As the global financial system buckles and strains, is Bitcoin about to take reigns?
Bond bondage
The global banking sector is having some issues lately. Those pesky risk managers at the banks apparently failed to manage interest rate risk. And, why should they have?
The banking business model is pretty simple, especially since 2008. Make a short-term plan to invest client money. If it works, great. If not, you get bailed out.
The bankers get to play a neat game, where they can basically use 10x leverage on customer deposits to create loans. One way they cover that 10x leverage is by “lending” money to the government through yield generating bonds.
Except for a brief period around 2018, bonds haven’t paid squat in yield. A short-duration bond might have generated 0.25% interest. But, a long-duration bond might have generated 0.5% interest.
Bonds have a face value at maturity. They also have a market value. The trouble the banks have is they bought long-duration bonds when rates were zero. They bought them to chase that little sliver of extra yield.
Now, rates are higher, so the market value of the low-yield, long-duration bonds collapsed. That’s not really a big deal, unless your depositors want their money back.
Well, depositors decided they want their money back.
Since the banks are levered up at 10:1, they only have 1/10th of the customer deposits. So, if enough of their deposit base wants their money back, the bank has to sell their bonds to cover the difference. Except now their 0.5% long-duration bonds are only worth 70 cents on the dollar (or less), so they have to sell them at a loss.
Rinse, repeat a few times and — *poof* — your bank collapses.
Oopsie.
Not to worry though, Uncle Sam, Uncle Powell, and Auntie Yellen will bail you out to “protect” depositors. They way they do that is by b̶u̶y̶i̶n̶g̶ holding your trash bonds and g̶i̶v̶i̶n̶g̶ loaning you the face value of those trash bonds.
Hurray! Now you can pay your depositors. Same basic game they played back in 2008, except they were outright buying trash OTC derivatives (“troubled assets”), instead of b̶u̶y̶i̶n̶g̶ holding trash bonds (“troubled bonds” anyone?).
What’s a few trillion among friends?
What we’re really watching is four decades of moral hazard coming home to roost. Beyond the ballooning Fed balance sheet, the inflation, and the destruction of purchasing power, the real trouble comes with liquidity saturation.
When the government creates money out of thin air by “lending” or “giving” it to cover “troubled assets”, it takes exponentially MORE vapour money to cover each expanding hole. From the Latin American debt crisis to the Dot-Com bubble, to the 2008 collapse, it takes more and more paper to cover up each new mess.
That’s because they never actually pay down the debts that are incurred through money printing. At a (very) theoretical core, all of that vapour money has to be accounted for through taxation. But, in order to pay for the money printing, either tax revenue has to come up, or government costs have to come down.
Voters don’t like either one, and politicians like to please voters. So, rather than “fix” the problem, they just keep inflating the money supply until the original debt gets papered over. Trouble is, all the “easy” money distorts market incentives and corrective measures, so a new bubble emerges.
And, then the government papers over it again.
But, each time, the total amount of debt goes up. The distortions become more pronounced. The corrective mechanisms are eventually silenced and we end up with a zombie economy.
Japan: The Godzilla of Zombie Economies
Way back in the 1980s, Japan took the first bold steps towards creating a zombie economy. In fact, they are the world leading experts in how to inflate real estate and equity bubbles, collapsing them and then never recovering.
To this day, their real estate and equities markets haven’t recovered. That big spike in the middle of the chart was the peak of the Japanese debt mania. At the height of the bubble in 1989, the Imperial Palace of Japan was worth more than all the real estate in the entire state of California.
Obviously, from a true Libertarian, laissez-faire market perspective, that is an impossibility. But, in a debt-fueled, tax-reducing, easy monetary policy landscape, it makes perfect sense. Likewise, it makes perfect sense when the whole thing collapses.
Today, Japan has their money printers on full-steam, and even with all the Covid stimulus and bond and currency market manipulation, all that comes out of Japan are legions of companies that would outright fail without easy money policies. Non-productive, non-profitable and a huge drain on the economy.
Remember, all this debt is (theoretically) backed up by tax revenue. Trouble is, if you take the vast majority of your tax base, reduce their spending power, and inflate real estate and asset prices beyond their ability to participate (and generate capital gains tax revenue), sooner or later you end up like Japan.
A flat-lined economy, zero-economic mobility, and constant inflation. It’s no longer a “bubble” economy, it’s a “life-support” economy. That’s what a Keynesian liquidity trap looks like.
It’s also what is pointed at our collective heads right now.
Is Bitcoin the answer?
In the short-term: no.
Like, no way, no how, zero chance. Well, I shouldn’t say “zero” chance. I should say, if Bitcoin becomes a legitimate option to manage global finance in the next year or two, the world as we know it will be on FIRE.
The Western standard of living would decline catastrophically within weeks, if not days. Like it or not, the world runs on a dollar denominated ledger, with central banks at the juicy centre.
If that gets violently displaced in a short time-frame, you and I are not going to be thinking about Bitcoin. We’ll be trying to figure out how to live without gasoline, electricity and food.
Which is also why that probably won’t happen.
What is more likely to happen is government financial m̶a̶n̶i̶p̶u̶l̶a̶t̶o̶r̶s̶ regulators will find a way to shoe-horn digital assets into the legacy financial system. They’ll do this (knowingly, or otherwise) so major finance companies and banks have somewhere new to d̶u̶m̶p̶ invest their never-ending supply of helicopter money.
And, if they do, your bags are going to PAMP.
The Bitcoin caveat
One nice, and hopeful outcome from such a shift would be that digital assets become a vehicle to raise the retained purchasing power of digital asset investors.
And, because digital asset markets are globally accessible 24 hours a day, anyone smart enough to get on the train now will be standing at the front of the global liquidity redistribution train.
Meaning, digital assets are a very feasible way out of the financial turmoil that 40+ years of institutional moral hazard has created. Digital assets are accessible, easily traded, and deeply fractionable.
From where I sit, the best, most hopeful, most egalitarian path forward for digital assets is to:
- Broadly encourage digital asset adoption and use by the “masses” as an investment vehicle through relaxed retail regulation;
- Limit institutional exposure and ability to manipulate through strict regulation;
- BUT, provide institutions enough exposure surface to incentivise adoption.
What would (ideally) happen in such a set-up is:
- Retail investors gain exposure to an asset class that appreciates as fast, or slightly faster than the rate of monetary debasement;
- Institutional investors (with significant guardrails) could also SLOWLY gain exposure to an asset class that appreciates as fast, or slightly faster than the rate of monetary debasement;
The rough idea behind all of this is, much as Japan has figured out, there is only so much room to inflate real-estate and equities before they become out of reach. Meaning, as vehicles to maintain purchasing power for the majority of the populace, they get too expensive.
However, if it’s necessary (as it is now) for central governments to continually inflate the money supply to maintain stability, then digital assets are a perfect place for those inflationary dollars to go when equities and real estate are maxed-out (as they are now).
In other words, digital assets are a way to bring the masses “up”, while still allowing the funny-money economy to keep going. The retail masses get digital assets straight from the tap, institutions pay a regulatory premium to access the same tap, and then everybody’s balance sheet goes up.
Institutions have a new place to generate revenue, while the retail masses can use digital asset price appreciation to maintain purchasing power. Such a scenario could allow our deeply flawed and fundamentally broken financial system to keep going for another 50 years.
We all want the same thing: a comfortable life and stability. If we’re smart, digital assets can be that solution. It’s not perfect, nothing is.
But, it’s certainly better than financial armageddon.
These are just my opinions. I’m not a financial advisor, this isn’t financial advice, and always DYOR. Following any of these ideas might cause you to lose all of your money. I am 100% serious about that. I like tinkering with this stuff, but I’m on record acting like a total baboon. Invest accordingly.
Until next time, be safe, be smart and be sure to tie the camel.
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