“History doesn’t repeat, but it often rhymes.” – Mark Twain

Summary:

-Fear of stocks crashing due to corona-virus-induced economic shutdown should be balanced by fear of stocks hyper-inflating; holders of cash lose wealth.

-The forces that caused the 2008 crash are still present today; we treated the financial symptoms but not the disease.

-The petrodollar system that has been the world-order since the end of World War II is in the beginning stages of restructuring.

The severity of the virus itself is not something on which I am qualified to opine. However, the financial effects of the economic shut down caused by the virus are my focus, and here I attempt to explain how the thing we call “money” changes in a post-corona-virus-shutdown world.

First, the approximate cause of the 2008 global financial crisis was a seizing of what is called the “wholesale funding markets.” Think of that as the raw materials that go into the financial system to produce the end product: a loan. The wholesale funding market is how banks get the money to loan to you for a mortgage or a new car or to start a business. The wholesale funding market is how cash comes out of the ATM, how large corporations like General Electric, IBM, AT&T, Google, etc. pay their employees every 2 weeks. The cause of that seizing up is complex, but we, as a society, treated the symptoms of the disease by allowing our politicians to bail out the banks and permitting the Federal Reserve to implement extraordinary monetary policy by creating reserves on the banks’ balance sheets (known as quantitative-easing or “QE”). These actions were a “triage” to save a critical patient, and they have stabilized the patient for a decade.

So what I believe is happening to our economy is beginning of the end of the petrodollar system. Petrodollar is a term used to mean the selling of OPEC oil in US dollars. After World War II, the civilized world needed to rebuild, but the entire capital base of Europe was destroyed. They didn’t have any factories with which to build the bulldozers to clear the rubble of destroyed buildings from their cities. So the US just printed it and gave it to them. Then they could use those US dollars to buy Caterpillar bulldozers from us to clear the rubble, buy steel from US Steel to rebuild, etc. The world also needed crude oil. Saudi Arabia was signed on the Marshall Plan to rebuild Europe to provide the energy with which the would could rebuild. Saudi agreed to accept US dollars for their crude oil- thus the term “petrodollar.” By selling crude to the world and receiving US dollars, Saudi was taking in more US dollars than they could ever spend- there simply wasn’t enough production in the world to buy for the relatively small population of Saudi Arabia. So the Saudis stockpiled their US dollars and the US Treasury sold the Saudis US bonds that promised to grow the Saudi’s cash faster than the value of their oil in the ground- thus giving them incentive to produce oil rather than leave it in the ground. This is the beginning of the US debt we are now dealing with. This debt is the cause of the financial disease.

The cure for this disease, in my opinion, is to cancel the debt. A debt jubilee is an event that has happened repeatedly throughout the history of civilization- since the creation of money in ancient Babylon. The last debt jubilee started before World War I and completed with the close of World War II. All the national debt was wiped out over this time and a new system of debt was created with the petrodollar. I believe we are now in the process of wiping out this debt system. If this is true, a probable outcome is the hyper-inflation of US Stocks. The reason is that cash (US dollars) will be of unknown purchasing power after the debt is inflated away (note the $2 trillion dollar spending bill about to become law today). This does not mean that I think stocks will go straight up. I do think that in the end of this process, a likely outcome is that stocks are multiples higher than what they are today. So the S&P 500 is at roughly $2,500 as of today, March 27, 2020. So maybe this corona-virus resolution ends with the S&P 500 at $10,000 in a couple years, maybe $50,000 in 5 years… Note that we won’t be richer as a society- we won’t be able to purchase 5 or 20 times more stuff, but the debt will still be in nominal dollars, so it will be a much more manageable number relative to the amount of dollars in existence. This is hyper inflation of assets. It doesn’t mean that the cost of our real world expenditures hyper-inflates, just asset prices; after all, debt is just a paper liability, so wouldn’t a hyper-inflation of paper assets make sense to balance the paper liability?

In conclusion, the hyper-inflation of paper assets is what I believe has been driving some degree of the stock market rally since 2009. The market has been anticipating the end of the petrodollar system for 10 years. I am worried that the economic shutdown of the entire world could make stocks revalue much lower than the current S&P 500 price of $2,500. However, I am also aware of the possibility that stocks may revalue much, much higher to compensate for decline in the value of the US dollar. How does one invest in a binary situation like this? All cash to avoid the stock market crash and you risk hyper-inflation making your cash worth much less. All in the market and you risk an economic shut down making your stocks worth much less. There is a fine line that navigates between these two disaster scenarios, and I don’t believe it is a traditional 60/40 portfolio…

What should we own to preserve wealth we have, and what should we own to create wealth? These are two questions that have the same answer. It is an elegant answer, and it is a time-tested answer to similar problems in the past. The answer is obvious to those who enjoy studying the history of money (remember, history doesn’t repeat, but it often rhymes)… Can you guess the answer?

Here are some clues:

-Executive Order 6102, 1933.

-Bretton Woods, 1944.

-President Nixon, 1971.

-Plaza Accord, 1985.

-Louvre Accord, 1987.

Can you guess? 🙂