What would you give to know the future? A friend from Europe asks me why are cryptos and stocks falling? It's a great time to ask this question, especially if you live in Europe, since one can look in the U.S. Right now and see the future of Europe. The U.S. is about six months ahead. Knowing the future should make you some money, right? Well, for most people, it won't because if you notice the price of every asset goes down, so it's hard to make money out of what I'm about to describe. But at least you can feel a bit better by understanding what is going on. For years, governments were printing lots of money. From 2016 to 2020. They were trying to stop printing that much money. But the pandemic hit and they started printing even more. Interestingly this excess of money wasn't affecting cheap stuff.
It was just expensive stuff like houses, collectibles, and of course, stocks that were getting more and more expensive. But those things with the help of some politics and some number magic weren't affecting inflation. So everyone was happy. But due to something that might also be political we are now experiencing a shortage of oil, computer chips and Chinese manufacturing capacity. That's bad because oil, computer chips and Chinese manufacturing capacity are all used to support every other asset class. So lots of money printing and no inflation? This seems to have been the missing piece of the puzzle supply-side inflation Things get more expensive because people want things and can't buy them because they're advertised, but not produced. The last Eurorack modules I bought. They're all used because no new ones get produced. Used cars' prices go up because there isn't enough supply of new ones. So it's easy to see why things get more expensive.
In the U.S. there is a thing called "the Fed", which has a double mandate. To keep inflation low while keeping the unemployment low. Through some very complex mechanism, they control the interest rates, the Fed by increasing interest rates, hopes to make inflation, go down. How? The idea is that by making interest rates go up, they will make people want to spend less. Increasing the interest rate has the effect of making the currency more valuable and more expensive. It will be harder to make money and when you make some, you will prefer to save them instead of spending them. So then theoretically speaking, you will choose cheaper products and negotiate harder with the folks you're buying stuff from. Indeed, that's a sound idea to beat the demand side inflation. When people have too much money, you increase interest rates, wait a few months, and then that money evaporates out of people's pockets. This did happen. U.S. savings rate has fallen to the lowest level in 12 years,
But inflation keeps getting worse. That's because that mechanism doesn't work with supply-side inflation. Because when, for example, there are no cars to sell. Businesses can only rise prices even more as interest rates increase to stay afloat. That will, by the way, be even more inflation. When a business makes no money and has fewer customers, it lays off people. And that's where the second mandate of the Fed kicks in. Keep unemployment low. If you're asking yourself, when will this whole thing finish? Don't look at inflation. This will keep getting worse. Look at unemployment. When there are millions of unemployed people, the Fed will stop increasing the interest rates. By that time, of course, we will clearly have a recession. And that's bad. The other case is, if supply-side issues are sold, which would require the Ukrainian war to stop, China resuming manufacturing and not having a new war or something.
But I suspect something very complex and political might be happening right now with this East versus West strong-arming through supply chain inflation. So I think that unemployment will hit Fed's breaks before the supply-side inflation is fixed. This is how the big machine works right now. In terms of stocks, the interest rate goes in the denominator of an equation that is called Discounted Cash Flow DCF, which is used to calculate the Net Present Value of an asset. As such when interest rate goes up, growth stocks, which are supposed to bring mostly future cashflows, go down disproportionally. You can observe the correction. in a thing that is called Price to Earnings Ratio. It has recovered to kind of normal levels compared to what was happening during the pandemic. That's good. S&P is de-bubbling. In terms of crypto, it was supposed to be an inflation hedge and it might very well be because it's supposed to be global and in general weird. But that doesn't mean that currently a large proportion of prices isn't due to applications affected by low interest rates. More specifically, if hedge-funds and banks in the last two years decided to treat crypto as tech stocks, then it became tech-stocks-like, and now it deleverages as expected. This has though, ripple effects. Before NFTs. The big thing in crypto was DeFi. Bottom line beyond some legitimate lending use cases, a large part of the DeFi space was Ponzi schemes. Quite obvious ones too. How does this make money? Oh, because of Metaverse and ZK-snacks and snake oil, and basically the price will go up, so that's how you make money! Okay. That's a Ponzi! So now that the prices stopped going up, most of the DeFi space will likely be wiped out along with the valuations.
This doesn't mean that Web3 and cryptocurrencies and NFTs will stop to deliver value. But the idea that I stake a coin and it somehow gives more than 5% interest will definitely become laughable. Now you understand why everything collapses. The Fed is the American story, but soon Europe will start increasing interest rates. The inflation, the U.S. sees is just pretty average in a global scale. Frankly, the U.S. bites the bullet and reacts relatively decisively, which is good. If you are outside the U.S. you might well know your future after watching this video. Should you sell? That's likely a good idea if you aren't okay for one or two years. Things will probably keep going down for a while. The Ethereum merge is potentially a good reason not to sell short-term, but that's pretty much the only good reason. Is it a good time to buy? Not the best, but not terrible either. If you have spare money and you're okay for a few years, you will find some great opportunities in the next few months. I hope you find this useful. Thanks for watching.
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