BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

Short-term volatility in the cryptocurrency market becomes irrelevant if you believe that the Fed’s balance sheet will grow exponentially from today’s levels.

BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

This article was written by Arthur Hayes, Founder of BitMEX

For those of you with a Bloomberg terminal, run the FARBAST Index. This is an index of the Fed’s balance sheet in millions of dollars and is updated weekly. I’ve been talking about this a lot, but this number and its trajectory are the only things that matter. If you believe that the Fed’s balance sheet will grow exponentially from today’s levels, then the short-term volatility in the cryptocurrency market becomes irrelevant.

To be clear, there are two things that are critical to my overall bullishness on macro cryptocurrency market capitalization.

The U.S. government will begin to implement nominal GDP targets, funded by the Fed’s purchases of Treasury bills, notes and bonds. As a result, the Fed’s balance sheet will be higher than it is today.

Decentralized finance (DeFi) will aggressively decentralize much of the rent-seeking activity performed by centralized financial services institutions. The savings from cheaper fees and greater inclusion will flow to end users and token holders.

The high growth of point 1 drives the acceleration of point 2.

Self-perpetuation and growth are two universal constants when assessing the potential behavior of an organism or a civilization as a collection of humans. Most modern societies have a potentially infinite growth assumption. Look at how we price stocks.

The value of a stock is the discounted stream of all future cash flows. The ultimate value assumes that the company continues to exist and grows forever. This is obviously empirically wrong, but let’s plug it into our fantasy model anyway. Therefore, my primary assumption is that growth is preferred and assumed. The problem is cost. There are many ways to achieve growth, and one of the most effective ways at the national level is to achieve GDP targets in the name of borrowing.

To fully understand why I am so confident that the Fed’s balance sheet could be 10 times higher in the short term, I will compare how the U.S. responded to the consequences of World War II with how it responded to the consequences of COVID-19. The political and economic conundrum has always been, “How does a country continue to thrive after a devastating crisis?”

I spend a lot of time talking about U.S. monetary policy, rather than the fundamental merits of a decentralized monetary and financial system versus the parasitic centralized system that currently dominates. We live in a dollar world. Anyone who reads Satoshi Nakamoto’s white paper understands that the 2008 financial crisis and the reaction of all the major central banks is one of the reasons why Satoshi Nakamoto believes something better can be created. Therefore, appreciation and confidence in the world’s most important financial institution, the Federal Reserve, would make any speculator dismissive of a 30% to 50% drop on that day, knowing that a tsunami of money printing in less than a decade would bring the combined cryptocurrency market cap to unimaginable levels.

Before we go back to 1939, take a look at this. Net federal spending is 31% of 2020 GDP as a result of the massive fiscal stimulus enacted in the U.S. to fight COVID. Measured by 2020 global GDP, this allows the U.S. government as an independent entity to be the third largest economy – behind only the U.S. private sector and China. The great thing about any large central government is that they collect a lot of statistics. You can’t manage what you can’t measure. So the wealth of statistics during and after World War II allowed anyone with an Internet connection to access it.

Let me first help make this easier for TikTok users to understand; I know the first sentence I wrote probably made you lose interest in reading it, but I hope now your attention can be spared for 2 minutes:.

1 What Happened After World War II
To pay for World War II expenses, the U.S. government borrowed money. To reduce the cost of money, the Federal Reserve purchased a sufficient number of bonds to fix the price of money. The long tail was fixed at no greater than 2.5%.

As a result, the Federal Reserve’s balance sheet grew 11 times from 1939 to 1946.

At its peak, the U.S. debt to GDP ratio reached 110%; in order to eliminate the debt incurred to win the war through inflation, the Fed continued to fix the price of the Treasury curve until the Monetary Agreement of 1951, when the Fed regained its independence from the Treasury.

Unfortunately, civilians were forbidden to privately own gold, so they suffered severe negative interest rates and hyperinflation. They had nowhere to invest except in government bonds and stocks.

By 1951, the U.S. government successfully delivered its balance sheet, reducing the debt/GDP ratio from 110% to 70%. The Federal Reserve now allows the free market to operate again in the U.S. Treasury market.

2 What Happened After COVID
In 2020, the war with COVID resulted in the largest drop in U.S. GDP since World War II.

In response, the Republican-led U.S. government spent the most money in U.S. history.

The Federal Reserve, while not explicitly pricing the Treasury curve, purchased 55% of all Treasuries issued in 2020. This results in a 76% increase in its balance sheet in 2020.

By the end of 2020, the U.S. debt to GDP ratio reached a record high of 130%.

When the Democrats came to power, just like the Republicans, they quickly enacted trillion dollar spending bills and promised to do more.

The U.S. is now a double-deficit country; it spends more than it collects in taxes (fiscal deficit) and imports more than it exports (negative capital account).

U.S. politicians of both parties are saying flatly that the government must aggressively expand fiscal spending to right past wrongs and ensure that labor is protected after COVID.

Foreigners will not wait to watch their $7 trillion worth of U.S. Treasuries shrink dramatically and are buying a net 8% of all Treasuries issued in 2020 and 42% of all Treasuries issued from 2002 to 2019.

The only politically acceptable option is to pay for aggressive fiscal spending through monetary printing by the Federal Reserve.

Thankfully, by 2021, we have crypto capital markets that are not the goal of some government agency or central bank.

While not all of the tens of trillions of dollars created by the Fed will flow into cryptocurrencies, some of it will-and because cryptocurrency is unhindered, it can rise to levels that allow holders to maintain purchasing power in the face of currency inflation.

My research assistant and I have been working hard to create informative charts that bring this hypothesis to life. Buckle up and get ready to fall in love with macroeconomic statistics over a cup or mug of Kombucha. When you’re done, I hope you feel more confident in your crypto portfolio and maybe you’ll buy low, buy low, buy low ……

3 War = Inflation
War is a terrible thing. It’s even worse when you as a taxpayer have to pay directly. That’s why the government would rather adopt a stealth inflation tax than aggressively raise taxes to pay for war. People can become a little too pacifist, leading to objections to the use of their tax dollars.

While raising certain taxes to pay for America’s involvement in WWII, like all governments before and since, they chose to borrow money to pay for the war. I will quote extensively from the Federal Bank of New York’s February 2020 working paper entitled Managing the Treasury Yield Curve in the 1940s (the italicized portion below is from this report).

When the U.S. decided to officially enter the war after Pearl Harbor in 1941, they had to figure out how to pay for the huge expenditures needed to fight. Remember – the government spent, and the Treasury paid for it by selling bonds. As always, you want to pay as little interest as possible when you borrow money. The Treasury politely asked the Federal Reserve to create excess bank reserves for the sole purpose of supporting its bond issues.

Pre-war.

The FOMC (Federal Open Market Committee) made no attempt to manage reserve levels or interest rate levels. Open market operations were limited to maintaining an “orderly market” for Treasuries, usually involving maturity swaps, rather than outright purchases or sales.

But then, the Treasury asked the Fed to help them set the price of money because the general public did not accept such low interest rates to help fund the U.S. government’s war effort.

The ⅜ percent bill rate did not have the same widespread support. Prior to the first major wartime financing-a $900 million 25-year bond issue of 2.5 percent in May 1942-Treasury officials asked the Federal Open Market Committee for a commitment to maintain adequate excess reserves. They hoped they could rely on the pressure of excess reserves to boost demand for the bonds.

Footnotes.

Council Chairman Marriner Eccles noted a few months ago that “if current financing essentially continues, …… will need to create significant excess reserves to put pressure on banks to purchase of government securities.” Minutes of the Federal Open Market Committee, March 2, 1942, p. 4.

What that means when translated is: the Treasury wants to borrow money very cheaply. You are dragging us, the Fed, screaming to set a policy where we have to buy an unlimited amount of bonds to fix prices at the level you, the Treasury, want. The result is that our balance sheet will explode.

BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

From 1939 to 1946, the Federal Reserve’s SOMA account balance ballooned more than tenfold as it performed its patriotic duty of fixing the price of money at the behest of the Treasury. Most importantly, the interest rate on long-term bonds was fixed at 2.5%.

BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

This chart clearly shows that the public did not want to lend to the U.S. government at artificially low prices. Unfortunately, back in the 1930s, President Roosevelt banned private ownership of gold. This traditional inflation hedge, which has been in place for thousands of years, is not available.

BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

I roughly define the real interest rate as the long-term bond rate minus the year-over-year nominal GDP growth rate. Any government can stimulate economic activity by printing money. If it pays a lower interest rate than the GDP growth created through debt financing, then it profits and the holders of its public debt lose. Each of the post-World War II “economic miracles” of the four Asian tigers owed their financial suppression of savers and the redirection of cheap financing to heavy industry. That’s how China was able to grow so fast from 1980 to now. The hard part is getting itself out of the national debt to improve its efficiency.

As we have seen, anyone who saved through deposits in the banking system or by holding U.S. Treasuries was hollowed out by severely negative interest rates so that the U.S. could afford to go to war. There is really nothing you can do about it – either put your savings in the bank or buy bonds. The stock market was still recovering from the Great Depression. From 1939 to 1951, the Dow Jones Industrial Average fell by 4.6%. There was no way to get out of the financial repression that had been inflicted on savers.

BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

This monetary inflation did penetrate into real goods and services. From 1939 to 1951, the CPI index almost doubled.

BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

I hate the inventory flow ratio (STFU), but it is popular, so I took STFU and used it in my analysis. The chart illustrates that the U.S. balance sheet was sacrificed in order to participate in the war.

Even after the end of hostilities, the Fed continued to fix the price of money. The US emerged with its physical infrastructure unscathed and rebuilt Europe. gdp growth surged. But interest rates did not. The result was a deleveraging of government balance sheets.

The Federal Reserve finally regained its independence in 1951. They fulfilled their patriotic duty and were then allowed to pursue an independent monetary policy.

The impasse lasted until mid-February 1951, when Snyder was admitted to the hospital and left Assistant Secretary William McChesney Martin to negotiate the so-called “Treasury-Federal Reserve Agreement.” On the evening of Saturday, March 3, 1951, Treasury and Federal Reserve officials announced that they “reached complete agreement on debt management and monetary policy to further their common goal of ensuring the successful financing of the government’s needs and, at the same time, to minimize the monetization of the public debt.” 51 Alan Meltzer (2003, p. 712) concludes that the agreement “ended a decade of inflexible interest rates” and was “a major achievement for the country.

I like this quote.

Alan Meltzer (2003, p. 712) concludes that the agreement “ended a decade of unchanging interest rates” and was “a major achievement for the country.

Translation: We artificially depressed the price of money to help the government use a stealth inflation tax to pay for the war.

Fortunately, the United States has the innate physical and natural capital to pursue such a blatantly inflationary monetary policy without any social unrest. That’s because the U.S. has a very strong domestic manufacturing base that can feed itself and has the industrial goods needed to produce real goods at home. As the expansion of the money supply led to severe inflation in real goods and services, most countries that pursued war-like payment policies fell into social chaos. That’s because most countries have not been blessed with nature’s bounty.

Britain had only just paid off its World War II debt to the United States in 2006. It took them nearly six years to fully pay for the war. It took the United States only five years – from 1946 to 1951 – to significantly inflate to remove the cost of the war. That’s the beauty of being the world’s reserve currency.

The key lessons to remember as we transition to the present are as follows.

Going to war is expensive, and governments prefer indirect taxation through inflation to direct taxation through payroll and capital taxes.

The independence of central banks is an illusion. When the domestic agenda requires the central bank to print money to lower the government’s borrowing costs, the central bank will always obey orders. In order to deleverage the government’s balance sheet, the government must be able to borrow money at a cost lower than the nominal GDP growth created by the debt expansion.

The valve is the central bank’s balance sheet, as it must increase as much as needed to absorb the government debt that the public refuses to buy at the government’s artificially depressed interest rates.

This monetary inflation will be reflected in financial assets and physical goods.

4 COVID-19 The Forever War
According to official statistics, approximately 600,000 Americans have died from COVID-19 in the past two years.

And approximately 400,000 Americans died during World War II. All human life is precious, but for a politician who is elected domestically, those who die within the sharp lines of the field are the most important.

In terms of lives lost, COVID-19 has been more devastating than WWII. This is further evidence that epidemics cause more human suffering and carnage than war. This is why policies to deal with pandemics can easily outweigh war.

Modern cities are proof of the impact of epidemics. Running water, sewer systems, and building codes all changed dramatically or were newly introduced in the 19th and 20th centuries to defeat the various infectious diseases that were rampant when humans lived in close proximity.

The U.S. GDP decline in 2020 is the largest since World War II, and the budget deficit enacted to combat COVID is at a post-World War II record. In the name of COVID, anything is possible now, especially since the pandemic outbreak accelerates a trend that is already happening.

A pay-to-play game

Let’s start by analyzing how the U.S. government will pay for the huge fiscal spending set for 2020.

Because of its status as a global reserve currency issuer, the U.S. is in a unique position in terms of its financing options. Most trade is denominated in dollars, so net exporters have their goods denominated in dollars. Unless they want to push up the value of their currencies by selling dollars and buying their own, overproducing countries must buy dollar-denominated financial assets. The United States must have an open capital account to fulfill its role as issuer of a global reserve currency. Most countries do not want foreigners to buy any type of financial assets, especially domestic property. This is why major economic powers like China and Japan refuse to take on the role of reserve currency issuer. They are very happy with closed or semi-closed capital markets.

Traditionally, due to their liquidity and perceived risk-free nature, overproducing countries recycle their export earnings into U.S. Treasuries. The U.S. Treasury releases monthly Treasury International Capital (TIC) data. It aggregates detailed information on who owns what types of dollar-denominated financial assets.

From 2002 to 2019, foreigners purchased 42% of the net issuance of U.S. Treasuries.

The Federal Reserve purchased 13%. At the margin, foreigners’ purchases helped the U.S. government finance its budget deficit at reasonable interest rates.

This all changes in 2020. the COVID destroys global trade and exposes ineffectiveness and underinvestment in global public health. Governments around the world are scrambling to figure out how to pay for shutting down the economy to stop the spread of the virus, ensure supplies of personal protective equipment and vaccines, and upgrade public health systems. They need all the money they can beg, borrow or print.

Unfortunately, most countries can’t expand government spending as generously as the United States can. If countries increase their fiscal spending by printing money, it will likely destroy their currencies and lead to higher commodity prices (and the ensuing social unrest). If civilians don’t get their bread, your hat is on the line.

The “America First” slogan comes in different styles, but both Democrats and Republicans promote it. It is widely believed that policies to help the working class, such as homegrown manufacturing, infrastructure spending and import tariffs, are the right thing to do for the first time in 50 years. Unfortunately, these policies are inflationary.

I did a quick estimate of the interest rate risk held by foreign holders of U.S. Treasuries.SIFMA provides a table that breaks down U.S. Treasury issuance by maturity. I looked at the composition of current outstanding Treasuries and used these ratios to calculate the estimated portfolio of foreign holders. I then used a function on Bloomberg to calculate the modified duration of each note or bond. Treasury bills have a duration of 2 to 10 years. This also includes floating rate notes. Treasuries are anything over 10 years, i.e., 20-year and 30-year bonds and TIPS.

I calculate the weighted average maturity for foreign holders to be 17.08 years.

Dollar value of one basis point (DV01) = Dollar face value * Duration * 0.0001

DV01 = $6.461 trillion * 17.08 * 0.0001 = $12.08 billion

This number may not mean much, but it is a huge interest rate risk. If interest rates rise by 1% or 100 basis points, I very loosely estimate that foreigners will cause $1.208 trillion in losses to the market. Given the nominal size of $6.461 trillion as of March 2021, a 100 basis point increase in interest rates would result in a loss of nearly 20%. can i get negative convexity!!!

Remember, if you are in long-term bonds, then you are in short-term rates. Rising interest rates are bad news for bondholders.

If you are a large foreign holder of U.S. Treasuries and the government tells you it prefers inflationary policies to support its domestic middle class, then you will opt out. That’s why foreigners went on strike when the U.S. government rained money in 2020, buying only 8.39% of issued Treasuries. Who made this difference?

The answer is simple: What happened in 1939 when the Treasury needed a sucker to buy those very expensive bonds? They called the “independent” central banks and told them to get the fuck out of the way. 2020, the Treasury didn’t even have to ask – the Fed bought 55% of all issued Treasuries. That’s how the Fed’s balance sheet grows by 76% in 2020.

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Let’s not forget about foreign bondholders. Later, when we discuss the U.S. government’s policy choices for the next decade, we’ll return to the dilemma they face.

There are a few technical details that could help the Fed maintain the argument that it is doing more than just running a money printing press to pay government bills.

The Fed has not yet set an explicit target for government bond yields. It seems they prefer an orderly, non-volatile rise in yields to some level we don’t yet know. Because they have not set a target, they can slate that they are not involved in yield curve control (YCC). This is important because remember what Governor Echols said earlier – if the Fed is implementing YCC, their balance sheet will expand to whatever level is necessary to keep yields at or below the target level. As the balance sheet expands, so does the money supply, which creates an environment for inflation.

The Fed’s liabilities are not fiat money. Simply put, the Fed does not just print money and spend it directly out of their accounts. Instead, they run a little game around the major dealers. The Treasury conducted an auction of Treasury bonds, large dealers bid on the bonds, and the Fed immediately bought the bonds from the dealers at a small markup. Everyone won. The U.S. government gets their backing, the banks get paid to take zero risk, and the Fed can claim they didn’t directly fund the government.

2020 is the year of the explosion. Cryptocurrency prices went to the moon and are currently under the terrible influence of Earth’s gravity. Is that all? Will the Fed’s balance sheet continue to rise, taking away all types of financial assets? Let’s look at the predictions.

5 Tapering Panic (Taper Tantrum)
Monetary inflation is only a problem when it manifests itself in a politically unacceptable way. The prices that politicians are most concerned about are the prices of labor (wages), and the prices of food and energy.

When COVID-19 hit, the U.S. government shut down the economy and sent checks to all those suffering from trouble – 1, 2, buckle up my shoes, 3, 4 walk out the door and invest in Robinhood with an economic stimulus check. When you add up all the various government checks, the minimum wage in most states is now $15 to $20 per hour, whereas before COVID, the legal minimum wage in many states was less than $10.

Businesses are now complaining that government largesse is preventing them from hiring enough workers. The stimulus checks definitely prevented businesses from hiring workers at the old low wage levels, but the solution was to pay more. After 50 years of losing to capital, the workforce will not accept anything but sustained real wage growth. there is an election coming up in 2022, red or blue, and if you don’t hand out the goodies, someone else will run on a Made in America, pro-union, high wage platform and defeat the pro-business candidate who would rather prioritize returns on capital. The spirit of the times has changed.

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The fact that mods on social media are making fun of the ridiculous prices America is paying for lumber tells you that inflation is here, and more importantly, people know it is here.

As wages and raw material prices rise, the Fed needs to slow down and speak up. The Fed needs to slow down and raise interest rates, or at least reduce the rate of growth of its balance sheet.

It doesn’t help that April’s consumer price index (CPI) was the highest in decades. CPI is a government-calculated index that measures inflation in the real economy. If the Fed is concerned about fighting inflation, then all the signs are there – now they need to change course.

Meanwhile, the White House is having trouble getting a key vote in the Senate to approve the next trillion-dollar infrastructure deal that will accompany the tax increase. It appears the urgency of the COVID pandemic has waned enough for partisan politics to re-emerge.

For the Fed’s balance sheet to continue to grow, two things need to happen.

The U.S. government needs to continue its spending spree.

The Fed needs to buy most of the bonds it issues in order to keep interest rates at a level that the U.S. government can afford.

It appears that both of these conditions are being questioned by policy makers. This is not a problem for my investment thesis. Now, I will explain why this tapering panic will subside and the U.S. government and the Fed will return to normal operations – the U.S. government will swipe the Fed’s dollar credit card and provide the necessary fiscal concessions.

6 The Risk of a Declining Fed Balance Sheet
Foreign Holders

Remember those foreign Treasury holders who decided to reduce their purchases of newly issued Treasuries by 80%? What could they do with their dollars?

Bloomberg has compiled an economic forecast of 6.50% of US GDP for 2021. If achieved, that would be the fastest growth since the early 1980s.

While politicians tend to put the supply chain onshore, this will not happen overnight.

BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

Source: World Bank

China, Germany and Japan will earn dollars by producing gadgets for U.S. consumers, who in turn spend big thanks to their checks. Japan and China are also the first and second largest holders of U.S. Treasuries, respectively. They earn the most dollars and therefore hold the most U.S. Treasuries.

To maintain their stock of Treasuries, they need to buy a different set of dollar-denominated assets that will not be significantly devalued by inflationary government policies. The U.S. stock market, especially technology stocks, the beneficiary of post-COVID behavior, blew the doors off in 2020. Instead of buying bonds, foreigners get smart and move heavily into the stock market.

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In 2020, foreigners bought $2.454 trillion worth of stonks (an intentional misspelling of “stocks,” a stunt often used in a humorous or ironic way, especially to comment on financial losses). That’s about 57% of U.S. Treasury debt issuance. Based on January-March 2021 data and straight-line extrapolation, foreigners are expected to buy another $3.224 trillion worth of stonks in 2021.

Instead of recycling their export earnings into U.S. Treasuries, foreigners are buying stocks – thanks to low interest rates and an expanding Federal Reserve balance sheet. Foreigners still hold $7.07 trillion worth of Treasuries.

Rising interest rates are bad for long-term bond and equity holders. If the Fed even hints at moving up the date for raising short-term interest rates and/or reducing monthly bond purchases, two things will happen. First, the stock market will struggle as foreigners sell off stocks. If the S&P 500 drops 20%, the fastest man in the world will be the Fed governor who backtracks on his own policies. Second, U.S. Treasury yields will soar. Let’s put this in a higher context – a 100 basis point increase in interest rates is enough to tattoo the word REKT (abused) on all financial asset classes.

7 The “all-powerful” U.S. government
Every regime implicitly or explicitly promises something to its citizens in return for their support. The architects of modern America were President Roosevelt and President LBJ.

If the people start saving, it will not spend. The main large costs that modern government is trying to eliminate/directly pay for are primarily related to health care. While health care in the United States is not completely free, the United States does provide free or heavily subsidized health care for the young, the elderly and the poor. The most important group for politicians is the aging worker. Baby boomers are the largest and wealthiest group in the United States. Older, wealthier people control the vote. So if you’re a politician, you have to support the things they care about. And older, wealthy people care about health care.

As they grew into productive adults, Baby Boomers received affordable/almost free health care. In addition, they received a dignified pension paid for by the Social Security Administration.

In return, they spend most of their income pursuing the American dream. A mansion full of knick-knacks, a pantry full of cheap processed foods, a two-car garage with a pickup truck and an SUV filled with cheap gasoline. This is how the American consumer accounts for 60 to 70 percent of annual GDP.

The U.S. government spending programs for Medicare, Medicaid and Social Security are collectively known as entitlement. People believe they are entitled to government-paid health care and pensions. Any politician who attempts to reform these “things” will be shut out at the ballot box.

U.S. defense spending is almost never reduced because it is expensive to be the world’s policeman. Especially when the goal is to ensure that cheap energy commodities produced in socially unstable regions are shipped to the United States every day.

The problem with entitlement and defense spending is that they are real, not monetary commodities. No matter how hard the Fed tries, it can’t print more nurses, hospitals or aircraft carriers. As the population gets progressively sicker and older, the already expensive health care system will transform into another expensive area.

Look at this – according to the U.S. Census Bureau, from 2010 to 2019, the population aged 65 and older increased by 7.74 percent. During the same period, Medicare and Social Security costs increased by 48.52%. For every 1 percent increase in seniors, their spending on government increases by 6 percent. Over the next decade, about 42 million people aged 55-64 will become 65 and older. Assuming no deaths, 13 percent of the population will begin actively seeking government support between now and 2030. If current trends hold, health care and retirement spending will need to increase another 78 percent.

Understanding the magnitude of health care, retirement and defense spending is the goal of this effort, and the next question is how the U.S. government will pay for the increased costs of programs that are critical to the compact with the people. Given the large amount of fiscal spending that has already occurred, many believe that the U.S. government will now resort to aggressively raising capital taxes to pay for the increasing spending.

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This chart shows annual tax revenues as a percentage of total Medicare, Medicaid, Social Security and defense spending. The conclusion is that taxes now barely cover 100 percent of the costs, compared to 200 percent 20 years ago. Over the past 20 years, the presidency has been held by Republicans 60 percent of the time and Democrats 40 percent of the time. Regardless of the party in power, spending has grown faster than revenues.

From 2000 to 2020, the cost of these programs increased by 207 percent, while taxes increased by 83 percent. If we extrapolate this trend for another decade, tax revenues would be only 90 percent. The government would still have about 30 to 40 percent of additional budget items to cover beyond entitlement and defense spending. This assumes that productivity and economic activity will not be affected by higher tax rates. The assumption that humans will produce the same or more output when they get less and less from their own efforts is itself a false assumption.

Taxes will never cover all the benefits promised by government. Like all governments, the U.S. government will borrow to meet its social obligations. This is especially true when the cost of doing so is relatively cheap, in this case because the U.S. government owns the printing press of the world’s reserve currency.

8 There is no choice but to move up
Slowing the pace of the Fed’s balance sheet growth is the same thing as raising interest rates. If the Fed does not raise rates, interest rates will be significantly higher because foreigners will not recycle their trade dollar earnings into the U.S. Treasury market.

No politically important stakeholder would benefit from higher interest rates.

Both domestic and foreign bondholders would suffer market losses on their portfolios.

Equity holders will suffer as the discount rate applied to future dividend streams rises, meaning valuations will be squeezed. Economic dogma holds that if the stock market rises, the real economy must do better. Therefore, if the stock market falls, the real economy will do worse. The point: don’t let the S&P fall.

The U.S. government must borrow more and more money each year to provide health care, pensions and defense equipment that become increasingly expensive as the population ages and the world order becomes more multipolar. Raising tax rates is neither popular nor sufficient to generate the needed revenue in extreme cases. The U.S. government needs the Federal Reserve to play a role and ensure that interest rates remain low while pumping debt into the economy to achieve above-trend growth.

The only winners from monetary tightening and fiscal policy are those who benefit from a strong and stable dollar. If the U.S. debt to GDP ratio was well below 100%, then it could be argued that the U.S. could afford to continue to bear the cost of a global reserve currency domestically. But now that it is a twin deficit country, with the lower and middle classes at home bearing the costs of the fiat dollar system for the past 50 years, the ability to sell austerity as a palatable policy no longer exists.

9 Try
All these great words and charts are great, but the Fed still wants to believe it has a choice. As a result, they will try to reduce the pace of bond purchases – with potentially disastrous effects. 2013 saw the market plunge when the acting Fed chairman talked about a possible tapering of bond purchases in the future. Stokes and Bond got their way, and Bernanke quickly nailed the plan. The bond purchases will go ahead as scheduled.

Whenever the Fed tries to get out of QE 4 EVA, the market says NYET (no). This time the stakes are even higher because the stated policy of the US government is that we are at war with COVID and therefore will spend everything we can. Similar to the period from 1939 to 1951, the Fed will be implicitly or explicitly required to buy bonds to engineer a Treasury yield curve that is below the annual economic growth rate.

Now there are two problems – the Fed is considering reducing the number of bonds it buys each month, and elected officials in the U.S. government have yet to pass any new massive spending bill. If the Fed and the U.S. government don’t work together to spend more money, the cryptocurrency market will pull the plug on what will happen in the stock and bond markets.

I fully expect the carnage across asset classes to continue into early fall. The Federal Reserve will have held two policy meetings in June and July. If they start talking seriously about tapering balance sheet growth, watch out.

The Democrats need to figure out how to pass their infrastructure bill. Who knows what compromises they will make to get out of the line, but we need more stimulus checks. the expanded $3,600 child credit check in 2021 is a good step toward maintaining stewardship and continued investment on the Washington side.

In summary, if the Fed’s balance sheet is to grow tenfold, more borrowing will need to happen quickly. Nothing goes up or down in a straight line. In the absence of falling stock prices and rising interest rates, the inertia of large bureaucratic organizations will include efforts to expand fiscally aggressively. Again, I believe we will see a negative reaction from global markets this summer and fall.

10 How high?
The point of this paper is to argue that the only politically acceptable course of action to fight COVID and avoid exacerbating social unrest is to pay for nominal GDP targets with borrowed money. To keep borrowing costs below the level of realized growth, the Fed would expand its balance sheet to whatever level was necessary.

The nominal GDP growth targeting policy works – the only problem is preventing runaway wage and commodity inflation. Sometimes, however, this is a politically acceptable outcome. During and after the war, governments always accepted this hyperinflation because it was the only thing they could take for this effort.

The trick is to spend the money on efforts where the real economic value exceeds the interest on the debt issued. China has pursued this strategy with great success from the late 1970s to today. Michael Pettis argues that the true cost of debt exceeded economic growth sometime after 2008. China has accumulated the largest debt stock in human history because it has adopted an extremely enthusiastic policy of nominal GDP targeting and because it does not issue a global reserve currency. If the U.S. also goes all in, there is no ceiling on how much debt the Fed can hoard.

I cannot predict with certainty how much the Fed’s balance sheet will grow. All I know is that if such a policy is to be implemented, the only way to do it is to print money. The question for us traders and investors is what financial assets we can have that will grow at least as fast as the Fed’s balance sheet.

The U.S. has already begun this process. Assuming a 2% yield on the 10-year U.S. Treasury and 6.5% GDP growth by the end of 2021, this is the current estimate by the Fed and “respected” economists. This is a negative 4% real yield.

You have a bad job

Water, water, everywhere.

All the boards have shrunk.

Water, water, everywhere, and

And not a drop of water to drink.

— The Rime of the Ancient Mariner

This is one of my favorite verses, and it fits the current liquidity situation perfectly. Liquidity has increased significantly due to the Federal Reserve’s monthly bond purchases; however, the only water we actually need can come from the massive spending bills passed by the U.S. government and Treasury, which require the issuance of more notes, bills, and bonds.

Unfortunately, this article is already too long, so I can’t delve into exactly how the transmission channel of quantitative easing works. But essentially, when the Fed buys Treasuries from banks that are too big to fail, it credits the reserves of the banks held by the Fed.

Because of capital adequacy rules, banks must hold additional capital against these reserves.

However, if they hold U.S. Treasuries, they need to hold less, or none at all.

When the Fed conducts an open market operation and buys U.S. Treasuries from banks, it takes away one type of high-quality collateral and replaces it with inferior collateral. The banks then need to come up with the funds to back those reserves. This essentially hinders the banks’ ability to provide more credit because they need to tie up capital to support their large and growing reserves held at the Fed.

The Fed is interested in this problem, so they do reverse repos. This means that the Fed swaps reserves for U.S. Treasuries. On the one hand, the Fed increases liquidity by buying Treasuries from banks, and on the other hand, it reduces liquidity by swapping them back to banks.

Thus, the net effect is that the overall liquidity position in the fixed income market remains unchanged in extreme cases.

BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

The number of people using the instrument at the New York Fed recently soared to an all-time high as market Treasury collateral ran out. It will take more money for the Treasury/U.S. government to borrow more money. Because if the Fed insists on buying $120 billion per month, about 70% of which is in U.S. Treasuries, there is not enough collateral available to run the banking system with short-term interest rates above 0%. There are multiple structural and legal reasons why the short end of the Treasury curve cannot go negative without causing serious disruptions to the way the U.S. money market works. in 2008, the Fed switched to a high-speed money printing mode. However, every Fed governor lamented that they could only do so much. Their quantitative easing measures are ineffective if the U.S. government does not spend more money and thus create more collateral for the national debt. Quantitative easing will only shift the balance sheets of banks and other financial institutions from assets held in Treasuries to those held in riskier corporate debt and equities. This does not mean that banks will risk lending to the real economy. It does not put the stimulus check in the hands of GameStop warriors. In essence, it does not correct the underperformance of labor relative to capital since the 1970s.

The Treasury is well aware of this fundamental problem.

11 Cryptocurrency as a Release Valve
When a measure becomes a target, it ceases to be a good measure. – Marilyn Strawson

Financial markets are a collection of various measures designed to tell us information about different aspects of the real economy. However, when central banks turn these measures into targets, they don’t mean anything. They then tell us only the extent to which the central bank will buy or sell assets to achieve a desired politically acceptable outcome.

Thankfully, unlike the people of the 1940s and 1950s, we have cryptocurrencies. Even though their domestic governments forbade them from holding gold, only the very rich really had the ability to express themselves financially. Everyone else just ate their humble pie and complained while their savings were emptied to pay for the world’s second full-scale war.

Here are the various measures and how they have already been turned into targets.

Government bonds – Almost every central bank in the world has distorted its domestic bond market through aggressive buying programs. As a result, government bond yields only tell us the extent to which central banks are willing to expand their balance sheets – it tells us nothing about the true and proper cost of money

Equities – Almost every central bank in the world is active in their respective domestic equity markets. The Fed is not yet, but as long as the S&P 500 continues to fall, they will find ways to support the stock market. Central bankers and most politicians believe their credit is an indication that the stock market is performing, which somehow means the real economy is healthy.

But if you can target stocks at any level by printing money to buy the necessary number of shares, then stock market performance will not tell you much about the actual health of the domestic public enterprise sector.

Housing – Almost every central bank in the world is active in their respective domestic housing finance markets. The mortgage-backed asset market in the U.S. has developed exceptionally well, but central banks and the federal government set stamp duties, mortgage rates and other affordability measures to encourage or discourage home purchases. This is not a good measure because there are too many special policies that distort the price of homes representing materials and imputed owner-occupied rents.

Gold – The interesting thing about gold is that it may be regaining its mojo. Starting this June, large bullion banks will face changes in accounting for and funding unallocated gold on their balance sheets. The new rules of Basel III may not be able to suppress the gold market by creating unlimited paper shorts. If this does become a reality, then gold may once again become a measure of monetary inflation rather than a sleeping rock sitting in vaults around the world.

12 Cryptocurrencies

BitMEX Founder: Learning from History and Why Shorting the Entire Crypto Market is Foolish

This is a chart of Bitcoin and Ether indexed to the Fed’s balance sheet in the post-COVID era. The data is indexed to 100 as of January 1, 2020. both have performed exceptionally well in terms of purchasing power growth even with the recent vicious sell-off.

Bitcoin and Ether outperform the Fed’s balance sheet by a factor of 2.3 and 15, respectively.

No organization that owns a printing press has a target price for any cryptocurrency. Quite the contrary, they believe that cryptocurrencies simply represent the madness of the internet crowd. This is perfect because cryptocurrencies can serve as the only effective smoke alarm for monetary inflation if/when the issuers of global reserve currencies resort to nominal GDP targets funded by their proprietary printing presses.

If you agree with me after all this text, then you’ll think that the volatility in the total market value of cryptocurrencies is irrelevant.

As the Fed’s balance sheet grows, cryptocurrency market capitalization will grow with it. The relative performance of tokens in the crypto market depends on the narrative, technology and adoption.

Now that I’ve laid out my global macro argument for why shorting the entire crypto market is foolish, I can return to an in-depth analysis of the micro market structure of cryptocurrencies and how DeFi will make most current financial institutions useful only to those who refuse to use digital payments.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/bitmex-founder-learning-from-history-and-why-shorting-the-entire-crypto-market-is-foolish/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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