Thesis Summary
The Fed is set to continue to raise rates and markets have been pricing this in for the past few months. However, a good investor stays ahead of the market and what I am pricing in, is when the Fed eventually loosens monetary policy again. I will discuss here some interesting new ways in which the Fed can loosen monetary policy, without necessarily loosening monetary policy.
Ultimately, this means that risk-on assets, like the Nasdaq and Crypto will do well in the medium to long-term, which is where I have my sights on.
The Invesco QQQ ETF (QQQ) and Grayscale Bitcoin Trust (OTC:GBTC) are two excellent vehicles to take advantage of this situation.
What’s the Deal with Inflation?
Inflation has been a hotly debated issue this year. It had been decades since we had these types of price increases and a lot of economists and analysts have finally been vindicated. For years, people have talked about how the Fed’s money printing would lead to this.
But that’s just it. The Fed has been printing money for over two decades, and inflation has only really materialized in the last year. Is this the effect of monetary policy? Let’s begin by reviewing some charts.
The first chart shows the Fed’s balance sheet, which has expanded over the last 10 years due to QE. Before 2008, QE wasn’t even a thing, and we can see that the Fed’s balance sheet did not grow at all. However, the Fed did begin to slash interest rates following the dot-com bubble so there was also “aggressive” monetary policy going on.
The other chart shows yearly inflation rates. Leading up to 2008, inflation was around the Fed target and growing. In 2008we had the housing crash and inflation disappeared. Following this, the Fed began with QE and inflation did manage to pick up somewhat. However, it began to taper off in 2012. The Fed increased its balance sheet more with some results but by 2020 inflation was just above 1%. And then, we got COVID.
Before we get into that I’d like to point out the clear difference between the decade before 2008 and the one that followed. We can observe that before the housing crash inflation was generally higher and had an increasing tendency. Since 2008 inflation has been generally lower and the tendency has been towards lower inflation. But how can that be? By any quantifiable measure monetary policy has been looser since 2008.
There are other forces at play here.
The first chart shows bank reserves at the Fed and the second Money Velocity as measured by M2.
Starting with bank reserves, there’s an obvious correlation between QE and the growth in bank reserves. The more QE takes place, the higher reserves go. The Fed tries to buy assets and provide liquidity, but banks don’t want to lend, not to the “real” economy anyway.
Proof of this can also be seen in money velocity. Money velocity is a measure of how fast a dollar moves through the economy. Leading up to 1999, money velocity was “healthy” and increasing. But since the Fed began to embark on ZIRP and QE, money velocity has been in a downtrend. This hasn’t changed even after returning to normalcy after COVID.
We can also see a strong relationship between money velocity and inflation. As velocity comes down, so does inflation. The bottom line is that it doesn’t matter how much money you print if you can’t control where that money goes and it explains why inflation has been falling despite more aggressive monetary policy.
But inflation now is at 8%, how do we explain that? Monetary policy did play a role, of course, and we can see that just the Fed printed more and faster than ever before. But there are more significant factors at play.
For starters, we got direct fiscal stimulus in the form of stimulus checks. Unlike money sitting in reserves, this money does flow into the real economy in a much more significant way. We also had direct stimulus in the form of loan programmes like PPP. The banks weren’t loaning before but with Uncle Sam ready to step in when things go wrong, they were happy to do so.
Lastly, we have to consider that COVID lockdowns created an unprecedented situation of pent-up demand and reduced investment in production. This misalignment, combined with supply chain disruptions has also led to an increase in prices, especially input prices like energy and commodities.
Here’s What Happens Next
What the Fed and western economies have been fighting for decades, is deflation, and I expect this trend to return in the medium to long-term unless the Fed does something about it.
The best way to understand this is that deflation and inflation are different sides of the same coin. When large amounts of “wealth” or debt have to be liquidated, this leads to deflation. Alternatively, inflation can get rid of these debts by making them worthless in the unit/currency that they are denominated in.
Deflation is “the market’s” preferred version of returning to normalcy and eliminating the excesses in the economy e.g. 2008 bubble. This process is painful, but it frees up capital which can then flow into more productive activities. This process of deleveraging is what the Fed and banking system have been trying to avoid for decades, maybe even as early as 2000, when rates were cut following the dot-com bubble. The Fed wants “tolerable” inflation, not deflation.
Therefore, while the Fed is raising rates now, to stop inflation, I believe inflation will stop itself in the medium to long-term. Western economies are still burdened with debt, which is slowing growth and money velocity. Eventually, the Fed will loosen monetary policy again and there will be new “tools” at play.
Firstly, I expect the Fed to soon raise its inflation target. Sounds crazy right? So did QE 15 years ago. This is a perfect way for the Fed to start loosening monetary policy, without actually loosening monetary policy. The current 2% target, is in my opinion already quite arbitrary, so why not make it 3% or 4%? While this may not be welcome, it will eventually be accepted, and ultimately there’s not much that could be done about it.
If you don’t believe me, watch as this CNBC host poses this question to an analyst.
So that’s the first step in loosening monetary policy, and it doesn’t even require QE or lower rates. Eventually, inflation will come down to earth, rates will be cut back again and QE restarted. And when that fails, it’s time to do the only thing that worked to raise inflation: Direct fiscal stimulus, this time, perhaps, with the help of CBDCs.
Unlike QE, which sits in bank reserves, the direct stimulus does create inflation. This can be done like last time, with government handouts, or it could even be implemented thanks to Central Bank Digital Currencies.
With CBDC every person could have an account at the Fed. Instead of QE just inflating bank reserves now QE could inflate everyone’s bank account, quick and easy with just the push of a button. This would be a game-changer and give the Fed the ultimate weapon to spark inflation.
Buy QQQ and GBTC to Stay Ahead of the Curve
So how do we play this? Will we have inflation or deflation? That depends on what the Fed does. Ultimately, you have to think of a future where the Fed is trying for inflation, but fighting a deflationary economy. For me, the best way to prepare for this is to buy “risk-on” assets, like tech stocks, which you can do through the Invesco QQQ ETF and Bitcoin (BTC-USD) which you can do easily by owning Grayscale Bitcoin Trust.
We can classify investments as “risk-on” or “risk-off”. Risk-on assets are equities, especially tech and high-growth stocks. As we can see, these types of investments have performed badly in the current tightening cycle but will be back in fashion soon enough.
The best way to get exposure to tech stocks is to own QQQ. This ETF tracks the performance of the Nasdaq. Around 50% of the stocks in the QQQ are in the tech sector, and 17% are in communications, which can also be seen as tech. This makes the QQQ a good way for investors to dip their feet back into tech, without suffering from the wild volatility that we have seen in individual stocks.
Furthermore, the QQQ has a healthy exposure to FAANG stocks, which are coming down to very attractive valuations. These mega-caps have performed incredibly well in the past decade, and I expect this trend to continue. For better and for worse, economic power is slowly concentrating into tech conglomerates.
GBTC, on the other hand, is a trust that owns Bitcoin, and therefore, tracks its price, to an extent. Let’s begin by addressing why you should own Bitcoin and then get into why GBTC is a good way to do this right now.
Bitcoin, for the last few years, has traded in line with the Nasdaq, like another “risk-on” asset. This means that Bitcoin will thrive in the environment I have described before. However, and as I’ve talked about extensively before, Bitcoin is also a store of value, and should perform well if and when inflation gets out of hand. Interestingly, this is not the case right now, Inflation has raged on and BTC has floundered, but we have also had a strong dollar. In any case, people still see Bitcoin as a speculative investment, but that is slowly changing. Adoption and usage are increasing, and in an increasingly politicized and fragmented world, Bitcoin is emerging as a decentralized currency that can be trusted by all.
So if you want to get into Bitcoin, GBTC is a great place to start. To begin with, GBTC can be easily bought from most brokerage accounts. You don’t need to go through the time and effort of going to an exchange. On top of that, your Bitcoin will be more secure with the Grayscale Bitcoin Trust than in an exchange. Of course, the most secure option would be to keep BTC in your offline wallet but that is adding yet another layer of difficulty.
Most importantly though, now is a great time to buy GBTC, since it is trading at a hefty discount, but it might not be for long. As of right now, based on the trust’s Bitcoin holdings, each share is worth close to $35. However, shares in the market are trading closer to $26. This hefty discount could quickly disappear if the fund succeeds in becoming an open-ended ETF. GBTC has been trying to do this for some time now, and I believe it will eventually succeed. Once this happens, the discount should quickly disappear through simple arbitrage.
Final Thoughts
In conclusion, while markets are pricing in rate hikes, I am staying ahead of the curve, by pricing in rate cuts. Tech stocks and crypto are the way to go for the next 5-10years and GBTC and QQQ are a great and easy way to gain exposure.
However, if you want to take things one step further, you can also buy individual tech stocks and altcoins, cryptocurrencies that aren’t Bitcoin. These investments have much more potential but can also carry significantly more risk. Finding tech stocks with high-growth potential and small cryptocurrencies that have yet to explode is what we specialize in at Technically Crypto.
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