THE DOLLAR, THE VIRUS, THE ECONOMY

Here’s my outlook on all three which starts with dispelling an important myth.

MYTH BUSTER: US DOLLAR IS “BACKED BY NOTHING”

This is simply entirely false. Quoting from my book “Blockchain Investor Manual”:

Currently, the US dollar accounts for at least half of cross-border trade invoices, an amount five times that of US exports and three times that of what the US imports. In financial markets, the US dollar accounts for close to two-thirds of global securities issuance and foreign-exchange reserves. Today, the US dollar is the basis for the world’s largest economic system, and the underlying asset for what is most certainly the greatest global payments network in history.

This chart from the book visualizes the Dollar as a System and helps us understand its levers of dominance:

Beyond its own economy (#1 in nominal GDP) the US enhances dollar utility by entering into agreements with some major exporters like Saudi Arabia to denominate their offshore oil sales in dollars (“petrodollars”), which ensures more involvement from US financial institutions and further extends their extra-territorial reach. Backstopping the regulatory support, the US spends more annually on the military than several of the other largest spenders including China, Saudi Arabia, India, France, Russia, United Kingdom, and Germany COMBINED. Viewed from this perspective, the dollar’s actual “backing” is quite substantial and valued at trillions upon trillions of economic, financial/legal, and military might. 

But like any system, regardless of its strengths it also has weaknesses and vulnerabilities (more on that later).

The Virus

This area I must clearly assert is only a matter of my opinion, I am no health expert – as such I would not want anyone to rely on my conclusions here. They are simply my own, but I state them nonetheless with this being the most important current fundamental, and hence formulating a weighted view is a requirement. 

With that in mind, once most economies re-open I think the effect of the virus will be much more subdued, based on the following:

• Herd Immunity: at least according to some medical experts more than half of the people in some major population centers like NYC are already infected;
• Most Vulnerable Already Mostly Impacted: from this figure may we also assume that the segment of the population most susceptible to mortality has already been disproportionately impacted?
• Ongoing Suppression Measures: many will continue, like the individual wearing of masks and more frequent hand washing, and workplace disinfecting.

Additionally, I don’t see another full-stop of the economy in larger part due to added medical capacity in facilities and supplies, including testing. In my opinion, the actual reason politicians' hands were forced into shutting down large parts of the economy in the first place wasn’t the increase in fatalities – we have heard many officials (including the President) assert that we as a nation already tolerate substantial fatalities per year from other transmissible illnesses and preventable accidents. What I do believe caused the shutdown was the lack of capacity at hospitals and even more sad at morgues – a crowding-out of other vital services and macabre scene that was simply intolerable. 

The Economy – Shape of 2020 Recovery

Adding to the above, I think the multiplier effect from many restarts will be high. For example, this two-story building in lower Manhattan across the street from me was in the process of adding an additional four-stories before the outbreak. 

They appeared about halfway thru completion (about another 6 months since it started late last summer) when a month ago NYC gave the order to stop all non-essential businesses, including residential construction. When it restarts the following will take place:

• Anywhere from 5 to 10 paid workers will go to the site daily
• Most likely they are coming in from other areas, thus paying transportation costs in tolls and/or fuel
• The materials delivered will of course be trucked and shipped in
• Importantly most of the materials they need like drywall, tiles, glass, and fixtures are not perishable and should be in plentiful supply (i.e. no supply constraints)
• The workers will support local businesses like lunch stops, coffee shops, and parking garages
• When the units get nearer completion, they will be sold and generate broker fees

While valuing each individual piece and their extensions is an exhaustive exercise, we can at least get a pretty good quick read on the broker fees: assuming the units sell for approximately $2.5 million apiece on average, at 5% commission that generates $500,000 in broker income. So this relatively small building alone is likely to generate well over $1,000,000 in marginal income (excluding developer return of capital from unit sales) in less than a year after it restarts – and we haven’t even mentioned the ongoing effects of mortgage payments and increased demand for local services when the new occupants move in. Of course, this is just one tiny piece of the City’s economy, and with similar activity taking place on many blocks across 5 boroughs one can see how this quickly adds up.

Conceding that not all businesses and supply chains can restart as quickly, rather than a Hard “V” I think we’ll likely see at least a “Soft V” (a description I borrowed from guitar neck shapes, for those interested).

Post 2020 Political, Economic and Dollar Risk

Whereas I think a good recovery is the most likely scenario for this year, it’s 2021 and beyond where I start getting concerned – REALLY CONCERNED.

In the US and other places isolationist rhetoric is starting to take hold, the idea being that “we can’t rely on foreigners for our supply chain.” That’s all well and good at least as it relates to building up capacity cushions (like the US does with strategic oil reserves), but to the extent it spills over into reducing international trade, it is downright lethal from an economic perspective. Specialization in production and exchanging surplus goods and services is as fundamental a component to a vibrant economy as can be imagined. For examples of what happens to an economy when access to international trade is severely curtailed, we need only compare those countries that have been blacklisted by the U.N. and U.S. relative to their nearest comparable (where they exist).

Clearly an economy more reliant on domestic production is looking at contraction, perhaps severe. With all the US dollars now in circulation this raises the further possibility of severe stagflation (low to negative growth combined with double digit inflation), a situation not seen in the US since the 1970’s. For the US the prospect is more serious than other industrialized nations; to understand why let’s revisit the Dollar as a System chart from the beginning of this article.

Yes it’s true the dollar has a staggering dominance on the global stage, which extends far beyond the size of its domestic economy, supported by non-US country exporters, a financial system the reach of which extends far beyond its borders, and a tremendous military advantage. However, its domestic economy is still quite large, nominally accounting for nearly 25% of the global economy. It is an integral component to dollar dominance, providing it with utility in foreign trade even when the US is not involved due to the reasonable expectation it will be useful for trading with the US too – the US economy cannot be extracted from the system without consequence.

Politics Not Aside, but Front and Center

So, in the case of the US not only would isolationism elevate the risk of stagflation, but also increase the chances of a re-ordering of the global financial system and away from the dollar. That the US is in a presidential election year most likely elevates these risks further, with both candidates currently competing to “out tough” each other on China relations (nominally the world’s 2nd largest economy). Before brushing this off as campaign rhetoric keep in mind such speech can shape policy especially when there’s a worked-up base.

In my opinion politicians would be wise to heed the warnings of history, resist the pull toward isolationism, and practice the gentler art of diplomacy and compromise. Perhaps something which will drive the point further home with both presidential candidates would be for them to consider the fate of both presidents elected in the US in the 70’s during its bout with stagflation: Carter failed to win re-election and Nixon resigned while facing impeachment.