Hi, how’s quarantine?
I explore the merits of dollar maximalism.
My complete realized P&L for the year, and how to get beat down by S&P futures.
Underrated NYC noir.
Investing seems like it’s largely about netting consistent but opposing narratives against one another. I say “narratives” when I really mean “risk;” narratives are just frameworks for creating halfway plausible projections of risk out of incomplete evidence.
For example, take the dollar.
There are two camps on the dollar: the dollar-bad camp says that the US has abused the “exorbitant privilege” of being the sole controller of the world’s reserve currency. We’ve done this by printing up a bunch of money to do things like bail ourselves out of financial crises and promise the continued operation of unsustainable programs like social security and medicare.
The dollar-bad camp argue that the rest of the world will soon grow tired of tolerating the inflation that we export to them to fund our own domestic excesses, and demand for the dollar will slow. International investors and foreign central banks will cease to buy Treasuries, and yields will go up. US gov can’t tolerate high yields on bonds because then our inability to roll debt becomes obvious and overspending becomes obviously problematic (well, you would hope), so the Fed will buy Treasuries to keep yields low. They might call this “yield-pinning.” Dollars will flood into the system.
Subsequently, the story goes, purchasing power of the dollar will decline and it will become more expensive for us to continue to import most of the things that American consumers buy. The subsidies that other nations have given us by providing us with cheap goods will dry up, and we will be forced to transition our economy back into something more rote and manufacturing-based that resembles the early twentieth century — with the commensurate hit to quality of life.
For a while, I’ve counted myself a member of this camp. It’s an intuitive story, and I think my latent Irish-Catholic guilt doesn’t allow me to feel good about spending indiscriminately on crumbling American institutions at the expense of end-users of the USD who don’t see any of the benefits. It feels like an unstable equilibrium.
Dollar bears often advocate buying gold or Bitcoin (or in my case both). Some notable dollar bears are Luke Gromen and Jim Rickards.
On the other side of the aisle, we have the dollar bulls. They argue that, like it or not, the dollar reigns supreme, and continuing dollar shortages will not only absorb any monetary/fiscal stimuli, but we’ll still have dollar shortages even after most conceivable printing sprees from Uncle Sam.
As far as I can tell, the bulls push the following arguments:
since the USD is used for a lot of international commerce, there are a bunch of outstanding (foreign) liabilities denominated in dollars. For example, if China makes a loan to a small African country, they denominate it in dollars. This can create a huge demand for USD during deleveraging events like, say, a pandemic shock. All of the sudden, everyone is rushing for dollars to cover their liabilities as cash flows unexpectedly contract. It’s a short squeeze.
If you think the Fed’s actions are scary, wait’ll you get a load of what the ECB, BoJ, and other foreign central banks are doing to their currencies. Europe’s been buying corporate debt for a while now, and never even feigned an attempt at normalizing rates. The BoJ owns 77% of the ETF market. China’s so loose with credit that the right analogies aren’t appropriate for this newsletter. Yes, we’re trashing our currency… but maybe it remains “the cleanest dirty shirt” in the pile?
the USD is essentially the fiber of the international financial system at the moment. Something something power laws, something something network effect. There’s a whole lot of convenience in Just Using the Dollar, and a whole lot of transaction cost in switching off of it.
similar to the argument about a comparison to other Central Banks, America remains a bastion of stability, freedom, and cultural export. We at least have the facade of a non-totalitarian state with a reasonably strong rule of law. Foreign investors don’t mind parking value here, even despite taking a haircut on whatever exported inflation, because America’s narrative is more or less in tact. I’d sure as shit rather live in America than China (can’t speak) or France (can’t fire your employees).
Increasingly, I’m becoming convinced of the merit of these arguments. If Bitcoin and software engineering have taught me anything, it’s to never discount the benefits of choosing the most widely used thing. The rationale of “maximalism” applies equally to currency as it does Linux distributions or third-party libraries. It’s totally old hat to say, but the power of network effects are very real.
And nothing, at the moment, has a stronger network effect than the dollar.
Recently this has been obvious if you’ve paid any attention to the USD, which has been on a tear:
Well known dollar bulls include Jeff Snider, Brent Johnson, and (lately) Raoul Pal. It’s worth noting that essentially all of these guys are what I would characterize as cynically bullish on the dollar. All of them agree with, say, Luke Gromen’s assessment that ultimately the dollar is headed for big loss of purchasing power, but they argue that timing matters and first the dollar’s going to rip.
Noted dollar bear (and great follow in general) Lyn Alden provides some counterpoint to the bullish argument about USD-denominated liabilities; this thread is worth a read.
As I mentioned in the beginning, investing is about netting narratives. Oftentimes this process will lead you to hold contrary outlooks that differ only in timing.
I still think that within the next fifty years or so, the dollar is in big trouble. But I’m coming around to the idea that the dollar is poised to be enormously strong during the covid crisis.
Even if your ceiling has a terrible leak, you’re not going to be re-roofing during a hurricane.
In the short-term I think cash will be the thing to own. As this crash continues, USD-denominated assets will be sold off to take down leverage and cover income shortages.
In the mid-term people will pile back into dollar-denominated assets once the bottom is widely perceived to be in (read: after a number of failed rallies in the equities market; I give this, I dunno, six months?). Investors will still want exposure to the dollar, but they’ll also want an inflation guard… i.e. stocks.
In the long-term (5-10 years+) the dollar story will get more and more grim as other countries get tired of subsidizing our domestic indulgence. Bitcoin and gold will be the things to own.
Obviously, and as always, you shouldn’t listen to me because I’m a 30 year old on the internet who has never held a job relating to finance.
Getting beat up
Here’s my entire realized summary for the year so far because, who am I kidding, I’m an exhibitionist.
I lost $20k on Friday being really short S&P futures. I hung onto this position until I hit my pre-decided stop, a slight 5 points below the weekly top. If I hadn’t stopped myself out, I would’ve saved a cool $10k. I’m beginning to grow the right receptors for masochism; the dull pain of that kind of loss is beginning to feel less and less novel.
On net, I’ve still made decent money during this crash, but it definitely isn’t the kind of return it once was. I’m still very net short and the last few days have been essentially nothing but rally upwards.
I’d be lying if it wasn’t uncomfortable, but to be honest I’m kind of wedded to it at this point. I remain convinced that we haven’t seen a shock like this since the world wars, and the bear market is far from over.
My capital-at-risk is sizable enough to indicate that I still have a lot of conviction that we’re headed lower, but it won’t be catastrophic if my shorts end up getting stopped out and my options expire worthless. Better to have tried and lost than remained an impotent spectator, I guess.
“Well, I guess if you fight a war long enough, you end up marrying the enemy.”
- Year of the Dragon (1985), a great but forgotten NYC noir
Thank you. Really, thank you so so much for taking the time to write this. You didn't have to do this, but the fact that you are willing to help a lot of us is a testament to your amazing values and principles. Appreicate it a lot, especially in such stressful times like this.
I appreciate the commentary on the dollar, but I still think a lot of very intelligent people in the USA clearly underestimate the impact of COVID-19.
All these figures and graphs in the above post are OUTdated. In a similar fashion, the narrative on the USD is now REDUNDANT if not completely IRRELEVANT already. This is not because somebody is lying or misinforming or mistaken. We are past the "True/False" debate at this point because people are waking up to the idea that a lot of their priorities need to be slamdunked in the massive rubbish plant cum graveyard called Planet Earth.
So, rather than trying to rewrite history before it happens like the USD Bulls and Bears are doing, investors should really keep their mind open to the fact that the world in which they operate has completely changed already. Therefore, using standardised measuring sticks in this four-fold crisis is akin to trying to fight Voldemort with chopsticks.
All is well and all the best. :)