The Hindsight Depression

lynalden.com/january-2021-newsletter

January 9, 2021

Recent Articles:

The Fraying of the US Global Currency Reserve System

This newsletter provides some historical context about the Great Depression, goes into
detail about the current economic situation in terms of how it relates to that depression,
and gives an overview of recent portfolio changes and ways I’m continuing to position for
the macro environment.

The Great Depression (1930s)

The Great Depression of the 1930s was one of the hardest times in American history, and
it had a profound impact on fiscal and monetary policy for the next century thereafter.

Leading up to the 1929 economic crash, substantial financial leverage piled up in the
system. When it came crashing down in the 1930s, it brought the banking system down
with it. Unlike 2008, however, there was no immediate bail-out, so outright deflation
occurred. The broad money supply (M2) contracted by 30% as thousands of banks went
bust, with no FDIC insurance for depositors.

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Data Source: US Census, Historical Statistics of the US Colonial Times to 1970

During that time, the unemployment rate was in the mid-teens for a decade straight, and
reached a peak rate of 20-25% during a four-year period from 1932 through 1935. Brutal.

On top of that, the world engaged in a trade war. The US passed the Smoot-Hawley Tariff
Act in 1930 to raise tariffs on thousand of imported goods. By 1934, with a new
government, this trade situation was reversed, but it wasn’t until post-WWII that
globalization fully opened back up.

As a final rotten cherry on top, improper farming techniques combined with a period of
droughts in the United States led to the Dust Bowl during the 1930s. Farming became
impossible in key parts of the country and massive clouds of dust rampaged the
landscape, devastating farmers and forcing millions of people, in extreme poverty, to
migrate cross-country in search of better opportunities.

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“Dumpster fire”, I believe, is the correct economic term to describe this combination of
problems.

The Hindsight Depression (2010s)

Alternative financial media often speculates about what would happen if the US were to
encounter another major depression: something as terrible and long-lasting as the Great
Depression.

However, the unfortunate truth is that by many metrics, the US and much of the rest of
the world have already been in a mild depression for the past 12 years, ever since the
2008 global financial crisis. It’s just not as obvious as the 1930s depression, because
higher levels of technology and anti-deflationary monetary policy disguised it in a
nominal sense.

Images of millions of people unemployed and hungry, with droughts and clouds of dust
blotting the landscape, are what we imagine a depression to look like. And in certain
developing countries, that’s still what a depression can look like.

But in a 21st century developed economy, assuming no total economic collapse or raging
environmental disaster happens, a depression doesn’t necessarily need to be that over-
the-top.

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A depression is characterized by a sustained downturn in economic activity, often with a
major banking crises occurring as well. Advanced technology can disguise its effects,
mitigating them in some ways, and the soaring values of tech stocks can conceal the
economic rot under the surface.

Another way to put it, is that if you had to go through a depression in the 1930s or the
2010s, it’s preferable to do it in the 2010s, when technology is way better.

And yet, when assessing the macroeconomic landscape and thinking about overall asset
allocation, it helps to contextualize the fact that, if we strip away the high-tech veneer,
we’ve been in a twelve-year mild depression in the United States. This also holds true for
large swaths of the world including Europe, Japan, and Latin America.

This depression was due to a series of events including the bursting of a long-term debt
cycle in the United States, Japan, and Europe, followed by a strong dollar period and a
gradual breakdown in the functioning of the global monetary system. We haven’t had a
true global economic “boom” in over a decade, and are facing a demographics shift.

The Long-Term Debt Cycle

This is a chart of total debt as a percentage of the GDP over the past 100 years for the
United States, along with short-term interest rates:

And here’s a chart that shows federal debt held by the public as a percentage of GDP and
nonfederal debt as a percentage of GDP as separate items, showing the one-two punch of
a private debt bubble and a public debt bubble about a decade apart that characterizes the

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peak of a long-term debt cycle:

A comparison I’ve made a number of times over the past year is that in many ways the
2010s were a lot like the 1930s, and the 2020s are shaping up to be a lot like the 1940s, in
terms of monetary and fiscal policy.

1930s: Private Debt Bubble, Banking Crisis, Disinflation

After the 1929 peak, a recession and major asset price collapse began. In the 1930s, total
debt as a percentage of money supply and GDP peaked, but it was primarily a private debt
bubble. Federal debt as a percentage of GDP was pretty low, while private debt was
extremely high. This massive crisis and deleveraging event resulted in a banking crisis
and the biggest economic contraction in US history. Banks were recapitalized with a
number of mechanisms including the devaluation of the gold peg. The first few years were
sharply deflationary, but then the dollar devaluation and bank recapitalization turned it
into a mildly reflationary environment, and the overall decade saw relatively low inflation.

1940s: Federal Debt Bubble, Wartime MMT, Inflation

By the 1940s, private debt had gone down considerably as a percentage of GDP due to a
combination of deleveraging and expansion of the money supply, but due to World War
II, federal debt skyrocketed. This era of wartime finance was inflationary due to massive
spending and industrialization, with peak federal deficits exceeding 30% of GDP.
However, the Federal Reserve used yield curve control (which was basically quantitative
easing; creating dollars to buy Treasuries as needed) to peg Treasury bond yields below
2.5% despite double-digit inflation. I’ve described this period as “wartime MMT” due to

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the combination of massive fiscal deficits and the central bank creating new bank reserves
to fund a lot of the bond issuance associated with those fiscal deficits. Treasuries and cash
significantly underperformed inflation for the decade, and so the government inflated
away a sizable chunk of its excess debt.

So far, we have an echo happening in the 2010s and 2020s, since we’re at the same phase
of the long-term debt cycle.

2010s: Private Debt Bubble, Banking Crisis, Disinflation

After the 2007 peak, a recession and major asset price collapse began. Total debt as a
percentage of GDP peaked in 2009, but it was primarily a private debt bubble. Federal
debt as a percentage of GDP was moderate (about 65%) at the start of the crisis, but
quickly grew to over 100% in the subsequent years as the private debt bubble was mainly
pushed up to the sovereign level. The massive private deleveraging resulted in a bank
crisis and the biggest economic contraction since the Great Depression. Banks were
recapitalized via quantitative easing, but due to the major destruction in other net worth
(stocks and houses) and several deflationary forces, and the fact that broad money supply
didn’t expand very quickly, it was still a disinflationary environment rather than an
inflationary environment.

2020s: Federal Debt Bubble, Pandemic MMT, Inflation?

By 2020, private debt had gone flat for a while as a percentage of GDP (household debt
was down while corporate debt was up), but federal debt began skyrocketing from an
already high 106% of GDP baseline due to the pandemic and subsequent economic
shutdown. Federal deficits reaching 15-20% of GDP in 2020 approached World War II
levels for the first time in modern history, resulting in federal debt levels rapidly moving
to 125-130% of GDP and likely higher in the years ahead. The Federal Reserve began
discussing yield curve control as an option, and bought a massive amount of Treasuries in
mid-March when foreigners and hedge funds sold hundreds of billion in Treasuries, and
the Fed continues to buy a significant percentage of Treasury issuance out of necessity.
Unlike the 2010s, the broad money supply went up extremely quickly in 2020, because
banks were already well-capitalized in this environment, so the combination of fiscal
spending and QE (“pandemic MMT”) injected those funds directly into the economy,
much like the 1940s.

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Chart Source: St. Louis Fed

The biggest difference in terms of policy choices between the Hindsight Depression and
the Great Depression, was the response time for the bank recapitalization and money-
printing. In the early 1930s, it took about 3 years to do, while in the late 2000s, it took
only months. As a result, during this second go-around, less private deleveraging was
allowed to occur, fewer banks failed, asset prices were more quickly reflated, and money
supply kept going up with no dip:

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Chart Source: St. Louis Fed

However, when we stop looking at things in dollar terms (because they are, after all,
expanding in number so rapidly these days), and start looking at things in terms of
fundamentals, we can see the similarities between the two depressions more clearly.

Flat Industrial Production

Here’s a century-long chart of US industrial production:

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Chart Source: St. Louis Fed

From 1930 to 1940, the US encountered a decade-long period of flat industrial

production.

Starting with World War II, industrial production began a rapid expansion, and despite a
series of pullbacks along the way, remained in a structurally increasing trend for over six
decades to 2007.

Since 2007, and in some ways since as far back as 2000, the US has been in another
industrial depression. During this period, the US offshored significant portions of its
industrial base to China and other emerging markets. The US’s industrial sector
represents a smaller share of its economy than most other developed nations in the world,
and is roughly tied near the bottom of the list of major countries in that metric, along with
France and the UK.

Flat Bank Stocks

During 2008/2009, several banks went bankrupt or were acquired during a period of
insolvency.

Some of the biggest ones, like Bank of America, survived in a crippled state due to share
dilution:

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Chart Source: F.A.S.T. Graphs

Bank of America stock has been in a 20-25 year bear market, and that’s in dollar terms.

In gold terms (as things were priced back in the 1920s/1930s), Bank of America stock is in
a 30+ year bear market. Some of the other big banks fared better, some fared worse, but
most have had issues with their stock price for about two decades.

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European and Japanese bank stocks are also in a multi-decade nominal bear market,
worse than US banks. Deutsche Bank, for example, is at half of the market capitalization
as it was twenty years ago, and its share price is one fourth of what it was twenty years
ago. Latin American banks have been flat and choppy for 12 years.

Only in a handful of countries, like Canada, Russia, and Singapore have large bank stocks
been any good in recent decades. Most of the world has been in a 10-30 year banking
depression.

Homelessness and Lower Life Expectancies

New York City’s population has been relatively flat over the past several decades, but here
is their number of homeless adults in shelters:

Chart Source: Coalition for the Homeless

Ever since 2008, twelve years ago, the number of homeless folks has skyrocketed. San
Francisco and other coastal cities have a well-known homeless crisis as well.

These economic problems also showed up in life expectancy. US life expectancy was rising
almost every year for decades straight. However, it peaked in 2014, and has been in a
multi-year sideways trend for the first time in decades.

This recent flat-lining in life expectancy has been a uniquely US phenomenon. Life
expectancy continues to increase in virtually every other highly-developed
country/continent. Life expectancy went up from 2014-present in Japan, the Euro Area,
Canada, Australia, etc. But not the US; we’ve fallen behind:

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Chart Source: World Bank

Even a few countries that MSCI still classifies as emerging markets have outpaced the
United States in life expectancy:

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Chart Source: World Bank

For the US, an uptick in “deaths of despair”, referring to deaths related to suicide, alcohol
abuse, and drug abuse, have played a large role in our diminishing life expectancy.

Here’s the chart of US opioid deaths:

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Chart Source: CDC

Here are US suicide deaths, alcohol-related deaths, and drug-related deaths:

Chart Source: TFAH

This is pre-pandemic data, through 2018. The government cracked down on opioids in
recent years, which helped bend the curve, but it’s unclear what the outcome will be post-
pandemic with so much economic hardship. There’s pain under the surface.

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This indirectly has a lot to do with the petrodollar system, as I described here. In order to
maintain global currency reserve status in the post-Bretton Woods system for the past 45-
50 years, the United States has undermined its middle class to a greater extent than most
other developed countries, by rendering its manufacturing sector uncompetitive and
running persistent trade deficits. This resulted in more outsourcing than most other
developed countries. The problems became acutely painful to many people over the past
decade.

Chart Source: Trading Economics

Macro analyst and CFA Luke Gromen, who is based in the Ohio area (one of the hardest-
hit areas by the industrial/outsourcing depression) has been highlighting those statistics
for years.

Those of us in the US that work in technology, finance, healthcare, or government have

done extremely well, while many folks involved with manufacturing or certain other
sectors suffered a lot of economic displacement.

As a result of this geopolitical policy and other fiscal policies, the median US net worth
(representing the middle 50th percentile, rather than the average), is lower than most of
our developed peer nations:

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Data Source: Credit Suisse 2019 Wealth Databook

The US has a lot of mean wealth, but not much median wealth, because our wealth is a lot
more top-heavy than most peer nations.

Germany on the chart is a unique case due to low rates of property ownership and high
reliance on a broad pension system. So, the median individual is pretty comfortable but it
doesn’t show up on their personal balance sheets. That leaves the US as the main outlier
on the chart in terms of the ratio of mean wealth to median wealth per capita.

Poverty is correlated with poor diet, obesity, substance abuse, and all sorts of health
issues. And the US continues to run by-far the most expensive healthcare system in the
world on a per-capita basis, which strains employers, individuals, and fiscal budgets.

2020s: Populism and Pandemic MMT

My base case is for a rather fast growth rate in the broad money supply throughout the
2020s, due to the combination of large fiscal deficits and continual central bank balance
sheet expansion to finance those deficits on the secondary market.

If that’s the case, the 2020s could look quite a bit different than the 1930s or 2010s;
perhaps more like the 1940s or 1970s in some ways, at least in terms of inflation and the
commodity cycle.

Meanwhile, the jobs market has been weak. Rather than a “V-shaped” recovery in jobs, it
has been a “backward square root sign” recovery. This chart shows the number of people
employed in the US:

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Chart Source: St. Louis Fed

The key risk now is to see if it rolls over and goes deeper into a lower-case “h-shaped”
recovery, or flattens out and then keeps grinding up slowly.

Rising Populism

After several decades of operating under the petrodollar system, with a widening wealth
gap and a hollowing-out of the industrial base, offset by bailouts for banks and
corporations, populism has been on the rise.

Populism is described by Britannica as “a political program or movement that champions,

or claims to champion, the common person, usually by favourable contrast with a real or
perceived elite or establishment”. It comes in many flavors, and can take rational forms,
irrational forms, and everything in between.

In 2010, this took the form of the Tea Party Movement from the right, and a year later, it
was Occupy Wall Street from the left.

It continued in 2016 with the election of Donald Trump on the right, a candidate outside
of the political establishment that was considered a longshot by most pundits at the start
of primary season, who ultimately won. Bernie Sanders on the left also came in stronger
than expected in the 2016 primary season, establishing himself as a national figure.

In recent years, populism has blossomed in myriad forms. QAnon on the right, Antifa on
the left, an uptick in hate groups, a rise in riots and protests, etc. In recent days, the US
Capitol building was stormed by pro-Trump rioters, resulting in a number of deaths
including protestors and a capitol police officer, as well as many more injured.

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Even the upcoming administration and legislative leadership group filled with long-term
establishment politicians (Biden/Harris/Pelosi/Schumer) is embracing ideas that a year
ago were more from the left, like federal student loan forgiveness and a third round of
stimulus checks. An August 2020 Gallup poll showed 70% of the country supported more
stimulus checks to the public. A week ago, the homes of Mitch McConnel and Nancy
Pelosi were vandalized with graffiti demanding more stimulus checks.

Some political analysts have suggested that McConnell’s reluctance towards $2k stimulus
checks, which were embraced by Democrats and President Trump alike (rather than
cleanly along party lines), played a role in the Democrats’ narrow win of Georgia’s
historically Republican-controlled Senate seats. Going forward, current news items are
suggesting that the Biden administration, with backing from Schumer and Pelosi, will
attempt another round of stimulus checks early in office, followed by a proposal for a
multi-trillion dollar infrastructure plan. Some Democrats, including Senator Joe
Manchin, are not fully on board, so we’ll see what passes.

Outside of these right/left dynamics, some folks such as Bloomberg’s Joe Weisenthal
argue that Bitcoin is a new religion, complete with prophets, apostles, sacred texts,
holidays, internal schisms, and frequently repeated sayings and incantations. Rather than
relating to metaphysics, however, it represents a cultural war against the global monetary
system as currently structured, with elements of libertarian politics and Austrian
economics.

However, out of the tens of millions of people that own Bitcoin, most are not part of the
“movement”. That cultural portion is perhaps numbered in the hundreds of thousands. I
studied the Bitcoin community extensively this year and got to personally know many of
the influencers, and advise a startup company in the space. Much of the Bitcoin
community’s memes are self-aware, and the community is manifesting itself as a form of
techno-populism that emphasizes self-sovereignty. Tons of smart developers and
financiers have been involved in the space for years. There are also folks on the Ethereum
side promoting a bankless life, based on decentralized finance blockchains.

This rise in populism throughout the 2010s, again, is similar to the 1930s, but of course it
takes different forms nearly a century later. Populism comes and goes in long cycles,
rising when something is seriously dysfunctional with the established system.

Within the broad tree of populism, however, different branches interpret the causes and
solutions for the problem in different ways. Some of those branches are more rational or
fact-based than others, but they all point towards economic pain and correctly sense that
something in the established system is dysfunctional.

When populism rises and hits a cultural shift, it tends to partially or radically transform
the existing system and institutions, becoming the “establishment” of the next system.
Whether that takes a light turn or a dark turn depends on which sorts of ideologies
ultimately win out.

Portfolio Expression

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A way to express a view of rising populism in a portfolio is by being long global stocks,
long commodities, and long scarce assets positions more broadly.

The US dollar seems to be undergoing its third major bear market within the post-1971
system vs a basket of major currencies, which tends to be very good for commodities and
emerging markets:

It’ll have bounces along the way, and we’re currently in one of those bounces, but it’ll be
key to watch the multi-quarter and multi-year trends here.

Besides the dollar specifically, most fiat currencies are debasing vs hard assets, due to
interest rates that are below the prevailing inflation rate, along with rapid growth in the
broad money supply.

Commodities have been in a bear market period of oversupply during the past 12 years,
due to a combination of emerging markets slowing down, the dollar strengthening, and
the rise in production of unprofitable shale oil. However, the commodities cycle may have
bottomed in 2020, particularly when the price of WTI crude went briefly negative.

The investment bank Stifel, with a chart shown in this MarketWatch article from several
months ago, directly links populism and reflationary commodity bull markets over the
past two centuries:

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Besides the sociopolitical outlook, I think that both the monetary/fiscal outlook and the
commodity capex cycle support this bullish commodities outcome in the 2020s decade.

It has already been showing up in some areas first, like gold, silver, copper, iron, and
uranium, but when it spreads to energy, which has had the most oversupply and is the
biggest commodity market, that’s when it starts to be rather inflationary for consumer
goods.

I also continue to be bullish on Bitcoin from current levels with an 8-month forward view,
despite being up more than 5x from my initial entry price in April 2020. However, by
many metrics, Bitcoin is overbought in the near-term. After such a strong run-up, it’s a
good time for folks to check and ensure that their position size is appropriate for their
unique financial situation and risk tolerance. There’s a difference between trying to
actively trade it, and making sure your position size makes sense for your portfolio’s
volatility budget.

Portfolio Updates
I have several investment accounts, and I provide updates on my asset allocation and
investment selections for some of the portfolios in each newsletter issue every six weeks.

These portfolios include the model portfolio account specifically for this newsletter and
my relatively passive indexed retirement account. Members of my premium research
service also have access to three additional model portfolios and my other holdings, with
more frequent updates.

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I use a free account at Personal Capital to easily keep track of all my accounts and
monitor my net worth.

M1 Finance Newsletter Portfolio

I started this account in September 2018 with $10k of new capital, and I put new money
in regularly. Currently I put in $1,000 per month.

It’s one of my smallest accounts, but the goal is for the portfolio to be accessible and to
show newsletter readers my best representation of where I think value is in the market.
It’s a low-turnover multi-asset globally diversified portfolio that focuses on liquid
investments and is scalable to virtually any size.

I chose M1 Finance because their platform is commission-free and allows for a combo of
ETF and individual stock selection with automatic and/or manual rebalancing. It makes
for a great model portfolio with high flexibility, and it’s the investment platform I
recommend to most people. (See my disclosure policy here regarding my affiliation with
M1.)

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And here’s the breakdown of the holdings in those slices:

Changes since the previous issue:

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I made rather few changes since the November newsletter. The coal ETF “KOL” was
delisted, so I sold that and shifted the funds into other industrial commodity producers. I
also slightly increased the allocations to ex-China emerging markets (RSX, INDA, ASEA,
ILF) in the international section.

Some folks ask me about Bitcoin as it relates to this portfolio. M1 Finance doesn’t have a
way to hold Bitcoin, but I hold it elsewhere. I do have MicroStrategy (MSTR) in the
portfolio as a small Bitcoin proxy. MSTR has more than tripled in price since it was added
to the portfolio this summer.

Primary Retirement Portfolio

My retirement portfolio consists of index funds that automatically rebalance themselves

regularly, and I rarely make changes.

Here’s the allocation today:

From 2010 through 2016, this account was aggressively positioned with 90% in equities
and enjoyed the long bull market.

Starting in 2017, in order to preserve capital, I dialed my equity allocation down to 60%
(40% domestic, 20% foreign) and increased allocations to short-term bonds and cash to
40%. This was due to higher stock valuations and being later in the market cycle more
generally.

After equities took a big hit in Q1 2020, I shifted some of the bonds back to equities, and it
is now 71% equities (46% domestic, 25% foreign), and short-term bonds and cash is now
down to 29%. For my TSP readers, this is equivalent to the 2040 Lifecycle Fund.

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This is an example of a portfolio strategy that takes a rather hands-off approach but that
still makes a tactical adjustment every few years if needed, based on market conditions,
which reduces volatility and makes the retirement account feel less like a casino than
many indices these days.

This employer-based retirement account is limited to a very small number of funds to

invest in, so my flexibility is limited compared to my other accounts. I would, for example,
have more exposure to precious metals, commodities, and digital assets in that account if
it were an option.

Other Model Portfolios and Accounts

I have three other real-money model portfolios that I share within my premium research
service, including:

Fortress Income Portfolio

ETF-Only Portfolio
No Limits Portfolio

Plus I have larger personal accounts at Fidelity and Schwab, and I share those within the
service as well.

The best-performing portfolio recently has been the No Limits portfolio, which I began in
June 2020 and is up about 42% since then despite relatively low turnover (mostly long-
term positions). As a normal brokerage account, I can include OTC securities in that
portfolio unlike M1 Finance, which gives it flexibility to hold things like the Grayscale
Bitcoin Trust (GBTC), which has been a nice source of alpha:

Final Thoughts
There’s an old saying that goes, “may you live in interesting times”.

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It’s a subtly ironic statement; on the surface expressing a blessing, but in reality
expressing a curse. Uninteresting times tend to be the peaceful ones, while interesting
times tend to be periods of turmoil and strife.

The year 2020 was unfortunately a very interesting one, and 2021 is shaping up to be so
as well.

Investors can reduce how “interesting” their portfolio action is by maintaining some
degree of diversification. Geographic diversification in equity exposure reduces
jurisdictional risks within any given country. Multiple asset classes give you a buffer
against rising and falling growth rates and inflation rates. Some spicy kickers, like Bitcoin
or uranium, can give you tail exposure to big moves without necessarily requiring large
positions.

From there, investors can choose how active to be. Some people prefer frequent trading,
while others prefer long-duration holding periods and more subtle tactical shifts when
needed around big trends.

Best regards,

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