jankythoughts2

Foreword

Beginning as early as Q1 2021, there was a lot of consternation from employers about an unusually large number of employees resigning. Coupled with a seemingly general lack of available candidates to fill in those empty roles, it seemed for the past year or so that a large number of workers just simply decided to stop working altogether.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

I quit!

The Great Resignation seems to have started around Q1 2021, though it really picked up steam around mid 2021 through the end of 2021 and into early 2022. A lot of ink has been spilled about potential causes, amongst which include job dissatisfaction, fear of Covid, as well as being unable to work due to Covid.

Left unsaid was how those folks were going to support themselves, especially since a large number of those who quit were relatively young, and thus not eligible for various retirement/social security schemes.

Anecdotally speaking…

From my personal experience, it seems like the enabling factor for many of these folks to essentially retire early, was a booming, speculative market, especially in crypto. Talking to various people in different forums, the common theme I’ve found, was that those who have decided to retire early all fell into one (or more) of the following categories:

• Got into crypto early, and at least at the end of 2021, had a large crypto portfolio.
• Began day trading stocks and/or crypto, especially since early 2021, and made semi-stable income from the trading.
• Made a lot of money speculating on options, especially during the Gamestop craze of Q1 2021.

Employment effects

The effects of the Great Resignation was easily predictable — as most of these folks seem to skew towards people in tech related companies, there was an acute shortage of tech employees, especially around Q3/Q4 2021. Many tech companies were offering double digit percentage increases in sign on bonuses as well as annual compensation — I’ve personally had multiple recruiters approach me with 7-figures annual compensation packages.

… and it’s gone

However, something broke in late 2021. When the Fed started talking about raising interest rates in Q4 2021, stocks and crypto started stalling. It was no longer possible to make ridiculous daily returns just by buying random short term calls.

At the start of 2022, this accelerated with dramatic (for that time) drawdowns in all 3 major US indices, cumulating today, with the NASDAQ composite down about 30%, and S&P 500 down about 20% year to date. Crypto fell anywhere between 70% to 100%.

And suddenly, instead of hearing friends and colleagues talking about early retirement, I start hearing about folks who had retired earlier starting to look for jobs.

Triple whammy

While some folks are starting to look for jobs again, the crypto market devastation resulted in multiple brokerages, funds and “banks” running into serious financial trouble. Three Arrow Capital was forced to liquidate, and rumor was it that their inability to settle their margin debts resulted in the insolvency of Celsius, BlockFi, Voyager, amongst others. Even Coinbase, previously seen as a bastion of stability in the US crypto market was not spared.

The stocks market drawdown(1) also has the market spooked, with many openly talking about impending recession, resulting in many companies, even large blue chip stocks, freezing hiring or even laying off employees.

These actions seem to be resulting in a surplus, at least temporarily, of tech workers, resulting in a triple whammy for those looking for jobs:

• Portfolio losses
• Increased competition from retrenched workers
• Reduced job openings due to companies tightening

Short term

In the short term, it seems like there’s going to be pain all around in the form of higher prices, higher unemployment, lower wages(2), lower consumer demand, lousier economy.

On a lark, I’ve initiated some small sized, short term, short positions(3) — you can follow the trades (made on 6/29) by following me on StockClubs(4). Let’s see how that goes!

Footnotes

1. Note that I’m only calling it a “drawdown”, as opposed to “meltdown” or other more bombastic terms as others have used. Because, honestly, 20-30% isn’t that big a deal. If this gets really bad, then we ain’t seen nothing yet.
2. To be clear, it seems like wages are still going up, though slower than inflation. Also, I was referring specifically to tech workers.
3. As always, this is not financial advice. I’m playing with a very, very small portion of my portfolio here, and it’s more gambling than anything else.
4. Full disclosure — StockClubs is an app founded by a friend, and I have made a small investment in that company. I am definitely conflicted with regards to the success of the app.

Foreword

It seems nowadays, just about everybody is complaining about the Federal Reserve’s “money printing” via Quantitative Easing (QE).

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Thought experiment 1

Let’s say you give me a $1 note. In return, I give you another $1 note.

Thought experiment 2

Let’s say you give me a $1 note. In return, I give you 4 quarters.

Thought experiment 3

Let’s say you give me a $1 note. In return, I write you an IOU saying that I owe you $1.

Additionally, I create a reasonably widely used infrastructure that accepts that IOU as payment for services and goods.

Finally, I subject myself to annual third party audits, which verify that as long as that IOU is outstanding, I indeed hold that $1, at all times.

Consider

I think in the first 2 cases, everyone would agree that whatever I gave you, is worth exactly $1, which is also exactly what you gave me.

In the 3rd case, it becomes a bit more iffy. Some people would say that the IOU I handed you is fiat, and in a sense they’d be correct.

But assuming that everybody is acting in good faith, i.e. the $1 backing that IOU exists, I think it’s fair to say that the IOU is indeed worth $1.

Banks

Banks generally work on the basis of Thought experiment 3 — a depositor gives the bank cash, which the bank keeps on its balance sheet. In exchange, the bank creates an account for the depositor indicating the bank owes the depositor $1, the IOU in question.

There are multiple money transfer networks (ACH, debit cards, FedWire, etc.) which allow the depositor to spend that $1 the bank owes them, and at least within the USA, these networks are widely accepted.

At the same time, the bank is subject to frequent third party audits, as well as various strict regulations to ensure that the $1 it claims it holds on its balance sheet actually exists in some form (1).

In short, most people would probably treat bank account balances as “money good” — as long as the bank remains solvent.

Money market funds

Money market funds generally work by taking money (cash) from investors, and then investing that cash in short term bonds, either corporate or government. In exchange for the cash, money market funds similarly create accounts for the investors, indicating that the funds owe the investors the amount invested.

Because bonds are fixed income assets with a predetermined maturity date and fixed coupon payments, the present value of the bond fluctuates over time — if interest rates go up, the current value of a bond will drop.

This presents a problem for money market funds — they are supposed to have $1 on their balance sheet for each $1 invested, so if the value of their holdings can fall arbitrarily, it seems like they are breaking the rules?

In general, this works out via 2 means:

1. Not every investor will want their money back at the same time. So the fund generally only needs a relatively small portion of its assets in actual cash to meet redemptions.
2. Since the bonds are short term, they’ll generally expire in the near future. While the present value of a bond can fluctuate based on interest rate, the terminal value of a bond (i.e. par payment + all coupons) is nominally fixed in value. That is, if the fund simply waits until all its bonds matures, it’ll have more than enough cash to meet the redemption of every investor (2).

Together, these allow for money market funds to be extremely stable in value, despite their underlying being subject to market pricing forces.

Like banks, money market funds are subject to frequent third party audits. Many brokerages and banks allow the use of money market funds in lieu of the customer keeping a cash balance to pay for their purchases, which effectively means that these money market funds are widely accepted for payments of goods and services.

In short, most people would probably treat money market fund balances as “money good”.

Stablecoins

There are 2 main types of stablecoins — algorithmic stablecoins which try to control the value of the coin via some sort of balancing algorithm and backed stablecoins, which keeps assets to offset the coins issued.

Algorithmic stablecoins have a terrible reputation, with multiple such coins “breaking the buck” and going to $0 (or close enough) within just the past few years. For our discussions, I am not talking about these.

Backed stablecoins, on the other hand, are supposed to hold assets that fully back their outstanding issued coins — for every $1 the stablecoin takes in, it issues $1 worth of stablecoin, while holding that original $1 taken in in some account.

Now, to be clear, there are a lot of problems with stablecoins:

• As far as I know, none of them are audited by well regarded, third party, large auditing firms.
• A lot of them are technically securities under the laws of the USA, which means that they either need to be registered with the SEC, or can only be sold to accredited investors. As far as I know, none of them are registered, yet all of them are sold to anyone who cares to buy them.
• A lot of them run on relatively immature infrastructure, which can have unforeseen problems (such as temporarily breaking the buck) during periods of high volume or stress.

But at least at a high level, stablecoins basically look like money market funds.

Generalization

In all the above, the process is similar:

• Entity takes Value from Customer.
• Entity holds Value on its balance sheet.
• Entity issues IOU to Customer.

Whether Entity is a bank, a money market fund or a stablecoin, whether Customer is a depositor, an investor or a speculator, whether Value is actual dollars or some other representation of value, and whether IOU is a bank statement, a money market fund statement or a stablecoin, the results are essentially the same — Value is transferred from Customer to Entity, and Entity issues an IOU, which Customer than can use to represent the Value given up.

Federal Reserve

And finally, we get to the big one. The one that everybody is arguing about.

Officially, the US dollar is a liability of the Federal Reserve, which is why the official name of the US dollar is “Federal Reserve Note” — “note” is a financial term meaning “short term debt”. Each US dollar is actually an IOU from the Fed, indicating it owes you $1 in value.

When the Fed conducts Quantitative Easing, what it is doing is buying Treasuries and other types of assets on the open market, in exchange for US dollars it essentially conjures up. The steps are:

• Fed takes Value from bank (the Fed only trades against banks).
• Fed holds Value on its balance sheet.
• Fed issues US dollar to bank.

Again, “US dollar” is, literally, an IOU issued by the Fed. Does the above process sound familiar?

In this case, Value generally takes the form of US Treasuries (3). In more recent cases, the Fed bought mortgage backed securities (MBS) and corporate bonds.

Most people would probably be fine with US Treasuries — if the US Treasuries default, we’ll have bigger problems to worry about, so most people treat US Treasuries as essentially “money good” (4). But MBS and corporate bonds are another matter — these can default, and they default quite often. What then?

Well, the Fed doesn’t actually just buy MBS nor corporate bonds. Instead, the Fed is actually buying the MBS/corporate bonds, as well as a put, an insurance, from the US Treasury. Effectively, if the MBS/corporate bonds default, the US Treasury has to reimburse the Fed any losses.

Effectively, balance sheet of the Fed is entirely backed by the US Treasury.

Just to clarify

So, just to clarify:

• In the case of banks, money market funds, stablecoins and the Fed’s QE, effectively some entity is taking value in exchange for an IOU indicating the same value.
• In all cases, the value is kept on the entity’s balance sheet, via an asset ultimately backed by the US Treasury.
• In all cases, the IOU issued is essentially conjured out of thin air.

As far as I can tell, very few people are really concerned about banks and money market funds. Some people are concerned about stablecoins, yet others are not. And funnily enough, the people not concerned about stablecoins, tend to be the ones most concerned about the Fed’s QE.

Huh.

Money printing

Many people call QE “money printing”. Technically, it is accurate — money, in the form of US dollars, is indeed conjured out of thin air.

But the term “money printing” hails from another time, when monetary and fiscal policies were both controlled by the same government entity, and the conjured up money was not used to buy up assets kept on balance sheets (effectively backing the conjured money), but instead spent.

Yes, in its original form, “money printing” is highly inflationary, but the modern day QE form of “money printing” isn’t quite the same, and as explained above, and in the prior “Inflation Model“, isn’t really inflationary, at least not without a fiscal component.

Fiat/currency debasement

Another common complaint is that QE is fiat/currency debasement. It is not.

Debasement is defined as the lowering of the value of the currency. Originally, this hails from government entities literally reducing the percentage of precious metals used in minting coins. In the modern day, it refers to the printing of money without a corresponding increase in output.

However, an exchange of value, as I’ve explained above, doesn’t really debase the currency. Just like nobody will say that Thought experiments 1 and 2 debases the $1 or 4 quarters I give you, most people should intuitively understand that the IOU given in Thought experiment 3 or the bank account statement or the money market fund statement, or the US dollar, isn’t really debased in the transactions noted above.

Liquidity

The problem, it seems to me, that most people have trouble wrapping their heads around, is the issue of “money supply”. They will point at M1/M2 during periods of QE, and correctly note that money supply goes up. But that’s mostly an illusion — as noted above, Value can take many forms. The main difference between a US dollar, and IOU issued by a bank backed by a US dollar, is that the US dollar is more widely accepted and thus counted as part of M1/M2, while the IOU is not (it is part of M3).

The issue isn’t that “value is created out of thin air”, it’s just that value has shifted in liquidity — QE shifts assets, such as Treasuries, MBS, corporate bonds from less liquid forms of money supply to more liquid forms of money supply.

In other words, QE shifts assets in M3 and above, to MB, which is part of M1 and M2 (see https://en.wikipedia.org/wiki/Money_supply for definitions). That’s why QE is said to be “providing liquidity” to the system — it is, literally, converting less liquid assets into more liquid ones via the Fed’s balance sheet.

This isn’t to say that QE is “good” or even “neutral”. There are issues with increasing (or decreasing) liquidity in the system via shifting the liquidity of assets. There are issues with an entity with essentially unlimited money putting out price insensitive bids on assets. But that’s not quite the same as “fiat/currency debasement” or “money printing” (the original, bad kind).

Footnotes

1. Technically, banks don’t hold actual cash on their balance sheets against deposits. Instead, the money is invested, similar to money market funds. However, the regulations are different because banks can invest in more risky assets, which subject them to a lot more rules to prevent bank failures.
2. I’m intentionally skipping the potential for bonds to default. In practice, market market funds buy very high quality bonds (government bonds, etc.) or buy insurance for any risky bonds for the bulk of their holdings. So while the possibility of a fund “breaking the buck” is not 0, it is extremely small. In reality, since such funds were introduced in the 70s, only 2 have ever “broken the buck” (fell below $1 per $1 invested). In both cases, the losses were relatively small (under 10%) and regulations were introduced to prevent similar issues from happening.
3. The confusion many people have, is that Treasuries are issued by the Fed, which seems to make the whole thing circular. But that’s not true — Treasuries are issued by the US Treasury (hence the name “Treasuries”), which is part of the government. The Fed is technically a private bank owned by other private banks (US banks are its main shareholders). Also, even if Treasuries are issued by the Fed, we just go back to Thought experiment 1 and 2 — while silly, the argument still stands.
4. Large institutions actually frequently conduct trades by paying with US Treasuries instead of actual cash.