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What's going on, guys?
It is Sunday, September 25th, and that means it's time for long, reads Sunday.
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Alright, everyone, well listen.
I named my first show of this week, Bleak Week, and Boy, did that end up being true.
It really was just a total sky as falling type of week to reference a quote that I used
on yesterday's show.
I continue to think that much of the gloom has to do with just how in between things
feel, aka are we in a recession or not, as well as just the severe cognitive dissonance
of economic signals pointing in different directions.
Whatever the case, it is gloomy out there, and for long reads Sunday this week, instead
of just reading one essay, I decided it might be good to read a variety of threads on different
I haven't done one of these thread shows for a while, and I've noticed a couple recently
that I liked, so I thought, hey, this could be a great time for that.
We're going to kick it off with a thread from Eric Bosmagian, who has rocketed into Fintuit
as one of the best new threaders in the game.
The thread I'm going to read is called America's Middle Classes Vanishing, and it comes from
September 20th, 2022.
In the last 20 years, the share of wealth held by the middle class dropped more than 8%
while the share of wealth held by the top 1% increased almost 8%.
Why is this happening and is this trend going to continue?
Let's find out.
Since 2002, the share of wealth held by the middle class has dropped from 36% to 28%.
Over the same period, the share of wealth held by the top 1% has increased from 25% to 32%.
In 2014, the share of wealth held by the top 1% exceeded the share of wealth held by the middle
class, defined here as the 50th to 90th percentile.
If we look at the share of wealth held by the top 1%, the trend looks extremely similar to
the trend in the stock market.
This makes sense.
wealthy people own a lot of assets, so if asset prices rise, that helps them.
The middle class doesn't hold nearly the amount of financial assets is the top 1%,
and are much more dependent on the real economy for wage growth.
Therefore, what we really have to analyze is why asset prices have outpaced the real economy
Wage growth is tied to economic growth, there is no way around it.
Weaker the normal wage growth is a symptom of weaker than average economic growth.
You cannot generate 5% wage growth with 2% GDP growth.
So we must also understand why economic growth has been so weak.
Over the long run, economic growth is a function of population growth and productivity growth.
Productivity growth is closely linked to debt levels.
When a use of debt doesn't generate an income stream, this is an unproductive use of debt
that crushes productivity.
Since the 1980s, we've taken a path of massively increasing debt.
The increase in the debt to GDP ratio tells us that this debt was not used productively.
One step levels became excessive, there was a sharp drop in economic growth and thus wage
So the high debt levels hurt economic growth, which reduced wage growth, harming the middle
Why were asset prices in the top 1% unaffected by this reduction in growth?
After the last 20 years, each time the economy ran into a debt problem, recession, the
answer was to lower interest rates.
Lower interest rates was an easy way to kick the can down the road rather than dealing
with the root cause, too much debt.
So interest rates declined and asset prices recovered because the debt was easier to
service, but the debt loads to remain, suppressing economic growth and thus wage growth.
Asset holders make it out alive while workers suffer the consequences of the debt.
When interest rates hit 0% after 2008, we still didn't want to solve the debt problem,
but we couldn't lower interest rates so we started quantitative easing.
This increased liquidity in financial markets, again, helping assets, but doing nothing
for the real economy.
The concept behind these policies was that the economy would rise to the level of asset
Asset holders were supposed to spend this newfound net worth into the economy, jumpstarting
the economic cycle.
Ben Bernanke said this exactly.
Note, this approach eased financial conditions in the past and so far looks to be effective
Stock prices rose and longterm interest rates fell when investors began to anticipate
this additional action.
Easier financial conditions will promote economic growth.
For example, lower mortgage rates will make housing more affordable and allow more homeowners
Lower corporate bond rates will encourage investment and higher stock prices will boost consumer
wealth and help increase confidence, which can also spur spending.
Increase spending will lead to higher incomes and profits that, in a virtuous circle, will
further support economic expansion.
And quote, but as Robert Schiller noted, as well as other academic research, the wealth
effect, particularly for the stock market, is a flawed concept.
It doesn't work.
Quote, the importance of housing market wealth and financial wealth and affecting consumption
is an empirical matter.
We have examined this wealth effect with two panels of cross sectional time series data that
are more comprehensive than any applied before and with a number of different econometrics
We find at best weak evidence of a stock market wealth effect, and quote.
So all that happened was that asset prices were bolstered by lower rates and increased
liquidity, but the economy still had to deal with the crushing debt burden that refused
to be solved.
Policy makers are very worried about correcting the debt problem because that means people
asset holders will lose a lot of money as the economy experiences debt deflation.
So instead, the policy choices have been to support asset prices, but the outcome has
been disastrous for the middle class.
The prices like homes have increased way faster than wages, creating a situation of gross
20 years of conducting policy in this fashion and what do we have?
We have asset prices that are dangerously elevated relative to the underlying economy,
and we still have all the debt.
Correcting the debt problem would result in short term extreme pain, but longer term prosperity
for all people as growth and wages could accelerate without a crushing debt burden.
Pursuing the same policies will result in the same outcome.
Increasing debt, lower economic growth, falling real wages, but potentially higher asset
prices that the decline in growth is met with lower rates and more liquidity.
This lower growth and inability to afford assets, homes, has resulted in delayed household
formation and lower birth rates, worsening our demographics.
This is happening in every major country pursuing the same policies, but that is a topic
for another day.
I think Eric is super sharp, and I think you should give him a follow at EPB Research
The risk with a thread on Twitter is that it inherently reduces things to a single vantage
Eric is looking through the lens of debt, and this is a common lens for people on Finn
Twitter, especially in Bitcoin Twitter, too, to look through.
I think broadly there's a ton of truth in what he writes, but I think that obviously there
is more to the story of the hollowing out of the middle class over the last 20 years
than just interest rate policy.
I don't think you can have a realistic conversation about the middle class, for example,
in that same time period without talking about China and the World Trade Organization and
choices we made along those lines.
Now that's obviously not to diminish anything in that thread, and like I said, I think
you should give Eric a follow.
My one concern is that I sometimes worry that this type of analysis actually contributes
to our overestimation of how much power monetary policy has to both fix or cause our
Anyway, Eric, thanks again for the great thread and keep up the good work we are loving
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Next up, we're going to read a thread by James Lavish that's all about Chairman Powell.
Fed Chairman Powell has mentioned Volker quite a bit recently, channeling his hawker stance,
but Powell is no Volker, and this is not 1980, time for a Fed thread.
Who is Volker anyway?
So who is this Paul Volker character we keep hearing about, like a federal reserve superhero
Why do we keep hearing his name 40 years after his so called moment at the Fed?
First, Paul Volker was an economist by study and trade, having studied public and international
affairs at Princeton, then public administration at Harvard grad school, and finally at
the London School of Economics.
His first job was as an economist at the Federal Reserve Bank of New York.
He then worked alternating stints at the US Treasury and Chase Manhattan Bank before returning
as the president of the New York Fed.
Then, 27 years into his career, he was appointed Chairman of the Federal Reserve.
In contrast, current Fed Chairman Jerome Powell is a lawyer slash politician by study and
trade, having studied politics at Princeton and law at Georgetown.
After a few years as a judge clerk and then an attorney, he moved into M&A Work at Dillion
Road, a New York City investment bank.
After that, Powell spent some time at the US Treasury, where he oversaw investigations
of Solomon Brothers Investment Bank, still an attorney, not an economist.
He then moved back into the private sector, working in M&A, and then a fund that he founded
Powell then returned to DC to work for a Think Tank back into politics.
This is where Powell worked to get Congress to raise the debt ceiling in 2011.
He was subsequently nominated as a Federal Board Governor by President Obama, and in 2017,
he took the helm as Chairman of the Fed, nominated by President Trump.
Okay, so now we have an idea of their career and experience differences.
Let's get back to Volker in the 80s.
What was Volker's moment?
First, Volker was not exactly a hero, no less superhero for the US economy.
Long before his moment, Volker was a key advisor to Nixon, suggesting the US's
bank infertability of the USD into gold back in 1971.
US went off the gold standard.
This move has been defined as a major contributor to ongoing financial manipulation by
the Fed, and hence, potential fiscal problems for the US.
Flash forward to the 1970s, and we saw many of these problems manifesting in the US economy.
See, for years, before 1965, inflation was quite stable, hovering right around 2%.
But increased spending by the government during the Vietnam War caused inflation to start
running hot, taking up over that magic 2% rate.
Then, when the US came off the gold standard, it began to escalate.
With the 1973 OPEC oil embargo, gas prices nearly quadrupled at inflation jumped to double
digits before settling in around the 7% level for years.
The Fed incrementally raised rates, attempting to tame inflation, but by 1979, surging energy
and food prices sent inflation to the 9% and 10% level, peaking at nearly 15%.
When Volker assumed the chair at the Fed in 1979, US GDP was 3.2%, unemployment was 6%,
and inflation was 11.3%.
To tackle inflation, even if it meant inducing recession, Volker raised the Fed funds target
rate aggressively, eventually up to 20%.
The effective Fed funds rate with the market actually prices in from the target rate reached
22% in December of 1980, bold, aggressive, effective.
By 1982, GDP was negative 1.8%, unemployment was 10.8%, and inflation was 6.2%.
The economy was firmly in a recession, people were protesting against the Fed, and prices
were calming down, so Volker backed off, reducing rates again, the Volker pivot.
By 1983, GDP was back to 4.6%, unemployment was 8.3%, and inflation 3.2%, mission accomplished.
Inflations since the 1990s has remained relatively in check, hovering around the 2% to 3% level,
until now, of course.
With quarter 3 GDP expected to be 2.8%, unemployment at historic lows of 3.5%, and inflation
at 8.3%, some people are calling for another Volker moment.
A shock raise of rates by current Fed share power to match the strength of Volker and
tackle inflation once and for all.
Not so fast, arms share economists, because today is not 1980, and the result could be
absolutely devastating to the US economy, and ultimately collapse the US Treasury.
Let's walk through why, shall we?
Party like it's 1980?
If you already follow me on Twitter, you've heard me sound warning bells about the massive
debt US has on its balance sheet.
This, along with falling tax revenues, creates a hefty deficit for the Treasury that it can
only meet by issuing additional debt.
But it's simply, we are a nation now built on borrowing, period.
For reference, in 1980, the US federal debt to GDP was 30%.
Today, it's 125%.
Since we're no longer in the gold standard, the United States has virtually no check
against the rate at which the money supply can be expanded.
In other words, it can print money at will, and it can borrow endlessly.
TLDR, the US perpetually operates in a deficit, as the deficit grows, it simply issues
more debt to fill in the gap between revenue, taxes, and expenses, entitlements to
fence and miscellaneous.
As interest rates rise, the cost of borrowing rises as well.
To illustrate, here's the current US budget situation estimated by the congressional budget
4.8 trillion in taxes, minus 3.7 trillion in entitlements, minus 800 billion in defense, equals
300 billion left over for interest expense.
Current interest expense on 30 trillion of treasuries, 400 billion.
300 billion minus 400 billion equals negative 100 billion.
Now, imagine Powell and the Fed getting tough really tough on inflation.
Imagine him taking interest rates up way up like Volker did.
Let's say you jacked up the target rate to 10%.
The annual interest cost on replacing the current 30 trillion of debt at 10%, would be
That's $2.7 trillion over budget, and that's before a massive reduction in capital gains tax
revenues from the market crash it would cause, as well as the plummeting of corporate taxes
due to increased borrowing costs and decreased company profitability.
Once worse, the treasuries would have to issue an additional 2.7 trillion of debt to cover
that gap at the new 10% interest rate.
In reality, the replacement cost would be higher as longer maturedies would have higher
interest rates than the Fed funds target rate, not going to happen.
Okay then, what if, since our rates have been so low for so long, that we use comparable
percentage of move hikes, rather than absolute percentage hikes to the Fed funds target rate?
Right now, and editors note this is before the FOMC meeting this week, we're sitting
at 2.5% at the high end of the Fed funds target rate.
Let's save Powell pulls a Volker and doubles that in two or three hikes all the way up to
And let's say the average replacement cost of treasury debt would then be 6%.
Replacing 30 trillion of debt at 6%, would cost 1.8 trillion an interest annually.
That's 1.5 trillion over budget.
Again, this is also before reduced tax revenues for that budget.
In reality, revenues would be far lower than even the estimate.
And this is also before the Fed is barely sold any of the 5.7 trillion of treasuries
it has on its balance sheet for its QT program.
Hiking rates up to 5% would induce much higher unemployment, severely affecting the mortgage
at housing market, and would significantly affect consumers ability to pay their variable
interest rate debts.
Forget softish lending, as Powell keeps saying he wants.
This would be a no size crash of the economy that could take a decade or more to recover
Bottom line, it's not going to happen either.
Remember, Volker's approach was shocking, and it was done in a series of moves over
the course of nearly three years.
There are too much around 50% of US debt would mature and need to be replaced in a similar
time frame today.
If Powell used a Volker shock, hiked rates to similar 1980 levels and held them there for
two plus years, the US economy, US treasury market, and US treasury itself would simply
Then what instead?
I believe the Fed has limited options.
Powell can hike rates just enough to appear tough on inflation without causing a market
crash in tanking US tax revenues.
He can hike two maybe three more times, but only to a terminal rate of about 3.5% at
Even if the inflation rate does not come back to the state of target of 2%, Powell may
back off for a while pointing to the direction of change in the inflation rate.
The Fed may then quietly accept a 3 to 4% on going inflation rate and declare victory.
And then he'll quickly do it Volker did in 1982, but this time he will have to do it sooner
by late 2023 instead.
He will have to pivot and begin to lower rates again.
It's just math, my friends.
Math that is not in the Fed or treasuries favor.
Higher inflation they can stomach, especially as it helps pay off past debt with cheaper
future dollars, and besides, the last thing Powell wants to do is crash the economy into
a depression and cause the whole house of debt to crater and end the borrowing charade.
So as an investor, what can you do?
You've heard me say it before, I think it is essential to own hard monies and assets that
hold their value over long periods of time, holding some cash in these times of uncertainty
as wise, especially if you have short term needs.
But owning gold, silver, and bitcoin will help in either a US Treasury meltdown and
or a hyperinflation scenario, still a long way off in my personal opinion.
Or much more likely, for when the pivot comes and queuing infinity begins, which we have
all come to expect eventually will.
Back to NLW here, and I guess I'm going to close it after that one just because it was
such a long and thorough thread, and I think actually goes great with Eric's thread as
This I believe is one of the questions that most lurks if you take a medium run view of
the economy and specifically monetary policy.
That's the question of how long the Fed can keep tightening, and it's not a question
that's based necessarily just on political will.
It's a question based perhaps as James suggests on math.
You can bet that the longer this tightening cycle goes on, the more people are going to
be asking exactly that question.
For now I want to say thanks to Eric and James for their great threads.
To my sponsors next to.io, channel us as an FTX for supporting the show, and thanks to
you guys for listening.
Until tomorrow, be safe, and take care of each other, peace.
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