The Mad Mob is Front-Running Nvidia

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XLK Weights

1 MSFT 23.5%
2 AAPL 20.0%
3 AVGO 4.6%
4 NVDA 4.4%
5 CRM 3.0%
6 AMD 2.8%
7 ADBE 2.4%
8 ACN 2.2%
9 CSCO 2.1%
10 ORCL 2.1%

Important Reminder – State Street’s Technology Sector ETF (XLK) has far less NVDA exposure than the company’s market cap suggests. Based on market cap alone NVDA should have a 16% weight in the fund, but rules and SEC requirements are causing this underweight in NVDA. Index and diversification rules cap NVDA’s weighting at 4.5% within the XLK, while MSFT and AAPL are both above 20%.

*Only $420B separates Apple AAPL and Nvidia NVDA this morning. So if NVDA is up 12% from here with AAPL off 6%, that’s a trigger. ALERT —  Will Goldman and a few hedge funds squeeze State Street into this trade? 

What if NVDA Surpasses AAPL Market Cap?

If NVDA surpasses AAPL in market cap, the $65 billion fund would have to sell perhaps $10bl of AAPL stock and buy $10bl of NVDA. NVDA’s $2.2TR market cap trails AAPL $2.6TR, but NVDA is gaining ground on AAPL after its frantic run in the last year. If NVDA overtakes AAPL in market cap for one of XLK’s quarterly rebalances, Apple will be capped at the 4.5% level and NVDA gets reweighted to 20%. His means approximately $10bl of XLK capital moving into NVDA and out of AAPL.

End of June

The S&P Select Industry Indices rebalance quarterly, and State Street follows this rebalancing methodology. In other words, the next quarterly rebalance comes up at the end of June.

“In 2021, the stock split was effective July 20th. From the earnings announcement until the stock split, NVDA increased by 40%, suggesting a lot of investors piled into the stock ahead of the split. Given the massive surge of NVDA over the last year, a repeat seems unlikely but NVDA would only need to appreciate by 20% ahead of the rebalance to overtake AAPL in the index reweight at the
end of June.” Bear Traps Report April 10, 2024.

In other words, as the Bear Traps Report noted in April when investors rush into the stock before the stock split becomes effective, and the stock overtakes AAPL by June 30, XLK may need to swap $10bl out of AAPL into NVDA. This sets up a recipe for a classic – front running-induced, near-term blow-off top.



Air Pocket

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What’s Under the Surface?
The heart of “conditioning bias” comes down to one sentence. The longer something works, the more players get drawn into playing the game. We know the junkies are on every street corner these days buying call options when the VIX is up 29% since late December with equities as measured by the S&P 500 – up just a touch more than 9% higher. 

Over the last 30 years — most of the time, the CBOE Volatility Index has been supported by investors looking for downside protection in buying puts. But 2024 is much like 1999. For most of that year, the same thing occurred, Today, many players on the field say “greed is good” and they’re all buying upside.

They Love to Buy the 20 Day Moving Average
As the market grinded higher – more and more capital came into the hands of algos and quants buying the 20-day moving average. This is an important area to keep an eye on. There are so many players involved, that a violation of the 20-day moving average will likely come with a meaningful flush lower. 

What Could Alter the Equation?

In the next several weeks, we could see about $300 billion of liquidity leaving the system. This is in large part due to the tax deadline on April 15. We should expect large tax revenues, in part because taxpayers have significant capital gains from the 2023 equity bull run. Treasury bill issuance will flip negative in Q2 to the tune of about $150 billion as the government runs a budget surplus for a cup of coffee. Add to that the $95 billion in monthly QT (quantitative tightening, Fed balance sheet reduction) and we could see $250 billion of liquidity drain. On top of that, this month about $75 billion of the emergency bank lending facility (BTFP loans) expired and since the facility is now closed, they may not get renewed. This causes another contraction in bank reserves.

Keep in mind, that S&P 500 companies are still in the buyback blackout period, which means that they cannot buy back their stock until they have reported earnings. Stock buybacks are about $100bl per month, so this upward pressure on stocks is currently gone.

Equity Volatility is Cheap vs. Encroaching Risks

The combination of the cocktail ingredients listed above makes the market very vulnerable and at risk of a larger drawdown if any geopolitical risk comes to the surface. Each week, Iran and Israel look toward retaliation, and the probability of escalation is rising. Brent is up nearly 30% since December, putting significant pressure on higher bond yields. Over the same period, the yield on U.S. 10-year Treasuries has moved from 378bps (3.78%) to 440bps (4.40%).

One of the biggest drivers of the stock market since early 2023, and especially since late October, has been liquidity.  In an election year of course, Treasury Secretary Yellen and Fed Chair Powell have carefully rebuilt a big chunk of the excess liquidity that underpinned the stock market rally. The two main reasons for the liquidity boost have been to — a) stabilize the banking system after SVB (Silicon Valley Bank) blew up a year ago and — b) to suppress volatility in the election year. A large amount of that liquidity has come from the Reverse Repo Facility (RRP). This is a facility the Fed brought to life in 2020 to mop up some of the excess liquidity from all the Fed’s juicy new programs used to stabilize the financial system during the Covid Financial Panic.

Pick up our latest book When Markets Speak which has been #1 on Amazon over the last week across most non-fiction, finance categories.

Remember, the Fed injected $3.3T of liquidity into the system that year. Fast forward to the end of 2022, and there was almost $2.5T in this RRP facility. Ever since, Treasury Secretary Yellen has been using this money in this honey pot, the RRP to finance her ~$2.5T of bill issuance. The way this works is that when the Treasury ramps up bill issuance, it will push up bill yields. At some point that yield we go above the rate on these reserve balances in the RRP. This is what the Fed pays investors, mostly money market funds, to keep money in the RRP. These investors get lured into the bills market with its higher rates and they take their money out of the RRP and buy bills with it. The money in the RRP is not considered to be part of overall liquidity, so if that money leaves the RRP and enters the bills market, it adds to the liquidity pool. Much of this money has ended up in a special component of the commercial banks’ balance sheet called the reserve balance held at the Fed. In the past, the Fed injected liquidity into the system via QE, which also increased these reserves. But in the last year, the bank reserves expanded primarily from the RRP depletion, and the Fed’s introduction of the Bank Term Funding Program in March of last year. This program allowed banks to borrow from the Fed and use their bonds at par as collateral. This was done to inject liquidity into the banking system to avoid a cash shortage at mainly regional banks following the blow-up of SVB.

Excess Liquidity, Bitcoin, and the S&PExcess liquidity have surged higher in the last year, which has pushed up risk assets, such as bitcoin and equities.

Together with the introduction of the BTFP in March ’23, the Fed and Treasury pushed up bank reserves from $3T on Oct 22, to $3.6T by March ’24. What do these reserves do? These reserves cannot leave the banking system and therefore cannot enter the “real economy”. It’s a financial form of money only for banks. They can transact in reserves with each other and settle repo and reverse repo transactions. They account for high-quality liquid assets (HQLA) together with bonds and mortgage-backed securities (MBS). Most importantly, banks use the reserves to buy bonds from each other. In this way, they drive liquidity into the market and drive investors into riskier assets. We see that almost every time reserves go up, risk assets benefit.

Bank Reserves Go Up when RRP Goes Down and Vice VersaAs the Treasury pushed money out of the RRP, bank reserves held at the Fed have gone up simultaneously. This has been one of the biggest driver of stock market gains

In the next few weeks, we could see liquidity reverse for two reasons.

1) Treasury bill issuance will flip negative in Q2 to the tune of about $150bl. In Q1, 400bl of capital went from the RRP into the bills market, and in Q2 this will reverse. Add to that the 95bl in monthly QT and we could see 250bl of liquidity drain.

2) Expiration of the BTFP. In April about 75bl of BTFP loans expire and since the facility is now closed, they may not get renewed. This causes another contraction in bank reserves.

Overall we could see over $300bl of contraction if Yellen/Powell do not step in to offset. We think they will step in but it might take a month or so for them to react.

In the meantime, we are still in the buyback blackout window ($100bl of monthly buybacks do not start anew until after GOOG/AAPL report in late April/Early May) so we could fly into an air pocket.

In the next blog post, we will explain how Yellen and Powell can and will come up with a solution if they see liquidity plunge too far or stock market volatility surges higher.



Divergence in the Banking System, What Gives?

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Banks in a lot of Pain

One Year Performance

Nasdaq Bank Index -13%
S&P 500 +25%

*Disclaimer – The banking system is pricing in commercial real estate pain, while the S&P 500 is far more optimistic. Looking back over dozens of one-year performance periods, this is a HIGHLY unusual divergence and has only occurred near recessions and extreme financial stress points. We see more than $1T of losses if the Fed really commits to a – “higher for longer” fantasy.

“US office properties, once a $3 trillion market, has now declined to about $1.8 trillion. In the fourth quarter of last year, the US office market experienced its fifth consecutive quarter of negative net absorption of office space. With 5 million square feet of new supply, the overall office vacancy rate reached a 30-year high of 18.6%.” Bloomberg

Summary: Wells Fargo (WFC)’s fake account scandal came to the surface in late 2016 and the bank has been living under a punitive consent order from the Fed for six years now. This has prohibited the bank from growing its assets and the stock has done nothing since 2018, while most of its peers went up by 100% to 200%. But last Thursday, the Office of the Controller of the Currency (OCC) surprisingly lifted its consent order. We believe that this is a sign that the Fed is getting close to lifting its punitive asset cap as well. The Fed knows the banks are seriously wounded, and commercial real estate data pain points are more telling by the day – the central bank MUST and will provide relief here, they have NO choice.  The timing may be tied to the election. With the order lifted, WFC can grow its assets by as much as $500bl. WFC is still the largest mortgage lender in the country and this action could help give a boost to mortgage lending, so more people can get in a home. Affordable housing is still a top concern among Americans and the Biden administration has made it a top priority for this year.

Trade: If WFC can grow its assets by $500bl when the Fed lifts the consent order it could translate into additional pre-tax profits of $5Bl per year. WFC trades 10x earnings, which suggests the stock has 26% upside in such a scenario. This means the stock going from the current price of $51.9 to $65.50. WFC also has a pristine balance sheet now because it couldn’t grow its loan book for years. Its office-CRE loan book, which is experiencing a lot of stress right now, is only $30bl or 1.6% of assets. Given the quality of its balance sheet and its growth potential, if the Fed lifts the cap, we think WFC could see some multiple expansion as well.

Top Concern for Americans (Source: Bank of America)

Wells Fargo – Flatlining Since 2016

Wells Fargo has underperformed the other major US banks by over 100% since the fake account scandal started in 2016.

Draconian Punishment

Following WFC’s phony-accounts scandal, the Fed implemented a consent order that prevented WFC from growing its balance sheet above $1.95TR in assets. In addition, two other regulators, the OCC¹ and the CFPB², have also imposed restrictions on the bank and are supervising the bank for its victim compensation and internal controls. WFC also has had some powerful foes on the Senate banking committee, including the committee chair Sherrod Brown (D, OH) and Elizabeth Warren (D, MA) which have been lambasting the bank year after year.

However, last Thursday the OCC surprisingly terminated its consent order regarding sales practices misconduct. That consent order required WFC to revamp how it offers and sells products and services to consumers and protect its customers and employees. We believe the lifting of this OCC consent order paves the way for the Fed to lift its own consent order in the coming months.

Zero Growth in Wells Fargo Balance Sheet

The big banks in the US have grown their balance sheet by 40% on average since 2018, except Wells Fargo, which was forced to keep its balance sheet flat

Why now?

Since the start of the coronavirus crisis, banks’ balance sheets have ballooned and the average GSIB³ score has increased by 229 points, the largest increase on record. These balance sheets expanded so much mainly due to demand for deposits and the Fed’s massive asset purchase program (QE). When the Fed buys assets, the Fed credits banks’ accounts with the cash with which it buys the asset. The Fed balance sheet has doubled since early 2020 to $8TR and accordingly, the assets of US banks increased by $4Tr as well. Most banks are now running up against their GSIB surcharge threshold, meaning they get hit with a higher surcharge if they further expand their balance sheet. To stay under these GSIB limits, banks are suppressing loan growth. The chart below shows how mortgage loans have stagnated at the big banks despite the housing boom.

WFC has no such problem because its balance sheet has remained stagnant since 2016. Their GSIB buffer is 1%, compared to 3% for JP Morgan (See below). This is an election year and WFC is still one of the largest mortgage underwriters in the US. By lifting the asset cap, it could help more people to get mortgages and alleviate some of the housing market stress.

Big Banks are Stingy with Mortgage Lending

The big banks have barely grown their mortgage books in the last few years. Mortgage brokers have picked up the slack but the government wants to avoid this because they care little about credit risk as they sell the mortgages to government-owned Fannie and Freddie.

What is Wells Fargo worth if the asset cap is gone?

If Wells Fargo’s balance sheet would have grown in line with their peers since 2016, assets would be between $2.4-$2.9TR instead of $1.9TR. Alternatively, if Wells Fargo maximizes the room it currently has under its GSIB buffer, its assets could be at $2.2TR. Taking the average of these two numbers, we could see $500bl of room for WFC to grow the assets when the Fed lifts the consent order. Given WFC 1% average return on assets, this could translate into $5Bl of additional pre-tax profit per year. To compare, WFC made $21bl in pre-tax profit last year. The stock trades 10x earnings, which suggests it 26% upside in such a scenario. In other words, the stock can go from the current price of $51.9 to $65.50. WFC also has a pristine balance sheet now, because of its inability to grow its loan book. Its office CRE loan book is only $30bl or 1.6% of assets. Given the quality of its balance sheet and its growth potential, if the Fed lifts the cap, WFC could see some multiple expansion as well. We do not take that into account in our valuation, but WFC used to trade at a higher multiple than JPM before 2016. It currently trades at a 20% discount.

What is the asset cap imposed on Wells Fargo?

The Fed’s asset cap order covers operational risk management, compliance risk management, and governance, and the CFPB and OCC’s 2018 orders cover compliance risk management, auto insurance, and mortgage rate lock extensions. This process has dragged on for much longer than both regulators and Wells Fargo initially expected, and Wells Fargo has taken much longer to develop a plan acceptable to the Fed. The bank was initially expected to complete these steps by September 2018. The asset cap is considered by most now to be an unduly draconian punishment for Wells (WFC) past scandals, especially because it has been kept on for so much longer than expected.

The Higher the Score, the Harder it Gets

The big US commercial banks have GSIB scores above 3%, except Wells Fargo. To illustrate, Core Equity Tier 1 ratios for the biggest US banks are now between 11% and 16%. The higher the score, the higher the GSIB surcharge is. This is an incentive for banks to curb their loan growth once they approach a GSIB threshold.

¹ Office of the Controller of the Currency
² Consumer Financial Protection Bureau
³ The GSIB surcharge requirement reflects the Federal Reserve’s unilateral assessment of systemic risk as measured by the weighted sum of a select set of indicators, expressed as a systemic risk score. The higher the score, the higher the applicable GSIB surcharge.

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An Epic Tax Loss Opportunity

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Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Most Crowded Trade – All Time

The S&P is on course to gain ~18%, but without the Magnificent 7 (+71% YTD), the S&P is only up 5% for the year. The Russell 2000 index of small caps is even down year to date. This dispersion in performance means that investors should have some large capital gains, but also some steep capital losses spread among a variety of the stocks in their portfolios. In years where we find significant divergence between winners and losers – the data shows that is where the opportunities are most attractive. 

Winners vs. Losers – S&P 500

This brings us to the January effect. There are two forces that have a significant influence over markets between November and January: Window dressing by mutual fund managers and tax loss selling by individual investors. By year-end, they want ALL of the ugly names off the pad – at the same time they all love to show off the winners. 

What is Window Dressing?

Mutual fund portfolio managers want to show as many of the year’s winners in their portfolios in their year-end statements. Their clients, the investors in their funds will receive those statements in early January and the more winners the portfolio has, the more impressed those investors are. As such, mutual fund managers tend to buy more of the best-performing stocks in the last two months and sell down their losers.

Q4 2022 Losers vs Winners
Many of the Q4 2022 losers became winners in early 2023.

Early Winners in 2023
Q4 losers into Q1 winners.

2023 Full Year
The year 2023 will go down as an epic haves vs. have nots.

In addition, other classes of investors that incur capital gains taxes also sell some of their losers in the last weeks of the year to offset their capital gains. This effect is especially pronounced in years of strong market gains. As such, the year’s strongest stocks tend to rally further into year-end, while losers continue to see selling pressure as the year ends.

The table above shows that in years when the S&P has strong returns, January is often a relatively weak month as people wait to sell their winners until January. At the same time, some of last year’s losers tend to rebound strongly in January, as the selling pressure disappears. This is the January effect.


Tax Loss Basket 2022 – A year ago, there was a Q4 overdose into DJIA names, and out of the QQQs, but we are seeing the climax opposite with positive divergence favoring the DJIA in Q1 2024. The Dow Industrials are extremely cheap vs. the ridiculously crowded QQQs. There is close to $19T in the Nasdaq 100, up from $12.5T in January 2023. 

This was the BearTraps’ Tax loss selling basket by the end of 2022
In 16 trade alerts, we positioned clients in beaten-down names in Q4 2022. NOT listed above was our CRM Salesforce position, CRM equity was up 70% in 1H 2023, see below.

CRM Trade Alerts
Our 7-Factor Capitulation model delivered a strong buy. We were aggressive buyers of CRM equity in Q4 2022.

Please reach out to to get on our CLIENT trade alerts.

So far in the year, the worst performers in the S&P are the solar stocks, Enphase (ENPH) and SolarEdge (SEDG), lithium miner FMC Corp. (FMC), Covid vaccine makers PFE and MRNA, and some retailers like DG and WBA.

1) Buy Solar: Enphase (ENPH) and Solar Edge (SEDG)
The TAN solar ETF is the cheapest to the QQQs all time.

What has plagued solar this year? A combination of high interest rates hitting demand, distributors working through high inventory levels, and a policy change reducing incentives in California, has made it a tough year for residential rooftop solar stocks. Higher interest rates make it more expensive to finance solar and it makes it less economical for companies and individuals to adopt solar. In addition, the plunge in prices of natural gas have limited electricity price inflation. This also removed an incentive for homeowners and corporations to adopt solar. Solar stocks have been the worst performers in 2023. Ultimately, ENPH is down 72% from the late 2022 highs and SEDG is down 80% from the all-time high. PMs and individual investors are undoubtedly dumping those stocks in the final weeks of the year as they want them out of the portfolio or to book capital losses. We think these stocks could rebound in January as the selling dries up. Some of these investors will buy back the very same stocks they sold for tax reasons. According to the tax code, an investor needs to wait 30 days before repurchasing the stock they sold.   A decline in interest rates, something the rates market is anticipating for 2024, would give a boost to the beleaguered solar stocks. In addition, we should get an update on the solar subsidies from the Inflation Reduction Act, which could help sentiment on these stocks.

2) Buy Fertilizer and Crop Protection

Crop protection companies vs Soft Commodities
FMC Corp (FMC) and Mosaic (MOS) have been among the worst-performing stocks this year, with FMC down 90% from the March ’22 highs. Fertilizer and crop protection stocks have been selling off all year together with crop commodities. We think FMC and MOS have now also become a victim of tax loss selling/window dressing and these stocks should improve once the tax loss selling has subsided.

3) Buy the Government Sponsored Enterprises (GSEs)

Fannie Mae (FNMA) soared when Trump was elected in 2016, and clobbered when SCOTUS killed the Sweep Lawsuits.
One of our favorite tax loss trades is Fannie Mae (FNMA) and Freddy Mac (FMCC) . These stocks were decimated in 2021 after the court rejected claims that the Federal Housing Finance Agency exceeded its authority in collecting more than $100 billion in profits from the Government Sponsored Enterprises (GSE). Hedge funds had crowded into this trade and sued the FHFA for this sweep, hoping the courts would decide in their favor. When they didn’t, hedge funds fled the stock and it collapsed. Surely there are still plenty of people who hold the stock at a loss, and we could see some selling pressure on the stock (and the preferreds) into New Year. However, the presidential elections are in November of 2024. While it is extremely hard to forecast who will win these elections, the polls currently favor Trump slightly, while the betting sites attach even odds to Biden and Trump (~40%). After the 2016 election, FNMA and FMCC common stock soared to $4.5 and $4.3 per share respectively on the hopes that the GSEs would be privatized. If we believe that a Trump victory could once again trigger speculation over a privatization, then the fair value of FNMA and FMCC is worth $1.8 and 1.72 per share and not 70 cents (40% odds of a $4.5 stock price after the election).

Polling Average for 2024 Election

Polling averages for the 2024 election shows Trump now with a slight lead over Biden.

4) Buy Disney (DIS)

DIS – Down 53% since February 2021 Top
There are a number of upcoming catalysts for the stock, including the Comcast/Hulu deal, NBA renewal, ESPN partnership announcement and potential asset sales. DIS in now in the process of controlling costs, and its booking progress. The next step for DIS will be to return to revenue growth. ESPN+ streaming and repositioning Disney + /Hulu are part of this growth strategy. A recent deal with Charter allows for Ad supported Disney + to be available to all 10ml Charter subscribers. For ESPN there is a catalyst to tie it to its newly forged $2bl sports betting alliance with PENN. The challenges for DIS are to halt or at least slow down the decline in linear media. Also, DIS will continue to have to invest in things like Disney + and NBA etc to return to growth. These FCF headwinds will continue to weigh on the stock in 2024. We like DIS especially because we believe it is a tax loss selling candidate and it is likely to enjoy a rebound in January as the tax loss selling subsides. The stock is no longer expensive, at 12x fwd EV/EBITDA.

5) Buy beaten-down Retailers and Apparel

Retail: NKE, TGT and VSCO
Many retailers and apparel companies have sold off hard throughout 2022 and 2023. One notable apparel bellwether that has fallen on hard times has been NKE. TGT is another retailer that has suffered from declining purchasing power among its customers and bloated inventories. VSCO spun off Bed & Bodyworks several years ago and has been challenged by consumer trends away from their core product (intimates) as well as a negative sentiment. We believe that these stocks should rebound in January, on more favorable comps (NKE, TGT) and an end to tax loss selling. Note that Dicks (DKS) reported robust Q3 results, which suggests athletic sales are improving.

6) Buy lithium

Albemarle (ALB) and Quimica (SQM)
ALB and SQM have been among the worst performing stocks this year, with FMC down 90% from the March ’22 highs and SQM 56% from the September ’22 high. We think FMC ad SQM have also become a victim of tax loss selling/window dressing. There is an excess inventory of lithium in the channel, and as a result lithium prices have weakened a lot, which explained their plunge this year. But China EV sales for October, the largest market in the world, were extremely strong. Rising EV sales will eventually translate into more lithium demand or inventory depletion. We think the selling in these stocks has been overdone and we should see a rebound in January.

7) Buy Cannabis MSOS

Strong Evidence – Seller Exhaustion
Our seven factor capitulation model is picking up on a few attractive developments. a) The MSOS ETF made a new low in Q3 2023, WITHOUT a confirmation from the weekly RSI. In other words, there is a positive divergence, the RSI has improved over the last 6-months. This is a sign of seller exhaustion, something you want to see in Q4, heading into the new year. b) Meaningful up volume arrived in recent months. Most of the weak hands that owned the shares much higher have been taken out, while a new class of MSOS share ownership, now owns the shares at a MUCH lower price. This is just what you want to see heading into the new year and speaks to potentially attractive returns in 1H 2024.

Special Thanks for ACG Analytics in Washington

And in the Senate now, despite passing a key committee vote and Senator Schumer “vowing” to hold a follow on vote, Steve Daines (lead R supporter) is saying he doesn’t want to hold a vote until he is sure that the House will pass it too… Which means there is a significant chance that this thing just sits in the Senate. Sets us an great year end buying opportunity as tax loss stress climax probably comes in mid November, most of the bear case is well prices in, shares are likely much higher by Q2 next year as the legislative cycle opens up a more attractive risk-reward. In a Presidential election year, we may see decent GOP support for a play for social justice reforms.

Reschedule developments and processes is MSOS Bullish, 1-3 from dangerous narcotic to lower class. Gets rid of the 280E biz deduction ban (a HUGE positive for MSOS companies), large corporate – this is a non-legislative best case. We thought this action would happen closer to the election, Biden admin sees real political upside. SAFE Banking, the latest developments decrease the urgency near term, but to us – SAFE is a near certainty, just timing. There is now more pressure on the GOP to fall in line, support SAFE in 2024. See below.

* In a letter to the Drug Enforcement Agency (DEA), the Department of Health and Human Services (HHS) has recommended that marijuana be reclassified from a Schedule I to Schedule III substance based on a study conducted by the Food & Drug Administration (FDA). The National Institute on Drug Abuse supported the FDA’s findings. This means that the HHS no longer believes that marijuana has “no currently accepted medical use in the United States, a lack of accepted safety for use under medical supervision, and a high potential for abuse,” as described in the Schedule I Definition of Controlled Substance Schedules.

8) Buy Biotechs

XBI Extremely Cheap to the QQQs
In recent weeks, the XBI biotech ETF reached 10-year extremes vs. the Nasdaq 100. A weekly RSI of 18.75 is extremely rare vs. the QQQs. The year 2023, has been another challenging one for biotech stocks. The XBI is 14% off multi-year lows. The ETF has a historically high percentage of companies trading at or below their cash value, making the sector ripe for M&A support. The biotech industry is well-positioned for AI upside, attractive  growth potential, and well known rapid advancements in drug developments. Growing demand to treat chronic diseases is always an upside catalyst, but AI innovations should give the sector a meaningful boost in the coming years.

One Year

XBI: -9%
QQQ: +37%

Two Years

XBI: -39%
QQQ: -1%

Three Years

XBI: -42%
QQQ: +34%

Five Years

XBI: -5%
QQQ: +153%

Bloomberg terminal data.

What is Different Looking Forward?

Generative AI is transforming the biotech industry by accelerating drug development and lowering expenses. It is used in virtual compound libraries, protein engineering, and customized medicine development. Deep learning algorithms and computational capacity fuel generative AI applications, expediting drug discovery and improving personalized medicine therapy.

In biotech, generative AI technologies such as generative models are being utilized to expedite drug discovery, protein engineering, and customized medicine. The AI in biotechnology market share is expected to grow at a 29.7% CAGR until 2032. With Rashmi Kumari.




Inflation’s Long Game

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Author Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Long-Term Inflation Trends

Lessons Drawn from the Inflation of the 16th & early 17th Centuries

A. Inflation comes in multiple waves.

B. Current global population trends (8.0B in 2023 vs. 7.2B in 2013 vs. 6.4B in 2003) vs. the commodity capex deficit trend is VERY inflationary.

C. Perceived demand shocks in the energy sector are a buy.

D. The Fed has far less control over inflation than meets the eye.

E. Inflation fuels real income inequality and that fuels the Power of Labor, and that fuels sustained inflation.

F.  Shrikflation is as old as time itself.

G. Hard asset, bull market trends surge in inflation’s second leg higher.

H. Inflation will trigger a colossal political shift, response.

Lessons Learned, is Anyone Listening?

In the last quarter of the 16th century, prices began to increase slowly in Germany and Italy. In Florence, during the 1490s, prices surged. Masses of starving poor crushed themselves trying to get at the granaries. As is usually the case, an epidemic followed the famine. Soon, Venice lost wars in the East to the Turks and in the West to the French. In 1527 Rome was sacked by the French. Such were the events that ended the Renaissance price equilibrium. Inflation didn’t peak until the mid-17th century.

There are priceless lessons behind us, we MUST take note.

While the price of grain started to rise in Florence starting in 1472, there were areas in Europe where grain prices didn’t increase until about 1500. The last significant price increases in Europe ended altogether in 1650, making for the longest sustained inflation period in the history of the continent. Now, here is the key first lesson. We today think it would be a fine and healthy thing to reach a 2% inflation. False. The sustained price inflation from 1470 to 1650 averaged only 1% a year. However, the length of it, and the compounding of it, wreaked havoc for decades. So, while we debate whether inflation has or will be “over” i.e. if it will ever get to 2%, what we are missing is the fact that even 1% inflation, if it lasts long enough, is extremely deleterious to the polity, as you shall see below. The reader may recall our recap of medieval inflation and how destructive that was. Well, it was only about half of one percent a year on average for its duration, and it was a disaster.

Another lesson, our second, from studying this longest of price rise periods comes from noticing the extreme price variations around the primary trend. There were periods where prices rose well above trend and there were other periods where prices fell well below trend. This is a second lesson from the period we are focusing on in this paper: inflation comes in multiple waves. In other words, the current bout of inflation we have just experienced would be unique in history if it were not followed by yet another. Furthermore, it is a myth that Volcker cured inflation. He greatly reduced it, but he didn’t get rid of it altogether. How so? Well, in the wake of Volcker’s success, the Fed and the rest of the government developed a propagandistic lie: that the only way to avoid the perils of deflation was “modest” inflation. That is a lie because there is a third paradigm: no inflation and no deflation i.e. price stability. The cure against deflation is the same cure as against inflation: zero inflation. 2% inflation is a disease. 1% inflation is a disease. It is utterly false to say our only choice is between high inflation and moderate inflation. If we look at the modern period in toto, we see bouts of inflation followed by bouts of moderation which overall destroy the average person’s standard of living. This is what happened during the period we are considering as well.

What caused the inflation that saw its first sparks in the late 15th century? Population growth. The increase in population strained Europe’s material resources. This is a third lesson that comes from a study of the period. We think about globalization all the time. Yet, for some baffling reason, we think of the present-day inflation as a US phenomenon or a US and EU phenomenon, or as the latter with pushes from OPEC+ and China. Each of these views has something to recommend, but the simple truth is that inflation is a global phenomenon, and if one refuses to look at the total global economy, one will fail to understand the inflationary forces at work in our own day. The fact is, while the US population is growing slightly, because of immigration, the world’s population growth is quite strong. Within a handful of decades, it will crest at over 9 billion souls, more than one billion extra mouths to feed than today. The planet’s basic material resources are not growing at a concomitant rate. Therefore global inflation is inevitable for the next couple of decades at least. And global inflation means the US will suffer inflationary pressures for the next couple of decades at least. Certainly, there will be years when inflation will be less. Just as certainly, there will be years during which inflation will be above trend. The key point is that because the world’s population is growing, long-run inflation is here to stay.

Most countries in Europe showed a catastrophic decline in population in the mid-fourteenth century, which decline continued at a less precipitous rate until the end of the fourteenth century. In the early 15th century, population growth returned, but at a moderate rate. After about 1460 or so, population growth accelerated at a rapid clip. Take England as an example, which, in 1430 to 1470 had a population of around 1 million people. By 1541 the population was 2.8 million. Why did the population stabilize and increase? Well, because real wages had been increasing which increased social optimism which increased family size. Real growth – sustained real growth – is a wonderful tonic if one is planning to have a family. From 1460 to 1510, people married earlier had children earlier, and had more of them.

What were the effects of population growth? The first impact came in the form of increased prices for food. Next came wages and industrial products. “Throughout the first three-quarters of the sixteenth century, agricultural prices rose faster than non-agricultural (in Spain),” writes Earl Hamilton. This was true across Europe. After food prices rose, energy prices rose. In the early years of the period under consideration, energy prices rose slowly. After this initial period of relative quietude, energy prices spiked. Why? Europe was losing its forest and its forest provided fuel: wood. Eventually, around 1530 or so, the prices for wood and charcoal went up faster than the prices for meat and grains. It should be added: not only did energy pricing increase rapidly, but so too did the volatility of those prices.

Energy – the Ultimate Inflation Hedge
Look carefully, oil is very often a CPI leader.  An oil reversal higher points to higher – follow on – CPI.

This is the fourth key lesson to remember as we trade energy today: BUY THE DIPS. Each time energy prices calmed down, another wave of energy price increases followed, for the simple reason that, whatever the peculiar circumstances of a particular season, overall there was simply not enough energy for the populace long-term. So too today: because of a dearth of investment in oil fields there is simply not enough energy for everyone at cheap prices. So, yes, there will be quarters where energy prices are soft, sure enough, but expect new highs down the road.

Intriguingly, industrial prices were slower in their rate rises. During the period, in England, energy prices rose six-fold while prices for industrial goods rose three-fold. This, therefore, is the fifth lesson our study provides: Core inflation is a false measure of inflation. By reducing the number of things that the Fed targets in its war against inflation, it solves its problem by avoiding measuring it. Effectively, the Fed isn’t fighting inflation because it can’t. The Fed has no influence over global population trends. The Fed has no influence over energy investment. Sadly, that means the Fed has no influence over long-term global inflation trends. Everyone is looking for the Fed to cure inflation. It can only have moments of relative success. A true long-term cure for inflation is simply beyond any Central Bank’s grasp. Thus, the market focus on Fed policy is a focus on an illusion.

Around the middle of the 16th century, a new element was added to the inflationary mix: a recognition that inflation existed, that inflation was not transitory, and that inflation was sticky. Once it became widely recognized that inflation existed, the first impulse was to blame someone. However, in essence, everyone was to blame. Inflation caused consumers to spend more money, which exacerbated inflation. People hoarded goods. This in turn caused speculation in goods. This in turn caused panic buying of goods. This in turn caused the degradation of goods: shrinkflation. Just like today as soda cans are smaller and Dorito bags have less chips in them, bakers in the 16th century started selling smaller loaves of bread at higher prices. Hence our sixth lesson: shrinkflation is an inflationary reaction to an already existing inflationary environment.  Shrinkflation is symptomatic of a conscious awareness that inflation is not going away.

A consequence of inflation and of its conscious awareness in the population was that some members of society were able to adapt to the changed circumstances better than others. Of course, there were social imbalances before inflation had set in, but these social imbalances were greatly enhanced because of inflation. While wages at one point increased along with food and energy, eventually they lagged significantly. By 1570 the average wage had been cut in half, or more, compared to the early stage of inflation. Who were most at risk? Those with no capital and few skills: the underclass. Landlords fared much better, so too those with capital. Rates of interest increased in keeping or exceeding the rate of inflation. The Hapsburgs ended up paying interest rates as high as 52%, exceptionally high, but indicative. Feudal lords raised rents. There were times when rents rose faster than energy and food prices.

Wages, Gasoline LEAD CPI
Wages and gasoline are FAR above where the Fed wants them to be. No one seems to care, for now.

Overall, rents in England, for instance, rose nine-fold from 1510 to 1640 during a period in which grain prices went up four-fold and wages merely two-fold. Increases in rent caused ferment in the countryside. Kett’s Rebellion of 1549 in England wanted rents to be rolled back to where they had been 65 years prior.  Real wages, wages adjusted for inflation, declined from the late 15th century into the early 17th century. Since the upper classes were relatively better off than the lower classes, one could even argue that inflation strengthened feudalism.

Here is our seventh lesson: Long-term inflation increases social inequality, reinforces the power of the rich, and increases the hatred of them by the lower classes. This is not irrelevant to the social and political tensions we see in our own time. Dominant elites gain strength. And they don’t give it up willingly. During the period under consideration, returns to capital were much greater than returns to labor, resulting in labor’s widespread discontent with the status quo. One consequence of increased inequality was squalor: in England, the number of vagabonds and homeless increased dramatically. We see this in our own time as well. The homelessness that so many of us decry is a direct consequence of inflation. Such is the lesson of history.

Another familiar consequence to prolonged inflation came in the form of monetary imbalances. The response to inflation was the creation of more money. Silver in circulation vaulted by 10,000 tons mid-sixteenth century to north of 34,000 tons in 1660, by some estimates. Where did this lucre come from? Silver and gold from America flooded Europe. It is key to understand that inflation was well underway for quite sometime before precious metals from the New World hit European markets. Prices in England and Germany had already doubled by the time Mexican silver reached them. Another argument against precious metals causing, as opposed to aggravating, inflation, is that their effects were not evenly distributed with the distribution of the metals. More silver and gold reached Spain than anywhere else in Europe, but its inflation was less intense than in the rest of Europe. Insofar as one looks only at inflation in Spain, it was worse in the half-century before its money increased than once the treasures began unloading at the port. Much of the silver in Europe came from the Potosi mine in Mexico, which opened in 1545. This mine was responsible for almost half the silver that arrived in Europe from the Americas. It was mined by indigenous slaves. It is quite something to go through museums and look at silver plate from 1550 to 1650 and realize that all that silver passed through Indian slaves’ hands.

Gold Silver Cross
Silver has been outperforming gold for months. As the Fed arrives to the end of the hiking cycle, look for silver (SLV) to outshine gold (GLD).

Silver and gold from the New World didn’t cause inflation but exacerbated it. The desire to increase the money supply existed in the Middle Ages as well during its inflationary period. Once people see inflation rise, they want more money. It is noteworthy that there were fluctuations in coinage that made this trend zigzag.

Hence our eighth lesson is: that inflation causes an increase in the money supply and in the volatility thereof. We saw a huge surge in the money supply recently and now that surge is over. It will reappear. The fluctuations in coinage during the sixteenth and early 17th centuries track quite neatly to the fluctuations in the price of wheat, for example. One might think that New World lucre was sufficient to satisfy money demand, but that assumption would be false. Every old and closed mine in Europe was eventually reopened, and new mines were found. Obviously, in our own time, we are not there yet, but that will change. All this was not lost upon thoughtful observers of the age. This is the period in which the monetary theory of inflation was invented. The first monetarist was, unsurprisingly, Spanish. Martin de Azpilcueta wrote: “Money is worth more when and where it is scarce than when it is abundant.” A decade later, the Frenchman Jean Bodin said much the same. Nicolaus Copernicus did as well. It became commonplace across Europe soon enough. Hence, while the primary cause for inflation was population growth, one aggravating cause was the supply of money.

Naturally, and familiarly enough, fiscal imbalances ran rife. In response to ongoing inflation, from the mid-sixteenth century on, fiscal imbalances ballooned as a primary governmental response. In response to increased fiscal deficits, taxes were increased. These taxes fell disproportionately on the lower classes. Some of the nobility remained exempt from taxation, and certainly from the most onerous taxes. Since government revenues still fell behind, government borrowing increased to make up for the difference. Once we reach the early 1540s, we find that a significant portion of the government of Spain’s revenue went to pay interest on debt, and this is from the primary beneficiary of Mexican silver mining. The fiscal imbalances interacted with the rest of the reactions to inflation, of course. The various inflationary responses to inflation that only increased inflation form a complex matrix in which sometimes one, sometimes inflationary force gained temporary dominance. Falling real wages and higher rents increased inequality as the rich gained yet more power which in turn caused the powerful to raise taxes on the weak only to see government coffers still unable to keep pace with inflation, causing those governments to debase their currencies. However, there were many other cross-currents besides that example.

Thus our ninth lesson is: that inflation causes fiscal imbalances which cause more inflation.
Naturally, all this led to social conflict. It is not pure accident that the Protestant Reformation, and the Catholic Counter-Reformation, moreover, occurred in the second half of the 16th century. The Diet of Worms in 1521 may mark the start of the Protestant Reformation, but it took increasing hold by the mid-16th century.

Social Conflict on the Rise
Ultimately, much like today – social unrest became violent. As inflation increased in the latter 16th century, so too did the volatility of prices. Prices catapulted and collapsed only to catapult again. Overall the trend was higher, but the year-to-year price swings were extreme. When four consecutive harvests failed, from 1594 to 1597 inclusive, famine and sickness increased. Medicine of course was not particularly advanced. Thus there were waves of population decline during this period. Epidemics reduced England’s population by 20% during a five-year period in the 1550s and prices softened commensurately. However, once the population grew again, inflation came back with a vengeance.

As high prices put the government in debt, that debt forces the debasement of currency which puts governments under greater fiscal pressure yet again. As this cycle repeated, social instability increased. Social instability was manifested and increased by war. The steepest increases in inflation were in the 1540s and 1550s, a period of increased war expenditure. Thus our tenth lesson is that inflation exacerbates social tension, the most strident manifestation of which is war, and this social tension in turn increases inflation still more. In our own time, it is obvious governments are spending more on the Ukraine conflict and it is easy enough to imagine other conflicts around the world that would lead to still more increased military expenditure. Yet even without that, who can deny the social conflicts within our own society today?

Matters eventually came to a head. The 1590s evolved into a prolonged crisis. The last quarter of the century was a period of stagflation: rising prices and less opportunity. In the last year of Queen Elizabeth’s reign, prices rose although the economy was in depression. Indeed, across Europe, real wages for laborers and artisans fell while capital continued its advance. As the inflationary cycle reached a climax, prices became more volatile with wild swings every few years in the price for wheat, barley, and oats. Starting in 1591, the weather was wet and cold for seven years running. It was a little ice age, with Alpine glaciers growing into inhabited valleys. Starvation increased. Again, the lack of economic material resources only served to increase economic inequality. A crime wave was the result. As the price of food increased, the incidence of crime increased as well. Given the year-over-year volatility in pricing, there were years when the price of food declined and then so too crime declined only to return once food prices increased again. We note that many retailers have been complaining about inventory shrinkage – theft. This is our eleventh lesson: as food prices increase, theft increases.

Food Inflation Trends are Sticky
Transitory inflation died 24 months ago.

With shortages in food, pandemics were rife. For example, half a million people died in the Iberian Peninsula between 1597 to 1602. In fact, the late 1500s into the early 1600s was the worst pandemic period since the Black Plague of the Middle Ages. Given the food shortages, fertility rates declined. Between the mid-16th century to 1617 in Toledo, baptisms declined by 50%. In fact, this period was the only time the population of Europe had declined since the Black Death. The European economy collapsed outright between 1610 and 1620. The number of ships counted in the Baltic Sea peaked in 1600 and declined steadily for half a century thereafter. Ship counting in the Baltic Sea continues to this day and we have upped the game with the Baltic Dry Index, a shipping freight-cost index, used by economists as an economic bellwether. Tonnage in Seville harbor peaked in 1610 then crashed and continued to decline thereafter for several decades. Industrial production in Amsterdam and Rotterdam peaked in 1620 and began an inexorable decline. War continued in various guises from 1590 to 1650 with only one year (1610) being a year without war. The armies of Europe had never been larger since the Roman Empire. The German population declined 40% from 1618 to 1648. That is a worse hit than even the Black Death. Deficit spending increased. Coinage was debased. Taxes on the lower classes increased. The result? Revolution. Catalonia and Portugal suffered a revolutionary conflict in 1640. Charles I in England faced a full-scale civil war and was beheaded. In France, rebellions, dubbed the Frondes, continued from 1648 to 1654. Altogether in France, there were 264 rebellions between 1596 to 1660. Naples and Sicily suffered civil unrest in 1647. The Netherlands did the same in 1650. Sweden did the same in 1650. Switzerland in 1654. Denmark in 1660. Scotland and Ireland faced a sequence of sanguinary revolts from 1638 to 1660.

However, leaving Germany to one side, the demographic disaster in Europe overall was less than the Black Plague, in part because the economy itself was more advanced. True, the inflation rate overall was higher, but the volatility, while high, wasn’t as high as experienced in the late Middle Ages. While the average price decline in the 16th and first half of the 17th century was double that of the inflationary period of the late Medieval era, the average volatility was about half as much as in the late Middle Ages. Productivity had obviously improved, and this helped to some degree. Markets were more integrated, and this helped as well. The 14th century saw the civilization of the High Middle Ages crumble away. The period we are now examining suffered no such fate. While the first half of the seventeenth century shocked civilization, it didn’t destroy it. Therein lies our twelfth (and optimistic) lesson: given our era’s advances in integrated markets and productivity, it seems unlikely that however bad the inflationary climax will be, in and of itself it is unlikely to destroy life as we know it, barring, of course, thermonuclear conflict.

Crises do end, and by the second half of the 17th century normalcy finally returned. Grain prices fell then leveled out. Energy prices and manufactured goods traded in a price range. Rents and interest rates fell while wages rose. Inequality lessened. The population grew slowly. Productivity improved some as did production overall. Real wages in England for laborers and builders almost doubled from 1650 to 1740 as the power of labor returned. Labor was more valuable than capital. A hectare of farmland that rented for around 12.8 francs in 1670 rented for only 7.5 francs by 1701. Interest rates in England fell from 10% at the beginning of the 17th century to 6% by its end. Overall prices fluctuated in a sideways pattern from 1650 to 1735. The price stability is remarkable. Meteorological shocks still affected food prices, but these prices soon recovered their former level and stability. All of this was bad news for the wealthy, who saw returns on capital decline, rents decline and labor costs increase while prices overall were flat. During this period, gold and silver still flooded Europe. Money supply increased but not inflation.

For instance, in France, from 1683 to 1730, silver livres in circulation increased from 500 million to 1.2 billion. Yet the cost of living remained constant. Not only that, but French coinage went through a series of debasements during those years. Price stability in France and Europe occurred despite monetary expansion, not because of monetary decline. How could this happen? The answer is that population growth stalled.

Population Trends
High levels of dependency and the relative scarcity of labor may induce a shift in the methods of production from labor-based R&D back to a reliance on natural resources. The global economy is going to pass through a severe population problem over the coming century, resulting from the simultaneous peak in global population levels with near-zero population growth (Roser et al. 2013, Giovanni and Tena Junguito 2023). This conflation of world firsts is seen above, which shows that global population is projected to reach a peak of approximately 11 billion individuals in the year 2100, at the same time that population growth is forecast to be moving asymptotically to zero. With Pedro Naso and Timothy Swanson.

Population growth did not accelerate until after 1730. When we look at Japan in the modern era, it has had low inflation and low to negative population growth. The population of the world overall, however, continues to grow in our age, and inflation has only briefly, if ever, run back to zero, where it should be. From 1650 to 1730, commerce was healthy, violent crime fell, and political structures stabilized. This period of low inflation and economic prosperity corresponds with the Enlightenment. This period developed two contrasting economic theories: mercantilism and laissez-faire. Just as the High Middle Ages went through an inflationary crisis and gave way to the glories of the Renaissance, the inflationary crisis of the late Renaissance gave way to the glories of the Enlightenment.

(The above is in part an encapsulation of work complied by David Fischer. We urge a read of his tome “The Great Wave.” Our twelve lessons inferred from the encapsulation we have done are made by the Bear Traps staff and we do not purport them to be explicitly spelled out in the referenced text as we have done in this paper.)




Pick Your Poison — Default or Financial Repression?

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Author Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

The Mind-Blowing Hole

After dinner drinks, a friend said these blood-curdling words;
“The US government has already spent $5.3 TRILLION this year. We are on track for the 4th consecutive year with $6 trillion or more in government spending. Since 2020, the US government has spent a jaw-dropping $25 TRILLION. To put this in perspective, the market cap of the S&P 500 is $37 trillion. Spending since 2020 is equivalent to 68% of the entire S&P 500 market cap.”

Walking away from ultra-low rates and Quantitative Easing isn’t so easy given the massive public debts from the governments Central Banks work for. It is universally agreed that debt levels are too high. The question is: How can those debt levels be reduced?

This problem has become particularly acute after the pandemic lockdowns. At 2020-year end, the US had a debt to GDP of 127% which looks conservative next to Japan’s 256% but certainly more aggressive than the EU’s 100%. Given various fiscal measures, these ratios don’t look to be improving any time soon. In this environment, higher interest rates threaten financial stability. High government debt limits Fed options. Volcker was aggressive in part because debt levels were relatively muted compared to today. Debt to GDP in 1979 was a mere 34%.  Volcker raised rates sharply and increased reserve requirements for banks, causing a recession stabilizing the dollar, and reducing inflation. It should be noted that deregulation led the way out of recession. Since then, various crises have been met with aggressive lowering of rates, as we all know. The consensus view among Central Banks has been that they cannot identify bubbles, but they can fix markets once those bubbles pop.


One way to reduce debt is through austerity. As an example, after WWI Italy was burdened with a debt to GDP ratio of 180%. In response, government spending was severely cut back and consumption on expenditures increased. As a result of continuous surpluses, the Italian lira stabilized as debt to GDP declined to 76%. Another example was Germany after unification. Public spending fell, future social benefits were cut. Growth declined but the current account balance went into surplus. It took nearly 20 years, but growth came back. As the economy finally grew, so did tax revenues. There followed investment in Southern and Eastern Europe. Another example was the EU after the Great Financial Crisis. Since EU membership precluded countries from individually depreciating their currencies, government expenditures were reduced. Nominal wages declined in many countries. However, debt to GDP levels didn’t improve, so the ECB loosened credit conditions. For Germany, this caused a real estate and export boom. As a result, debt to GDP levels declined.


Another way to improve debt to GDP ratios is through hidden debt reduction i.e. inflation. It is an old truism that inflation is a tax, and that raising taxes outright is considered an unpalatable risk politically. Higher inflation does reduce the real value of tax revenues. Financial repression means to keep the return to savers below the inflation rate. This is what the US and the UK did after WWII. The UK public debt to GDP was 250% after WWII. In the US, it was 120%. Not only were low interest rates pursued but interest on savings were capped. Various regulations were put in place the effect of which was to direct credit to government. The forced low-interest rate on government bonds reduced debt in two ways. With low-interest rates, compounding was held at least somewhat in check. Additionally, low to negative interest rates devalued the debt that already existed. However, when these techniques were used in emerging economies to protect non-competitive industries, debt to GDP ratios did not improve. Recent history in the US, UK and EU suggests that financial repression has been used with increasing similarity to emerging economies.


Another example of hidden debt reduction is hyperinflation as in Germany after WWI. While a slow-but-steady financial repression gradually transfers wealth from creditors to debtors, hyperinflation does the same thing but very quickly. Workers respond by demanding higher wages, and the increase in money demand is met with an increase in money supply. Germany’s hyperinflation of 1923 was caused by excessive money growth to fund the prior war’s expenses. The transfer of gold from Germany to its enemies didn’t help matters. To offset the negative economic and monetary consequences of the Treaty of Versailles, the Reichsbank extended credit to the German government. Eventually, the German government stopped paying reparations in 1923 causing France and Belgium to occupy Germany’s industrial heartland. That didn’t help matters. The German economy collapsed. The government asked workers to go on strike and compensated them with their normal wages by printing money. Hyperinflation ensued.


Argentina, a country people like lending to at par in order to lose money in the most predictable way possible, followed a not dissimilar path in the 1970s. The twist was that much of the capital used to finance its inflation came from overseas and was denominated in a foreign currency: the US dollar. Local debt is not indexed to inflation, and so is devalued through inflation. The central bank would accumulated government bonds, financed by monetary expansion, which fuels inflation. As inflation rose, so too did nominal GDP thereby reducing the debt to GDP ratio. However, when most of your debt is in USD and the dollar appreciates against the peso, default ensues. Eventually, by 2020 over three-quarters of Argentina’s debt was in foreign denominations, roughly $250 billion of it. Argentina has defaulted five times since the 1980s. The government usually expands the money supply in order to buy bonds: financial repression. This causes inflation and lowers the value of public debt. Furthermore, by lowering the currency exchange rate, prices for imported goods increase. Eventually, the market demanded bonds indexed to inflation if they were in local currency. Another Argentinian government tactic was to exchange its foreign reserve holdings with non-transferable dollar-denominated Argentinian Government obligations. However, instead of paying them off at maturity, the government just rolled it over into new debt. In other words, one method of financial repression was theft. The stolen lucre was spent and that exacerbated inflation. Interest rates were held artificially low, and defaults were delayed a year or two. Capital controls and monetary sterilization techniques are employed as well, with inflationary consequences. Ultimately, however, the easiest way to lower debt to GDP is to default, restructure/exchange liabilities for lower nominal amounts, and thus lower debt. Argentina defaults on a regular basis because it is basic to its debt management practice. Ultimately, then, hidden debt reduction becomes unveiled debt reduction.


Besides austerity and severe inflation, there is a third route to improving debt to GDP ratios: extreme economic and currency reform. The classic example was Germany after WWII. No one worked for money, it was worthless. Barter was common. Since debt to GDP was almost 250% of GDP, the fork in the road to lower debt to GDP and thus to bring value to money and a return of money exchange purchase transactions couldn’t be the hyperinflation of the Weimar Republic, which, after all, was an experience that all Germans remembered. Hence currency reform was implemented. Excess liquidity was drained by a reduction in the money supply. Because Germany was occupied militarily, that perforce led to a change in the country’s economic structure. A currency reform combined with a reduction in money is effectively at least a partial default. Once a new currency is introduced at some ratio vs the old currency, the entire economy is changed. To make the velocity of money return to normal, the supply of money had to be reduced by 90%. The architects of reform had all liabilities to the former government and the Nazi party annulled for political reasons. Deutsche Mark debts were reduced by 90%. Those who benefited from the currency and debt reform were taxed at 100%, payable in installments. The remaining assets were taxed at 50%, paid in installments. This redistributed wealth. A liberal market economy was introduced, replacing the planned economy. The path forward resulted in Germany becoming a major global economic powerhouse.


Going forward, one may imagine a fourth way of reducing debt to GDP via inflation would be a digital currency, which might be particularly appealing for the ECB since there is no common fisc backing the currency. Euro money supply would be increased by the ECB purchasing ECB bonds. The money supply would be nominally guided by the expected growth of the Euro area. Money supply would be increased by government purchases of debt, not by loan origination from the banks. The banks themselves would be reduced to interest rate arbitrageurs, effectively. The system would take bond out of the system since they would be owned by the ECB. The ECB could double its inventory of bonds, to EUR 6 trillion and could even suspend payments to its own inventory and/or coupons could be changed to zero. Any kind of large-scale reform, where the more conservative northern countries would take a hit for the benefit for the heavily indebted southern countries in exchange for promises that the southern countries would behave going forward. In other words: digitization of the Euro currency could be accompanied by increased influence of the ECB, decreased influence of the traditional banking system, and realignment of debt levels punishing the well-behaved in exchange for a verbal promise from the perpetually profligate. It would fail ultimately, of course, but not immediately. Bottom line: a EUR digital currency will be more camouflage than substance.


From the above one may easily conclude that the long period of super low rates in developed economies have created excesses and fragilities that cannot rebalance debt to GDP without measures that would be felt as catastrophic to its citizens in its immediate effects. Central banks are driven by events. Central banks don’t pre-empt events. Therefore, we find it hard to believe that financial repression will be avoided until a crisis leaves them no choice. Between now and then there is one clear path: inflation.


“The Federal Reserve may not be that bright, but they are not so stupid as to replicate the Weimar Republic’s hyperinflationary monetary policy. They want to slow-walk financial repression, keeping government interest expense below the rate of inflation by a modest yet significant degree which means keeping what savers can earn lending to the US government below the rate of inflation. This isn’t being done as in some emerging economies as part of a plan to protect inefficient industries. It is being done by the largest economy and greatest military power the world has ever seen, by the country that has the dominant and deepest financial markets, that can be chipped away a bit but not rejected out of hand. You can’t pretend the USA doesn’t exist. What the US does ends up being copied by the rest of the planet. The US government’s financial repression is a back door way of lowering government debt thereby improving the debt-to-GDP ratio to a sustainable level. Politicians are loath to outright raise taxes on the middle class, so they tax everybody via inflation. The Fed doesn’t want inflation to go away. It wants inflation to stay above the US government’s average interest rate expense. The secondary, but vital concern, is to do that without causing hyperinflation. Hence the slow walk. It’s a 15-year program, not a 15-month program. It is no accident the Fed pauses with Fed Funds matching the inflation rate. The Fed spends more time looking at Treasury’s blended average interest rate vs the inflation rate than at the inflation rate itself in isolation.”





Inflation, looking back for forward insights

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email – Thank you.

Author Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Lessons Looking Back and Forward

We have all heard the phrase — “Those Who Do Not Learn History Are Doomed To Repeat It.” As we place our lens on modern inflation, let us take a look back for clues that may help us look down the road ahead.

Global Population Trends
There is a price to pay for all that cheap underwear at Walmart. Think of the last 40 years, we have decimated the U.S. Rustbelt. The good news is millions of people have been pulled out of poverty globally. From 1998 to 2021, the U.S. lost more than 5 million manufacturing jobs thanks to the growing trade deficit in manufactured goods with China, Japan, Mexico, the European Union, and other countries. – EPI Data. The bad news? The per capita consumption of commodities is exploding globally. There are 1 billion human beings in India that do NOT have air conditioning. Another 1 billion in China do NOT own an automobile.  We are suppressing the supply (hello ESG) of many key commodities all around the planet, while at the same time roiding up future demand.  There is a price to pay for exporting higher-paying jobs out of the United States, and the consequences are fast approaching. 

Economic cycles were much slower in the Middle Ages, given the transmission mechanisms of the time. However, broadly, many of the factors that affected prices in Medieval times will be familiar to those who have studied the most recent inflationary bout. Generically, prices increased on average by no more than half of one percent from 1225 to 1345. The main and initial cause of this price increase was an increasing population: a medieval baby boom. Price increases were not uniform, however. Inflation was especially strong in four areas: energy, food, shelter, and raw materials. Of the four, initially, the most striking was the cost of energy.

From 1261 to 1320, English charcoal and firewood rose quite rapidly. Why? Because England, like the rest of Europe, cut down its forests, not just for fuel, but to build cathedrals, while using much stone, and use much lumber as well. Timber and charcoal began to be traded internationally. It was at this time that the coal mines of England, Belgium, and France were developed. Air pollution in London in the 13th century was awful. Nor were forests replanted. Thus, inflation was caused by an increase in demand. The population increased causing trade to increase. The increase in commerce caused an increase in industrial development. Expanding markets increased the velocity of money. As monetary inflation was added to demand inflation, prices rose inexorably.

Eventually, consumers got used to the idea that prices always went up. This led to governments expanding the money supply. In the thirteenth century, that meant expanding the silver supply. England created 200,000 silver coins from 1210 to 1218. In the 1240s, this increased to 500,000 silver coins for the decade. For the decade of the 1280s, silver coin production totaled 1,000,000. The Italian city-states began to mint gold coins for the first time since the fall of Rome. In southern Europe, peppercorns began to be used as a form of currency. The Florentines and then the Genovese invented credit instruments: contracts of exchange and bank transfers.

With the notable exception of Florence (currency = florins) and the Serene Republic of Venice (currency = ducats), currencies were systematically debased. The result was that Venetian and Florentine money was the most sought-after in Europe for international trade.

As a result of the above drivers, inflation became self-reinforcing, “sticky.” Higher prices created a demand for more money. The demand for money was met with an increase in its supply, but as international trade continued to expand, so too did the velocity of money, fueling inflation still more.

Wages are NOT Coming Down
U.S. government spending is UP 10% year over year. We are looking at a near $2T deficit. There are 70,000,000 Americans receiving an 8% COLA (cost of living adjustment). What many people fail to understand, are the colossal social and political drivers of inflation.  Once inflation gets above 6%, the follow-on effects linger on for years.  It´s like spilling a can of Coca-Cola in the backseat of the car. It gets under the seat cushions, it´s in the seams and is extremely hard to kill. Especially with government spending ripping higher which after all was a reaction to higher inflation in the first place!

As inflation continued, by the mid-13th century wages began to lag. Real wages fell slowly at first, then with increased rapidity. By 1320, real wages were 25% to 40% lower than they had been 100 years earlier. Meanwhile, rents and interest had risen. Eventually, rents and land values increased more than energy. Interest rates in the Italian city-states rose from 12% a year in 1230 to 20% towards the end of the century. Thus, the cost of capital and shelter increased as real wages fell. Not everyone was harmed.

Core Inflation is Double the Fed´s Target
The “power of labor” and rents are keeping core inflation high – more than double the Fed´s target. Labor strikes are everywhere, inflation is empowering organized labor. Some 20,000 railway workers will strike on July 20, 22, and 29 as part of the ongoing national rail dispute, the RMT union announced Friday.  A strike from 340,000 UPS workers could cause major disruptions across the U.S., and would be the country’s biggest work stoppage since a steelworkers strike in 1959, CBS News reported.

What happened was merchants would lend money out in debased currency but made sure laws were enacted so that they would only get paid back in Venetian ducats and/or Florentine florins. The arbitrage between debased currencies and currencies that held their worth through a constant metal content made some merchant families enormously wealthy. Thus, there was a growing economic inequality between the merchant class and the working-class peasantry. The key is, the growing gap between returns on capital and the returns on labor stimulated economic inequality.

Another effect of constant inflation was an increased imbalance between governments’ public income and expenditures. Basically, governments borrowed more money the longer inflation lasted. Public deficits increased dramatically. This weakened government power, and, ultimately, Feudalism.

As inflation hummed along, it became more volatile. Price swings higher and lower became more extreme. Production and productivity fell, both for land and for labor, reducing much of the populace to subsistence living. This meant greater sensitivity to poor harvests. In those days, a harvest reduction of only 10% could cause severe problems for the lower 50% of the population. A harvest 20% below normal caused widespread starvation.

Governments would come to the breaking point and face up to inflation via “recoinage” or a new setting of the metal content, and, in fact, such recoinages did last for certain lengths of time. Debasement drove prices up. Recoinage drove prices down. Every single time a recoinage happened, the price of oxen fell, for example.

As one might imagine, exchange rates in the 14th century destabilized. Especially when banking families collapsed. In the late 13th century, the large Italian banks extended too much credit to too few monarchs: extreme leverage plus concentration risk. Of course, such loans (if the payments were on time) made the banking families enormously wealthy. However, a banking panic cropped up in 1298. Siena’s most important bank was the Gran Tavola of the Buonsignori. This bank lent to all the governments, all the great merchant families, and to the pope. Its agents were in every major trading center of Europe. It managed to hold on even as its loan portfolio began to sour, but by 1307, the bank collapsed, taking many businesses downs along with it, and crippling the Sienese economy for many years.

The failure of the Gran Tavola of the Buonsignori was the first bank failure, but not the last. In the early 14th century, various Florentine banks fell: the Mozzi in 1302, the Franzesi in 1307, the Pulci and Rimbertini in 1309, the Frescobaldi in 1312, and the Scali in 1326. Six more banks failed in 1342. Between 1343 and 1346 the three huge banks of the Peruzzi, Acciaiuoli, and Bardi imploded. It would take many years for Tuscany to recover.

Another response to rising inflation was the hoarding of precious metals. Inflation demanded an increase in stocks of inventory of silver and gold. This in turn fueled inflation. This pushed many governments to the brink of bankruptcy. As noted above, the decline in real wages made subsistence razor-thin for the masses as well. Poverty and hunger spread throughout the West. Crime increased, mainly the theft of food but also of anything that could easily be exchanged for food. The worst famine in European history occurred from 1315 to 1317, right in the middle of the rolling bank crisis. The population decreased by 10% because of that famine. After famine came epidemics. That in turn led to more crime.

Wars happen in clusters. After 1294, there was a notable increase in military conflict. This strained government purses when they could least afford it. Domestic riots became more common as well.

Then the Black Death struck. The population of Europe in the early 14th century was approximately 80 million. After the Black Death, it was about 60 million. That makes it the worst population decline in European history. The effects of the Black Death varied over time. When it first appeared, food prices went through the roof. However, as the population collapsed, food prices collapsed as well. However, as the artisan class was all but wiped out, the cost of finished goods went through the roof.  Massacres of Jews and foreigners became commonplace. Eventually, the Black Death spelled the end of Medieval civilization.

The Hundred Years’ War between England and France (which had many multi-year hiatuses) left huge swaths of the countryside in complete anarchy. Mercenaries, released from their duties for a year or more, preyed upon the peasantry of the countryside. No one could stop them. Some gangs were as large as a brigade today. Obviously, this curtailed trade, not only agricultural production. Many farms were simply abandoned. This hurt population growth as well. Even after the Black Death subsided, the low point of the European population wasn’t hit until 1401 to 1402.

During the late 1300s, money in circulation declined. The amount of gold and silver in Europe fell. Much of it was hoarded only to be discovered today. Since Europe couldn’t produce enough food and goods, the balance of trade with Asia gradually depleted the money stock in Europe. The decline in money created further economic depression. Land values fell proportionally to the population decline. Grain prices went down, but a shortage of labor made wages go up. The cost of unskilled labor in some towns increased 50% from 1350 to 1400. In real terms, wages increased dramatically throughout Europe.

The result? A new society. As a result of increased real wages, the serfs were emancipated, and Feudalism ended. The Feudal economy had lasted over 700 years. Many of its social structures remained (class consciousness, what have you) but as an economic system, it was finished. As the power of labor increased, the labor class gained political power and peasant rebellions became more frequent and more intense: the Jacquerie in France (1358), the Ciompi in Florence (1378), the Peasant Rebellion in England (1381). The lower classes rose against the upper classes. By the time we reach the reign of Queen Elizabeth in the mid-sixteenth century, rural serfdom no longer existed in England.

Early in the 15th century, prices still fluctuated but began to be more regular and less intense. Commodity prices declined and then stabilized. Real wage gains were permanent. The result? The Renaissance. The fall of Byzantium created a one-time windfall of cultural knowledge for Europe. And now there was steady, healthy demand for it.

Our take: there are parallels between Medieval inflation and contemporary inflation. Surely, the increase in the global population is one factor in long-range multi-generational inflation. Another parallel is the increased consumption of energy combined with a lack of investment in replacement energy. More similarities may be marked in the long-range increase in the supply of money and an increased tendency to believe in higher long-term inflation. Fiat currencies are in a debasement cycle. The collapse in real wages and the concomitant increase in inequality are also familiar. Increased FX volatility, bank failures, and Central Banks hoarding precious metals also have a familiar ring. The increase in the power of labor after a global pandemic is almost eerie in its parallels.  What is most surprising, perhaps, is how even a low rate of inflation (well below the 2% target of the Federal Reserve) can over a century lead to disaster, how even a low rate of inflation leads to yet higher rates of inflation, fluctuations aside. History repeats.

These days, it is a stretch if people discuss inflation from half a century ago, so we thought it might be helpful to look at Medieval inflation. Above is an encapsulation of work complied with by David Fischer. We urge a read of his tome “The Great Wave.” However, for those who lack the time, here above is a summary.






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