On November 27, John P. Hussman, an American stock analyst and former Professor of Economics and International Finance at the University of Michigan, pointed out that society may be in the midst of a bubble as extreme as that seen in 1929.
“Congratulations to the Federal Reserve!”
In a recent Tweet, Hussman congratulated the American Federal Reserve (the “Fed”) for creating “the most extreme, pre-collapse yield-seeking bubble in U.S. history.”
Despite the alarmist tone, the sentiment is backed up by nearly a century’s worth of financial data. The hedge fund manager draws from the nominal total return of the S&P 500, annual Treasury bonds, and Treasury bills (T-bills).
Standard and Poor’s 500 Index tracks the top 500 stocks from American companies and is widely regarded as the best metric for measuring the health of the economy. Treasury bonds are debt securities issued by the U.S. government that reach maturity after five or ten years. T-Bills are relatively similar, but usually mature within one year.
The latter two financial instruments are issued by the Fed, America’s central banking system. Both are regarded as near risk-free investments as the United States government has never defaulted on its debt in the current era.
These two tools give the Fed a means of supervising the greater economy. By buying or selling Treasury bonds in exchange for cash they can increase or decrease the money supply, respectively. Buying and selling bonds can affect interest rates too.
This is because of the direct effect that buying and selling bonds have on the money supply. If the Fed buys bonds on the open market, they are effectively exchanging bonds for cash with whoever is selling the bonds. This increases the money supply which, in turn, pushes interest down to incentivize spending.
These open market operations (OMO) have, unfortunately, been abused in the past. From Hussman’s data below, one can identify a few specific highs and lows.
The chart indicates high returns throughout the 1980s, a time which The Washington Post called the “Roaring ‘80s.”
At that time, journalist David A. Vise wrote that “in 1989 the Dow Jones industrial average of 30 stocks soared by about 25 percent, capping off the greatest decade of stock market performance since the 1950s.”
On the far end of the spectrum are the negative return rates endured at the beginning of the 1930s. In the 1920s, stocks were extremely overvalued across most reliable measures until eventually crashing in 1929 and beginning the Great Depression in the United States.
The Fed responded at this time by contracting the money supply and letting affected banks suffer. In 2008, the opposite occurred as the government spent $700 billion to buy mortgage-backed securities on the verge of defaulting.
Both strategies have been deeply criticized by current and former financial experts, with those from the crypto community claiming the Fed should be abolished altogether.
Further investigation of Hussman’s findings also indicates that the current economy more closely resembles the 1930s than the golden era of the 1980s. Hussman said that “the most reliable measures suggest prices are ~ 3x the level that would imply future long-term returns close to the ~10% historical norm,” adding:
“Our projection of 12-year total returns on a conventional 60% SPX [S&P 500], 30% T-bond, 10% T-bill mix is now within 0.01% of the historic low set in Aug 1929.”
Though the rates may remain profitable over the short term, over a 10- to 12-year time span they are bound to turn negative according to Hussman. Others in the financial sector, like senior economic adviser at Allianz, Mohamed El-Erian, have also indicated the presence of short term profits.
In an interview with Yahoo Finance regarding the recent behavior of the Fed, El-Erian said,
“Very short term, this is great for investors. How often do we get the trifecta of high returns, not only on your risk assets, but also on your risk mitigation assets, on your bonds?”
The Wall Street Journal reported in October that the Fed has been buying bonds and lowering interest rates at a rate of $60 billion per month since October 2019. The reason for this was to get better control of interest rates following a spate of volatility in money markets.
A representative from the central bank said that the move was not to be interpreted as a form of quantitative easing, but instead would return bank reserves to or above “the level that prevailed in early September 2019.”
Fueling the Crypto Narrative
Nic Carter, a partner at Castle Island Ventures and the co-founder of Coinmetrics.io, was one of the first from the crypto industry to draw attention to Hussman’s findings. It is not, however, the first time a crypto pundit has highlighted the failings of traditional financial markets.
Wall Street has lots of mercenaries.
Bitcoin has lots of missionaries.
Historically, missionaries outlast mercenaries.
— Pomp 🌪 (@APompliano) November 29, 2019
Since its inception in 2008, Bitcoin has been championed as the beginning of a new era of finance.
Supporters claimed that it would end crony capitalism, render taxes obsolete, and onboard the roughly 1.7 billion unbanked adults in the world. More importantly, cryptocurrencies like Bitcoin do not have a centralized authority to supervise its supply.
It is for this reason that Bitcoin is seen as a “solution” to government intervention. And insofar as market doomsayers predict an incoming financial collapse, crypto advocates have unscrupulously labeled such predictions as Bitcoin “buying opportunities.”
One must not forget, however, that during the Great Depression crime and suicide rates rose, cases of malnutrition became more and more common, and mass unemployment devastated the country.
The consequences of a crash in 2019 might not be as dire, but such a crash does not inevitably mean a rise in the price of Bitcoin.
Bitcoin’s degree of correlation to the wider markets is hotly debated. Though there are emerging signs that it may be the case, an analysis by Coin Metrics concluded that the data does not meaningfully support this narrative so far — neither positive nor negative correlation was observed.
Thus, if cryptocurrencies reveal themselves immune to bullish or bearish sentiment in traditional markets, commentators hoping for a market crash would appear both wrong and boarish. Ethereum co-founder, Vitalik Buterin, put it best in December 2017.
He Tweeted, “So total cryptocoin market cap just hit $0.5T today. But have we *earned* it?” adding, “How many unbanked people have we banked?”
Indeed the ability to serve those most in need will go a lot further in raising the sector’s credibility than the hopes for any Depression-grade market downturn.