Welcome to our Friday mailbag edition!
Every week, we receive great questions from your fellow readers. And every Friday, I answer as many as I can.
Up first this week, reader John L. weighs in on my recent essay, “Bitcoin Is a Guaranteed Buyer of Cheap, Excess Energy”…
Thank you for your very interesting article, one of many that I have had the privilege to enjoy. I genuinely believe that the best way forward for all of humanity is to bypass big banks altogether.
I would really appreciate your thoughts on the role that you believe blockchain technology and more specifically Bitcoin plays in the near to medium term for the future of the world economy. I am a subscriber to both Palm Beach Confidential and Jim Rickards, as well as Bill Bonner.
As a mature member of society with a limited lifespan, I am incredibly grateful for your insight. I would value your thoughts on whether you believe that the best interests for us all lie in a decentralized world where we own our identity and can be appropriately remunerated for our contribution.
Thank you once again for your contribution towards seeking the truth and finding the “medium course” that can best provide for each individual subscriber and their family’s needs.
– John L.
Hi John, thank you for your kind words and perspective on the big Wall Street banks. It is one that I am sure is shared by many of your fellow readers.
I just published my seventh book, Permanent Distortion. It’s about the unending disconnect between the market and the real economy stoked by the Federal Reserve and fiat money.
When I was writing it, I included a chapter about crypto and decentralized finance. My publisher wasn’t sure that was a good idea. He was concerned that Bitcoin was too volatile and might be considered a passing fad.
I persevered, however, because I thought that chapter was critical. Here’s why…
I believe that innovations in decentralized finance give us a way to gain more direct control over our money.
Those innovations include the ability for people to transfer payments… As well as to save, lend, and invest money online or through smartphone apps… All outside of the auspices of the big banks.
Bitcoin is still in its nascency as a currency. And I believe there does need to be some oversight or guarantee that people won’t lose their Bitcoin via nefarious platforms or practices.
There is still a lot of volatility in Bitcoin’s price, too. And, as the recent string of collapses shows – from FTX to Voyager and Three Arrows Capital… there are still a lot of things the industry needs to figure out as a whole to better protect its users.
Still, that doesn’t take away from crypto’s long-term potential. And overall, it’s off to a quick and hopeful start. Just think about how much it’s grown since Bitcoin was born in 2009.
At the start of 2020, the crypto markets were worth around $200 billion. Last November, that number was close to $3 trillion. And despite recent struggles, it’s still at $830 billion.
Will those recent struggles set back trust and confidence in crypto for some people? They may. But as I wrote on Wednesday, as a whole, the crypto industry will eventually bounce back.
In short, I believe that Bitcoin has the legs to transform the financial system for decades to come. And so does the blockchain technology behind it.
Moving on, reader Jim L. shares John’s distrust of big banks…
Lehman went under due to no liquidity. Their competition refused their repos and put them into bankruptcy. A major competitor eliminated.
Do you recall Hank Paulson threatened to destroy Bank of America if they stopped the acquisition of Merrill Lynch after Merrill had raided the coffers for all the bonuses? Then the Securities and Exchange Commission (SEC) sued Bank of America because they didn’t “disclose” that Merrill had raided the coffers.
By the by, are banks still doing their end-of-the-quarter repo tricks?
– Jim L.
Hi Jim, thanks for writing in and for your observations about banks.
Yes, that is one of the main reasons Lehman Brothers had to declare bankruptcy on September 15, 2008. It had borrowed, on margin, too much money against its book of “toxic assets.”
Those were the assets associated with defaulting subprime loans and faulty derivative securities.
Rather than extend the time of that margin call, Lehman Brothers’ lenders decided to push the firm into bankruptcy.
And yes, by doing that, they eliminated a major competitor. JPMorgan Chase, my former employer, was one of those lenders.
You mention Hank Paulson. He was my boss when I worked at Goldman Sachs. I was a Managing Director there, and Paulson was the Chairman and CEO.
That was before he became U.S. Treasury Secretary in 2006, under President Bush.
When the 2008 crisis hit, Paulson decided to help his old number three, John Thain.
Thain was the President of Goldman Sachs, under Paulson, when I worked there. He then became head of the New York Stock Exchange in 2003, and then Chairman of the investment bank Merrill Lynch.
It was Merrill Lynch that Bank of America offered to buy. It then got cold feet.
So Paulson stepped in and pushed that deal through. The deal included paying Thain and his executives mega bonuses – even though the financial system was being bailed out.
I wrote about that incident back then in an article. Thain’s lawyers wanted to sue me for that article, but I won out.
That all shows that cronyism was alive and well between the inner circles of Wall Street and Washington.
And that brings us to your last question. You mention the repo markets. To this day, Wall Street banks operate in the repo markets.
These are non-public markets where they lend each other – and their major corporate clients – money overnight. They do that with the expectation that it will be repaid with interest.
In the fall of 2019, the repo markets were in danger due to looming credit problems. So the Fed stepped in with a backdoor Wall Street bailout. This is also something I wrote about in my new book, Permanent Distortion.
I believe that Wall Street still uses the repo market to make their books look better during earnings periods.
They can do this by borrowing a lot of money at the end of the quarter. From an accounting standpoint, that makes it look like they have more money. And that makes their books look healthier.
Finally, reader William B. weighs in on one of my recent essays about former Fed chair Ben Bernanke.
There, I wrote that the Federal Reserve will have to stop its aggressive rate hikes sooner or later. But William sees things differently…
Disagree. When Jimmy Carter kept raising rates in the ‘70s inflation got higher & higher. Reagan was elected & he stated we are going to stop fighting inflation and put people back to work. In less than a year, inflation was less than 2%.
– William B.
Hi William, thank you for writing in. It is true that inflation was ultimately contained during the Reagan administration.
Paul Volcker was chairman of the Fed under both Presidents Carter and Reagan.
Under Volcker’s monetary policy, the Fed raised the federal funds rate to fight inflation. Rates went from an average of 11.2% in 1979 to 20% in June 1981.
Volcker held that position under both presidents. But his hawkish policy had ramifications.
Among them, it caused the 1980-1982 recession as Reagan took office. During that recession, the U.S. unemployment rate hit a peak of 10.8%.
The doubling of interest rates also caused a credit crunch. And that led to a contraction of the economy that helped ease inflationary prices as well.
Americans were hurt by inflation and its “remedy” of raising rates. This is similar to what’s unfolding today.
When Reagan took office in 1980, inflation hit 13.9% in January. It hit 14.6% by April 1980. But it did also fall under Reagan. It went down to 9.7% in 1981, and then down to 4.8%.
Now, part of that fall is attributed to high interest rates constricting borrowing, and leading to a recession.
Reagan did triple the national debt from $995 billion to $2.9 trillion by the end of his presidency. Today, that national debt is $31 trillion. Meanwhile, the ratio of debt to GDP under Reagan was 33%. Today, it’s 121%.
But given the lower ratio of debt to GDP back then, and lower use of credit in general by Americans… I think that the drop in inflation had more to do with market dynamics and timing.
The energy shocks of the late 1970s, for instance, abated during the Reagan years. And that had nothing to do with Volcker.
In short, I still believe the Fed will have to start pivoting away from its hawkish policy soon. And for reasons I wrote about in the October 27 Inside Wall Street, that pivot could start as early as this winter.
And that’s all for this week’s mailbag. Thanks to everyone who wrote in!
If I didn’t get to your question this week, look out for my response in a future Friday mailbag edition.
I do my best to respond to as many of your questions and comments as I can. Just remember, I can’t give personal investment advice.
And if there are any other topics you’d like me to write about, I’d love to hear from you. You can write me at [email protected].
Happy investing… and have a fantastic weekend!
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins