A Leveraged Buyout of the US: Why America Can Print Its Way Out of Any Crisis
In 2016, I wrote in Forbes why Twitter should better change to become a public good—a paid announcement tool of sorts for the prominent only. The question I tried to answer was simple: Is Twitter’s user base (and hence, revenue line) inherently limited to affluent people with some form of a media exposure and a desire to be heard? With Twitter’s share price recently nearing its all-time low—despite three years of Jack Dorsey’s magic, reinventing Twitter—I suspect that question is still relevant.
Twitter is an excellent medium. I am not suggesting it is going away, of course. But it is also representative of a generation of businesses that came to be after the 2007 meltdown; companies propelled by a QE-drunk world. The ‘07 crisis ushered the world into an era of easy money. We’ve just lived through a decade of the most hated bull market in history, and it was hated for a reason. The growth was not based on fundamentals but debt. Money became cheap; leverage was easy. That is, money was easy but only for the already affluent elite.
The Rich Get Richer
Quantitative easing (QE) was actually deflationary. To oversimplify, this is because—as the renowned investor Christopher Wood writes—the velocity of money has decreased and interest rates went sharply down for a long, long time. Lower rates increased asset prices of the wealthy minority, since they were now discounted at a lower rate, but the money didn’t flow into the economy.
With capital concentrated in a few hands, it has flown to nonessential businesses and share buybacks.
Dynamite and Corporate Debt
As a result, we’ve built a fragile system. The virus exposed this when it very nearly set off the dynamite of corporate debt. In the QE-drunk world, companies could borrow too cheaply, too easily as investors were hungry for any yield.
The government’s response to the virus essentially made all forms of economic output illegal. With the global economy at a standstill, investors began worrying that many companies would go bankrupt or fail to meet their debt payments—rates sharply went up and liquidity dried up. Things got really scary because many companies could get downgraded to a lower credit rating, which could induce the largest investors in this world, like insurers and pension funds, to sell their debt en masse, since they cannot hold lower rated debt. We were not too far off from another financial meltdown.
The Fed to the Rescue
This time, the Federal Reserve isn’t playing. It is using more of the same, but with an urgency and magnitude that does not have a precedence outside of wartime periods. The Fed is essentially using the U.S. Treasury as a buyout special purpose vehicle of sorts, levered up and buying everything in its way—from corporate bonds (even high yield! as of April 9) to student loans—to stop the cracks in the debt market. And, this time, it is in the trillions, not billions. The government joined in and kicked off the most generous cash-giving program in history, the CARES act, offering relief such as cash grants and small business loans.
Where does all of this money come from? More debt, of course. That is, the government issues new debt (much, much more new debt), and the Fed prints money and buys it.
This isn’t just a U.S. thing. Markets are falling everywhere; economies have stopped in other countries too. Governments all around the world unveiled similar measures to stop the bleeding, and they all have to issue more debt, which central banks then have to mop up.
But the Fed can do this forever. Why?
Money Printing in America
There is nothing new about money printing. Governments have always been tempted to print their way out of debt—to inflate their currencies and reduce the value of their debt. This wasn’t easy when we used the gold standard, since countries would be punished for overly eager printing by an outflow of gold; when the pegged and guaranteed value of a country’s currency is higher than what it should be because of inflation, people bring the money back to country’s central bank and ask for gold to profit from the difference, of course.
World War I brought an end to the economic dominance of the UK and Europe more widely. Countries had to abandon the gold standard and anchor the value of their currencies to the U.S. dollar, which became the world’s reserve currency, and the only one backed by gold. But that only shifted the problem of gold outflow on to the U.S. With Nixon’s decision to abandon gold altogether in 1971, the supremacy of the U.S. dollar became complete and unlimited.
Because the dollar is the world’s reserve currency, most international trade and almost all transactions that take place internationally (not just the ones involving the U.S.) use the U.S. dollar. This means that importers, exporters, banks that are servicing them, central banks all around the world and many other market participants need to hold the U.S. dollar or liquid dollar-denominated assets. Like anyone else, they like to keep their wealth safe, and so they buy from the U.S. Treasury.
This is why there is unlimited demand for U.S. debt. The Fed can print ad infinitum. Just to make this clear: The Fed is not going bust. The world will keep buying U.S. debt. The U.S. is not going to default on its debt. Global trade will not abandon the U.S. dollar. Already, as a result of the coronavirus crash, the U.S. dollar has spiked, and the U.S. Treasury yield fell because investors cannot get enough treasury securities as they run for safety.
And things seem to be working for the U.S. again. Liquidity returned to the debt markets, so companies can issue debt but also service their debt payments because the rates fell back to (more) normal levels. Markets calmed down, even rallied; Wall Street is starting to see the light at the end of the tunnel. And some hedge funds made good money along the way—following the Fed was a career-saving moment for many hedge fund managers.
We’ll Be Alright
So now that’s sorted. Except there’s probably something that still bothers you about the whole thing—it defies natural law.
The conundrum of dollar hegemony is not a light subject, and certainly not one that people on the streets would avidly talk about. That is, except for in the times of crisis. After the 2007 meltdown, the worry about whether China would continue buying U.S. debt turned mainstream, and for a long period, gold strongly appreciated as people looked for an alternative store of wealth.
It’s the same this time, only more so. There are many who prophesize the demise of the greenback in one way or another. Some arguments are weaker, others are based on a strong logic that you will find hard to argue with. The main schools of thought can be broadly divided into two groups—those who see warlike scenarios and those who think that some form of global currency reform is more likely.
The War Against Capitalism
Billionaire investor Ray Dalio has transformed into something of a philosopher in recent years; his books and essays published on LinkedIn are lengthy, and somewhat mechanistic, but also brilliant. They have become quite dark recently. Dalio explains the economy and markets like mechanisms, in terms of causes and effect, and overlays that with historical observations.
Though Dalio has yet to make this conclusion directly, his analysis likens the U.S. to failed empires of the past—whether that be the decline of the Chinese Empire after the Opium Wars or Britain’s loss of the status as an economic superpower after WWI. To tackle the question of how the U.S. dollar could lose its dominant position, Dalio leans on his mechanistic analysis: Investors will simply stop lending at unattractive rates.
“I think that the [low-inflation] paradigm that we are in will most likely end when a) real interest rate returns are pushed so low that investors holding the debt won’t want to hold it and will start to move to something they think is better and b) simultaneously, the large need for money to fund liabilities will contribute to the ‘big squeeze,’” Dalio wrote in a July 2019 LinkedIn post. “These circumstances will likely increase the conflicts between the capitalist haves and the socialist have-nots.”
Some other notable thinkers also subscribe to this strand of thinking. Nouriel Roubini is certainly one, though his theatrical being somewhat discounts his arguments.
Currency Market Reform
Brent Johnson, the CEO of Santiago Capital, has gained a lot of attention in recent months with his “milkshake theory”—a magicians-to-oil-barons narrative (Johnson draws on scenes from the film about magicians, Prestige, as well as the oil-sucking tragedy, There Will Be Blood) explaining why the demand for the U.S. dollar is going to rise with more QE.
Johnson says that when countries engage in even more quantitative easing as a response to COVID-19, all of this new capital will flow into the U.S., exchanged to the dollar. Hence, the “milkshake theory,” because like the tragic old baron in a scene from the latter film, the U.S. will “put a straw into ground and suck up all capital, no matter if it’s behind the fence.”
Johnson goes on to explain that this is because the U.S. dollar, as well as the payment and financial infrastructure around it, is simply far superior to any alternative—this is both in terms of payment system and depth of the financial market (when a large corporation wants to take a giant hedge position, it is going to the U.S. derivatives market).
In addition, as countries and other giant market participants have to borrow dollars to operate (buying resources on the international market, or making any type of international transaction per se), they will never be able to repay their debt in full (which would, essentially, delete that U.S. dollar balance from existence) and will have to keep paying interest rates indefinitely, which puts an eternal floor under the U.S. dollar, as there is a constant unwavering demand for the greenback.
Johnson expects that the rise in demand will become unsustainable and that nations will have to act together again in an event akin to the Plaza Accord.
Another famous investor who sees the bubble popping, but does not necessarily expect it to erupt in the form of a global conflict, is hedge fund manager Mark Spitznagel, who is also currently enjoying media attention after The Wall Street Journal reported that he made 4,000 percent return from his bet on the coronavirus crash.
The Next Big Thing
These theories (and their lesser alternatives) are pure logical constructs. Allow me to make a more esoteric argument. Of course, the dollar’s supremacy rests on the mechanisms described above, but its dominance is also dependent on the sense of Americanism.
The U.S. is an incredibly potent superpower, born out of a celebration of greed and opportunity. From newsboy to millionaire was the American promise to its early immigrants, and it hasn’t changed since.
This love for entrepreneurship, this pursuit of material excess is so deeply entrenched in the American mentality that it gives the U.S. the patent for market bubbles—that is, America has the unique ability to inspire the rest of the world to chase the next big thing. It was mass consumerism in the 1960s, financial complexity in the 2000s and Uber-ization after 2007.
That flow of international capital into the U.S. is both mechanistic and organic. The question is: What will the next thing be after America recovers from the virus crash?