Patience is essential in the financial markets.
Since the US banking crisis broke out this year, I and many others have been saying that the US and global fiat currency banking systems will be rescued by a new round of central bank money printing (which will drive up risk asset prices). However, after Bitcoin and gold completed their initial gains, these hard currency assets have retreated some.
In the case of Bitcoin, both spot and derivative volatility and volumes have fallen. Some are beginning to wonder why Bitcoin hasn’t continued to rise if we are truly in a banking crisis. Likewise, why hasn’t the Fed started cutting rates and why hasn’t the U.S. started yield curve control.
My answer to the skeptics is: be patient. Nothing goes straight up or down, we will zigzag. Remember: the destination is known, but the path is unknown.
Money printing, yield curve control, bank failures, etc., will all happen, starting with the US and eventually spreading to all major fiat currencies. The goal of this article is to explore why I believe the real Bitcoin bull run will begin in late Q3 and early Q4 of this year. Until then, chill out. Take a vacation, enjoy nature and your friends and family. Because come fall, you better buckle up and get ready for TO THE MOON.
As I have said many times, the price of Bitcoin is a result of fiat currency liquidity and technology. Most of my writing this year has focused on global macro events that impact fiat currency liquidity. Hopefully, during the lull in the northern hemisphere summer, I can turn to writing about exciting things on the Bitcoin and cryptocurrency technology frontier.
The goal of this article is to give readers a clear roadmap of what to expect over the next few months in the evolution of fiat liquidity. Once we are comfortable with the expansion of USD and fiat liquidity by the end of the year, we can focus entirely on which technical aspects of certain coins are most exciting. When you combine the "buzzing of the printing presses" with truly innovative technology, your rewards far outweigh the cost of the effort. This is what we always strive for.
premise
The bureaucrats in charge of central banks and global monetary policy believe they can rule over a market of more than 8 billion people. Their arrogance is reflected in the way they talk about everything being certain, based on economic theories developed in academia over the past few hundred years. But whether they want to believe it or not, they have not solved the monetary version of the three-body problem.
When the equation of "debt vs. production output" gets out of balance, the "laws" of the economy break down. This is similar to the way water changes state at seemingly random temperatures. We can only understand the behavior of water through hindsight and experimentation, not through theoretical speculation in ivory towers. Our monetary rulers refuse to actually apply empirical data to guide the way they adjust policy, instead insisting that the theories taught by their respected professors are correct, regardless of objective results.
In this article, I will delve into why, contrary to common monetary theory, raising interest rates will cause the quantity of money and inflation to rise, not fall, due to current debt-to-productive output conditions. This will result in higher inflation no matter which path the Fed chooses, whether it is raising or lowering rates, and will trigger a general exodus from the parasitic fiat currency financial system.
As true believers in Satoshi, we want to trade as carefully as possible based on the timing of this mass exodus. I hope to earn good gains in fiat until it is time to sell USD and go all in on Bitcoin. Of course, I am also showing a bit of hubris myself because I believe I can predict the best time to exit without self-destructing. But what can I say? At the end of the day, we are all flawed humans, but at least we have to try to understand what the future may look like.
With that out of the way, let’s move on to some (controversial) statements of fact.
Every major fiat currency regime faces the same problems regardless of where they are in the economic system. That is, they are all heavily indebted, have declining working-age populations, and have banking systems whose assets are primarily low-yielding government and corporate bonds/loans. Rising global inflation has rendered the global fiat currency banking system functionally insolvent.
The United States faces these problems more than any other country and is in the most dire situation because of its role as the world’s largest economy and issuer of the reserve currency.
Groupthink among central bankers does exist because all senior officials and staff study at the same “elite” universities, which teach different versions of the same economic theories.
So whatever the Fed does, all other central banks will eventually follow.
With that in mind, I want to focus on the situation in the U.S. Let’s take a quick look at the various players in this tragedy.
The Fed exerts influence through its ability to print money and hold assets on its balance sheet.
The U.S. Treasury Department influences the situation by issuing debt to raise money to finance the federal government.
The U.S. banking system exerts influence by taking deposits and lending them out to create credit and provide funding to businesses and the government. The solvency of the banking system is ultimately backed by the Federal Reserve and the U.S. Treasury with printed money or taxpayer dollars.
The U.S. federal government exerts influence through its ability to tax and spend on various government programs.
Private businesses and individuals exert influence through their decisions about where and how to save money and whether to borrow from the banking system.
Foreign actors, particularly other nations, exert influence by deciding whether to buy, hold, or sell U.S. Treasuries.
At the end of this article, I hope to summarize the main decisions of each stakeholder into a framework, showing how we have reached a situation where each player has little room for maneuver. This lack of flexibility allows us to predict with a high degree of confidence how they will respond to the current US monetary problems. Finally, because the financial crisis is still closely linked to the cycle of agricultural harvests, we can predict with a fair degree of certainty that the market will wake up and realize the bad situation at exactly the scheduled time in September or October of this year.
reward
Bear with me, because before we get into the details, I have some groundwork to lay out. I will lay out some basic assumptions that I believe will play out or intensify as we approach the fall.
Inflation will reach a local low this summer and reaccelerate by the end of the year
I am referring specifically to the US Consumer Price Index (CPI). Due to a statistical phenomenon known as the base effect, high month-over-month (MoM) inflation figures in 2022 will be replaced by lower MoM inflation figures in the summer of 2023. If CPI MoM inflation is 1% in June 2022 and 0.4% in June 2023, the year-over-year CPI will be lower.
Some of the highest MoM CPI numbers last year (which are factored into the current YoY numbers) were in May and June. For 2023, the MoM CPI average is 0.4%, which means if we just take the average and replace all the numbers from May to December 2022 with 0.4%, the Fed doesn’t care about real inflation, they care about this made-up concept of “core inflation” that strips out factors people actually care about (like food and energy).
The conclusion is that the Fed will not be able to reach its 2% core inflation target in 2023. This means that if you believe what Powell and other Federal Reserve System Governors are saying, the Fed will continue to raise interest rates. This is important because it means that the interest rate on funds parked in reverse repo (RRP) and interest on reserves (IORB) facilities will continue to rise. It will also cause the interest rate on US Treasury short-term notes (<1 year maturity) to rise.
Don’t get hung up on why these inflation measures don’t match the price changes you and your family are actually feeling. That’s not an exercise in intellectual honesty — instead, we’re just trying to understand the indicators that influence how the Fed adjusts its policy rate.
The US federal government cannot reduce its deficit because of Social Security spending
Baby boomers, the wealthiest and most powerful members of the American electorate, are also getting older and sicker. That means a politician who campaigns on a platform of reducing Social Security and Medicare benefits promised by boomers would be digging his own grave.
HHS (Department of Health and Human Services) + SSA (Social Security Administration) = Elderly and Medical Benefits
Treasury = interest paid on outstanding debt
Defense = War
Elderly and health care benefits and defense spending will only keep increasing. This means that the US government's fiscal deficit will continue to rise. It is estimated that deficits of $1 to $2 trillion per year will become the norm over the next decade, and unfortunately, neither party in the United States has the political will to change this trend.
The end result is that the market has to absorb a continued massive amount of debt.
Foreign Participants
As I have written in several articles this year, foreign participants have turned into net sellers of U.S. Treasuries (UST) for a number of reasons, here are a few:
Property rights depend on whether you are a friend or an enemy of American politicians. We have seen the rule of law give way to national interests, with the US freezing Russian state assets in the Western financial system. Therefore, as a foreign holder of US Treasuries, you cannot be sure that you will be allowed to access your wealth when you need it.
More countries have China as their largest trading partner than the United States. This means that from a purely trade-driven perspective, it makes more sense to pay for goods in China's fiat currency than in dollars. As a result, more and more goods are invoiced directly in that fiat currency. This leads to a decline in the marginal demand for dollars and US Treasuries. Over the past two decades, US Treasuries have lost purchasing power in terms of energy. Gold has maintained its purchasing power in terms of energy. Therefore, in a world where energy is in short supply, it is better to save gold on the margin than US Treasuries.
Long-term U.S. Treasury bonds have underperformed oil prices by 50% in total return. However, gold has outperformed oil prices by 190% since 2002.
This has led to a decline in foreign holdings of U.S. Treasuries. Governments outside the United States are no longer buying newly issued Treasuries and are also selling their existing Treasuries.
In short: if there is a lot of debt that needs to be sold, you can't expect foreigners to buy it.
Private companies and individuals in the United States - Private sector
Our biggest concern for this group is what they will do with their savings. Remember, during the pandemic, the U.S. government provided stimulus money to everyone. The U.S. provided more stimulus than any other country to combat the catastrophic economic effects of the lockdown.
Those stimulus funds were deposited into the U.S. banking system, and the private sector has been spending their free money on whatever they like ever since.
When deposits, money market funds, and short-term U.S. Treasury bills were yielding essentially 0%, the U.S. private sector was happy to park its money in banks. As a result, deposits in the banking system surged. But when the Federal Reserve decided to fight inflation by raising interest rates faster, the U.S. private sector suddenly faced a choice:
Continue to earn essentially 0% in the bank.
Or, open their mobile banking app and buy money market funds or U.S. Treasuries with yields up to 10 times their original value in minutes.
Given how easy it is to move money from low- to zero-yielding bank accounts into higher-yielding assets, hundreds of billions of dollars began to pour out of the U.S. banking system late last year.
More than $1 trillion has been withdrawn from the U.S. banking system since last year.
The big question going forward is, will this exodus continue? Will businesses and individuals continue to move money from bank accounts paying 0% into money market funds paying 5% or 6%?
Logic tells us the answer is an obvious, "Of course they would." If they can increase their interest income 10-fold by just spending a few minutes on their smartphone, why wouldn't they do it? The U.S. private sector will continue to extract funds from the U.S. banking system until banks offer competitive interest rates that match at least the federal funds rate.
The next question is, if the U.S. Treasury is selling debt, what type of debt, if any, would the public want to buy? This question is also easy to answer.
Everyone feels the effects of inflation and therefore has a high liquidity preference. Everyone wants immediate access to money because they don’t know where inflation is headed and, given that inflation is already high, they want to buy goods now before they become more expensive in the future. If the U.S. Treasury offered you a one-year note that yielded 5% or a 30-year bond that yielded 3% because the yield curve is inverted, which would you choose?
Of course, you would choose the one-year note. Not only do you get a higher yield, you get your money back sooner and are only exposed to inflation risk for 1 year instead of 30 years. The U.S. private sector prefers short-term U.S. Treasuries. They express this preference by buying money market funds and exchange-traded funds (ETFs) that can only hold short-term debt.
Note: An inverted yield curve means that long-term returns are lower than short-term debt. Naturally, you would expect to receive more income for lending money longer. But an inverted yield curve is unnatural and indicates a serious economic dysfunction.
Fed
I have touched upon similar themes above, but allow me to expand upon the same in a more vivid and graphic way.
Imagine there are two politicians.
Oprah Winfrey wants everyone to be happy and live the best life possible. She makes sure everyone has food on the table, a car full of gas in the garage, and the best healthcare until they die. She also said she would not raise taxes to pay for those benefits. She would borrow money from the rest of the world to make it happen, and she believes she can do it because the United States is the issuer of the world's reserve currency.
Scrooge McDuck is a miser who hates debt. He provides almost no government benefits because he doesn't want to raise taxes and borrow money to pay for things the government can't afford. If you have a job that allows you to afford a full refrigerator, a pickup truck, and first-rate health care, that's your business. But if you can't afford those things, that's also your business. He doesn't believe it's the government's responsibility to provide you with those things. He wants to maintain the value of the dollar and make sure there's no reason for investors to hold other assets.
Imagine you are in the late stages of an empire where income inequality is increasing dramatically. Mathematically, most people will always have below average incomes, so who wins? Oprah Winfrey wins every time. Free stuff paid for by others through the use of a money printing press always wins.
A politician's first job is to win elections. So no matter which party they belong to, they will always prioritize spending money they don't have in order to win the support of the majority.
Unless long-term debt markets or hyperinflation give a heavy hand, there is no reason not to adopt a platform based on "free stuff". This means that from now on, I do not expect to see any substantial changes in US federal government spending habits. As for this analysis, trillions of dollars will continue to be borrowed every year to pay for these benefits.
U.S. Banking System
In short, the U.S. banking system, along with other major banking systems, is in trouble. I’ll quickly review why.
Assets in the banking system swelled due to stimulus provided by governments around the world. Banks were regulated to lend these deposits to governments and businesses at very low interest rates. This worked for a while because banks were earning 0% interest on deposits, but they were earning 2-3% interest on loans to others through longer-term loans. But then inflation set in and all major central banks (with the Fed being the most aggressive) raised their short-term policy rates sharply, far exceeding the yields on government bonds, mortgages, corporate loans, etc. Depositors could now earn higher yields by buying money market funds that invested in the Fed's reverse repurchase agreements (RRPs) or short-term US Treasuries. So depositors began to take their money out of banks to get better yields. Banks could not compete with governments because it would destroy their profitability - imagine a bank that was lending at 3% but paying 5% on deposits. One day, that bank would go bankrupt. So bank shareholders began to sell bank stocks because they realized that these banks could not mathematically make a profit. This led to a self-fulfilling prophecy and the solvency of some banks was called into question as their stock prices dropped dramatically.
In my recent interview at Bitcoin Miami, I asked Zoltan Pozar what he thought of the U.S. banking system. He responded that the system is fundamentally sound, with just a few rotten apples. This is the same statement made by various Federal Reserve Chairs and U.S. Treasury Secretary Janet Yellen. I strongly disagree.
Bank of America now faces two choices:
Option 1: Sell assets (U.S. Treasuries, mortgages, auto loans, commercial real estate loans, etc.) at a huge loss, then raise deposit rates to attract customers back to the bank.
This option means recognizing implicit losses on the balance sheet, but guarantees that the bank cannot continue to make profits. The yield curve is inverted, which means that banks will pay higher short-term deposit rates and cannot lend these deposits for longer-term at higher rates.
U.S. Treasury 10-year yield minus 2-year yield
Banks cannot buy long-term government bonds because they would incur losses – very important!
The only thing banks can buy is short-term government bonds, or park their funds at the Federal Reserve (IORB) and earn interest slightly higher than the deposits paid. With this strategy, it is difficult for banks to achieve a Net Interest Margin (NIM) of more than 0.5%.
Option 2: Do nothing and exchange your assets with the Fed for newly printed dollars as depositors flee.
This is essentially what the Bank Term Funding Program (BTFP) does. I discuss this in detail in a previous article. Never mind whether the assets held on banks’ balance sheets qualify for the BTFP – the real issue is banks’ inability to grow their deposit base and then use those deposits to buy long-term government bonds.
U.S. Treasury Department
I know the media and markets are focused on the question of when the U.S. debt ceiling will be reached and whether the two political parties will find a compromise to raise it. Ignore the circus - the debt ceiling will be raised (as it always has, given more draconian alternatives). And when it is raised, perhaps this summer, the U.S. Treasury has some work to do.
The US Treasury must issue trillions of dollars in debt to fund the government. It is important to focus on the maturity structure of the debt being issued. Obviously, it would be great if the US Treasury could issue trillions of dollars in 30-year bonds, as these bonds yield nearly 2% less than short-term bonds < 1 year. But can the market withstand it? Absolutely not!
Between now and the end of 2024, the debt that needs to be rolled over is about $9.3 trillion. As you can see, the U.S. Treasury is unwilling or unable to issue most of its long-term debt, and is instead financing itself with short-term debt. Uh-oh! That’s bad news, because short-term interest rates are higher than long-term rates, which increases interest expenses.
There is no major buyer willing or able to purchase long-term U.S. Treasuries. So if the U.S. Treasury tried to flood the market with trillions of dollars of long-term debt, the market would demand higher yields. Imagine if the 30-year yield went from 3.5% to 7%. This would cause bond prices to plummet, spelling the end for many financial institutions. This is because these financial institutions were encouraged by regulators to use almost unlimited amounts of leverage to buy large amounts of long-term debt. That would be the end for sure!
Yellen is not stupid. She and her advisers know that issuing the needed debt at the long end of the yield curve is impossible. So they will issue debt where the demand is very strong: at the short end of the yield curve. Everyone wants to get the benefits of high short-term interest rates, and those rates are likely to rise further later this year as inflation picks up.
As the U.S. Treasury sells $1-2 trillion in debt, short-term interest rates will rise. This will further exacerbate the problems in the banking system as depositors get better terms from borrowing from the government rather than from the banks. This in turn ensures that banks cannot profitably buy long-term bonds. The death spiral is rapidly approaching.
Fed
In this final section, Powell has a pretty messy situation on his hands. Each stakeholder is pulling his central bank in a different direction.
Rate cuts
The Fed controls/manipulates short-term interest rates by setting the interest rates of the RRP and IORB. Money market funds can earn returns from the RRP, and banks can earn returns from the IORB. Without these two tools, the Fed would not be able to regulate interest rates as it wishes.
The Fed could significantly cut rates on both facilities, which would immediately steepen the yield curve. Benefits would include:
Banks are profitable again. They can compete with the rates offered by money market funds, rebuild their deposit base, and begin making long-term loans to businesses and governments. The U.S. banking crisis is over. The U.S. economy will boom because everyone will have access to cheap credit again.
The U.S. Treasury can issue more debt with longer maturities because the yield curve is positively sloped. Interest rates on the short end will fall, but rates on the long end will remain the same. This is desirable because it means the interest expense on long-term debt remains the same, but the debt becomes more attractive as an investment.
The downside is that inflation will accelerate. The value of money will fall, and the prices of things voters care about (like food and fuel) will continue to rise faster than wages.
Rate hikes
If Powell wants to continue to fight inflation, he must continue to raise interest rates. For economic experts, according to the Taylor rule, US interest rates are still deeply negative.
Here are the negative consequences of continued rate hikes:
The private sector continues to prefer borrowing from the Fed through money market funds and RRPs rather than depositing money in banks. US banks continue to fail and be bailed out as their deposit base declines. The Fed’s balance sheet may not be stockpiling these bad loans, but the FDIC is now full of bad loans. This is still fundamentally inflationary because depositors will be repaid in full in the form of printed money, and they are able to earn more and more interest income by borrowing from the government rather than from banks.
The yield curve continues to invert, which makes it impossible for the U.S. Treasury to issue long-term debt on the scale needed.
I would like to further elaborate on the point that raising interest rates will also cause inflation. I agree that the quantity of money is more important than the price of money. What I am focusing on here is the amount of dollars that are injected into the global market.
As interest rates rise, there are three ways for global investors to receive income in the form of printed dollars. Printed money can come from the Fed or the U.S. Treasury. The Fed pays interest to holders through reverse repos and banks' deposit reserves. Remember: the Fed must have these tools if it wants to continue to manipulate short-term interest rates.
If the U.S. Treasury issues more debt and/or the interest rate on new debt rises, it will pay more interest to debt holders. Both of these things are happening.
All things considered, the interest paid by the Fed through the RRP and IORB, and the interest paid on the U.S. Treasury debt, has a stimulative effect. But shouldn’t the Fed be reducing the quantity of money and credit through the quantitative tightening (QT) program? Yes, that’s correct, but now, let’s analyze the net effect and how it will play out in the future.
As we can see, the effect of QT has been completely offset by interest paid in other ways. The quantity of money has continued to increase despite the Fed shrinking its balance sheet and raising interest rates. But will this continue to happen in the future, and to what extent? Here are my thoughts:
1. The private sector and US banks prefer to keep their funds at the Fed, so the balances at the RRP and IORB will increase.
2. If the Fed wants to raise interest rates, it must raise the interest rate on funds parked in RRPs and IORBs.
3. The U.S. Treasury will soon need to finance a $1-2 trillion deficit for the foreseeable future, and will have to do so at high and rising short-term interest rates. Given the maturities of total U.S. debt, we know that real money interest payments can only mathematically go up.
Putting these three factors together, we know that the net effect of U.S. monetary policy is currently stimulative, with the money printing press producing more and more fiat currency. Remember, this is because the Fed is raising interest rates to fight inflation. But if raising interest rates actually increases the money supply, then it can be inferred that raising interest rates actually increases inflation. Mind-blowing!
Of course, the Fed could accelerate QT to offset these effects, but this would require the Fed to eventually become a direct seller of Treasuries and mortgage-backed securities (MBS) to foreign investors and the banking system. If the largest bond holder is also selling (the Fed), the dysfunction of the Treasury market will rise. This will panic investors and cause long-term yields to soar as everyone rushes to sell their bonds before the Fed starts selling.
Transaction related
If you are a believer in Satoshi Nakamoto, time will be on your side. If you choose to join hands with the devil of traditional finance, the time bomb is ticking...
Between now and the fall harvest, something important will happen.
First, the U.S. debt ceiling will be raised this summer. This will allow the U.S. Treasury to begin issuing debt to finance the government. As the U.S. Treasury pays off maturing debt and issues new debt, the net effect will be more debt outstanding and higher interest rates. The issuance of debt may temporarily put some pressure on dollar liquidity because the Treasury's general account (TGA) will increase. But over time, as the Treasury spends money, the TGA declines and dollar liquidity increases.
Second, as I have argued before, inflation will bottom out and begin to slowly rise. This means that the Fed will likely pause in June, only to reignite the fire and raise rates at its July meeting. By the time central bankers gather at Jackson Hole in late August, the policy rate could be close to 6%. Higher rates will increase the amount of interest paid on RRP and IORB balances.
Finally, depositors will continue to move funds from non-SIBs to SIBs, or into money market funds. Money market funds park their funds in RRPs, while SIBs park their funds in IORBs. In both cases, the balances in RRPs and/or IORBs grow. SIBs have a lot of cash, which is why they pay little or no interest on deposits and park any additional funds received in the Federal Reserve System (hence the rise in the IORB). This increases the amount of money the Fed prints to pay for the funds deposited in these facilities.
In summary, the amount of USD liquidity injected into the system every day will continue to grow. The rate of change of USD liquidity injection will also accelerate, because the larger the balance, the more interest will be paid. Compound interest is a geometric progression.
Bitcoin has experienced a roughly 10% correction from its April high. All of these interest payments are actually a stimulus package for wealthy asset holders. When they have more money than they need, wealthy asset holders buy risky assets. Gold, Bitcoin, AI tech stocks, etc. will all be beneficiaries of the “wealth” that governments print and distribute.
I expect Bitcoin to remain stable here. I do not believe we will retest $20,000 or close to this price. As money gradually flows into global risk asset markets, a strong support base will form. Volatility and trading volume are usually disappointing during the northern hemisphere summer, so I am not surprised that risk-takers who are plagued by boredom have temporarily left crypto trading. I will use this quiet time to gradually increase my Bitcoin allocation after TGA refills.
As more and more pundits start talking about the billions of dollars being printed by the Federal Reserve and the U.S. Treasury and distributed as interest, there will once again be widespread recognition that the money printing presses are humming. And when the printing presses are humming, Bitcoin will boom!