Use Your Illusions
What Happens to Asset Prices When All Is Well in "Dixie"land?
Before getting into what I really want to talk about today, I will state that yes, I know that Elon Musk’s Tweet flash crashed the digital asset market, and today’s edition of the newsletter isn’t about that because the market will likely bounce within a few days. I will quickly add, though, that I am sure the media will have a field day with Musk’s reading from whatever script one of his “environmentally conscious” board members handed him about how bad Bitcoin is for the environment (yet, none of these media outlets, nor Musk himself will state that somewhere between 39% and 77% of Bitcoin is mined with renewable energy and that this number will likely increase in years to come). It also seems odd to me that no one on the board of Tesla, an “environmentally friendly” company, seems to be all that worried about what mining lithium for batteries does to the environment, nor the human suffering associated with mining cobalt for lithium-ion batteries. Or maybe it was the U.S. government that handed him the script, since they’ve given Tesla $4.9 billion in tax subsidies. Who knows? It’s all noise. Zoom out.
For the record, below is what I think Musk really thinks about Bitcoin and its energy consumption, but he probably can’t say it because his hands are tied for one reason or another.
And if Musk and his board were really so against Bitcoin, they wouldn’t continue to keep $1.5 billion of it on Tesla’s balance sheet. So, instead of getting caught up in all of the hoopla, I am just going to share what I wrote yesterday and intended to publish today. So, please keep in mind that the below was written before the Musk-induced flash crash.
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Lots of red in the stock and digital asset markets yesterday. Why was that?
It was due, in large part, to the effects of what is illustrated in the chart below.
The U.S. Dollar Index, or the “DXY” (sometimes also referred to as the “USDX”, “DX”, or “Dixie”) is a measure for the U.S Dollar against a basket (group) of other currencies. Today, for one reason or another, the U.S. Dollar gained strength versus other currencies. I don’t know exactly what caused the strength of the dollar to rise today, but it could have been the fact that the Fed (The U.S. Federal Reserve) has been talking about raising lending rates in efforts to stave off inflation. To translate that last sentence into layperson’s terms, the Fed is lending money to major banks at an interest rate of 0% right now. Who wouldn’t borrow money at an interest rate of 0%, especially while the market is so hot? If the Fed raises this rate, banks might borrow less money, which makes dollars more scarce in the market. Often times, when something becomes more scarce, it also becomes more valuable. In short, if the Fed does raise rates, the dollar will likely become more valuable. When the dollar becomes more valuable, you can buy more with it, and that “more” includes assets. So, when we see charts like the one above, charts that show the dollar’s strength rising, we tend to see charts like the ones below, as well.
The S&P 500 v. the U.S. Dollar
Bitcoin v. the U.S. Dollar
As you can see in the charts above, both the S&P 500 and Bitcoin were down yesterday. The reason for this is not simply because the S&P 500 and Bitcoin suddenly “lost value”; it is that they “lost value versus the U.S. Dollar.” This is a key distinction to keep in mind.
I use these charts and what happened yesterday as a lesson, because similar to what happened in the Weimar Republic (Germany) in the 1930s, people thought that they were getting rich because asset prices went up by huge percentages very rapidly. However, it wasn’t necessarily that they all of a sudden owned assets that were worth more (though, that could partially be the case, like in the case of the stock for company like Zoom during the pandemic), it was simply that the currency in which these assets were priced was suddenly worth less (and ultimately worthless). And this is where Guns N’ Roses, my favorite rock band of all time, comes into the picture.
When Guns N’ Roses titled their epic double album of the early 90s Use Your Illusions, they were likely forecasting the way we would all come to view asset prices in 2020-2021. (Fun fact: Duff McKagan from GN’R actually went on to study accountancy and became an investment guru!) Obviously, Guns N’ Roses understood everything and made the whole world better for us with not only their rock, but their financial foresight.
They understood that one day, we would think that everything that we owned was increasing in value, when in reality, it was the denominator, the U.S. Dollar, and more broadly speaking, fiat currencies around the world, that were losing value. They knew that most of us would “use our illusions”, instead of trying to figure out what was actually going on. Your wisdom is infinite, Guns N’ Roses; I now see now what you were trying to tell us, and I thank you for it.
Also, I’ve been asking myself the following question lately: If we have printed 35% of the U.S. Dollars that ever existed in the last 10 months, does that mean everyone’s net wealth would have had to have increased by 35% in the process for them to have simply broken even? According to VC Naval Ravikant, the answer to that question is “Yes”.
My next question is, what percentage of purchasing power was lost for people who do not own assets that have inflated in price? Have they lost 35% of their purchasing power? I am hardly Captain Math-y Pants, so if you know how to calculate this, please share how to do so in the comments.
Please Give Back
Since I’ve already mentioned some of my heroes (Guns N’ Roses) in this edition of the newsletter, I am going to go ahead and mention another one, my aunt who works for Covenant House. CH is organization that works with homeless youth across the Americas. Both my aunt and CH do absolutely incredible work in helping to keep kids off of the streets and in helping them to not just survive, but thrive.
I’ve met a handful of the employees at CH and can vouch for the fact that they are mission driven and dedicated to the people that they serve. You can donate to CH here. Yes, yes, I know it’s harder to part with money when markets are down a bit compared to two days ago, but zoom out and realize that one, you’ve probably made more money this year in markets than in any other year of your life, and, two, you have a roof over your head, food in your belly, and a warm bed to sleep in, and many of the people that CH helps don’t. Even a small donation goes a long way with CH. And since today is my birthday, feel free to make a donation in the name of this newsletter.
Lastly, if you’d like to give me the best possible birthday present, I’d love if you could share this newsletter with some friends who you think might be interested in it. I’ve continued to enjoy growing this audience, and I would greatly appreciate any help you might be willing to give me in doing so!
Best,
Frank
Twitter: @frankcorva
Currently Listening To: “November Rain”, by Guns N’ Roses (Skip to 4:11 if you want to see what I imagined my life as an adult would be like when I was nine years old.)
I think Ran's take on Crypto Banter is plausible - that there is a bit of internal confusion at Tesla, and that Elon tends to go off on his own without getting all the decision-makers at Tesla to sign off on it first.
I think we'll start seeing a brighter spotlight on Elon's fraud. There a lot to admire about him but there's also a darker side to his business ethics that many folks turn a blind eye to.