The Wizards of The Federal Reserve

  
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To investors,

The movie Wizard of Oz can teach us a lot about life. In the film, there is ruler of the Land of Oz that is highly respected by all of his subjects. The various characters in the movie believe that this prophetic ruler, the Wizard of Oz, can solve all of their problems, so they travel a long distance to speak with him.

As you would expect, this all turns out to be a sham. According to the Wikipedia description, “it is revealed that Oz is actually none of these things, but rather an ordinary conman from Omaha, Nebraska, who has been using elaborate magic tricks and props to make himself seem "great and powerful". Working as a magician for a circus, he wrote OZ (the initials of his first two forenames, Oscar being his first, and Zoroaster being the first of his seven middle names) on the side of his hot air balloon for promotional purposes. One day his balloon sailed into the Land of Oz and he found himself worshipped as a great sorcerer. As Oz had no leadership at the time, he became Supreme Ruler of the kingdom and did his best to sustain the myth.

History has taught us over and over again that the “great and powerful” organizations and people tend to be something different. Nowhere is this more obvious in real life than at the Federal Reserve. I thought of the Wizard of Oz this morning, while reading an article in CNBC titled “The Fed is expected to make a major commitment to ramping up inflation soon.

As you read through the piece, you realize that the Federal Reserve actually believes they are similar to the Wizard of Oz. The central bankers are finalizing a year-long policy review that is likely to end in a set of policy recommendations to keep interest rates artificially low for a number of years as they attempt to increase inflation and decrease joblessness. There is one major problem though — the Federal Reserve has been horrible at hitting their targets in the past.

The Federal Reserve has held a 2% inflation target for many years, yet they have only come within +/- 10% of that target 3 of the last 10 years.

This lack of accuracy and effectiveness around the inflation target is not necessarily because the Federal Reserve is clueless. In fact, there are an incredible number of highly intelligent people that work there. The challenge is that a large economy like the United States is a complex system that is nearly impossible to manipulate with nuanced control.

Due to this complexity and lack of control, I am worried that the Federal Reserve is about to embark on a path that could end disastrously. The general premise is that the organization will keep rates artificially low for an extended period of time. This should increase inflation and lead to less joblessness. Jeff Cox eloquently outlined the scary part though when he wrote:

“The Fed and other global central banks have been trying to gin up inflation for years under the reasoning that a low level of price appreciation is healthy for a growing economy. They also worry that low inflation is a problem that feeds on itself, keeping interest rates low and giving policymakers little wiggle room to ease policy during downturns.

In the latest shot at getting inflation going, the Fed would commit to enhanced “forward guidance,” or a commitment not to raise rates until its benchmarks are hit and, in the case of inflation, perhaps exceeded.

In recent days, Fed regional presidents Robert Kaplan of Dallas and Charles Evans of Chicago have expressed varying levels of support for enhanced guidance. Evans in particular said he would like to keep rates where they are until inflation gets up around 2.5%, which it has not been for most of the past decade.”

That is right — the Federal Reserve is talking about keeping interest rates low (probably at 0%) until we see inflation over 2% and potentially even higher than 2.5%. This is absolute madness for a number of reasons:

  1. The Federal Reserve believing that they have nuanced control of inflation and an economy makes little sense. They are batting .300 over the last decade, so they don’t exactly have the best track record with hitting their targets, nor being able to effectively manipulate various aspects of the system.

  2. Higher levels of inflation means that the wealth inequality gap will continue to widen. The rich will get richer and the poor will get poorer. Quite literally, this policy decision is a direct attack on the bottom 50% of Americans and their wealth.

  3. Every socioeconomic class experiences different levels of inflation. There are plenty of people who believe that coming out of the 2008 crisis the lowest socioeconomic classes saw inflation reach 6-10%, while the official numbers remained below 2%. If that is true (and I tend to believe that it is), than we could see the lowest socioeconomic classes experiencing 10-20% inflation with these new inflation targets and policies.

  4. Asset prices are already detached from economic reality, so a continued pursuit of higher inflation will only pump the asset prices higher. This extended detachment is the equivalent of kicking the can down the road. As I continue to warn, you can only do that for so long until you have to pay for your sins. The further the difference between prices and reality, the more painful the day of reckoning will be.

The worst case scenario would be a situation where the Federal Reserve overshoots their inflation target, we have continued economic issues, and they are caught in a situation where they can’t increase rates quickly and they are forced to print more stimulus. If that were to happen, the Federal Reserve would be accelerating inflation at the exact moment that they should be reigning it in.

I wish that I could argue that this scenario would be hard to see coming, but rather I think it is actually likely. We have seen time and again that the economy will start to gyrate and experience issues when the government stops printing money and tries to raise interest rates. By allowing inflation to overshoot in such a dramatic way (some analysts are predicting as high as 4% in the official numbers), we could be staring at an absolute decimation of the middle and lower class.

Just as the Wizard of Oz ended up being a regular Joe with no special powers, I believe the Federal Reserve will eventually be shown to be without magical powers as well. This means that investors can not blindly trust the government and Fed to protect their wealth, nor can they continue to believe that the decisions being made are in their best interest. Instead, investors must realize that low interest rates, massive quantitative easing, and artificially high inflation are all signs that asset prices are going to skyrocket.

My anticipation is that real estate, gold, Bitcoin and stocks are all going to run much, much higher than they already have. Bitcoin is going to be the largest winner out of all assets since it is the most volatile. Or as Paul Tudor Jones said, it will be the fastest horse. Regardless of how you invest your capital, just don’t get caught holding cash while the Federal Reserve is systematically devaluing the asset under the guise of creating economic activity.

The financial system is based on 50% of people not understanding how money works. Get yourself educated and position yourself to not only be protected from what is coming, but also benefit from it. The wealthiest people in the world aren’t sitting in cash when the Fed is aggressively going to work on rates and inflation. It probably makes sense for you to follow suit.

Talk tomorrow.

-Pomp


This installment of The Pomp Letter is free for everyone. I send this email to our investors daily. If you would also like to receive it every morning, join the 50,000 other investors today.


THE RUNDOWN:

Bitcoin’s Pause May Serve as Consolidation Before Push Higher: Bitcoin’s surge over the past week got a lot of hearts pumping. Now technical indicators suggest enthusiasts could see it make another major move higher soon. Based on its recent price trend, Bitcoin appears to be consolidating before its next jump, which could take it back to $12,000, a resistance level dating back to last August. Read more.

Anthony Levandowski Sentenced to 18 Months in Prison: Anthony Levandowski, the former Google engineer and serial entrepreneur who was at the center of a lawsuit between Uber and Waymo, has been sentenced to 18 months on one count of stealing trade secrets. Judge Alsup said that home confinement would “[give] a green light to every future brilliant engineer to steal trade secrets. Prison time is the answer to that.” Read more.

SEC Seeking ‘Smart Contract’ Tracing Tool That Can Spot Security Vulnerabilities: The U.S. Securities and Exchange Commission wants to procure a blockchain forensics tool that can analyze smart contracts and, preferably, highlight their security issues. Read more.

INX Scales Down US IPO Target to $117M – Still Set to Be Crypto’s Largest: Cryptocurrency and security token exchange INX has shifted its sights for a planned initial public offering in the U.S. The Gibraltar-based trading group filed an F-1 Form – a securities registration for non-U.S. issuers – with the Securities and Exchange Commission on Monday. Originally slated for Q2 2020, the sale is now expected to take place before the end of the year, according to the revised prospectus. Read more.

SpaceX Successfully Flies Its Starship Prototype to a Height of Around 500 Feet: SpaceX  has been developing Starship, its next-generation spacecraft, at its site in Boca Chica, Texas. The company has built a number of different Starship prototypes to date, include one prior version called the Starhopper that was essentially just the bottom portion of the rocket. Today, the company flew its first full-scale prototype (minus the domed cap that will appear on the final version, and without the control fins that will appear lower down on its sides), achieving an initial flight of around 150 m (just under 500 feet). Read more.


LISTEN TO THIS EPISODE OF THE POMP PODCAST HERE


Caleb Pressley is one of the most electric people on the internet. He currently works at Barstool Sports, runs the @thinker account on Instagram, and previously played football at the University of North Carolina. We had a blast recording this episode and I think people will find it entertaining.

In this conversation, Caleb and I discuss:

  • College football

  • Pro athletes creating content and building audiences

  • Social media trends

  • Default digital value of assets

  • Volatility as Bitcoin's PR team

  • Many behind the scenes stories of Caleb's escapades

I really enjoyed this conversation with Caleb. Hopefully you enjoy it too.

LISTEN TO THIS EPISODE OF THE POMP PODCAST HERE


We have started a new show exclusive to YouTube called Lunch Money. The goal is to cover current events in business, finance, and technology from the perspective of the every day citizen, rather than the talking heads on television. It is just as funny and entertaining as it is educational. Hope you enjoy it and make sure you go subscribe to the YouTube channel!


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