Cumberland Advisors Market Commentary – Libra and Other Cryptocurrencies

Congressional hearings this past week were the first of what are likely to be a number of investigations into Facebook’s proposed Libra cryptocurrency and associated Calibra wallet.

Cumberland Advisors Market Commentary - Libra & Other Cryptocurrencies

The initial reactions of legislators at the hearings ranged from a desire to support and encourage financial innovation to downright skepticism and hostility. Some of the questioners asked very pointed and perceptive questions, which Facebook’s David Marcus had difficulty addressing. One of the most telling revelations was that it was represented that Swiss regulatory authorities would provide oversight of Libra and Calibra, a spokesman for the principal Swiss agency that oversees data security said that it had not yet been contacted by Facebook representatives. That revelation was critical when it came to some congressional members’ willingness to accept Mr. Marcus’s representations as being credible.

Facebook has made a lot of claims of the potential benefits of the Libra innovation, but some were viewed by Congress as either questionable or highly optimistic. For example, Facebook claims that Libra and Calibra could potentially enable the 1.7 billion or so unbanked customers to have access to a payments system, but it isn’t clear how that might come about. It was pointed out in the hearings that about half the number of the world’s unbanked households are in only seven countries (Bangladesh, China, India, Indonesia, Mexico, Nigeria, and Pakistan).[1] None of these countries are represented at this time in the consortium behind Libra, nor are any of those countries’ currencies included in the reserve fund designed to back the value of Libra. China, which is home to about 13% of the world’s unbanked residents, has even prohibited the use of cryptocurrencies by its citizens.

As was pointed out at the hearing on Wednesday, July 17, one of the reasons that people are unbanked is that they have little or no cash. But to use Libra, a person must have a smartphone and be able to buy Libra with cash. This means that the underbanked in the above six countries and elsewhere will presumably have to buy Libra in using their own domestic currencies, whose value may be uncertain. Moreover, it isn’t clear that local businesses or residents would accept Libra in payment for goods or services – unbanked people are not engaged in international trade, and counting on remittances to generate volume is optimistic. In fact there is a startup and scale issue on a country by country basis  that hasn’t yet been addressed by Libra advocates. To this point, the Libra white paper is silent on how currency conversions would take place into and then out of Libra when the currency involved is not one in the reserve, or how the exchange rates would be determined.

Mr. Marcus stated that Libra will be backed by a basket of financial assets, predominantly denominated in dollars, euros, and Japanese yen, thus ensuring its stability; but there was no discussion of how funds paid into the Libra system that are not denominated in the reserve currencies will be handled and/or valued. Will redemptions take place at the rate initially paid or at the current market rate at the time of redemption? If the former, then users in countries with high inflation will quickly realize that they have experienced significant losses in real value and will back away.

As part of the House hearings, there was an excellent follow-up panel of experts – mainly academic lawyers – who raised a number of interesting issues concerning the Libra/Calibra proposal. First, it was argued that the reserve backup structure was subject to potential runs on the reserve assets that could threaten the fund’s stability and ability to convert Libra back into local currencies. Second, because the assets constituting the reserves were either government-guaranteed or federally insured, the Libra reserve was essentially free-riding on government guarantees should the stability of the reserve’s assets be threatened. Third, it was pointed out that the reserve was essentially an investment vehicle generating returns and profits that would be paid to initial investors in the Libra investment tokens, which are essentially securities. The investment vehicle would be a closed and centrally controlled vehicle owned by a group of large corporations and private entities. Fourth, because of the international nature of the proposed Libra structure, no one regulatory body could determine or regulate the rules of operation when it came to knowledge of customers, data privacy, or prudential operators. Furthermore, since other entities and exchanges could be layered on top of the Libra structure, the ability to monitor how those entities might impact customers, data privacy, or system vulnerabilities to hacking and cybersecurity risks could be compromised. In short, the systemic issues raised were analogous to the problems that the government faced when money-market mutual funds broke the buck during the Great Recession and the Federal Reserve intervened to provide emergency liquidity. Finally, at the hearings it was noted that the terms and conditions of the Libra operations are subject to change at any time.

One of the experts who testified, Meltem Demirors, went so far as to argue that Libra was not really a cryptocurrency at all, for several reasons. She noted that it was a closed and centralized system, not an open and decentralized system like Bitcoin, as one example. Libra was designed to be collateralized, unlike other cryptocurrencies that are uncollateralized assets. Investors in the Libra structure receive investment returns, unlike holders of other cryptocurrencies, which offer no such returns. The Libra system also has custodial risk, unlike Bitcoin, for example. Her criticisms, along with those of the other experts who were on the House panel, deserve careful consideration.

Another focus of the hearings concerned where US regulation and oversight would fit in. Since Libra and Calibra would be operated out of cryptocurrency-friendly Switzerland, it isn’t clear how US regulations would apply or how oversight would take place. The assertion (or hope) was that the business and wallets constructed upon Libra would be regulated in the countries in which they were domiciled, but that is just conjecture. The hearings clearly raised many issues and offered few answers.

For those who want to learn more about cryptocurrencies, how they have worked or not worked so far, how they have facilitated criminal activity, and where the key systemic risks are located, we highly recommend the recent statement put out by the Financial Economist Roundtable (FER), a group of nationally and internationally known finance professors and economists.[2] The FER met and considered the issues surrounding cryptocurrencies last year and published their findings, entitled “Crypto Assets Require Better Regulation,” and their report was published in the Financial Analyst Journal and can be accessed online.[3]

FER make several key points, some of which are summarized below, but we recommend the full report (only six pages), which contains a useful summary of the experience with cryptocurrencies to date and offers some good references for those who might want to dig deeper. Here are some of the key points in the report:

  1. While there may be some potential benefits from cryptocurrencies, and more specifically from the blockchain technology, there are significant risks and costs including use in illegal activities, the illusion of anonymity (the Libra/Calibra model is clearly not anonymous), vulnerability to hacking and theft, and price manipulation.
  2. Since cryptocurrency models are designed to work across national borders, no one regulator or set of national rules and regulations for privacy and consumer protections can work. The significance of this point seems to have been lost in the House and Senate hearings.
  3. All cryptocurrencies ultimately need exchanges to work efficiently. To date, exchanges are where the key cryptocurrency vulnerabilities have existed and where most of the hacking, fraud and losses have taken place. Again, the challenge requires an international solution, not merely individual-country regulation.
  4. Because of the risks, some countries, such as China, have actually banned cryptocurrencies.

FER made several policy recommendations designed to address some of the key concerns but at the same time to allow the experiment to continue.

  1. In the US, uncertainty exists as to whether cryptocurrencies are securities or commodities, what the tax status of returns earned in cryptocurrencies is, and these issues need to be addressed. The uncertain treatment of cryptocurrencies was highlighted in the hearings as one of the reasons Facebook chose to operate Libra out of Switzerland.
  2. The exchanges facilitating the conversion between cryptocurrencies and fiat currencies should employ cutting-edge security protections and should be subject to minimum capital requirements.
  3. Policies should ensure that crypto asset exchanges provide regulator tax reports to regulators and clients that describe all trading activity, like the reports required of US brokers and money market funds via IRS form 1099-B. Such reports would help law enforcement and discourage money laundering.

There is a lot to digest as the world explores the potential of blockchain technologies, and it is appropriate that the approach that Chairman Powell suggested during his testimony on monetary policy that Congress should pursue a cautious deliberation and not a sprint to implementation.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] https://globalfindex.worldbank.org/sites/globalfindex/files/chapters/2017%20Findex%20full%20report_chapter2.pdf
[2] Dr. Eisenbeis is a member of the FER and participated in its deliberations on cryptocurrencies.

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Cumberland Advisors Market Commentary – Clams Or Gold Responses

We received several comments from readers concerning some of the key points in our recent commentary “Clams or Gold.[1] Below is an abbreviated version of the questions, to which responses are then supplied.

Cumberland Advisors Market Commentary - Clams or Gold

Comment: You may have seriously misled readers because both the purity of the official gold bullion and measurement of ounces have remained constant, or at least they have been for the period of your nineteen-year study. As both the quantity and quality of gold have remained constant over these nineteen years, it is not that gold has inflated by nine percent, but those pesky fiat currencies, i.e. the USD in this case, have lost value by nine percent per year.

Reply: The issue here is not the measurement, quality, or purity of gold. The evidence suggests that other forces besides the value of the dollar have affected the price of gold more over time. Data show that the dollar has not inflated to the same degree that the price of gold has changed. Moreover, since we are looking at only the dollar price of gold, the movement in the price can’t be due to fiat currency value changes. Gold is scarce and people want it. (Note that 52% of all gold mined is used for jewelry.) Gold is priced in a world market, but we are not looking at the price of gold in other currencies, just in dollars. So the main point is that the price of gold is and has been more unstable than the value of the dollar. More detail to illustrate this point is contained below.

Comment: Consider that the cost of postage has increased by 9.2 percent over a 44-year period. Housing, oil, land, etc. also cost more. These are generally more difficult to quantify, but the energy in a barrel of oil today, i.e. BTUs, is probably the same as say in 1970 when oil was about $2 per barrel; now it is $60. Have oil, gold, or land, postage, etc. become unstable or are fiat currencies unstable? Perhaps I misunderstood the main point in the article, but my 10,000 fiat dollars that bought a brand-new car in 1989 will not even come close to buying a new car today. It is the fiat currency that has lost value, not the car, gold, land, haircut, etc.

Reply: What we need to look at here is the nominal value of certain goods compared to their real value and adjust for the fact that not only have prices changed over time but also our incomes have changed as has the quality of the goods we consume. In the case of oil, the main demand in the US is for gasoline, which cost about 36 cents per gallon in 1970, as compared with a national average price today of about $2.80. But clearly we cannot compare the nominal price of a gallon of gas in 1970 with the nominal price today, when we know that supplies (and incomes) then were not nearly what they are today. We all know about OPEC and how it has artificially manipulated oil prices over time. The point is that oil is a commodity, and both its real and nominal prices have changed due to shifts in supply and demand conditions. Oil’s nominal price has also been influenced by both politics and inflation (the main inflationary period in the US being in the 1970s).

The following chart shows the inflation-adjusted history of gasoline prices versus the nominal price in 2015 terms. You will notice that the real price of gasoline hit a low in 1998. Interestingly, in the 1930s, gas prices in inflation-adjusted terms were not much different from what they are now; but note that movement in inflation-adjusted prices doesn’t always mirror the upward movement in nominal prices that began in the ’70s.

Source: https://inflationdata.com/articles/inflation-adjusted-prices/inflation-adjusted-gasoline-prices/

On top of variations in barrel prices, US gasoline prices have been significantly impacted over time by the imposition of both state and federal taxes, which are also implicitly reflected in the above chart. The federal tax on gasoline has been flat since 1993 at 18.3 cents per gallon, but state and local gasoline taxes have increased steadily. (Pennsylvania now has the highest in the country at an average of 77.10 cents per gallon. The lowest is Alaska, with an average tax of 32.74 cents per gallon.[2])

One last point is that the demand for gasoline is a derived demand, in that we don’t want to keep gasoline in our garage; we demand it for travel. Therefore, we need to consider what the cost per mile is when we think about gasoline prices. We know that fuel economy has increased significantly, putting downward pressure on our travel costs. The average car in 1970 got 13.5 miles per gallon, whereas today the average is 23.6 miles per gallon. So we are getting much more work done with a barrel of oil today than we did in 1970.

Let us consider a different example by posing the question, what would a quality TV cost you today and what would it have cost you in 1954 in today’s dollars? In 2017 a 55-inch LG TV had a list price of $2300, or a price per square inch of $1.78. In 1954, the best TV you could get was a 21-inch Westinghouse for $495, which in today’s dollars is $11,875, or a price per square inch of $110.20. Put another way, if you were to use 1954 dollars to buy today’s LG TV, it would be substantially cheaper than the 21-inch TV. The Westinghouse cost $495, while today’s LG TV would cost $241. [3] Clearly there would be no demand for that Westinghouse TV today, and there are both quality and size differences that make true comparisons difficult. But the point is that goods change, quality increases, and real costs can decline. We could clearly pull out similar comparisons of today’s cars versus yesterdays.

This makes the gold comparison interesting because there are no quality issues associated with gold. As a reader pointed out, a bar produced today is virtually indistinguishable from one produced in 1920. But as I argued above, gold’s price has been much more variable and has increased much more than our rate of inflation. The chart below shows the nominal and inflation-adjusted price of gold in 2018 dollars.[4] The chart demonstrates that the real price of gold, when we net out the influence of inflation, is not only volatile but also that volatility is not due to variations in fiat currencies, including the US dollar. Note too that since the financial crisis there has been very little difference between the nominal and inflation-adjusted prices, suggesting that something besides inflation is driving the price of gold.

Comment: Economists should start talking about “Net Worth,” not GDP, and how much nations’ and individuals’ “Net Worth” are changing. The reason this world is in such an economic mess is that we only look at GDP, the credit side of the ledger.

Reply: GDP is not a nominal measure but a real measure of our economy’s output. As such it is a very relevant measure of what is being produced and can be compared over time to assess real growth, productivity, and how well the economy is doing. Moreover, it focuses on domestic production and not total production, which is captured in gross national product, GNP. If the main criterion for assessing our economy is how people’s net worth is increasing, then that is a whole different issue. The difference is wealth versus output. One is a stock, and the other is a flow. I might also add that wealth measures don’t help us understand employment or what segments are contributing to growth and employment.

Comment: I also question your argument about the unsustainability of gold mining. The price of gold can be inflated to match GDP, Net Worth, etc. A constant quantity of gold could also be inflated to mirror the world aggregate GDP, Net Worth, etc.

Reply: The statement about the unsustainability of gold mining is related to available information about the real current mining and resource costs involved in extracting an increasingly scarce commodity versus what miners can sell the gold for. The comment about sustainability reflects the calculation that the real costs of extraction will exceed the real value of the gold mined after adjusting for price changes.



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Cumberland Advisors Market Commentary – Clams or Gold

Johnny Hart, the creator of the comic strip BC, created an economy in which clams served as currency. Clams were plentiful, so no one ran out of currency, except that an occasional clam had cartoon legs and opted for a different career. A currency in the form of a good is of course nothing new in the history of world economies, but one good – gold – seems to have legs that have endured the test of time, or so we are led to believe. The argument is that a gold-backed currency provides a stable store of value and discipline when compared to fiat currencies.

Cumberland Advisors' Bob Eisenbeis

Such a currency requires a government standing ready to convert the currency into gold at a fixed price – the government cannot increase the supply of money without having enough gold to meet its redemption obligations. A similar argument lies behind cryptocurrencies like Bitcoin, whose production, like that of gold, is dependent upon mining – in the case of Bitcoin through the use of computers to solve a mathematical problem. In both cases, real resources, combined with a limit on the outstanding quantity of those resources, natural or otherwise, are needed to increase the amount of gold or Bitcoins outstanding. They do not depend on reliance upon governments to responsibly manage the supply of fiat money.

The stability arguments for such arrangements, however, are not borne out by history, especially when we look at the events surrounding the Great Depression, where adherence to the gold standard led to a collapse of the US money supply and a worldwide economic slump. Because of Europe’s need to finance World War I, it incurred substantial deficits to the US in purchasing war-related goods. Gold flowed into the US; and to offset the increase in the money supply that the inflows implied, the Federal Reserve sold bonds in an attempt to sterilize the inflationary pressures. When the Great Depression hit, the inflows of gold required the Fed to contract the money supply instead of expanding it to stimulate the economy. Friedman and Schwartz claim that the money supply declined by one-third, exacerbating the economic decline.

As another example, the price of gold at the end of 2000 was $272.65 per oz., as compared to $1392.35 as of July 9, 2019, which represents an implied compound rate of inflation of about 9% per year, as compared with the average change in the CPI of 2.1% per year over that period. At a rate of increase of 9% per year, it would take only about eight years for the price level to double. Hardly an endorsement for the stability of gold as a benchmark to which to tie our currency.

While some push the benefits of the gold standard, it may be worthwhile to take a look at some key questions before we opt to potentially turn over a key component of our monetary base to outsiders. Since a return to a gold standard would tend to benefit those who have the gold, it is fair to ask who owns the existing gold stock, where known deposits of gold are yet in the ground, who stands to gain the most from mining their existing stocks, and how long mining might continue until the known stocks are exhausted.
In terms of ownership of the existing gold stock, EU governments and central banks are the largest holders of gold, with about 9,817 metric tons, worth about $445 billion at current prices, an amount that represents about 32% of all government and central bank holdings of gold. The US is second with 8,122 metric tons, worth about $369 billion, which is about 26% of the world total. Interestingly, the IMF is in third place with 2,814 metric tons, worth about $128 billion, or 9% of the world total. China and Russia follow, each holding about 6% of the total.

But world holdings of gold are only part of the picture. Going forward, it is important to know who the key producers are and where the known reserves are located. The biggest mines in order of size are in Indonesia (Grasberg mine), South Africa (South Deep mine), Papua New Guinea (Lihir mine), Russia (Olimpiada mine), Dominican Republic (Pueblo Viejo mine), and Australia (Boddington mine). The following table shows the countries that are the key producers of gold and what their estimated in-ground reserves are.

Not all the gold produced goes into currency reserves. In fact, typically only 25% of annual production goes into gold bars and currency, while another 5% is absorbed by central banks. Jewelry accounts for about 52% of production, with the only other significant use being in the manufacture of certain electronics.
In terms of US production, our 221 metric tons per year would be valued at about $10.9 billion per year. To put that number in context, between 2017 and 2018 the Fed had to increase its balance sheet by about $100 billion, just to accommodate the increase in currency demand. That’s an amount about nine times the value of the gold reserves available to be mined in the US. This means that were the US currency to be backed by gold, the Fed would have to purchase about two-thirds of the world’s production annually at current output levels. Furthermore, if only the US were to go on the gold standard, this move would create a windfall for those countries with large gold reserves and would also put the US money supply at the mercy of Russia, China, and a few other countries who are not our strongest allies at the moment.

Finally, given that world’s economies are continuing to grow, the demand for whatever commodity was used to back government money supplies would also need to grow at pace. If currencies are backed by gold, supply would need to keep up with demand or the price would skyrocket. Provident Metals has reported that, based upon known supplies of gold in the ground and assuming that about 3,000 metric tons of gold are mined every year, it is likely that mining would become economically unsustainable by about 2050.
Given the limited supply of gold reserves, the lack of price stability, the fact that the large known in-ground reserves are located outside the US in some not-so-friendly countries, and the fact that over 52% of existing production is absorbed by jewelry demand, gold may be one commodity that is better used for decoration and jewelry than to support currencies and financial markets. What is equally clear is that we don’t want to base our money on clams located on someone else’s beach.

Bob

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


EDITOR’S NOTE: A follow up piece was written by Robert Eisenbeis, Ph.D. which includes replies to comments and questions submitted by you, our community and audience. Read it here: Clams Or Gold Responses


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Fed Independence

In the wake of the turmoil in Washington, DC, over his performance in Helsinki, President Trump also took a sideswipe at the Federal Reserve, criticizing the FOMC’s recent efforts to normalize policy.

He argued that raising rates threatens the expansion and on top of it has contributed to the rise in the value of the dollar, just when the euro was shrinking, the effect of which is to further disadvantage US producers.

Most presidents – though not all – have understood that Fed independence ensures separation from the Treasury and serves as a check on fiscal excesses. When a central bank takes orders from the fiscal side of government, history shows that inflation and economic decline soon follow. Witness the German inflation of the Weimar Republic, the 1992–1994 experience in Yugoslavia, the 1990 experience in Peru when inflation doubled every 13 days, the persistent problems in Venezuela, and the hyperinflation of Zimbabwe, just to name a few.

There have been many times in the past when presidents expressed frustration with Federal Reserve actions, but those criticisms lacked teeth when it came to actually affecting the Fed’s conduct of monetary policy. One noteworthy period when there was a cozy relationship between Fed leadership and the president was during the chairmanship of Arthur Burns. Burns steered policy in such a way to accommodate the fiscal interests of President Nixon, and the result was stagflation in the 1970s and a disastrous experiment with wage and price controls. We experienced an unprecedented inflation that took courageous action by then-Chairman Paul Volcker to break the back of inflation at the cost of a recession, thus proving that the lack of independence represents a severe threat to economic stability and prosperity. Similarly, President George H. W. Bush blamed the Fed for not cutting rates, and that reluctance to act he alleged cost him the election.

Interestingly, the issue of independence came up last week, on Wednesday, in two entirely different contexts and different venues, in both instances during hearings by the House Financial Services Committee. The first occurred during Chairman Powell’s semiannual testimony on monetary policy before the full House Financial Services Committee, when Congressman Hensarling suggested that the size of the Fed’s balance sheet in itself might pose a threat to its independence because of the temptation on the part of Congress to induce or cause the Fed to purchase private sector assets. As evidence he also referenced the fact that raiding the Fed’s balance sheet has already taken place. Two examples he gave were the use of Fed resources to fund the Consumer Financial Protection Bureau and the deployment of some of the Fed’s surplus to fund the Highway Bill. While Congressman Hensarling’s concern is valid, neither congressional action was related to the size of the Fed’s balance sheet per se. The Fed doesn’t act like a private bank, attracting deposits and then making loans. Rather, it purchases assets – in the present case Treasuries and mortgage-backed securities (MBS) – by simply creating reserves. That is, it purchases assets and pays for them with high-powered money – which ends up as reserves on commercial bank balance sheets.

The real threat is simply that Congress has viewed the Fed more and more as a piggy bank whose resources can be tapped to fund pet projects, seemly at zero cost to the budget. This temptation has been stoked, in part, by the Fed’s willingness to purchase newly issued MBS – which in this case were liabilities of another set of now-government entities, Freddie and Fannie, which are in conservatorship and whose liabilities are effectively guaranteed by the Treasury.

If Congressman Hensarling and his colleagues are truly interested in protecting the independence of the Fed, to counter this trend they should restrict the Fed’s asset purchases to US Treasury obligations – except in extreme emergencies, such as envisioned in the Dodd-Frank Act – and encourage the rundown of the Fed’s holdings of MBS as soon as feasible.

The second time the issue of Fed independence was implicitly raised was in an entirely different context during a hearing on digital currencies that took place that same Wednesday before the House Financial Services Subcommittee on Monetary Policy and Trade. The discussion was wide-ranging, but some participants argued that if digital currencies proved to be a more efficient means of payments than cash, then such currencies should be made legal tender. Furthermore, the Fed should get into the retail digital currency business. But what was lost in their brainstorming was the logical implication of the Fed’s getting into retail payments. Fedcoins, by virtue of the government’s backing, would likely dominate private sector digital currencies and would surely supplant demand deposits as a component of payments as well. However, the advent of Fedcoins would also imply a huge increase in the Fed’s balance sheet on the liability side, an increase that would have to be balanced with assets – presumably Treasuries. But banks rely upon demand deposits to fund their lending activities; and to the extent that this funding source was significantly reduced or disappeared, then banking as we know it would also be adversely impacted. The political fallout from this disruption would be large, and we do not know what implications such a change would have for financial stability or the implementation of monetary policy. Worst case is that the Fed would be dragged into consumer lending. So the role of digital currencies in the US economy is, as of this writing, not clear; nor is the structure of Bitcoin and similar currencies as anonymous or safe as proponents would have us believe [1].

The threats to Fed independence from the legislative branch have a long history. Congressman Wright Patman (in Congress from 1929–1976) was longtime chairman of what was then the House Committee on Banking, Finance, and Urban Affairs [2]. A populist, he favored low interest rates and continually threatened to subject the Fed to appropriations and/or audit [3]. His main concern was that the Fed was too independent and lacked transparency in its operations and decision-making [4]. Remember, during that period the Fed did not reveal its decisions, nor did it produce meeting minutes. Furthermore, Fed chairmen and governors made only infrequent appearances before Congress.

Patman’s crusade was picked up by Henry Gonzales, another Texan, who rose to the chairmanship of the House Banking Committee in 1989, and who vigorously sought to make the Fed more accountable [5]. Under Gonzales it was revealed that the Fed kept secret minutes of its meetings, destroyed many meeting records, and concealed information on a fleet of airplanes it operated, just to mention a few examples of covert Fed actions [6]. Gonzales even initiated an unsuccessful proceeding to impeach Fed Chairman Paul Volcker. Under Gonzales’ tenure the Fed began publishing minutes of its meetings.

So attacks on the Fed from both the executive and legislative branches of government are real but have mainly succeeded – appropriately so – in making the Fed’s decision process more transparent. But those efforts have had minimal influence on actually policy decisions. The president may not appreciate that the Fed is a creature of Congress and not the executive branch, and that he has little or no power to force either the chairman of the Board of Governors or the FOMC to do his bidding. Nor can he fire them.

How will the Fed respond to these recent pressures? Some have speculated that attempts to influence the Fed will cause the Fed to overreact and accelerate its tightening policy just to demonstrate its independence. If the past is any guide, however, there is little evidence that the Fed has deviated from what it deems to be the appropriate policy path just to stick it to its critics. While most of the FOMC participants and governors are relatively new to the table, the best guess is that Fed’s culture and history will provide them with the backbone to steady the course and not bow to outside political pressures. The bigger risk is that the economy could weaken sufficiently towards the end of this year to cause a change in policy, especially if this slowdown occurs before the election. A backtrack on policy in that economic scenario would pose a formidable communications challenge for the Fed – to explain the change while not appearing to be bowing to outside pressure, especially from a president who is likely to claim credit for the change in policy. This is where the real short-term threat to Fed independence will come from. Over the longer run, however, the real threats may come from a Congress tempted to look for cheap financing for projects, and we can only hope there that the true issues are understood.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] Anyone who doubts this assertion should just read the recent indictment handed down by the Justice Department in the case of 12 Russians accused of meddling in the US 2016 election. See https://www.vox.com/2018/7/13/17568806/mueller-russia-intelligence-indictment-full-text.
[2] I concentrate here on the period after the 1951 Treasury-Fed Accord and after the Fed stopped pegging interest rates, a policy instituted during WWII that made the Fed effectively subservient to the Treasury.
[3] Having been at the Board of Governors during part of Patman’s tenure in Congress, I can attest to the fact that the mere threat of appropriations or an audit instilled more financial discipline in the Fed’s operations than could be observed in agencies that were subject to appropriations and audit.
[4] See Harrison, William B., “Annals of a Crusade: Wright Patman and the Federal Reserve System,” American Journal of Economics and Sociology, Vol. 40, No. 3, July 1981.
[5] The Committee’s name has changed several times, so for simplicity it is simply referred to as the House Banking Committee.
[6] See history.house.gov/People/Detail/13906.


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Bursting Bitcoin Bubble?

Fundstrat Daily reports that “YTD, the crypto market is down -60.7%” as of July 2.

We have been asked again about Bitcoin and “bubbles” following the recent gyrations and the plunge. “Should I buy it?” asked a reader.


First, we offer the required disclosure: We don’t own any cryptocurrency in any Cumberland managed account. And we don’t own any derivative or other form of crypto. We have avoided the group. We don’t see crypto as a deep-enough and mature-enough assemblage of tokens to qualify as an asset class – yet. That assessment may change at some point but not likely soon.

Nick Colas and Jessica Rabe have been tracking Bitcoin for a while. They write about it from time to time. See http://datatrekresearch.com.

“We’ve been tracking Bitcoin wallet growth and Google search term volumes… as the carnage has unfolded. Our repeated message in these pages: the former is growing only slowly, and the latter is in outright decline. Bitcoin is ultimately a technology, and without incremental adoption growth it has a tough row to hoe.”

Later in their research they add the following warning: “To be clear: we’re not calling a bottom on Bitcoin, but its complete decoupling from stocks may be one sign of a washout [s]ince it now resembles the time before anyone but computer nerds really cared about it.”

Thank you, Datatrek, for keeping us up to date.

Readers may recall that in previous writings we argued that the world wants the use of crypto and security of blockchain linkage in a secret transaction. Illegal use is one reason. Privacy is another. So is having a wealth-hoarding mechanism that cannot be confiscated if the owner has to flee. As Fundstrat Daily noted (on July 2), “When comparing Bitcoin to other major asset classes (stocks, bonds, hedge funds, oil and gold), Bitcoin has the highest correlation to Gold (4.4%) and the lowest correlation to S&P 500 (-15.2%).”

We also see the eventual rollout of credible asset-backed crypto as an evolution in progress. Many gold-backed tokens are in the works or are in the start-up phase of issuance. That activity is mostly outside the US. We think it will expand and will intensify once the Venezuelan selling of gold has run its course. For more information about gold-backed crypto, see Goldscape’s weekly blog and guide at http://www.goldscape.net.

Note that Russia and China are continuously buying gold, according to official reports. Also note that a Sharia-approved, gold-backed crypto called OneGram (https://onegram.org/whitepaper) has launched in the Arab world. (This link is provided so readers can see this evolutionary development in crypto. It is not an endorsement.)

In sum, crypto is not over, though the Bitcoin bubble, having burst, may yet have more deflating to do.

The bursting of bubbles has a long history in finance and economics. That means the making of those bubbles is equally long in history. For a great recitation of bubble history see Charles MacKay’s famous classic, Extraordinary Popular Delusions and the Madness of Crowds (https://www.amazon.com/Extraordinary-Popular-Delusions-Madness-Crowds/dp/1539849589/ or find the PDF online.)

Commodities have bubbles. Silver, gold, copper and oil are examples.

Real estate has bubbles – housing, shopping centers, offices, the Florida land boom a century ago. The Florida condo boom today may become a future bubble.

Stock market bubbles are renowned –  bowling alley stocks, casinos, tech stocks, home builders, banks, savings and loans. From tulips to Trump’s Taj Mahal, the history of bubbles is littered with casualties.

Could FAANMG be the current stock market bubble? Is the hotel, leisure, cruise ship sector about to become a bubble, too?

Note that the bursting of a bubble doesn’t mean the selloff goes to zero. When the Nasdaq bubble burst 18 years ago, the Nasdaq lost two thirds of its value from peak to trough, but it didn’t go to zero. Some of the start-up companies that traded at price/fantasy ratios went to zero. Similarly, some start-up crypto ventures are now at zero.

In the end, markets clear to reasonable values, and the range of those reasonable values includes zero if the value is worthless.

Some have argued that Bitcoin’s rise was tied to stock market success and that the cryptocurrency’s subsequent decline portends a stock market crash. We’re not so sure of that linkage. We agree with the Datatrek conclusion: Despite occasionally looking like a barometer for systematic risk appetite, there continues to be no proof that Bitcoin’s price presages where the S&P 500 may go in the near term.”

We’re a lot more worried about the consequences of a trade war than we are about Bitcoin. We think the US economy is peaking in growth rate in Q2. The Trump-Navarro policy and an escalating trade war are already starting to bite. Ask Harley-Davidson. Ask a soybean farmer. Ask a Maine lobsterman. This is only the beginning.

We have some cash reserve. We took a defensive position in consumer staples. We favor small and midcap and domestic US versus international. We sold the overweight tech exposure.

David R. Kotok
Chairman & Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Cryptocurrency Investors Worry, Wait After Bitcoin Price Drop

Excerpt below:

In the wake of this week’s crash, the top post in the Reddit forum /r/CryptoCurrency was about how to contact a suicide hotline, apparently a response to distress on the part of recent investors.

Some economists say this is a familiar pattern.

“Twenty years ago, the technology stocks and new Internet stocks achieved an excess valuation of $7 trillion because of speculation,” said David Kotok, chairman and chief investment officer of Cumberland Advisors. “The prices of shares were bid up to very high levels. When they collapsed, investors … they got very hurt. We see similar characteristics in cryptocurrencies right now.”

Bitcoin investors know this trend as well.

“I think [cryptocurrencies] are highly speculative,” Kotok said. “Putting money into cryptocurrencies is a speculative thing to do. You might make a profit, but what we are seeing is people who — in the last month or two — put money into bitcoin, are having trouble getting cash back when they sell and are now watching the price fall and panicking.”

Read the complete article at WPSU Radio




Longboat Kiwanis Club hosts financial expert to discuss Bitcoin

An expert on one of the world’s suddenly hot, but still mystifying, investments is the scheduled luncheon speaker at the Kiwanis Club of Longboat Key’s Jan. 18 meeting at Portofino Restaurant at the Longboat Key Club.

David Kotok, chairman and chief investment officer of Sarasota based Cumberland Advisors, will discuss Bitcoin, Blockchain and other financial topics at his 11:45 a.m. presentation.

Read full article at YourObserver.com




Bitcoin price WARNING: HILARIOUS moment investor compares cryptocurrency to CHOCOLATE COIN

BITCOIN is as tangible as a chocolate coin a top investor has warned in a hilarious quip about the cryptocurrency.

 

Appearing on Bloomberg, Mr Kotok offered the hosts a “New Year’s gift” – a chocolate coin shaped like a bitcoin.

Handing out the sweet treat, he said: “I brought proof that bitcoin can be tangible, here’s a New Year’s gift for each of you.”

The delighted presenters asked if the gift was chocolate.

Mr Kotok said that the chocolate version of the cryptocurrency had more value than the real thing.

He said: “That is a chocolate covered bitcoin, that is the most tangible value you will see in bitcoin.”

See original article here: https://www.express.co.uk/finance


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Fed, Bonds & Interest Rates

Ben White had this to say about Fed appointments last week in his Politico “Morning Money” column:

“FED TALK – Look for the vice chair nomination to come fairly soon. Mohamed El-Erian remains in the mix but could also be a candidate for the New York Fed. John Taylor sounds like a no-go for vice chair. The White House is looking for a hard-core economist for the vice chair slot, given that with Jay Powell, Randy Quarles, and Michelle Bowman for the community banker slot, Brainard would be the only remaining economist.

“The White House could also look to fill all the remaining slots after Chair Yellen leaves, bringing the Fed board up to its full seven and giving President Trump a massive imprint on the make-up of the nation’s central bank.” (https://www.politico.com/newsletters/morning-money/2017/11/22/murkowski-looks-like-a-yes-on-taxes-030978)

My colleague Bob Eisenbeis has just written on this subject. Bob’s distinguished career has included serving at the Fed under five different chairmen. Here is the link to his recent missive: http://www.cumber.com/chair-yellen-resigns/.

What do we know?

A year from now the central bank of the United States – the lender of last resort to the US banking system and therefore to the world – will be a very different assemblage of folks than we have been accustomed to. Ten years of QE 1-2-3 and near-ZIRP are over.

What else do we know?

The last ten years of financial tailwinds are giving way to headwinds. Note that one may sail forward against a headwind by tacking back and forth. The process is slow and requires hard work. That is different from the ease of movement experienced with a tailwind.

The US federal deficit ran high for the last ten years, and aggregate US debt under three presidents has increased by nearly $11 trillion in a decade. Meanwhile, the interest expense line item in the federal budget has been flat as interest rates remained low and US debt service was refinanced at low rates. That tailwind is over.

The tax reform bill will raise the authorization to borrow and to add $1.5 trillion to the deficit. This is incremental to existing deficit projections which are already rising.  The total interest bill will be rising. The total debt-to-GDP ratio is headed for 100% with the tax reform bill addition, a level that reminds us of the end of World War II.

In its early stages, trouble in financial markets appears in places where credit and lending issues can be seen and measured. That is where to look for warnings. A partial list of such places follows, along with some stellar observations by Chris Whalen.

Chris has penned an essay on the Fed and on a bright yellow flag. He asks, “Q. Besides stocks, what asset class has benefitted the most from the radical monetary policies of the Federal Open Market Committee? A: Multifamily real estate. And what asset class most worries federal bank regulators today? Same answer.”

See https://t.co/4XvERiw8du for the discussion. We thank Chris for permission to share this with our readers. To subscribe to Chris’s The Institutional Risk Analyst, please email your request to info@rcwhalen.com.

There are other places to worry about credit risk, too. Credit card delinquencies have started to rise. High Yield spreads are very low by historical standards but are recently starting to widen.  Private equity financing of commercial real estate shows trouble spots. Note that twice as many retail spaces closed as opened in the last report period. Note empty mall and highway retail space. Note the secondary effects of these changes on employment and on city, county, and school board tax receipts.

Finally, we have the credit risk around the hot topic of Bitcoin, with its wild price fluctuations. New buyers of crypto and crypto derivatives emerge every day. Some are leveraging; thus credit risk is added to speculative risk.

Even outgoing Fed Chair Janet Yellen admits that too much QE for too long with a ZIRP can lead to difficulty.

We are in the post-Thanksgiving to New Year’s period, which is traditionally upbeat. We encourage you to enjoy the season – but when you ring the bell, we advise you not to drop it on your foot.

Our Cumberland US stock market ETF portfolios are now overweight the smaller and mid-cap area. Our overweight of Tech has been reduced.

Our bond accounts emphasize higher-quality credit, and we are not chasing the high-yield space.

We expect a tax reform bill to pass both houses of Congress and to be signed into law. Political leaders are desperate to produce it, so they will do anything to make a deal and get an “aye” vote.

Next year portends rising volatility and massive political swings of sentiment as we run up to the midterm elections.

Current polling suggests that the Democrats may capture the House majority and thus chair all House committees. An impeachment bill is likely if they prevail.

2018 promises to be an interesting year.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Wealth Managers Are Being Inundated With Calls About Bitcoin

At 74, Cumberland Advisors’ David Kotok has guided wealthy clients through a long career’s worth of bubbles and crashes. Now he’s being inundated with questions about the latest soaring asset to confound investors — bitcoin.

“Clients bring up bitcoin all the time,” said Kotok. “They think it’s cool. It has the newness, which is attractive to some people, though others would say newness is a risk they don’t want to take.”

Read full article here: https://www.bloomberg.com