Wise Castle Mikko: On the Impact of Dollar Liquidity on Digital Currencies

Affected by the epidemic, the Federal Reserve has been stimulating the U.S. economy through monetary policy (commonly known as the “Great Discharge”) to revive the U.S. economy. Last year’s “big release” also gave rise to the bull market in the cryptocurrency world.

Wise Castle Mikko: On the Impact of Dollar Liquidity on Digital Currencies

Author Zhu Dust Mikko

The topic I’m sharing today is about dollar liquidity and digital currencies. In opening the whole topic, it is necessary for me to go with you on running through some things, and the process may break your foundational perception of money creation.

The nature of money creation
First of all, where do people think the money that banks lend you comes from? Most people think that banks, as financial intermediaries, absorb everyone’s savings and then lend it to another person. Actually, banks do not have the right to do this. The bank has a money creation move when it lends: it creates a sum of money (a deposit) to you, rather than taking another person’s deposit and giving it to you. So how does the bank create this deposit? Here the double-entry bookkeeping method and the T-table will be introduced to break down the process of money creation.

Double-entry bookkeeping is a form of bookkeeping in accounting, and the T-sheet (balance sheet) is the structure of double-entry bookkeeping. In the balance sheet, assets are the investment of all your monetary resources, such as when you buy a piece of real estate, or a bitcoin. And liabilities are your debts, such as credit card or spending money owed. Equity is your real money, a monetary resource that doesn’t involve any liabilities. For example, if your parents give you $100, that’s your equity. So the left side of this T-chart is assets, and the right side is liabilities plus equity.

Let’s take the example of a bank lending you money. The bank lends you $100, and you need to pay the bank back. Let’s say that after you apply for a bank loan from ICBC, and after ICBC has approved it, you can withdraw the credit line given to you by the bank at any time in your ICBC account, at which point you have an additional deposit with the bank. When the bank lends money, it actually creates a sum of money and creates a deposit for you.

So the bank has $100 in assets + loans and $100 in liabilities + $100 in deposits

Your liability + $100 loan, because it needs to be paid off in the future, adds $100 to the bank deposit on the asset side.

Bank
Assets Liabilities + Equity
Loan of $100 Deposit of $100
Personal
Asset Liability + Equity
Deposits $100 Loans $100
The most classic example of money creation is that loans create deposits, not deposits create loans.

The deluge led to the explosion of the digital currency market
Last year was a special year for the Federal Reserve to revive the U.S. economy through monetary policy stimulus (commonly known as the “big flood”) due to the impact of the epidemic. Last year’s “big let-down” also gave rise to a bull market in the cryptocurrency world. In the last financial crisis, most of the money created by the Fed went into the hands of banks and non-bank institutions (including hedge funds, money management companies, etc.).

The current stimulus is of a different nature, as the Fed issued additional money while the U.S. Treasury absorbed the additional money through debt issuance and then distributed it to the people. Banks and hedge funds can hardly buy coins because the move does not comply with regulatory requirements, while the people can go buy coins. Last year’s market for both US stocks and digital currencies revealed a very interesting feature: the market was not entirely dominated by institutional investors, but by retail retail investors. Here will use the T-table to explain how the dollars flow into the hands of the people after the Federal Reserve issues more dollars.

Here you need to list the T-table of the Fed, the banks, the US Treasury and you. First of all, before the Fed implemented quantitative easing, banks had a large amount of treasury bonds on the asset side as its asset allocation, and investors also had U.S. bonds in their hands.

Banks
Assets Liabilities + Equity
U.S. debt
Investors
Assets Liabilities + Equity
U.S. Debt
The Federal Reserve buys Treasuries from banks and individuals and pays them for deposits. Since individuals do not have the means to open accounts with the Fed, the Fed buys Treasuries from individuals or non-bank institutions by paying the money to the agent banks that are the subjects of these sales of Treasuries, such as JP Morgan Chase. Then JP Morgan Chase receives the reserve deposit given to him by the Federal Reserve after a deposit is recorded on the investor’s account.

Thus, the asset side of the Fed + Treasuries, the liability side + deposits (reserves)

Federal Reserve (QE)
Assets Liabilities + Equity

  • treasuries + deposits (reserves)
    (This money is printed)

At the same time, the asset side of banks and individuals because of the sale of treasuries

Asset side of banks – Treasuries + deposits (reserves).

Asset side of individuals – treasury bonds + deposits

Banks
Assets Liabilities + equity
+deposits -reserves for treasury bonds
-Treasury bonds + investor’s bank deposits

Investors
Assets Liabilities + Equity
-Treasury bonds +Treasury bonds
+Bank Deposits
Next, the U.S. Treasury issues a new Treasury bond. By U.S. law, U.S. primary dealers are required to subscribe to U.S. Treasuries in the primary market. The U.S. Treasury issued as much U.S. debt as the primary dealers had to undertake. Therefore, the bank’s reserve (printed money) becomes U.S. debt again, and it can hold U.S. debt itself or sell it to customers. Then when the bank in the process of increasing the U.S. debt, his deposits and reserves are spent. The money flowed to the deposit account of the Treasury. At this point, the Treasury’s account has been made even.

U.S. Treasury liabilities + Treasury bonds (U.S. bonds purchased by banks and investors);

U.S. Treasury assets + Treasury deposits

Bank Assets – Reserves + U.S. Debt

Banks
Assets Liabilities + Equity

  • U.S. debt
    -Deposits (reserves)
    U.S. Treasury
    Assets Liabilities + Equity
  • Treasury Deposits + U.S. Debt

Then, the U.S. Treasury has to implement a policy of spreading money and granting subsidies to individuals for stimulating economic recovery.

U.S. Treasury Assets – Deposits

Personal Assets + Deposits

U.S. Treasury
Assets Liabilities + Equity
-Treasury deposits (spreading money)
Personal
Assets Liabilities + Equity

  • personal deposits (Treasury issued deposits)
    Regarding the Fed QE, you will find that the U.S. financial system is a money creation cycle, and its funds are just idling inside the financial system without any relation to the real economy. When you receive the Treasury Department to give you a deposit subsidy, there are two options: the first is to foolishly take this deposit in the United States to enjoy close to 0% interest on deposits, the second option is to allocate it to higher risk assets (such as digital assets and some technology stocks in the U.S. stock market). In fact, the Federal Reserve issued a total of nearly $4 trillion in additional money last year, and if you include the deposits created by loans in the banking system, the entire liquidity creation last year should be the most in history. When investors face the whole risky asset market last year is no brainer, because as long as the assets are rising.

The impact of dollar liquidity on digital currencies
Next, I’ll tell you about the recent dollar liquidity problem. From this hard money data, we can see how much the currency has increased. The blue line in this chart is the current dollar in circulation, and from 2008 to 2020, this blue line it has been going up. According to the Federal Reserve, it is growing at a rate of $90 billion per year.

We can see that last year the bank reserves grew to $400 million a year, which is a very impressive figure. Because the Fed’s reserve level was only about $2 trillion during 13 or 14 years. The current level of $4 trillion would be equivalent to doubling the deposits of all financial institutions, and if asset prices don’t double, is it still reasonable? This is just the money in the Fed’s table, and we haven’t counted the commercial banks.

The green line is the deposits of the Treasury, and its logic I have already talked about before. First of all, the Fed prints money, and then the printed money flows back to the U.S. Treasury; the U.S. Treasury spends the money (to individuals), and individuals exist in the bank will become deposits. So the red line and the green line will sometimes run in the same direction, and sometimes in the opposite direction. The same direction indicates that too much money is being printed, while the opposite direction indicates that money is being printed at a slower rate, and money is structurally moving through the accounts of individuals and banks.

Wise Castle Mikko: On the Impact of Dollar Liquidity on Digital Currencies
Wise Castle Mikko: On the Impact of Dollar Liquidity on Digital Currencies

From these two charts, we see that the size of deposits in U.S. commercial banks is rising, while the size of loans is not rising much, just 400 billion. This shows that money creation is currently led directly by the Fed, not by commercial banks through loan deposit creation. Why aren’t commercial banks lending at a sufficient rate of growth? Because the U.S. economy is more depressed in the midst of the epidemic, and credit demand is more depressed. With insufficient spending power, insufficient lending, and money creation with no intention of helping the real economy, money can only go into the stock, futures, and digital currency markets.

Wise Castle Mikko: On the Impact of Dollar Liquidity on Digital Currencies

The above graph indicates that not only the Fed is printing money (issuing more money), but central banks all over the world are printing money. We can see that the ECB (European Central Bank) and BOJ (Bank of Japan) have a strong ability to print money. The BOJ’s balance sheet is about the same size as the ECB and the Federal Reserve, while Japan’s economic volume is not comparable to theirs. So, the BOJ’s printing scale is also more exaggerated.

The only more Buddhist is our People’s Bank of China (PBOC), the country’s monetary policy is also relatively tight compared to developed economies, the main reason is that our epidemic is still relatively well controlled, there is no need to support the recovery through a large amount of stimulus. In one way, the increase in monetary issuance is good for GDP: more money on the market also naturally allows people to spend and spend, and various business practices to be carried out.

Digital currencies are classified as an alternative asset class

Wise Castle Mikko: On the Impact of Dollar Liquidity on Digital Currencies

J.P. Morgan Report on tether
Do you have a sense that mainstream investment banks are now including bitcoin and digital assets as a very important alternative asset class? Recently, J.P. Morgan’s US fixed income team wrote a research report on Tether, which recently announced its asset mix, and more than half of its assets are commercial paper. Here’s why commercial paper makes up such a large portion.

The premise of Tether’s USDT issuance is that it has sufficient reserve assets. Previously, Tether had dollar deposits with large banks, such as JPMorgan Chase. To address compliance issues, the big banks rejected Tether’s deposits. So Tether deposited the dollar deposits with another small bank. So these smaller banks (which usually open accounts with JPMorgan Chase because they don’t have the ability to settle at the central bank) deposit the money with JPMorgan Chase. Because the financial system is nested, the Tether deposits end up on the balance sheets of the big banks.

Commercial paper is actually private IOUs with shorter maturities. There are two types of institutions that now issue such invoices in the U.S. market, large corporations with traditional businesses (like Coca-Cola) and technology companies (like Apple, for example). So Tether is taking his dollar deposits and buying IOUs from Apple and Coca-Cola.

So is Tether’s liquidity reserve at risk? There is risk. Of course you could argue that the IOUs of Coca-Cola and Apple are very low risk, and that their issuance rates may be lower than some sovereign countries. But the commercial paper of these companies is also at risk. Because these companies don’t have the ability to print money, they have to pay it back with real money earned. So why are people willing to accept Tether even though it has liquidity risk? Because speculative users really don’t particularly care about how much Tether’s asset reserve is, speculative users never care about risk.

After Tether’s asset reserves were announced, why did it receive a lot of attention from investment banks? Because it is one of the largest CP holders in the US. This suggests that digital currencies are not small anymore either, which is a very worthwhile focus for the liquidity mothership. And the system is getting bigger and bigger, and that doesn’t include other stablecoins.

Two days ago, Federal Reserve Governor Brainard said that the U.S. CBDC (the U.S. central bank’s digital currency) must be launched as soon as possible and dominate the global digital currency. Why? Because he found that what the government doesn’t do is already being done for him. If the Fed doesn’t go ahead and issue a digital currency, then his future market share is all Tether’s. Here’s a lesson from the past. The People’s Bank of China is in a hurry to launch CBDC because 80% to 90% of its payment market share comes from WeChat and Alipay. And these large tech giants can open reserve accounts directly with the central bank. When users keep their money on Alipay, which keeps 100% of it with the People’s Bank of China, then their deposits are virtually risk-free. In other words, Alipay can claim to be the world’s largest stable digital currency, one because it is digital, and two because Alipay and WeChat Pay together account for 80 to 90 percent of the entire payment ratio. And the intention of China’s CBDC launch is to re-dominate the payments business through the CBDC system.

The current monetary environment is not conducive to digital currencies
The macro environment afterwards will be unfavorable for the digital currency market. Here is an excerpt from the Fed’s minutes: Many participants stressed that the committee must communicate well in advance to the market about Taper before the economic situation is assessed as “substantial progress”. Because the money printed last year is too much, it may take 5 to 10 years to digest the additional money issued. Second, the June meeting the Fed may begin to release a signal – tighten the dollar liquidity.

The U.S. Congressional Budget Office recently released a report called options for reducing the deficit, which indicates that the U.S. wants to reduce its own fiscal deficit in the next 10 years. And the U.S. Treasury has a deficit that is too large. Because the U.S. Treasury has to give money to the people, and the money issued is the Federal Reserve to help monetary increase out to support the issuance of debt, the Treasury absorbed a large amount of liquidity to fill the deficit spending. Recently U.S. Treasury Secretary Yellen has done a lot of things, hoping to reduce the deficit. She wants to change the global tax system, including raising personal taxes, increasing estate taxes, and increasing capital profits taxes. Because she wants to change the revenue and expenditure structure of the Treasury Department so that the revenue exceeds the expenditure. People may need to pay speculation tax to the Treasury account in the future.

One big theme in the U.S. starting later this year is the slow tightening of the currency over the next 10 years. The dollar has hardly ever tightened in the last 10 years or so. It has a very large balance sheet despite a rate hike cycle from ’15 to ’18. The U.S. government has not substantially tightened its monetary liquidity. When the Clinton administration suddenly started tightening fiscal policy in ’98 and ’99, the bull market in U.S. stocks for a decade or two made people form an inertia; but when monetary policy started tightening, people realized that the government did not just implement easing policies. Currently, the US has a very high debt/GDP ratio. And the U.S. debt can only be rolled over through taxes or new monetary issuance. And the Fed has issued a lot more money, which will make asset prices even more inflated and will pose a bubble risk.

Despite the less favorable macro environment, there are still lifesavers, and digital assets are an important part of the asset allocation. One of Goldman Sachs’ most core research report series is called Top of mind, which is a research report done by Goldman Sachs using its entire research network and its think tank contacts. In the research report, Goldman Sachs believes crypto will become an important asset class. The report also shows that if you allocate a certain percentage of bitcoin to a 60/40 equity/bond portfolio, it will enhance your total return. This is because bitcoin is not as strongly correlated with real assets. Bitcoin has a significantly negative correlation with the US dollar. So the only enemy of digital assets is the U.S. dollar, but the U.S. dollar is the thing that made it happen. So right now the dollar index is moving very weakly, and it’s in a weak trend that digital assets and risk assets are up so much. If and when the dollar index starts to pick up, watch out for the risk.

Wise Castle Mikko: On the Impact of Dollar Liquidity on Digital Currencies

Finally, the so-called digital currency cannot be called a digital currency. First of all, all currencies under the financial system are now digital, for example, your deposits are digital and so is Alipay. So the word digital doesn’t add anything extra to the meaning of money. Second, digital currencies such as Bitcoin are not a currency, they are an alternative asset. No one is going to use bitcoin as a currency in a mainstream monetary environment, that’s the point everyone has to acknowledge. usdt has some currency-like qualities, but it can’t be called a currency either. So you should not buy digital assets with the illusion that it will replace the US dollar in the future.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/wise-castle-mikko-on-the-impact-of-dollar-liquidity-on-digital-currencies/
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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