FWIW # 45 Extraordinary Delusions and the Madness of Crowds

When I first thought about a career in investing, my research led me to a book, Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay, with a foreword by Bernard M. Baruch, the legendary speculator. This book gives the reader histories of times and events that were grossly illogical and ended in financial ruin for those taken into the psychological dream world of each situation. What’s important to understand is this: At the time the delusions were evolving, there was a kernel of reason and truth behind the developing actions. The amount of money I saved by reading this book is incalculable. I keep it close by and read parts on a regular basis. Other books dealing with this subject are also helpful, such as The Crowd by Gustave Le Bon, Charisma: A Psychoanalytic Look at Mass Society by Irvine Schiffer, and Panic on Wall Street: A History of America’s Financial Disasters by Robert Sobel. These books, however, did cause clients who felt I were too cautious in deploying their investments to seek management elsewhere. What I’m focused on now is an article in the Wall Street Journal this past week, “The Shadow Dollar That’s Fueling the Financial Underworld.”

The article is about Tether, the digital private cryptocurrency. Tether is pegged to the US dollar on a one-to-one basis. It’s a stablecoin, meaning it’s designed to always be exchangeable for US dollars on a par (equal) basis. It’s used by criminals, sanction busters, legitimate individuals living in countries with hyperinflation, and individuals who believe cryptocurrencies will protect them against governments, including the US government.

Let me start by discussing the logic of Tether protecting individuals from the US government. The primary way the US government and central bank systematically and deliberately undermine citizens is through inflation, what some call the invisible tax. Stop and think about the last four years. The US debt in the beginning of 2021 was a total of $26.9 trillion. Put aside for the moment the increase in national debt since then (additional $8.8 trillion). This $26.9 trillion was borrowed from individuals, institutions, businesses, retirement plans, or other governments. If the US government had paid off all its outstanding debt at the start of 2021, its creditors would have been able to buy a certain amount of goods and services.

Fast-forward to today. Again, ignore the increase in debt since January 2021. The purchasing power of the $26.9 trillion outstanding in January 2021 has fallen by 21.2%, or $5.7 trillion, due to inflation. In essence, since the federal government and central bank are the sole creators of inflation, irrespective of any excuses like COVID or supply chain disruptions, which are just smokescreens, the US government has confiscated $5.7 trillion of purchasing power from its creditors.

Tether, the stablecoin touted as an alternative to the US dollar, hasn’t saved the creditor from this purchasing power loss since a Tether holder puts up a dollar, and when they sell the Tether, they get back a dollar. So, protecting the Tether holder from inflationary actions by the federal government is a myth. If that’s the case, how does it protect the holder? Let’s look at the issues discussed in the WSJ article.

1.Tether is a privately owned and privately issued currency designed to be exchanged on par with US dollars. Besides making a transaction fee, why would someone choose to issue a private currency tied to a government-issued currency? Since speculators or those attempting to avoid government-enforced legal restrictions on the U.S. dollar want the private currency, which is no more than an entry in a computer system, Tether Ltd. is exchanging unrestricted computer currency access for the government’s real currency. The company promises to return the real government-issued dollars whenever the holder of the private currency wants to reverse the transaction. Tether Ltd. then invests the real governmental currency (US dollars) and keeps the interest, dividends, and appreciation of the assets it buys with the dollars deposited—gold. The WSJ article estimates Tether Ltd. made over $6.2 billion in profit last year. Again, what is Tether? It’s an entry in a computer, nothing more and nothing less. This entry is believed to be a currency by millions of individuals and is considered safe for use in transactions and as a store of value in a digital wallet (a specially created place on an exchange or on Tether’s main computer).

2.Tether Ltd. claims over 300 million people use the stablecoin. Tether gives people who are denied access to US dollars a way of owning dollars, assuming it’s truly convertible into dollars.

3.Most importantly, the US government and other governments are aware of the reasons most people use Tether. At some point, these governments may take steps to end Tether’s convertibility.

4.The users of Tether must have concerns when they read that Tether Ltd. collaborates with law enforcement agencies. The company indicates it can track every transaction on public blockchain ledgers and can seize and destroy Tether held in any wallet. Read that last sentence again. And again.

Extraordinary popular delusions and the madness of crowds are real. Cryptocurrency is just one of the delusions evidencing themselves today. Generative artificial intelligence (GenAI) is another. The massive flow of speculative money into this area is breathtaking. The saving grace is that at least GenAI is real in the sense that the computer code and algorithms are the building blocks of functional productivity. Nevertheless, delusions of the riches to be made sometime in the future are far greater than reality.

The surge—and there is no other word for it—of gambling on everything from the weather to sports to politics is still another delusion gripping tens of millions of people today.

What do all of these delusions have in common? In every instance, the delusion costs the deluded person money. No one knows the future. Looking at history leaves an observer with the sense that the accelerating search for something that will bring relief from the drudgery of life or the oppressive actions of increasingly disconnected political leaders will not end well. It’s incumbent on all of us to protect ourselves so that whatever happens in the unknown future may financially bend us but not break us.

Last week Fed Chairman Powell said the economy was doing fine and the labor force was still in the zone of full employment. He then announced the Fed was cutting interest rates by 50 basis points (half a percent). As stated in previous FWIWs, the Fed announcement of an upcoming rate cut last June or July was a political statement designed to assist the Washington establishment’s election chances. Cutting rates in September further reinforced the Fed’s hand in shaping elections. Cutting 50 basis points instead of 25 was an even stronger signal that the current Washington establishment should be left in place. Announcing at the same time that at least another 50 basis points would be cut before the end of the year was just in case someone wasn’t paying attention to the other signals. Is this good or bad? Neither—it’s reality. Reality must be part of every investor's investment strategy.

Cutting interest rates and leaving unusually large amounts of liquidity in the monetary system stimulates and increases demand for goods and services. When demand increases faster than the supply of goods and services, inflation results. If a citizen owns stocks, real estate, gold, silver, trees, or anything else tangible, they will have the opportunity to offset some or all inflation. The problem for any country stems from the fact that not everyone owns assets. That includes approximately 45% of the US population. These hardworking citizens live from paycheck to paycheck. When this segment gets trampled on long enough by what they consider an unfair government and central bank, they will decide to do something about it. The populist movement today will pale in comparison.

Extraordinary popular delusions and the madness of crowds end suddenly. The shock can be shattering.