TheCoin 2020–04

NOTE: This was originally sent to subscribers of https://thecoin.io newsletter in 2020. It’s been republished here mostly for easy later reference

Inflation and the price of eggs.

In the last several weeks, you may have noticed that your checkout bill from your local supermarket is higher than usual. There’s less of some items — specifically, fresh fruit and vegetables — and for the majority of our weekly purchases, there is a small, but noticeable increase in the costs. For example, there are reports of the price of eggs tripling in the last month. There are several reasons for this, and it’s useful to look at what’s happening through the lens of an economist and to consider what’s happening to the main driving force of all economies; supply and demand.

To begin, let’s take a step back and think about what that all means. Supply is basically everything that’s being produced. When strawberries are grown in Florida, for example, shipped 2500km north and sold in a Montreal supermarket, that is part of our supply of food. When we buy those strawberries and eat them, we are part of the demand.

Normally, supply and demand are fairly well balanced. Too much supply means there are more strawberries to sell, and the price of strawberries will decrease until more people buy them. When this happens, the people growing strawberries will make less money and fewer people will want to grow strawberries. Too much demand and the grocery store can charge more for the strawberries because the people who really want strawberries — and can afford the higher prices — will buy them. Growers will realize they can make a greater profit and will put more effort into growing strawberries, increasing supply until we reach a balance. This is what’s being referred to when people talk about the free market; when you have more of something, it generally decreases in price.

There’s a mirror-side to this equation that’s talked about less often, however; that money itself is simply another commodity that follows the same rules of supply and demand. As we increase the supply of money by printing new dollars, or decrease the demand by reducing our international trade, the value of our dollar reduces. We see the effect of this as all of our purchases becoming more expensive and call it inflation. Although there is a lot of variation year-to-year as the cost of the products goes up and down, the government tries to keep inflation overall at a consistent 2%.

This year is a bit different, however, and we are in an unprecedented situation. There are no economic models as of yet that account for a global simultaneous shutdown of all advanced economies such as this. However, we can use these basic economic principles to look at some of the really big shifts.

First, the Canadian dollar has been hit by a double-whammy of an increased supply and reduced demand due to the Covid-19 pandemic, which has forced the government to create an unprecedented emergency stimulus. This stimulus must be paid for, but with the corresponding drop in employment, the government is now receiving significantly less in taxes. The only way this can be paid for is by the central bank buying government bonds, essentially a form of printing money. We don’t know exactly how much, but we do know they’ve committed to printing a minimum of $5 billion every week until the crisis ends. This works out to $131 minimum for every person in Canada. For a 4-person household, that is $526 of value. Printing money increases the supply of dollars, and with all other things being equal, reduces the value of the dollar until it matches the demand. Printing money cannot create value, it simply moves it from those who have dollars in their accounts to those who control the printing press.

The other factor that has had a major impact on the Canadian dollar is the drop in the price of oil. As the price drops, it lessens the cost to produce many other products, which is a welcome relief. However, it’s also made it difficult for Canadian oil producers to sell their product, receiving far fewer dollars for it. When we export a product overseas, oil or any other product, the buyer needs Canadian dollars to pay for it. This is demand, as foreign currency is used to buy Canadian currency. So far, the value of our dollar has dropped by roughly 5% versus the USD. This may not sound like much, but if you have a family budget of ~$1000 for a month, it will now cost an extra $600 per year for exactly the same supplies. This is a substantial monthly increase.

While demand has undoubtedly dropped in the last month, supply has dropped much faster. It’s now more complicated and much more expensive to produce just about everything, and we need to pay for it with dollars that are consistently dropping in value. We would normally expect production to adjust, but in this time of global lockdowns, it’s unlikely to be resolved swiftly. Even though we don’t expect to see food shortages becoming a serious threat, we do expect to see the cost of our daily lives continue to increase in the medium term. Even once the lockdowns are over, the ripple effects are unlikely to bring our prices back to what we used to think were “normal”.

The coming recession, and why cash is trash:

The IMF recently released a forecast estimating that Canada’s economy will contract 6.2% this year. Judging by CERB applications, our jobless rate has leaped above 30%. These stark figures are on-par with the worst periods of the Great Depression. And all of this is happening in a country with $1.77 of debt for every $1 earned — the highest level in the G7. This is, quite frankly, terrifying. We recommend preparing for the worst. We hope for better, but hope is not a sound investment strategy. Despite the fact that we are almost certainly in for a global depression, we continue to firmly recommend that you move all of your assets out of cash. It’s the asset most likely to decrease in value in our circumstances, and this is mostly due to the lesson learned in the great financial crisis of 2008.

Most economists agree that monetary policy during the great depression made it much worse. In a very short explainer, we don’t really know what singular event started it all. We do know that as the crisis went on, people started hoarding cash. That meant there was less cash going around, which is the same as less supply, which means it went up in value. As cash went up in value, it meant businesses had to sell their products for less, which meant they made less money, which meant they struggled to pay their employees and get loans. As unemployment rose, people had less and less money, which created more demand for cash, and raised the pressure even further. This is known as a positive feedback loop. Positive feedback loops can create very powerful forces, and we find them in recessions and booms, viruses, and climate change.

History never repeats, but it does rhyme.

The fundamental reason we will not see a repeat of the Great Depression is that our dollars are no longer on the Gold Standard. As money stops moving, and it’s demand rises, the Central Bank can just print more of them to increase supply. Problem solved, right?

The lesson learned from the 2008 financial crisis was that we can print our way out of it. And it worked! As the economy slowed down, demand for dollars went up, and printing money simply counter-acted that effect. We didn’t see much inflation because while there was a lot more new money in the system, it mostly went to the wealthy. The wealthy spend far less as a percentage of their wealth and so the velocity of money continued to drop, and the value of money was maintained.

Today we are in what looks to be a worse crisis than 2008. In response, the government is printing money at an incredible rate. This is necessary, and we aren’t criticizing them for it. However, unlike the great depression, we are seeing a drop in supply greater than the drop in demand. This means higher prices and a lower value for the Canadian dollar. This is unlike either the Great Depression or the Great Financial Crisis. We expect this to continue, as supply stays tight but Canadians spend their emergency benefit. In fact, we expect it will accelerate considerably when restrictions are lifted and all the pent-up demand is released.

Cash has a consistent losing record, is uniquely vulnerable to crises like the one we’re currently in, and is the one asset that can be taken by governments at will. This is what makes it so risky, and is the primary reason why we think the right amount of cash to hold is $0. We are not alone in this view; Ray Dalio, manager of the world’s biggest hedge fund, shares this same mindset and provides an explanation in this video. We are only in the beginning stages of this global crisis, and already his predictions are beginning to come to fruition.

As stated above, this recession is unlike previous recessions in that we are suffering a severe supply-side shock. We would expect inflation to result even without the central banks printing money. When we add the two together, it seems more and more likely that cash is going to go through a very rough patch.

What should I do?

Sell dollars. Buy something that can’t be devalued at will. Both gold and stocks tend to do well against inflation. However, stocks do well in periods of normal growth as well, and this is the reason we based TheCoin on the stock market, rather than gold. Whether our predictions about the economy are right or wrong, stocks are the best long-term investment, and cash is the worst.

One of our primary reasons for creating TheCoin was to give every single person a safe place to shelter and expand their wealth. Considering cash is the worst asset to hold by far, we make it possible to eliminate it entirely. Normally, the poorer segments of society hold a large percentage of their wealth in cash, with unfortunate and completely predictable long-term consequences.

If you can afford it, you should look into holding some other assets too though. Being 100% in any asset is a risk. If you own a house, you are automatically diversified by having a large investment in real estate. Otherwise, owning gold is a reasonable option. We do not think bonds — or anything that earns interest — are a good idea. There is no way interest rates are going up in this environment, and you are certain to lose against inflation. If you would like more advice or guidance, we are happy to answer any questions or recommend asking some questions on reddits personal finance Q&A board. If you can only afford one choice, however, we recommend a simple index fund that mirrors the US stock market such as SPY for the S&P500, or TheCoin, which is similar but keeps the ability to be usable as a currency.

Does this mean the market will go up?

In the short term, we can’t say for sure, and neither can anyone else. The market is unpredictable day-to-day. The unforeseen future is exactly why we recommended in our last update to start buying when the market was 10% lower than it is now. We applaud those who took the plunge! There are countless studies that show time and time again that simply buying and holding is the safest option. Our position is indeed more aggressive than most but is based on the idea that we should recommend what is best for you, using well-researched empirical data. We don’t recommend risky options like trying to beat the market. 95% of regular people who do this fail, and even God couldn’t beat buy & hold as an investment strategy.

Conclusion:

Congratulations for making it to the end! We know this was a long read, but now more than ever it’s important that the basis of our major concern — inflation — is clearly explained. We hope you were able to gain some new insight, as there is a lot more research that goes into this than can be condensed into a 4 page summary. If you have any questions, we would be more than happy to answer them — just post on our facebook page, or alternatively reach out to us at info@thecoin.io.