google, Apple, Amazon, Netflix, and so on create the apps, websites, and experiences that dominate other nations. There hadn’t been much of a reversal — until TikTok.

Then, too, a significant percentage of Washington, and a non-trivial percentage of Americans, view China as a growing national security threat.

The argument is that China has a twofold power projection strategy for global dominance.

First, American hawks see China looking to establish physical outposts of hard power throughout the world. This means things like building a port in an emerging market country, and then enabling a military presence in conjunction with that port — repeating this exercise until blanket coverage of key “choke points” are achieved. By this view, China’s “Belt and Road” initiative is really a military outpost initiative.

Second, American hawks see China establishing soft power inroads to go with the hard power outposts. This means finding ways to shape, manipulate, or control national culture from the inside out.

China is perceived as a special threat here because, in the eyes of the American hawks, there is no such thing as a truly neutral Chinese company — because of the way the constitution of China’s Communist Party (CCP) is structured, every Chinese company is a potential conduit for government espionage.

The American hawks have a point in their concerns. China really does seem to be pursuing a twofold power projection strategy.

But those with a sympathetic view of China also have a fair response: Over the course of the 20th century, the United States did exactly the same thing.

By this reasoning, America does not need a strategy for projecting hard and soft power around the globe – because it already happened after World War II. The dominance of American pop culture, the presence of American military outposts in dozens of countries, and the ability of the U.S. government to financially punish bad actors in the global financial system by cutting off their access to dollar flows all amount to the U.S. already having the exact kind of power that China is now feared to be seeking.

And this takes us back to Graham T. Allison, the Harvard professor who predicted, back in 2015, that the U.S. and China could be at war within a decade.

Allison’s prediction is based on something called “the Thucydides Trap,” which is based on a quote from the Greek historian Thucydides from the fifth century BC:

“It was the rise of Athens, and the fear that this inspired in Sparta, that made war inevitable.”

In the Thucydides trap metaphor, China is Athens and America is Sparta.

The basic concept is that, when a rising power is observed by an existing great power, the existing great power becomes fearful.

The fear might be wholly justified, or it might not be justified at all (or somewhere in between). Either way, fear can lead to countermeasures, increasingly strenuous containment efforts, and low-level conflict escalation over a period of years — with war as the ultimate result.

To back up his prediction, Graham T. Allison and his research team analyzed the historical record to conclude that, in 12 out of 16 cases of great power clashes over the past 500 years, the result was war.

Based on that rule of thumb, if the analysis is on point, the odds of a U.S.-China military conflict could reasonably be estimated at 75%.

It is also sobering to hear how bloodshed was avoided in the 25% of cases (4 out of 16) where war did not come about. “When the parties avoided war,” Allison observed, “it required huge, painful adjustments in attitudes and actions on the part not just of the challenger but also the challenged.”

As matters stand here and now, we are not seeing “adjustments in attitudes and actions” on either side when it comes to the potential for U.S.-China conflict.

In fact, one might argue we are approaching a point of no return where attitude adjustments become impossible, with each country — an established great power and a rising one — seeing the other more and more as a long-term existential threat.

The best hope for avoiding a U.S.-China military conflict, if such a hope exists, is probably the deeply enmeshed web of commerce and trade relationships between the two countries. But as we are seeing now, with escalation around the TikTok situation, those ties are being frayed, and potentially unwound.

Then, too, a threat of U.S.-China conflict and trade war escalation leading to technology freeze-out or something worse, can remain theoretical in the eyes of Wall Street as long as no American company’s revenue and profit outlook are impacted.

But unfortunately Apple, and a handful of others, have major exposure to China, in terms of both supply chain fulfillment, device assembly, and mainland China sales revenues.

Imagine a child’s favorite food is birthday cake. He loves it so much that his fondest wish is to eat birthday cake for every single meal.

Then, in some Twilight Zone version of reality, his wish is granted. He gets nothing but birthday cake, for every single meal. Morning, noon, and night.

At first this would be great. The kid would be ecstatic. Eventually though, he would get sick of it. After a long-enough period, he would be sick of birthday cake. The sight of it would turn his stomach. A food he once loved would give him pure indigestion.

The Federal Reserve promised to hold interest rates near zero until 2023 this week. This was the equivalent of more birthday cake for investors — lots and lots of birthday cake, as far as the eye can see.

Investors weren’t thrilled. Technology stocks stumbled this week, even in the aftermath of the Fed’s endless birthday cake announcement.

Not even the joyful ruckus of the Snowflake initial public offering — the largest software IPO in history, by far — kept the Nasdaq Composite from struggling to hold its 50-day moving average.

At a certain point, enough is enough.

Part of the problem is that even the cash-rich juggernauts — the FANG names (Facebook, Amazon, Apple, Netflix, Google/Alphabet) making money hand over fist — feel the pull of gravity at their outer reaches of valuation.

The higher the multiple goes, the greater the force that gravity’s pull exerts. This makes the climb harder and harder as price extremes are reached.

It’s kind of funny, actually: When you have a stock whose valuation is completely nuts, like Tesla (TSLA), the price can go anywhere, because the valuation means nothing. A multiple on crazy is just more crazy.

But this mentality works best when there aren’t any cash flows — when the company is all blue sky and hype, allowing superfan investors to dream up any future story they want.

When a company has a bulletproof stream of cash flows, in the manner of, say, Apple (AAPL) or Facebook (FB), investors are paying a premium for those cash flows. This creates a tether to the real world. Investors can find ways to justify ever higher multiples, but eventually the logic is maxed out.

Imagine a company guaranteed billions in profit, every single quarter, for years or even decades into the future. The stock price of this company — by way of the multiple — will “price in” future earnings.

If the stock has priced in, say, the next 20 years of stellar earnings, it will cease to matter how bulletproof the cash flows are. It will be hard for the stock to go much higher.

When interest rates stay near the zero-bound for long enough, and valuation multiples are bid high enough, the likelihood of further stock upside goes down. The multiple simply maxes itself out.

It’s possible we are moving closer to that point.

Take Apple, for example, a company whose wild price appreciation, and multiple expansion, was more about limited choices in a zero-rate world than any positive shift in Apple’s business prospects.

On Sept. 1, at the peak of the post-split frenzy, AAPL shares traded at a forward-price-to-sales multiple of 7.7X.

Never before in all of history had such an extreme level been reached. Dating back to 2007, when the iPhone launched, Apple’s typical price-to-sales range was somewhere between 2X and 4X.

Given that rule of thumb, in 2020 we have seen a near-doubling of Apple’s share price — a more than 90% share price rise — on nothing at all but multiple expansion.

The cash flows remain impressive. Investors simply decided to bid the multiple on those cash flows to incredible new heights, thanks to the multi-year outlook for a zero-interest-rate world.

As of this writing Apple’s forward-price-to-sales multiple is 6.6X. This means that Apple could go on being Apple, booking huge profits every quarter, and a mere mean reversion to the top of its old price-to-sales range — not the bottom, mind you, but the top — could mean a roughly 40% share-price drop.

If it merely fell to the middle of the old range, in terms of this standard valuation measure, Apple’s share price could fall by more than half. And this could come in the absence of any bad news on the China front or the iPhone sales front. 

Is the point here to make a doom-and-gloom forecast for Apple? No, not at all.

The point is that the Federal Reserve has fed investors so much birthday cake (in the form of a zero-rate environment) that investors have bid up cash-rich tech stocks to multiples where prices could fall sharply, even dramatically, without requiring any slowdown in the business of these companies, or any kind of dent in the profit outlook.

That, in turn, means high-profile technology stocks could trade like currencies or commodities in the months and years to come, responding more to changes in the macro environment than to ups or downs in the business model (assuming business continues to go well).

An investor loaded up on Apple shares, if they are honest and macro-aware, would have to make a plausible argument for why Apple’s valuation multiple is now so wildly inflated, in a time where smartphone markets are mature, relative to all the years in which Apple has made iPhones.

And that is fine. The investor could make that argument, to be sure.

But the problem is that, if Apple is now trading at hyper-inflated multiples on the basis of macro factors, then shifts to the macro — changes to the economic growth outlook, changes to inflation expectations, things like that — could start swinging Apple’s share price around far more than the fundamentals of, you know, actually selling iPhones.

Then, too, Apple is just a prime example. This goes for the whole FANG group.

To the extent these stocks are appreciated for their bulletproof cash flow streams, and bid to stratospheric multiples on the basis of birthday cake, their super-inflated share prices have the potential to now go down, not just up, in multi-month trends that could last for months at a time, or even whole quarters at a time.

This means that traders who understand macro-influenced trading instruments — like, say, commodities and currencies — could have a significant edge in handling tech stocks moving forward, while investors who are still trying to invest based on fundamentals, for example looking at the outlook for the new MacBook Pro, will be out of the loop.

This is also part of a broader theme. As the whole world goes more “macro” — thanks in part to the distortions of interest rates at the zero bound for years, and debt levels at historic extremes not seen since World War II — the trading component of trading and investing will become more and more important.

That, in turn, means to expect more trends that run for months in both directions — down as well as up — with greater ability to respond to price movements and fundamentals together, rather than investment assumptions alone.

We recently explained why stocks could retest the March lows before the year is out. This made some readers upset.

Some of the feedback we received was along the lines of, “There is no way we could revisit the fear of the March lows.” The idea of replicating the fear conditions that existed in March seems impossible.

To which we say, yes and no. It is a bit more complicated than that.  

First off, as we said when explaining the scenario, a test of the March lows is “not the base case.” This means it is something that could happen — but not something that necessarily will happen. The point was that it could.

As Elroy Dimson once said, “risk means more things can happen than will happen.”

There are scenarios that could reasonably occur, which will never actually take place — and in the name of risk management, we want to be aware of those possibilities.

It is somewhat like buying hurricane insurance for your beach house. Hopefully the hurricane never shows up — and buying insurance doesn’t mean you expect it to. But having awareness, and being proactive, is good risk management. Then, too, big market declines don’t have to be based in fear. Sometimes they can occur with no fearfulness at all. At other times, the fear is like an avalanche — the fear unleashes a small move, but then other things trigger that cause a much larger move.

In our view, this also describes what happened in March 2020. The violent decline that started in late February was triggered by the pandemic, but the severity of the decline was caused by market structure. 

Traders have a term for large declines and crashes that are driven by something other than fundamentals or investor emotions. They are “market structure events.”

The mother of all market structure events was the Crash of 1987.

The crash of 1987 seemed to come out of the blue. It wasn’t really based on investor sentiment, or what was happening with international trade, or what Treasury Secretary James Baker said on TV (though all those things were blamed).

Paul Tudor Jones, a legendary hedge fund manager who made hundreds of millions in the 1987 crash — and hundreds of millions yet again three years later, in the Nikkei crash of 1990 — described the 1987 crash as an “embedded derivatives accident” due to a concept known as portfolio insurance.

Portfolio insurance was a hot concept among institutional investors in the late 1980s. The idea was that, if the market started to decline, you could hedge the risk in your long equity portfolio by selling S&P 500 futures against it.

The problem with portfolio insurance was that, the more the market declined, the greater the number of S&P 500 futures contracts the client had to sell.

This was fine if, say, a handful of institutions used portfolio insurance. But when a critical mass of them used it, the “hedge” became a self-fulfilling prophecy.

In the crash of 1987, because of portfolio insurance, a modest market decline created a cascading feedback loop, in which each tick downward triggered even more selling of S&P 500 futures contracts, which added more selling pressure in a vicious cycle.

The reason we are fearful of a crash-type market structure event in the last few months of 2020 — and the reason we described a “retest of the lows” scenario — is because the amount of distortion created by frenzied call-option buying feels beyond extreme.

It has gotten so intense that Wall Street hedge funds and high frequency trading firms are becoming obsessed with retail trader buy-and-sell data, and scraping keywords from retail trader chat rooms and message boards, in an effort to get the jump on what the Robinhood crowd buys next.

When behavior gets this lopsided and distorted, to the point where a critical mass of tech stocks are trading far beyond rational levels, you don’t need an outbreak of panic to see a sharp correction turn into a cascading feedback loop.

All you need is the wrong combination of events, in which buyers step aside or run out of cash, for a “market structure event” to occur — a crash scenario that isn’t based on fear, but instead relates to a group of traders or investors who all start doing something, or all stop doing something, at the same time.

To make an avalanche analogy, this would be akin to the loud noise that dislodges an unstable configuration of snowpack on a mountain side. Imagine, say, the Dow declining 500 to 1,000 points on the basis of election jitters, or the Nasdaq dropping enough to take a critical mass of Robinhooders out of the game, and then a cascading feedback loop taking over in the manner of 1987. (Then, too, we don’t have portfolio insurance these days, but we do have high-frequency algorithms that aggressively piggyback short-term market trends, amplifying their magnitude in doing so.)

Again, such a scenario is not the base case. But nor is it far-fetched.

This is why a combination of inexperience, greed, and a significant amount of leverage (in this case via call options) is frightening to observe. Experienced traders and investors know that combinations like that can end badly — and it doesn’t even require extreme negative emotion (like fear or panic) for that to happen.

Again, this doesn’t make a major decline the base case. It is just a scenario we are aware of, and wary of, because of how extreme the market structure distortions of 2020 have become.

In the TradeSmith Decoder we still have a portfolio with a dozen or so long positions, including a core holding in Amazon (AMZN) that is up more than 40% as of this writing.

If the base case holds, and markets climb higher on a long-term outlook of inflationary pressure and currency debasement, we expect these positions to do quite well.

But at the same time, we are cognizant of the extra risks embedded in this crazy market, because of the extraordinary wildness of 2020 and the unhinged nature of what the Robinhood crowd is doing.

And that is why, if the high-alert danger scenario starts to unfold — with, say, another round of market declines on election uncertainty morphing into something bigger — we will honor our risk points and go to cash as necessary, rather than assuming that things won’t get bad.

Because under the wrong circumstances, the market structure as currently configured could collapse, particularly in terms of highly concentrated Robinhood names. We are solidly long and will continue to be long — with rapidly growing enthusiasm for precious metals and precious metals stocks — but want to stay cognizant of that.

The Bank of International Settlements, or BIS for short, is known as the central bank for other central banks. In January 2020, the BIS published a new research paper — not its first one — on central bank digital currencies (CBDCs).

Eight months ago, the BIS found that 80% of all the central banks they surveyed were investigating CBDCs, and 40% had moved from the research stage to the concept and design stage.

Meanwhile the U.S. Federal Reserve and European Central Bank (ECB) have expressed interest in digital currency and research, and the People’s Bank of China (PBOC) is potentially years ahead of the competition in rolling out an e-yuan, with mass trials underway involving real-world commercial use.

It is often hard to tell how serious an experimental technology actually is, or how close it is to creating real change. There is a wide gap between purely theoretical concepts (the stuff of science fiction) and hard-edged application (stuff that shows up at your doorstep, or on your smartphone).

That made it intriguing to see a Sept. 9 press release from Mastercard (MA), the payments processing giant, titled: “Mastercard Launches Central Bank Digital Currencies (CBDCs) Testing Platform, Enabling Central Banks to Assess and Explore National Digital Currencies.”

“With the global economy racing to embrace digital payments,” Mastercard opines, “central banks are also looking to the future and investigating how to support innovation while maintaining monetary policy and financial stability as they issue and distribute a currency.”

Mastercard, a payment processing juggernaut, wants a piece of CBDC action because the scale is huge, and the transactions are guaranteed.

One can imagine central banks like the Fed or ECB using a form of digital currency to directly distribute payments to tens of millions, or even hundreds of millions, of citizens at a time. (China is already doing something like this, on a trial basis and with small amounts of digital currency, for millions of workers.)

Further imagine these payments bypassing SWIFT (Society for Worldwide Interbank Financial Telecommunication), the international system for wiring money, and traditional bank account routing mechanisms, and all manner of other third-party intermediaries, to simply show up in citizens’ wallets.

For Mastercard, Visa (V), and the like, helping to build and maintain these payment rails could become one of the biggest lines of business since credit card transactions — and on a far larger scale, in currency volume terms, because CBDCs could be used to pay taxes and fund government programs.

Mastercard’s CBDC testing platform is meant to be a simulated environment, allowing a central bank to test the behavior of a CBDC as it moves through a virtual financial ecosystem. A real-world CBDC will have to make its way from commercial accounts to consumer wallets and back again, while enabling a wide array of transactions.

The Mastercard platform is designed to help the central bank test all that, before unleashing an experimental currency in a real-world setting.

In some ways, CBDCs are an economic version of the old space race between the USSR and the United States. In this metaphor, China’s e-yuan is comparable to the Soviet Union’s Sputnik 1, the world’s first functional man-made satellite.

CBDCs have created a space-race mentality because of the potential leverage inherent in the technology.

A country with a widely distributed, highly efficient and technologically versatile CBDC will, at least in theory, have fine-grained control over its economic policy, enabling possibilities that never existed before.

Imagine stimulus funds appearing instantly in a region struck by natural disaster, or mortgage lending automatically restricted in a region with overheated home prices, or targeted payments going directly to households with annual income below a certain level.

None of that is possible with existing systems, which are too crude, and not nearly efficient enough or data-driven enough, to fine tune currency distribution, and payment restriction, as a matter of policy. With a CBDC you could do all of that and far more.

The capabilities of a high-functioning CBDC sound Orwellian, but governments who embrace that power will have an economic advantage, at least in theory.

CBDCs will also create advantages in the realm of global trade: Picture instant settlements between trading partners, or shipment contracts settled instantly when goods arrive in a port.

Then, too, the more popular CBDCs become, the more that foreign exchange risk will be reduced, because transaction settlement periods will converge on being instant. That will erode the demand for the ultimate middle-man currency, the U.S. dollar, which has long acted as a settlement go-between.

The rise of CBDCs in the next few years is inevitable — and will come on an accelerated timeline — due to the fear component involved.

If, say, China and Europe both have high-functioning CBDC networks and the United States does not, that technology gap will be seen as an economic and geopolitical security threat. 

As it turns out, all of this is excellent news for Bitcoin, because Bitcoin has zero competition.

Any CBDC administered and controlled by a government, no matter how sophisticated, will have the potential for infinite supply expansion, simply because a government controls it.

It will thus be literally impossible for CBDCs — for any CBDC — to replicate Bitcoin’s No. 1 feature, which is absolute scarcity enforced by the iron laws of mathematics.

In a world dominated by CBDCs, currency accounts will be accessed by a web browser or a smartphone app, just as they are today. One-touch payments, which are already here, will also feel much the same as they do today (but with billions more people getting used to them).

The big differences, in contrast, will exist behind the scenes. Crypto-enabled payment rails will make it easy to switch from one base currency to another, automatically, which in turn will make it easy to, say, keep a savings account in Bitcoin while transacting with a CBDC.

Meanwhile, a third-party enabler of the payments layer, like Apple (AAPL), Mastercard, PayPal (PYPL), might handle the details for a nominal fee, the way PayPal works today.

The thing that won’t go away is consumer choice, with respect to the choice of whether or not to keep one’s savings in a currency that gets debased by central banks.

As some have put it, Bitcoin is a kind of peaceful protest in this regard, a means of fighting back against the untrustworthy actor in the global financial system — which turns out to be the government itself.