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Monday, December 25, 2017

America, Your Gift Is Still En Route

All of the following events happened in just ten days:

12/15/2017 – Bloomberg publishes a story about how Coinbase is working to expand its business by leveraging its relationship with regulators and leveraging the confidence investors have in it by virtue of the fact it hasn't been hacked. As of 12/15, bitcoin traded at $17,589.

12/15/2017 – Reuters relayed reports from South Korea that North Korean hackers were responsible for attacks on cryptocurrency exchanges throughout 2017, resulting in control over roughly $6.99 million worth of currency being stolen.

12/20/2017 – The House re-voted to re-pass an amended version of a previously amended version of a tax bill conservatively estimated to generate $1.48 trillion in deficits after virtually no Congressional members supporting the bill had read ANY of it. As of 12/20, Bitcoin traded at $16,359.

12/21/2017 – Goldman Sachs announced it was created a trading desk to facilitate trading in digital currencies for its clients and – Goldman Sachs does NOTHING purely for its clients – for its own account. Operations are targeted to begin as soon as June 2018. (Hold that thought…). Bitcoin closed at $15,530 on 12/21.

12/22/2017 – Bitcoin dropped from a high of $19,600 to $13,868, trading as low as $12,148 mid-day. And other crypto-currencies all dropped by more than 20 percent the same day.

12/23/2017 – Bitcoin trading closed at $14,583, reflecting a 20% rebound from the $12,148 mid-day low the day before. We're back baby!

12/24/2017 – Bitcoin trading closed at $13,827, down 5.2% from the prior day rebound.

12/25/2017 – A Los Angeles area psychologist delivered a large box of horse manure to the Bel Air residence of Treasury Secretary Steve Mnuchin with a card attached stating it was a return of the December tax bill, signed "Warmest wishes from the American People."


Even after dropping that last little holiday prank off the list, the remaining collection of events above should be raising the hair on the back of the neck of anyone capable of remembering what happened starting exactly ten years ago and WHY it happened.

The American economy began collapsing in 2007 due to the feedback loop created by the interaction of four crucial problems in markets:

1) a price bubble in the housing market fueled by fraudulent lending
2) incorrect risk assessments of banks due to over-confidence in securitization as a means of spreading risk from bad loans
3) continued participation in a bubble market by banks who knew better but coldly banked on their too-big-to-fail status as a guarantee from taxpayers if something bad happened
4) completely ineffectual regulation of financial markets by the government

Behind those direct factors, the larger economy was failing to produce new jobs beyond population growth despite the combined tailwind of wartime spending, large deficits and the aforementioned housing bubble.

With all of those factors combined, America's then $15 trillion dollar economy had zero margin for error when failures in the mortgage sector triggered liquidity problems in commercial paper lending segments that literally lubricate the economy and keep things moving on a daily basis. As investors caught wind of looming failures of one institution after another, the failure ricocheted into the core of the financial system, inducing a seizure in the entire economy. Economic output as reflected in GDP dropped $410 billion in 2008 from 2007, dropped another $40 billion in 2009, and didn't return to pre-crash levels until 2011.

However, those dry GDP statistics really don't convey the true cost of the collapse. In reality, many jobs just vanished and never came back, never to be reflected in unemployment statistics which don't capture adults who leave the market. Government spending and revenue, which had been creating deficits ranging from $161 billion and $413 from 2004 to 2007 jumped to between $1,087 billion and $1,413 billion from 2009 to 2012. If you assume there was some magic way to defuse the economic bomb wired by Wall Street leading up to 2008, then what the US government actually did by raising public debt to bail out massive private failures added nearly $3.4 trillion to the national debt that didn't need to be there.

In the present, you have news stories spread over a mere ten days that make it clear the financial industry and the government are wiring up a similar economic bomb to that of 2008. Oh sure, the trigger mechanism is different. In 2008, it was highly leveraged investments based upon fraudulent home mortgages and inflated real estate prices. In 2017, the trigger mechanism is financial institutions setting up trading desks for the benefit of "special clients" to participate in the bubble market of all bubble markets – cryptocurrencies built upon synthesis of new cryptographic token chains based on computing power that can be stolen via viruses to run algorithms no one in government understands.

At the heart of the cryptocurrency evolution is a question few seem to be asking. Exactly WHO is going to back Bitcoin? When you say it's worth $18,760 and I say it's worth $11,900, how is that debate going to be settled? The American dollar isn't worth what we think it is worth just because we have the most colorful flag or our accounting systems produce nice quarterly reports or we look honest. Our currency is worth what it is because other entities have SOME faith we will be around to pay our bills and operate our economy because we can protect that economy. That faith can (and will) fade over time but it certainly doesn't vary 40 percent in a day. A currency fluctuating that much in a month or a year is worthless as a store of value, much less fluctuating that much in a DAY.

To be perfectly clear, no one buying bitcoin on exchanges is "investing" in ANY productive sense of the word. Anyone buying cryptocurrencies at this point is playing the lottery or possibly trying to launder money to buy the fixin's for nuclear weapons. However, it's not Joe Public that we need to worry about if he's stupid enough to buy in. No one in government is going to backstop Joe's bet if he puts Junior's college money in Bitcoin, loses 40 percent of it and has to pack the kid off to Whatsamatta U instead of an Ivy League school.

No, the real worry is if a Wall Street exec bets big on cryptocurrencies they don't understand, leverages those bets with "real" assets, then produces a liquidity crisis after a 5-10 percent swing in the wrong direction. And what if one of those arrogant, testosterone fueled traders starts mixing his personal gambles on a cryptocurrency with his firm's book and no one catches it for a few weeks and he suddenly gets caught short – in the company's book?

It can't happen? It DID happen. Remember the "London Whale" working for JP Morgan? If you believe Jamie Dimon, that trader lost $2.3 billion over two months from attempts to hedge risks which instead magnified them, eventually wiping $10 billion off JP Morgan's stock price. And that happened AFTER the 2008 meltdown, when big banks were supposed to be far more cautious than they were prior to 2008.

And as an unsurprising footnote, it's worth mentioning that no one at JP Morgan wound up going to jail. US Attorneys dropped all charges after the trader, Bruno Iksil, changed testimony he was going to give in the trial of two other traders to state that he was hired by JP Morgan execs including Dimon as a cover for trading strategies they had already decided to pursue in 2010.

If another meltdown occurs, the government lending required to restore liquidity is unimaginable and the country's fiscal position has even less slack to smooth out a shock even if nothing else goes wrong.

Steve Mnunchin may have had a box of horse manure delivered to his house as a gag gift for the holidays. But don't worry America, your real gift is still en route. It's impossible to know exactly when it will arrive, but there will be no problem recognizing it when it comes. Sure as ****.