How a Crash in the US Stock Market Will Happen:
A Bond Trading Desk Perspective with Monetary Data Science
There are plenty of articles and talk about a potential crash in the US Financial Markets. The majority of the knowledge base of people and their methodology is flawed, and most financial market traders are on the wrong side of the market. Below I will show how Speculators who are betting against the US Dollar will eventually cover their trading positions by selling their US Stock Market positions for cash and therefore cause a US Stock Market crash. My central premise is the betting against the US Dollar without knowing the estimated number of US Dollars and its sources is foolish. However, if you do not have time, then scroll down to part 3 and view the chart summary at the far bottom.
1. Background
The US Stock Market has never represented the US Economy because companies have been delisting their stock from the US Stock Market and not going public for decades. No Econometric or Data Scientist model proves the US Stock Market represents the US Economy. The shrinking dimensions and influence lead to a market type more manipulative by outside forces such as from a more representative US Bond Market. Later we will see how the US Government Bond Market is the cause, and the US Stock Market is the effect of a US Financial Market crash.
The US Stock Market has gone up so much in the past years for many reasons, but the primary narrative is the near-zero interest rates. One business in particular that has driven the upward trend is Repurchase Agreements or Repos. Cash generation from the Repos has financed many trading desks for various institutions as the bidding up of stock prices push demand over supply. Originating in the 1990s, the repo rates, especially for very short-term overnight contracts, have had a downward trend near — zero as the global financial markets’ financial plumbing layer. If interest rate levels in the US were higher, then the repo rates would provide less cash for traders and lower return rates in the US Stock Market. Later we will see how this directly affects the Global Money Supply of the US Dollar.
In addition, to contribute to US stock price appreciation, many companies are doing Stock Buybacks that reduce the supply of shares in the market, which again pushes demand over supply levels with favorable return rates. Public companies trading on US Stock Markets are not doing much with their earnings to contribute to the US economy. Company stock earnings contribute as income to Gross the Domestic Product (GDP), which is one crucial US Economy variable of many. The deviation of company stock price appreciation from company earnings contributes to the US Stock Market’s departure and its economy. There is more we can go here with carry trades that also generate cash for other trading desks, but the focus should be on the non — public investment sector, which has grown substantially in the past couple of decades in terms of private equity, venture capital, private lending and many other components that make up the Shadow Banking Industry.
2. Correcting the False Narrative
Where do the waters come from when they crash on a beach? Oceans like the US Dollar cause us to focus on proximity as we cannot judge the exact horizon in front of us or, more importantly, what is further beyond us. All we can do is inspect the immediate and struggle to withhold judgment. Whether visible or not, the operations of the Global Financial Markets are like an ocean that always works things out.
The current monetary system with the US Dollar as the reserve currency is widely misunderstood. We used to have a monetary system with good estimates on the quantity of supply to derive a price. In 1971, former US President Richard Nixon ended the Gold Standard when the fixed quantities of gold would drive economic transactions, but today we have no idea what the total quantity of US Dollars are available in the world. In 1976, after some iterations moving way from gold, the US Government legally defined the US Dollar within a free-floating exchange rate of currencies and the rest of the world followed. The geology of Gold and its mining of who discovers, maintains, distributes and prices the supply to money gave way to the financial economics of a Global Debt Based US Dollar Economy.
Since the 1970s, the quantity of foreign US Dollar deposits outside the United States has always been greater than the domestic US Dollar deposits because of the Euro — Dollar System and the Repo Market. US Dollar-denominated deposits beginning in Europe gave the label of a Euro — Dollar System as it grew exponentially, moving away from the Gold Standard, and again rose even more to other parts of the world. We have lost the global variable on the quantity of US Dollars worldwide to solve a global system of equations. Nobody is monitoring the foreign deposits of US Dollars that are layered, dynamic, and solidified into so many locations in so many countries for the past half-century. There has been a six-fold increase in the past two decades of global non — bank debt alone for the US Dollar from 2 to 12 trillion.
US Dollar Debt is the top dark blue line above, and then the debt in Euros, British Pound Sterling, Japanese Yen, and Swiss Franc at the bottom. To be clear, if all of the US Dollars reserves around the world were cut in half, then the US Dollar would still be the reserve currency. More importantly, the total quantity of US Dollar-denominated debt overseas is much larger than the total quantity of US debt in US households, US companies, or US governments.
For the past quarter-century, the engine of the Euro — Dollar System is the Repo Markets. Traditionally, increases in big commercial bank deposits would increase the quantity of the US money supply in the US economy like an unconstrained maximization function as many people would take figures from the US Central Bank, i.e., the Federal Reserve, like M1 or M2 to explain the quantity of US Dollars. Complexity was introduced by Repurchase Agreements between the Federal Reserve and private banks when their Repo transactions changed the quantity of the money supply. For decades, low repo rates have given incentives for private banks to raise cash for their business lines by selling securities to the US Government. The cash generation increases the US Dollar Money Supply regardless of commercial deposit levels, so it is more of a constrained optimization function to understand the quantity of the US money supply.
Lastly, to finish up this section with a much larger volume of influence in Global Trade Finance. With an impressive business and academic background, Andrew Collier found in 2017 that about half of the lending in China was in the Shadow Banking Industry was equivalent to $4.1 trillion, in his book, “Shadow Banking and the Rise of Capitalism in China”. The local money creation in non — US Dollars that is 25 trillion Renminbi catapulted domestic inflation leaving the Central Bank of China to conduct foreign exchange operations. Local Chinese businesses would export for profit, but it would be a loss if their local currency appreciated above the US Dollar, so the Central Bank of China would buy US Dollars to stop domestic inflation. In other words, a local shopkeeper would raise the price of their goods if there was more demand, but you cannot assume that if the customers have a different currency. To aggregate this logic across the dozens of countries globally, we see a persistent demand for US Dollars to stop domestic inflation to ensure exporting profits. Later, we will see how billions to trillions of US Dollar debt are always bought in the Global Debt Based US Dollar Economy.
3. Examples from the Bond Trading Desk
There are many ways to trade against the US Dollar so let’s focus on keeping it short on a financial product that has been persistently representative from a statistical point of view as the US 30 Year Government Bond. Less risky than a single direct cash injection of US Dollars is a schedule of conservative, secure, stable, and trustworthy financial market of US Government debt. Essentially a form of cash, just with a term — length and rate, the international and US domestic purchases of the US Dollar with long-dated US Government securities are typical for the past several decades, but currently, Speculators expect a disruption.
When a 1.80 yield is reached on the US Treasury Government 30 Year Bond and stays above 1.80, for days, weeks, but less than a month, then the quantity of US Government Treasuries available will be removed and become worthless. This false narrative that rising bond yields push bond prices down to financial ruin is based on an incomplete and incorrect knowledge base coupled with ignorance on the sources of demand of the US Dollar and US Government Debt. Primary Dealers, most of which are major banks, will buy at any price for their internal accounts, brokerage networks, and repo collateral collections because they can always find another buyer like a Speculator betting against the US Dollar via the US Government Debt market. Short positions from other major banks, Hedge Funds, and other Speculators have accumulated in 2020 in the Derivative Markets by borrowing from a Primary Dealer. The original US 30 Year Government Bond is with the Primary Dealer, and a duplicate in derivative contract form is with a Speculator. Aggregating across many operations in the Global Financial Markets, you have borrowed supply added to the Global US Dollar Supply.
Speculator short positions will need to cover their derivative contract positions as bond yields will not stay above 1.80 on the US 30 Year Government Bond and turn to sell their US Stock Market positions to raise cash. The fall in US Stock Market demand will plummet prices and cause a massive US Stock Market crash. Specifically, the Off–The — Run US Treasury Government Bonds, not issued recently, are the bond type Speculators betting against to profit in their trading books. The dealers who lent to short Speculators of the US Bond Market will require payment as stock selling for cash will be the only recourse because all derivative contract positions have an end date. From the chart below, it is likely the retesting of March 2020 lows of 1.20 and lower on the US Treasury Government 30 Year will cause a US Stock Market Crash.
4. Towards a Monetary Data Science
The focus should be on more data to understand the US Dollar relationships to the Global Debt — Based Economy such as in Foreign Exchange Markets, Global Trade, US Inflation, and the Shadow Banking Industry both domestically and internationally. After two decades of experience in both the business and technology sides for Hedge Funds, Big Banks, and other Financial Institutions, I have a lot of knowledge transfer that goes far beyond my bachelor’s degree from the Department of Economics at the University of California, Los Angeles.
First, what drives the global US Dollar Money Supply is the primary sources of the Federal Reserve, Big Commercial Banks, Foreign Central Banks, and the Domestic and Foreign Shadow Banking Industry. Every month, the domestic US Dollar Money Supply increases are neutralized by Federal Reserve operations such as Repos and even larger volume offsets overseas in critical exporting industries and the multi-trillion-dollar overseas Shadow Banking Industry. Countries outside the US hold about 7 trillion US Dollars in US Government Debt consistently for quite some time. (https://ticdata.treasury.gov/Publish/mfh.txt)
Even if we irrationally ignore the multi-trillion-dollar exporting industry in the world and dozens of domestic inflation issues with local currencies, then how would a US Dollar devaluation happen? If you expect the US Dollar to fall in value, then fall against what? The Foreign Exchange Market works with currency pairs so, the major currencies against the US Dollars are Euros, British Pound Sterling, Swiss Francs, Japanese Yen, and the currencies of Australia, Canada, and New Zealand that are also named the Dollar. A collective appreciation against the US Dollar would be a multilateral effort with the cooperative agreement of demand with no overwhelming idiosyncrasies. When has this ever happened at this multi-trillion-dollar scale in human history? There are even more currencies worldwide, so this is an irrational expectation, not to mention with no viable alternatives to the US Dollar. Foreign demand for US Dollars is not transitory but permanent because of exports at a minimum.
Second, the US Treasury Department’s auctions for US Government Bonds consistently demonstrate strong demand observations of the US Dollar from multiple bidders like a statistical survey. Every month the Federal Reserve requires 5 billion US dollars or more for their operations or 60 billion a year. (The Fed buys from securities dealers and not the US Treasury). The World Trade Organization (WTO) claims that exports are about 20 trillion US Dollars a year, whether destined to the US or not. One example of Foreign Central Banks buying US Dollars is the recent US Treasury auction on the 30 year below.
This is just one maturity point for one month of the year on the US Treasury Curve, so there is more like in the 10 year and even more like in the Shadow Banking Industry such as US Investment Bankers raising private US Dollar money for a foreign start-up. The Shadow Banking Industry is a variety of US financial products such as Securitization Vehicles, Structured Investment Vehicles, Asset-Backed Commercial Paper, Money Market Funds, Repos, Investment Banks, Mortgage Companies, but also non — US lenders like in China, India and many other countries with US Dollar Denominated Accounts.
Third, US Inflation is widely misunderstood and leads to further problems with so-called money printing by the Federal Reserve’s actions, especially the policy action of Quantitative Easing. From the start, the Consumer Price Inflation (CPI) is not an accurate measure of US inflation because it does not account for the costliest medical care in the world coupled with very high bills for university education. Furthermore, Quantitative Easing is a large-scale asset purchase program (LSAP) of US Treasuries and US Mortgage-Backed Securities when the Trading Desk of the Federal Reserve of New York buys from various securities dealers and injects an additional supply of reserves into the banking system. The security dealers do not hold the purchase payments but are instead stored in the reserve balances at the Federal Reserve so banks can lend. No Econometric or Data Science model proves Quantitative Easing is money printing, inflationary, or conclusive evidence of weakening the US Dollar because it is an expansionary monetary policy to decrease interest rates to raise the supply of lending by switching reserve accounts. For more, read the explanation from the Federal Reserve because Quantitative Easing is deflationary. https://www.stlouisfed.org/open-vault/2019/august/open-market-operations-monetary-policy-tools-explained
Fourth, during economic recessions in a particular country, region, or globally, US Dollar demand rises in a Global Debt — Based Economic because there is a perpetual US Dollar shortage. There is substantial evidence of US Dollars rising against other currencies, especially in the last Great Recession of 2008, which is the gray-colored area below by the Federal Reserve. The US dollar rises about 20% from the trade-weighted index from the high 80’s to around 105 or so . . .
Fifth, recent alternatives like open ledger currency products like Blockchain, Bitcoin and Cryptocurrencies would go against the massive demand trends like US private equity and the Shadow Banking Industry that has been going on for decades. Of course, I can understand someone with poor financial economics knowledge would believe in digital currencies, but as a current graduate student at Northwestern University studying Data Science, I do not think Blockchain, Bitcoin or Cryptocurrencies will overtake the US Dollar. Risks in Cybersecurity, enforcement of refunds, government regulations, and horrible price volatility compared to the US Dollar, to name a few problems. More importantly, a single market participant or an oligopoly may conduct a series of transactions to control the supply because of the classic financial problem called Cornering the Market. Not to mention, how do digital currency products work in Repo Markets and the dozens of Shadow Banking Industry products? We have to accept the nature of global finance will always have a significant bilateral component with no open ledgers that multiply non — digitally in various forms in a decentralized manner because there is no alternative to the concrete levels of trust, confidence, and price stability of the US Dollar.
In closing, most people will disagree with this article I have written in December 2020, and my arguments will have no value, regardless of how sound and logical. I am not pessimistic, nor do I lack any confidence, but I am realistic. We need to move towards a Monetary Data Science to help Financial Economics to find a target estimate of the Global Money Supply of US Dollars such as Feature Selection with Stochastic Optimization Algorithms. To make a long story short, the critical part of the overall code is below . . .
The Global Monetary System is not broken as it is evolving, changing, creating new (shadow) products, and most importantly, growing in various bilateral relationships with mostly opaque ledgers, but we need more visibility with better data. Today, the United States of America and its supreme US Dollar is the dominant economic engine above all other countries as the persistent low economic growth of Europe is like a museum, and the high average age in Japan is like a nursing home. The rest of us are struggling against impossible odds, so we must come to a thorough understanding. If the journey towards truth sells, then who’s buying?
