Re: Crude Oil/Inflation-Feedback Loops & Weimar Discussion.

One of the (only) fond memories I have from my first undergraduate physics course was when the prof showed us a video of the Tacoma Narrows Bridge collapse to demonstrate the concept of resonance.

Here is that video:

According to Wikipedia, “Resonance describes the phenomenon of increased amplitude that occurs when the frequency of
a periodically applied force (or a Fourier component of it) is equal or close to a natural frequency of the system on which it acts.”

Resonance is an example of how a positive (self-reinforcing) feedback loop creates ever-increasing oscillations that eventually exceed the physical limitations of whatever physical system is experiencing resonance.

Positive feedback loops are destabilizing in their very nature and tend to break things in their path. Sometimes it’s a bridge that gets wrecked. Sometimes it’s brick-and- mortar retailers that get wrecked. Sometimes it’s a financial market.

George Soros famously coined the term “reflexivity” to express the same notion applied to financial markets.

Tremendous gains can be made in the markets by identifying these trends early on, BUT the key is having the discipline to get out before some kind of physical limit causes something to break.

Negative feedback loops, despite their pejorative moniker, are actually stabilizing/self-correcting loops. In my early career as a commodities trader, I often heard the adage, “The cure of low prices is low prices, and the cure of high prices is high prices.”

Economics 101 and the basic law of supply/demand give an illustration of negative feedback loops in action.

In this interview, I presented my thesis about two potential feedback loops that may arise out of the insane amount of monetary/fiscal stimulus being heaped into the markets by the powers that be.

https://www.realvision.com/shows/the-expert-view/videos/is-crude-oil-the-best-inflation-hedge-and-other-oil-questions-9vpD?utm_source=twitter&utm_medium=social&utm_campaign=2021422_EXPVIEW_MR_TW_W1_LINK&tab=details

The first is a positive feedback loop: stimulus funnels $ into lowest wealth deciles of society -> most of this $ is spent on “opex commodities” like gasoline/food -> commodity price inflation disproportionately hurts lowest wealth deciles most -> need for more stimulus.

If this continues, what eventually “breaks” is the USD collapsing from its reserve currency status. I believe this is the narrative that is dominating all the current comparisons of our money-printing to the dynamics leading up to the Weiman Hyperinflation of 1923.

This angst, in turn, is driving the parabolic ascent of BTC as the only “way out.” To quote Sting, “I don’t subscribe to this point of view.” Let’s pause for a brief digression on Weimar.

First, the circumstances of post-WWI Germany were VERY different: 1) War reparation “debt” was almost 3x of pre-war GDP, 2) There was massive political instability with rampant assassinations pressuring the establishment to keep spending to assuage the “mob.”

The resultant hyperinflation came from extreme political instability leading to a total collapse in confidence of the Reichsmark as opposed to the amount of currency in circulation. Specific catalyst: France’s invasion of the Ruhr Valley when Germany missed its reparation pmts.

Despite the current (and worrisome) levels of profligacy of our government, we are neither close to those debt/GDP levels nor are we in that kind of extreme unstable political environment.

This doesn’t mean I don’t think there will be inflation. Quite the contrary. Because of the various dynamics I spoke about in the RealVision interview, I believe commodity price inflation will be the key to breaking the positive feedback loop that many fear.

In my talk, I spoke of a second, negative feedback loop: Commodity price inflation -> Bond market “taper tantrum” effectively wrests control of the risk-free rate (the linchpin of ALL financial assets) away from the Fed -> Absent YCC, this leads to a pricking of asset bubbles.

The reason why I’ve been paying so much attention to MSTR and BTC is because the asset bubbles I see most at risk are those that have benefited most from this hyperinflation angst, which I don’t buy into.

That said, I believe there WILL be potentially several commodity price inflation, but eventually, “the cure for high prices is...high prices.”

This is my base case. I don’t know when this happens, but I have a feeling the Fed will be faced with some hard decisions sooner than later. The fact that Robert Kaplan of the Dallas Fed mentioned tapering TODAY tells me that this Overton Window may already be shifting.

Forgot to include all other "financial hernias" that have benefited most from negative implied discount rates/market risk premiums: concept tech stocks, NFTs, altcoins, etc.

Oops: "severe commodity price inflation" I meant.

Going to cap today’s thoughts with the following summary: positive feedback loop narratives are seductive but not realistic. Why? Because we live in the real world with frictions, both physical and financial.

When positive feedback loops create oscillations beyond the carrying capacity of the physical system in question, things break — like the Tacoma Narrows Bridge. In markets, prices correct.

That is how what starts off as a positive feedback loop shunts into a negative, self- correcting feedback loop. In today’s environment, I see commodity price inflation as the crucible for that changeover.

By the way, we’ve seen this story before. There are all sorts of ex-post explanations for what caused the GFC. I will leave you with one chart of crude oil as food for thought for what might’ve been the proverbial “straw that broke the camel’s back.”

Here's the MSTR discussion I alluded to, for anyone interested.

Re: MSTR-A Real Options Analysis.