Past Rate Hike Cycles and Why We're Likely to Skip a Few Steps Before The Next Crisis

I was watching CNBC for the rate announcement this past week when I heard something that dropped my jaw, but all the talking heads seemed to smile and nod at. Bill Gross had said, and I'm paraphrasing, that the Fed would not be able to get the fed funds rate much above 2%. Another panelist said he agreed because at 3% Corporate America would have no free cash flow. I'm not surprised by this, because I know how dependent business have become on cheap money, but to hear it from the bobble heads on CNBC without the slightest reaction was shocking. It should have been a collective "wait...what!" moment.

It got me thinking about past fed interest rate cycles and how it would be good to provide some charts to illustrate to myself and others what has happened, and what is likely about to happen in the near future.

In the below chart I took some liberties. I attempted to determine an equivalent negative interest rate for the various QE programs based on the duration and size. It was done for continuity and is far from perfect, but it gets the point across.

Bitcoin Price Implications if Craig Wright is Satoshi

Though certainly not 100% definitive, the evidence laid out in both the Wired and Gizmoto's stories on Craig Wright being Satoshi is the most convincing of all the possible candidates I have seen thus far. There are two possibilities, an elaborate hoax or he is the real McCoy. The truth will be revealed in time but it's worth discussing what the ramifications will be on the value of bitcoin if he is the creator. From my prospective there is good and bad news. I'll start with the good.

Bitcoin has had its fair share of price spikes, most being the result of minor monetary and banking crisis including price jumps as a result of the Greek debt crisis, twice, the Cypriot banking bail-in, and the Ruble crisis of 2014. I say that these issues were minor because they did not result in a systemic crisis and, at least for the time being, have been resolved. The other apparent catalyst has been a result of increased exposure for the crypto currency. The most notable being the US congressional hearings held in late 2013 which helped propel bitcoin's price. This spectacular rise in bitcoin was not the largest in relative terms but is by far the largest in dollar terms and was the direct result of the increased attention bitcoin gained from the congressional hearings.

The details of the Wired and Gizmoto stories about Dr. Wright's possible involvement in the creation of bitcoin read like a major Hollywood Blockbuster, and even with the added media attention, I don't think that the C-span congressional hearings would hold a candle to a movie starting Russel Crowe as Wright with his apparent partner David Kleiman being played by Steve Carrell. When Wright/Satoshi story broke, bitcoin saw an immediate $20 rise from the $390's to over $415. Much of the remaining rise to over $460 since may have been influenced by Chinese capital controls, but the increased media attention certainly didn't hurt. If Wright proved to be Satoshi, or part of what is known as Satoshi, the huge media attention and, as I see it inevitable movie, could see bitcoin rise easily into four figures. Short term it would be very bullish to see this story hold up.

Unfortunately, there is also the long run bad news. From everything I have read and seen, Wright seems to be a screaming libertarian who, if he is the inventor, did it with a raised middle digit to the banking industry, central banks, governments, and the rest of the money creation mechanisms of the world. This is supported by several points (if true of course). First was a little fact I picked up in the story. Wright allegedly attempted to build a pencil from scratch. This may not sound like much but it is a clear attempt to participate in the example Milton Friedman used to show the power of capitalism. This is the excerpt from the Wired story describing Wright and his attempt to create a pencil:

He's a climate-change denier, a serial entrepreneur who started companies ranging from security consultancies to a bitcoin bank, and an eccentric who wrote on his blog that he once accepted a challenge to create a pencil from scratch and spent years on the problem, going so far as to make his own bricks to build his own kiln in which to mix the pencil's graphite.

Here is Milton Friedman's illustration of the power of the free market with The Pencil.

You are not going to get someone to attempt this pencil experiment unless they are pretty obsessed with the free market. I love the example, but to attempt to construct a pencil myself would be a whole new level of fanaticism.

The second example of Wright's clear libertarian leanings, and government contempt, is shown when he discusses his supposed Tulip super-computer in the video below. Well not so much about the computer itself but why he called it 'Tulip'. It was a reference to the infamous Tulip bubble in Holland, but he mentioned it for a reason I had not known (again if true). He claimed that part of the reason the bubble popped was because the Dutch Government broke contracts for tulips. He discusses it around minute 9:00. I still need to do some research on the bubble to determine if his claims are true but again it shows his anti-government leanings.

In the same video, at about 14:15, Wright goes on about how it is trade that mainly differentiates us from animals, he also discusses, quite passionately, private property rights. This little rant makes him appears as if he is a screaming libertarian, if not a borderline anarcho capitalist.

My final piece of evidence is a story that recently broke indicating that according to court documents Wright attempted to buy 60 million dollars worth of software and gold using bitcoin. If true it would lend credence to Mr. Wright being Satoshi simply due to the dollar amounts involved, but again this is for others to determine. If again we assume he is Satoshi, buying gold would again indicate someone with an Austrian economic/libertarian bent.

The reason this is important to the long term price of bitcoin is clear, here is someone, that if he invented bitcoin, did it with the mindset of usurping governments and the banking industry from the money creation industry. I for one would love a world in which free markets determined the medium of exchange, and in that world I have little doubt bitcoin would take much of the monetary market share. Unfortunately we don't live in that world and as the loathsome Jamie Dimon indicates below, if governments around the world declare bitcoin illegal it will all but be destroyed. Of course you could not un-invent the blockchain technology, and it would be used, unfortunately it would probably be incorporated in national currencies. More of my thoughts on Dimon's video here.

Why is Wright's, or any Satoshi's, motivation important? Simple, if bitcoins creator is doing is as a big F-U to the government and banks they are waving a red flag in front of the of those money creation behemoths with likely dangerous consequences.

Many attempting to build infrastructure around bitcoin have been trying to distance the crypto-currency from its anti government grass roots in hopes of it going mainstream with the governments blessing. If Wright, or any other libertarian is the creator, that separation will be impossible.

So who would be the ideal creator. I would say a shy, political independent, computer cryptography genius, who's part of as many protected classes as humanly possible, spends as much time giving to charity as he/she can; who created bitcoin simply as a challenge, and the result just happened to be useful. Unfortunately, that probably won't be the case. If the creator is anything like Wright, it will paint a bulls eye on bitcoin. Full disclosure: I hold 0.2% of my portfolio in bitcoin and am slowly adding to the position.

Rate Hike?

My readers fully understand how the bull market in stocks have been the result of ultra easy monetary policy. During the entirety of the bull market of the last 7 years we have had interest rates stuck at zero, and thus Fed interest rate policy has been a constant. The variable has been the other monetary experiments, the four QE programs and operation twist. I divide up QE3 into two distinct programs, the main QE period and the Taper period. Below is a chart, not only showing the bull market, but its drivers, and I'm not talking about healthy economic expansion.