PEOPLE

Translation: BitMEX founder criticizes central banks harshly, optimistic about how macroeconomics will benefit cryptocurrencies.

2021/11/17

This article is written by BitMEX co-founder Arthur Hayes and was published on November 11. The Chinese version is provided for reference only. For any doubts, please refer to the original article "Chain Reaction".

Table of Contents

Chain Reaction

Combining acid and alkali produces salt and water. Basic chemistry knowledge. If my high school chemistry teacher knew that after years of teaching, all I remembered was this, he would surely be disappointed.

Among the various known components in the current global macro environment, the invention of Bitcoin is equally inevitable: when you combine the internet, cryptography, and an outdated and unfair analog financial system, you will eventually get a reactive technological development that attempts to improve this nauseating status quo. Bitcoin and blockchain are precisely the result of this.

You are about to join this competition. Various ideas spring from the respected Satoshi Nakamoto's whitepaper, allowing me to write an article about novel and interesting topics in the crypto ecosystem every two weeks. DeFi, NFTs, Metaverse, DAOs, and all things decentralized are the results of reactions between many naturally occurring inputs. Two of the most important components are Bitcoin and an analog system that should be upgraded to adapt to the computer and internet age.

As we revel in the bull market of all cryptocurrencies, we must not forget the macroeconomic environment, which provides a fertile foundation driving technological advancements. Even as the most fervent supporters of fiscal and monetary policies pause, the post-COVID era of money printing and economic stimulus continues. These policies are significantly disrupting global social structures in areas such as food, housing, and transportation.

They call it "transitory," but in reality, they know the guillotine is permanent. So let them eat cake. Note: "Let them eat cake," derived from the story of the last queen of France, Marie Antoinette, akin to the context of "Why don't they eat meat?"

The debates among the global elites are no longer important. While a few influential and powerful individuals benefit greatly from the injection of global liquidity, the potential cost of a revolution is driven by those who work harder but benefit less, which is a significant and undeniable matter. Therefore, as we enter the fourth quarter, the question becomes: How do we safely handle the inevitable aftermath as monetary and fiscal stimuli gradually diminish?

For the next two weeks, I will temporarily halt the discussion of the flourishing metaverse and return to the macro foundations. I will strive to answer the question of whether slowing down money printing will have adverse effects on our crypto assets. Perhaps those weary of being financial serfs in TradFi (traditional finance) may overcome tighter monetary policies due to their interest in crypto assets and continue to drive the growth of cryptocurrencies, but I will not make that assumption lightly.

Coffee Time

Fortunate for the readers of this letter, I recently chatted with my favorite volatility hedge fund manager at a new coffee shop. He is the same person who inspired me to write "Pumping Iron", and I will call him Jesse. If you can tell me why I chose that name, I will give you extra points. The place we often visited was recently forced to close and remains a victim of COVID lockdown measures. Fortunately, the new shop is right next door. Both shops provide affordable coffee, catering to the proletarian white-collar class.

As I mentioned earlier, during this gathering, I was concerned about whether I underestimated the central bank governors, who are actually seriously combating inflation risks by reducing bond purchases and raising short-term policy rates. My fundamental idea is that central banks continuing to fund government stimulus plans by expanding their balance sheets is a political expedient. I also believe that all major central banks have an unofficial mandate to ensure the stock market continues to rise. The inflationary pressures from these policies are a necessary evil to ensure domestic spending plans can be funded with continuously rising asset prices. Stopping the money printing policy would weaken asset prices and leave many financial institutions and governments insolvent. Therefore, it is fundamentally impossible, or at least I believe so.

Mark Twain said it best: "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."

With these thoughts in mind, I entered this coffee meeting, prepared to test my worldview with people smarter than me. I am more bullish on cryptocurrencies and believe these authorities are not prepared to handle the aftermath of quantitative easing. In the next thousand words, I will recap our conversation and annotate key points with some charts.

Boomerang

I started our conversation by asking him about the recent trend in the Australian dollar exchange rate. In Australia, the Reserve Bank of Australia (RBA) had previously committed to capping the 2-year bond rate at 0.10% (this is textbook yield curve control, or YCC, where they lower the rate to 0.10% or below by buying enough bonds whenever the market ticked up a bit). However, the RBA recently decided to stop suppressing the price of the 2-year bond.

The chart above, along with its depiction of the significant rate increase, clearly illustrates what happens when you remove the tight corset of central bank bond market purchases. The part not shown in the chart is: the soaring yields leading to a sharp drop in bond prices.

Anyone who isn't concerned about rates jumping from 0.10% to 0.80% needs to understand the basics of total bond return calculations. In just a few trading days, yields increased by 8 times. This move took down many masters working in big-name hedge funds. Jesse started mentioning the names of some large hedge funds whose credit desks were cut. Fortunately, hedge funds only lose their clients' money. If this were a "too big to fail" bank trading platform, they would seek government help and get bailed out... for "market stability." Can you not love the privatization of gains and socialization of losses?

Next, I asked Jesse why he thought the Australian central bank allowed the market to reprice the curve, especially since the RBA holds nearly 70% of the 2-year government bond supply. They are indeed the market.

His reason aligns with mine, which is housing inflation. Let me explain.

I have many Australian friends. We often discuss the red-hot Australian property market. The Australian real estate market has not experienced a true commercial cycle in modern history, meaning it has not experienced cyclical major price adjustments. The median price-to-income ratio in Sydney and Melbourne is one of the highest in the world. The higher the ratio, the less affordable housing becomes.

The Australian central bank has faced political heat due to its citizens being unable to afford properties. For an economy that exports many global economic support raw materials and delicious food, their monetary policy is very loose. Sometimes, keeping rates far below the nominal growth rate due to inflationary pressures becomes too much, and the Reserve Bank of Australia has to step in.

The concern in other parts of the world is whether the major central bank centers in the US, EU, Japan, and China will make similar decisions and when. Keeping this question in mind, Jesse has some ideas about the path the real players intend to take in the near future.

Butterfly Effect

The surge in Australian dollar rates serves as a catalyst for similar movements in other global rate markets. Every major economic entity, regardless of its economic model, manipulates its government bond market. Therefore, all central banks must adhere to the rules; otherwise, the market may overwhelm the perceived control of central banks. This is Jesse's viewpoint, as he checks off several rate markets where he can profit from the sharp increase in short-term rate implied volatility.

My good friend Jim Bianco from Bianco Research has produced some great charts showing how the market is beginning to test central bankers. You wouldn't guess his capabilities from his appearance and age, but Jim is a junk bond player and believes in the promise of DeFi. I salute him.

Short-term rates surge in New Zealand, Canada, and Australia:

Short-term rates surge in the US and UK:

To maintain the charade of central banks' omnipotence, any central bank governor who steps out of line and attempts to normalize anti-inflationary monetary policies must be dealt with. The sudden eruption in the 2-year rate market cannot be allowed to continue. Therefore, the whimsical central bank governors need to regain their faith. Letting market pressures appropriately reflect inflationary pressures of various domestic economies is unacceptable.

Make It Stop

The only thing preventing central bank governors and politicians from continuing their reckless money printing policy is inflation. This is not the hedonically adjusted inflation statistics defined by the government but the kind that drives people to the streets. It's the kind that makes everyday workers unable to afford bread, milk, sugar, rice, rent, fuel, and more. It's the kind that deceives you into believing you are an important labor force but leaves you hungry.

If central banks want to continue printing money, they must make the market believe that if inflation appears, they will respond by reducing bond purchases and raising short-term policy rates. This way, the market won't panic and sell government bonds. However, central banks must also make people believe that the inflation in their basic needs such as food, housing, and transportation is not permanent but a part of a healthy and growing economy. This way, people won't express their dissatisfaction through votes or worse, take to the streets.

As we discussed this, Jesse incessantly talked about some central bank matters. Before the recent G20 meeting, they pledged to significantly reduce bond purchases and/or raise rates, but afterward, they intensified QE and zero rate policies. The best example is the Bank of England.

After digesting this, my next question was, "What will the Fed do?" Everyone else is just a minor player in this global central bank orchestra. The Fed is a violinist, while others play the viola. Viola... who the hell plays the viola?

When will the Fed hike by 0.025% to 0.5%:

When will the Fed hike for the second time by 0.5% to 0.75%:

At the recent meeting, the Fed initiated "tapering." From now until June next year, they will start reducing the amount of currency printed monthly. By then, the bond-buying spree will stop, and the market believes they will raise policy rates above zero at that time.

The market may think the Fed will start hiking in June 2022. However, Jesse believes that if the Fed can keep rates at zero almost consequence-free, they will do so. They have no need to end the party before it's absolutely necessary. Every time they have done so since late 2008, it has led to annoying corrections in the stock market. The taper tantrum of 2013 and the attempt to hint at a rate hike in 2018 are the two main examples of the challenges the Fed and its global brethren face.

June is quite close to the most important month for the US: November. In 2022, the US will hold midterm elections in November. People always vote in their best interest, and the ruling party either gains trust for the next presidential election in 2024 or faces condemnation early. Now, their money buys less and less. The only way to stop this downward trend is for wage growth to match the cost of people's expenditures. If wages grow at the same rate as the money supply, then the inflation tax doesn't work. Therefore, all actions are aimed at making regular workers believe there is no inflation, and wages are enough for a happy life. If they don't believe it, they may organize strikes to demand higher wages.

Like any organism, politicians first care about survival. Inflationary policies allow organizations supporting their election to fill rich people's pockets. The richest 10% of Americans own nearly 90% of US stocks, but if they are voted out due to people not believing "inflation is temporary," they will turn their backs on central banks and attempt to control inflation. If they betray central banks for political expediency, and central banks are forced to stop money printing, it will reflect the true cost of currency in the market after.

While the pace of bond purchases may slow down, this damn game continues until the Fed meeting in June 2022. The only thing you can't be 100% sure of is fixed-income instruments.

Is there any data that can prove me wrong? The Fed's real (unofficial) mission is to ensure the S&P 500 index remains high and continues to rise. Whether you like it or not, it is the standard used to measure the health of the US economy for everyone, rich or poor. The higher it goes, the wealthier people feel, the more they spend, the more economic activity is generated, and the more taxes are collected. This is the prevailing notion. Whether this logic is correct is inconsequential because important people believe it is true.

If the circuit breaker stops for the S&P 500 index and there is downward gravity, it means the reduction in bond purchases is starting to have a negative impact on the risk asset market. This is a sign that all risk assets may start to experience annoying pullbacks. In this environment, the only thing that will fare well is to long the US dollar, as various individuals and institutions will sell risk assets to raise dollars to repay debts. This doesn't necessarily mean a negative impact on crypto, but it will be a cautious indicator.

Smoke Alarm

Bitcoin and the vast crypto ecosystem provide two useful services to humanity. Firstly, they offer a different way to organize and incentivize humans in a decentralized manner through superior technology. Secondly, they are the only effective smoke alarm in the global financial system.

If government bonds provided true real yields to compensate holders for inflation and future growth, there would be no reason to use Bitcoin and other cryptocurrencies as inflation hedges. Cryptocurrencies would only be traded based on whether a specific project can provide useful and transformative technology for humanity. Unfortunately or fortunately, most junk coins have poor liquidity. They inflate prices because the time value of money has been severely distorted, making no distinction between investing in Dogecoin or a productive enterprise. In fact, buying Dogecoin makes more sense because at least it is a 24/7 liquid market. Investing in entities that benefit humanity comes with poor liquidity, is difficult to value, and only a few can use.

Therefore, as 2021 draws to a close, I cautiously remain optimistic about the foundation of central bank money printing, which will continue to bring pathological returns to various crypto assets. Thanks to Jesse for providing terrible coffee, engaging conversation, and being a pillar of knowledge to reaffirm my respect for the genius Satoshi Nakamoto and his angelic faith.

I want to share some sentiments with those who have spare money to invest in major assets:

Stocks, oh yes, give me some S&P 500 index. No real yields... who cares. As long as I can buy it on Robinhood—preferably with out-of-the-money call options—I'm ready.

Real estate, please let me get a 0% down payment mortgage because my job doesn't allow me to afford a mid-priced house. If I don't own a home, 75% of my income will go to rent. Please, private equity firms, don't buy up all the single-family and multi-family homes with cash. I can't compete with you.

Cryptocurrencies, hell yes, baby! I want DOGEBONK, SHIB, FLOKI, and any other meme coins. I want to become a super-rich crypto mogul so I can quit my job. Then I can become a digital nomad, move to Tulum, and party with Solomun on weekends.

Bonds, um, those are for... nobody. No one should own these things. Let the central banks have them, they want them, they can have them.