Arthur Hayes Blog: Saving Banks with BTFP Global Infinite Money Printing

Original source: Arthur Hayes

Compiled by: GaryMa Wu Says Blockchain

Since the Federal Reserve began raising interest rates in March 2022, I have believed that the ultimate outcome would always be significant financial turmoil, followed by a return to printing money. It is important to remember that the best interest of the Federal Reserve and all other major central banks is to keep our current financial system going (under which they can maintain power), so it is practically impossible to cleanse the shocking debt and leverage that has been built up in the system since World War II. Therefore, we can almost certainly predict that they will respond to any substantial banking or financial crisis by printing money and encouraging a new round of behaviors that first put us in danger.

Like many other analysts, I had predicted on our virtual forums that the Federal Reserve would continue to raise interest rates until something broke. No one knows exactly what will collapse first, but we are all certain that it will happen. However, do not jump to conclusions too early; some people (myself included) have long believed that a rupture in some part of the U.S. financial system in 2023 would force the Federal Reserve to reverse the tightening cycle that has been ongoing for the past year, and it now appears that we are on that trajectory.

I discussed the implications of the Federal Reserve's new Bank Term Funding Program (BTFP) with my favorite hedge fund manager. BTFP also signals "Buy The Fucking Pivot"! I thought I understood the significance of what the Fed just did, but I did not fully realize how profound the true impact of this policy would be. I will elaborate on what I learned later, but suffice it to say that BTFP is a very clever way to repackage yield curve control (YCC) in a brand new, shiny, and more palatable form, enabling infinite purchases of government bonds without actually buying them.

To fully understand why this BTFP program is so groundbreaking and ultimately destructive to savers, let’s review how we got here. We must first understand why these banks failed and why BTFP is a very elegant response to this crisis.

That March: The Pandemic Unleashes the Floodgates

The origin of everything began in March 2020, when the Federal Reserve promised to take all necessary measures to combat the financial stress brought on by the pandemic.

In Western countries (especially the U.S.), the pandemic was a minor issue that occurred in China/Asia. The elites claimed that everything was fine. However, suddenly, people began to get sick. Lockdowns began to appear in the U.S., and the American markets started to decline. The corporate bond market soon followed, quickly falling into a state of freeze. The malaise spread rapidly, subsequently eroding the U.S. Treasury market. Cornered into a significant position, the Federal Reserve quickly took action to nationalize the U.S. corporate credit market and inject massive liquidity into the system.

The U.S. federal government took action to directly deposit money into people's bank accounts (in the form of stimulus checks), creating the largest fiscal deficit since World War II. The Federal Reserve effectively cashed the government's checks. The government had to issue a large amount of new Treasury bonds to raise funds, which the Federal Reserve dutifully purchased to keep interest rates close to zero. This was a highly inflationary practice, but it did not matter at the time because we were facing a once-in-a-century pandemic.

Unsurprisingly, an unprecedented financial boom began. Everyone had stimulus checks to spend, whether rich or poor. At the same time, the cost of capital for asset speculators dropped to zero, encouraging wild risk-taking. Everyone became wealthy, and everything turned into a practice of pumping up prices!

Bull Market

With the public flush with so much new money, banks were inundated with deposits. Remember, when we purchase goods, services, or financial assets, the money does not leave the banking system; it merely shifts from one bank to another. Thus, most of the newly printed money ultimately became deposit balances at some bank.

For major systemic banks like JP Morgan, Citibank, and Bank of America, the proportion of deposits increased, but not excessively. However, for small and medium-sized banks, this was a massive growth.

The weaker banks in the U.S. banking sector (sometimes referred to as regional banks) had never had such a rich deposit base. When banks accept deposits, they use those deposits to make loans. These banks needed to find places to park all this new money to earn net interest margin (also known as net interest spread). Given that yields were either zero or slightly above zero, placing funds at the Federal Reserve Bank and earning interest on their excess reserves could not cover their operating costs, so banks had to increase earnings by taking on some credit and/or duration risk.

The risk of borrowers not repaying is known as credit risk. The highest-rated credit (i.e., the lowest credit risk) you can invest in is U.S. government debt, also known as Treasuries, because the government can legally print money to pay off its debts. The highest credit risk you can invest in is the debt of companies like FTX. The higher the credit risk a lender is willing to take, the higher the interest rate they will demand from the borrower. If the market perceives that the risk of a company being unable to pay its bills is increasing, credit risk will rise. This will lead to a decline in bond prices.

Most banks, overall, are very averse to credit risk (i.e., they do not want to lend money to companies or individuals they believe may default). However, in a market where the most obvious and safest alternative—investing in short-term U.S. government debt—has yields close to 0%, they needed to find ways to earn a profit. Therefore, many banks began to increase earnings by taking on duration risk.

Duration risk refers to the risk that rising interest rates will cause the price of a given bond to fall. I won’t go into detail on how to calculate the duration of a bond, but you can think of duration as the sensitivity of a bond's price to changes in interest rates. The longer the maturity of a given bond, the higher its interest rate or duration risk. Duration risk also changes with interest rate levels, meaning the relationship between duration risk and a specific interest rate level is not constant. This means that when interest rates rise from 0% to 1%, bonds become more sensitive to interest rates, while when rates rise from 1% to 2%, bonds become less sensitive to interest rates. This is known as convexity or gamma.

Overall, most banks limit credit risk by borrowing from various departments of the U.S. government (rather than risky companies) but increase their interest income by purchasing bonds with longer maturities (which have more duration risk). This means that as interest rates rise, they will soon incur significant losses due to falling bond prices. Of course, banks can hedge their interest rate exposure through interest rate swaps. Some banks did this, while many did not. You can read about some very foolish decisions made by SVB management regarding the massive interest rate risk embedded in their government bond portfolio.

Let’s run through an example. If a bank absorbs $100 in deposits, they will purchase $100 worth of U.S. government debt, such as Treasuries (UST) or mortgage-backed securities (MBS). So far, this asset-liability management strategy has no issues. In fact, the ratio of deposits to loans should be less than 1:1 to maintain a sufficient safety buffer against loan losses.

As shown in the image above, U.S. banks purchased a large amount of U.S. Treasuries in 2020 and 2021. This was very beneficial for the U.S. government, which needed funding to support stimulus checks. But it was less favorable for the banks, as interest rates were at their lowest in 5,000 years. A slight rise in general interest rates would lead to massive market value losses in the banks' bond portfolios. The Federal Deposit Insurance Corporation estimated that due to rising interest rates causing depreciation in government bond portfolios, U.S. commercial banks faced a total unrealized loss of $620 billion.

How did banks hide these massive unrealized losses to avoid impacting their depositors and shareholders? Banks used many legitimate accounting tricks to conceal losses. Banks that had already issued loans did not want to see their earnings fluctuate with the market value of their tradable bond portfolios. Otherwise, the whole world would see the tricks they were playing. This could suppress their stock prices or force regulators to shut them down for violating capital adequacy requirements. Therefore, if a bank intends not to sell a bond before it matures, it allows the bond to be marked as "held to maturity." This means they mark the bond at its purchase price until it matures. After that, regardless of how the bond trades in the open market, the bank can ignore the unrealized losses.

The situation for small banks progressed smoothly. They did not pay interest on customer deposits but lent those deposits to the U.S. government at rates of 1% to 2% (UST) and to U.S. homebuyers at rates of 3% to 4% (MBS). This may seem trivial, but it is meaningful income on billions of dollars in loans. Thanks to these "great" earnings, bank stocks soared.

KRE US --- SPDR S&P Regional Banking ETF

This ETF rose over 150% from the pandemic low in 2020 to the end of 2021.

However, inflation soon followed.

He is not Arthur Burns; he is Paul Volcker

A brief history lesson about former Federal Reserve Chairmen.

Arthur Burns served as Chairman of the Federal Reserve from 1970 to 1978. Contemporary monetary historians are not fond of Mr. Burns. His legacy is one of refusing to address the inflation problem in the early 1970s.

Paul Volcker served as Chairman of the Federal Reserve from 1979 to 1987. Contemporary monetary historians praise Mr. Volcker for his commitment to eliminating the inflation problem that his predecessor faced weakly. Mr. Volcker is described as brave and bold, while Mr. Burns is described as weak and ineffective.

Powell wants to be more like Volcker than Burns. He is very concerned about his historical legacy. Powell is not in this job for the paycheck; he is likely a billionaire. Everything he does is to solidify his position as a monetary reformer. That is why, when inflation surged to a 40-year high post-pandemic, he donned his best Volcker attire and walked into the Mariner Eccles building ready to do something big.

By the end of 2021, the Federal Reserve stated that inflation was a problem. Specifically, the Federal Reserve indicated it would begin raising interest rates above 0% and reduce the size of its balance sheet. From November 2021 to early January 2022, high-risk asset prices peaked. The painful train was ready to depart.

This tightening cycle by the Federal Reserve was the fastest on record (i.e., the Fed raised rates faster than ever before). Thus, 2022 was the worst year for bondholders in centuries.

Powell felt he was doing what needed to be done. The financial asset portfolios of the rich took a backseat to lower prices for most Americans (who have no financial assets). He was not worried about a hedge fund crashing hard for the year or bankers' bonuses being cut. So what… Eat the rich, the U.S. economy is strong, and unemployment is low. This meant he could continue to raise rates and dispel the notion that the Federal Reserve only cared about pushing financial asset prices to help the wealthy. What a heroic figure!

However, trouble was brewing in the banking sector.

Insolvency

As a bank depositor, you would think that when the Federal Reserve raises rates, your deposits would earn higher interest. Wrong.

The chart above from Bianco Research shows that deposit rates lag significantly behind the higher money market fund rates that move in sync with the Federal Reserve's policy rates.

Those large "too big to fail" banks do not need to raise deposit rates because they do not actually need deposits. They have trillions of dollars in excess reserves at the Federal Reserve. Moreover, their clients are often larger corporate clients whose deposits are sticky. A CFO of a Fortune 500 company is not going to abandon JP Morgan for a regional bank in the U.S. hinterlands just to earn a few extra basis points. Large corporations also receive other services from these large banks, such as cheap loans, in return for being loyal depositors.

On the other hand, smaller banks cannot raise deposit rates because they cannot afford to do so. The U.S. Treasuries and mortgage-backed securities held by these banks have yields lower than the current federal funds rate. This means that if they raise loan rates to match the Federal Reserve, they will face a massive negative interest spread. Instead, they just hope depositors do not notice that they could earn nearly risk-free 5% returns by pulling their funds from the bank and investing in money market funds. Clearly, this strategy is not sustainable.

The result is that depositors fled small banks and found new homes in higher-yielding money market funds.

As deposits left small banks, they had to sell the most liquid items on their balance sheets. U.S. Treasuries and mortgage-backed securities (MBS) are very liquid. However, because they were purchased in 2020 and 2021, when they were marked to market at the end of 2022 or early 2023, the value of these bonds had plummeted.

Game Over

ps: "Canary in the coal mine" is a figurative metaphor referring to the first signals or signs that warn of danger or instability in an environment.

The "canary in the coal mine" for the banking sector was the bankruptcy of Silvergate. After becoming the most crypto-friendly bank, Silvergate transformed from an obscure California bank into the preferred bank for all the largest exchanges, traders, and cryptocurrency holders needing dollar banking services. Their deposit base rapidly expanded, and they invested depositors' money in U.S. government debt, which is typically one of the safest investments you can make. This was not like dealing with unreliable companies or individuals like Three Arrows Capital; they were lending money to the richest and most powerful nation in the world.

Silvergate's cryptocurrency depositors decided to flee; depositors did not want to deal with the hassle and did not want to know whether Silvergate had in any way facilitated (or even just been aware of) the suspicious and potentially illegal activities emanating from FTX. So they withdrew, and the bank had to sell its loans and bonds at a loss to pay off the withdrawals. This is why Silvergate reported a staggering $754 million loss in 2022.

What happened next was a failed equity offering by SVB. An equity offering refers to a company selling stock to large institutional investors at a price below the current market price, often in collaboration with an investment bank.

The equity offering by SVB was notable for its execution sequence. Goldman Sachs was both the bank bidding on SVB's underwater bond portfolio and coordinating the equity offering.

The question is, why did SVB sell the bonds to Goldman Sachs first and then conduct the equity offering? Once SVB sold the bonds, it had to recognize the losses and would clearly violate regulatory capital requirements. It also had to disclose all this information to investors (i.e., potential stock purchasers). If just moments earlier, the bank announced it had suffered massive losses and might violate capital adequacy, why would you want to buy the bank's stock? Clearly, no one would buy, and indeed no one did. After the equity offering's disastrous failure, tech luminaries instructed their portfolio companies to withdraw their funds from SVB immediately, and days later, the bank collapsed.

The lesson from this tragic story is that the poor execution of SVB's equity offering further raised market awareness of the unrealized losses on regional banks' balance sheets. The market began to ask more questions. Who else might be in trouble?

It turned out that the entire U.S. regional banking sector had similar issues to Silvergate and SVB. To summarize why these banks got into trouble:

1. Their deposit bases ballooned while lending money at historically low interest rates.

2. As the Federal Reserve raised policy rates, these banks' bond and loan portfolios incurred significant unrealized losses.

3. Depositors wanted higher interest than regional banks could offer, so they began to flow out and invest in high-yield products like money market funds and short-term U.S. Treasury bills. Banks could not absorb these losses because they could not pay depositors the federal funds rate, as the interest they earned on their bond and loan portfolios was far below that rate.

4. The market had always known this would eventually become a problem, but it was not until the failures of Silvergate and SVB that the severity of the issues became apparent. Thus, now every regional bank is seen as having limited time left.

Over the weekend, the world was watching the impact on deposits of cryptocurrency and tech companies due to the issues at Silvergate and SVB. Circle's USDC stablecoin also depegged, dropping below $0.90 due to its significant connections with Silvergate, SVB, and possibly Signature Bank. Many believed that this issue was not about cryptocurrency or tech but that all banks not deemed systemically important were facing systemic problems.

Thus, everyone knew that when the U.S. stock market opened on Monday, many banks would be punished. Specifically, many were concerned about the possibility of a nationwide bank run.

Emergency Rescue

The Federal Reserve and the U.S. Treasury did not let a good crisis go to waste. They designed a truly elegant solution to address some systemic issues. Most importantly, they could blame the mismanagement of cryptocurrency and tech-focused banks for having to intervene and do something they were going to do anyway.

Now, I will detail the truly game-changing document that describes BTFP. (The quotes in the document are shown in bold and italics, with detailed explanations of the actual impacts below each quote.)

Bank Term Funding Program

Plan: To provide liquidity to U.S. deposit institutions, each Federal Reserve Bank will lend to eligible borrowers against certain securities as collateral.

Borrower Eligibility: Any U.S. federally insured deposit institution (including banks, savings associations, or credit unions) or a foreign bank's U.S. branch that meets primary credit eligibility (see 12 CFR 201.4(a)) is eligible to borrow under this program.

This is straightforward; you need to be a U.S. bank to participate in the program.

Eligible Collateral: Eligible collateral includes any collateral that is eligible for purchase by the Federal Reserve Bank in open market operations (see 12 CFR 201.108(b)), provided that the collateral is owned by the borrower as of March 12, 2023.

This means that the financial instruments available as collateral under the program are essentially limited to U.S. Treasuries and mortgage-backed securities. By setting a cutoff date, the Federal Reserve Bank limited the scope of the program to the total amount of U.S. Treasuries and mortgage-backed securities held by U.S. banks (approximately $4.4 trillion).

Funding Limits: The funding limits will be constrained by the value of the collateral pledged by eligible borrowers.

There are no limits on the funding amounts. If your bank holds $100 billion in U.S. Treasuries and mortgage-backed securities, you can submit that total amount to utilize BTFP for funding. This means the Federal Reserve can theoretically lend against all U.S. Treasuries and mortgage-backed securities held on U.S. banks' balance sheets.

The first two paragraphs of BTFP are very important and need to be understood. The Federal Reserve has effectively conducted $4.4 trillion in quantitative easing in another form. Let me explain.

Quantitative easing refers to the process by which the Federal Reserve provides reserves to banks in exchange for banks selling their U.S. Treasuries and mortgage-backed securities holdings. Under BTFP, the Federal Reserve is not directly buying bonds from banks but is printing money and providing loans against the U.S. Treasuries and mortgage-backed securities pledged by banks. If depositors want $4.4 trillion in cash, banks simply need to pledge their entire U.S. Treasuries and mortgage-backed securities portfolios to the Federal Reserve in exchange for cash, and then pass that cash on to depositors. Whether through quantitative easing or BTFP, the amount of money the Federal Reserve creates and injects into circulation is increasing.

Interest Rate: The interest rate on loans will be the one-year overnight index swap rate plus 10 basis points; the rate will remain fixed from the date of loan issuance.

Collateral Valuation: The collateral will be valued at par. The margin will be 100% of the par value.

The Federal Reserve's funding pricing is based on the one-year rate. Since short-term rates are higher than long-term rates, this means that banks will bear negative rates for most of the loan term. While losses are bad, banks can swap undervalued bonds instead of recognizing losses and going bankrupt. Everyone can keep their jobs, except for the unfortunate companies like Silvergate, SVB, and Signature.

Loan Term: Eligible borrowers can receive loans for a maximum term of one year.

Program Duration: Eligible borrowers can apply for loans under the program until March 11, 2024.

The program is stipulated to last only one year; when has the government ever returned the power it has granted to the people during a crisis? This program will almost certainly be extended preemptively; otherwise, the market will create enough turmoil due to the need to print money, and the program will be extended anyway.

Impact of BTFP

Bigger than Pandemic Flooding

The Federal Reserve printed $4.189 trillion in response to the pandemic crisis. After implementing BTFP, the Federal Reserve implicitly printed $4.4 trillion. During the pandemic printing, the price of Bitcoin rose from $3,000 to $69,000. How will it perform this time?

Banks are Bad Investments

Unlike the 2008 financial crisis, this time the Federal Reserve will not bail out banks and let them participate in the upswing. Banks must pay the one-year interest rate. The one-year interest rate is much higher than the ten-year interest rate (also known as an inverted yield curve). Banks borrow short-term from depositors and lend long-term to the government. When the yield curve is inverted, this trade is bound to lose money. Similarly, any bank using BTFP will need to pay the Federal Reserve more than the deposit rate.

U.S. Treasury 10-Year Yield Minus U.S. Treasury 1-Year Yield

Banks will experience negative earnings until either the yield curve becomes positively sloped again or short-term rates fall below their blended rates on loans and bonds. BTFP does not solve the problem of banks being unable to afford the high short-term rates that depositors can earn in money market funds or Treasuries. Deposits will still flow to these instruments, but banks can borrow from the Federal Reserve to fill the gap. From an accounting perspective, banks and their shareholders will incur losses, but banks will not go bankrupt. I expect that until their balance sheets are repaired, bank stocks will significantly underperform the broader market.

Housing Prices Surge

30-Year Mortgage Rate Minus 1-Year Treasury Yield

Purchasing mortgage-backed securities will still be profitable for banks, as the spread compared to the one-year rate is positive. As banks arbitrate with the Federal Reserve, the rates on mortgage-backed securities will converge towards the one-year rate. Imagine a bank that absorbed $100 in deposits in 2021 and purchased $100 in Treasuries. By 2023, the value of those Treasuries has dropped to $60, leaving the bank unable to repay. The bank borrows from the Federal Reserve using BTFP, returns its Treasuries to the Federal Reserve, and receives $100 but must pay 5% interest to the Federal Reserve. The bank now purchases a government-backed mortgage-backed security yielding 6%, earning a 1% risk-free profit.

Mortgage rates will move in sync with the one-year rate. The Federal Reserve has immense control over short-term yields. It can essentially set mortgage rates at any level it likes and never have to "buy" a single mortgage-backed security again.

As mortgage rates decline, home sales will rebound. In the U.S., real estate is a significant industry, just like in most other countries. As financing becomes more affordable, the increase in sales will help boost economic activity. If you think properties will become more affordable, you need to reconsider. The Federal Reserve is back, pushing housing prices up again.

Dollar Strengthens Again

If you can access a U.S. bank account and the Federal Reserve has just guaranteed your deposits, why would you keep your money in other banks without central bank guarantees? Outside capital will flood into the U.S., strengthening the dollar.

As this process unfolds, central banks in all other major developed countries will have to follow the Federal Reserve and implement similar guarantees to stem the outflow of bank deposits and weaken their currencies. Central banks like the European Central Bank, Bank of England, Bank of Japan, Reserve Bank of Australia, Bank of Canada, and Swiss National Bank may be quite pleased. The Federal Reserve has just implemented a form of unlimited money printing, so now they can do the same. The problems facing the U.S. banking system are the same as those facing other banking systems. Everyone has the same trade, and now—under the leadership of Sir Powell—every central bank can take the same measures in response without being blamed for triggering hyperinflation in fiat currency.

A few nights ago, Credit Suisse was effectively failing. The Swiss National Bank had to provide a CHF 50 billion coverage loan to stem the outflow of credit. It is expected that a large bank in every major developed Western country will come close to failing, and I believe that in each case, the response will be comprehensive deposit guarantees (similar to the Federal Reserve's approach) to prevent the crisis from spreading.

The Road to Infinity

As stated in the BTFP document, the program only accepts collateral that appeared on bank balance sheets before March 12, 2023, and ends one year later. But as I mentioned above, I do not believe this program will end, and I also believe that the quantity of eligible collateral will be relaxed to include any government bonds present on the balance sheets of authorized U.S. banks. How do we move from limited support to unlimited support?

Once people realize there is nothing shameful about utilizing BTFP, the fear of bank runs will dissipate. At that point, depositors will stop stuffing funds into large, too-big-to-fail banks like JPM and begin withdrawing funds to purchase money market funds (MMF) and U.S. Treasuries with maturities of two years or less. Banks will be unable to lend to businesses as their deposit bases flow into Federal Reserve repurchase facilities and short-term government bonds. This will be extremely recessionary for the U.S. and all other countries implementing similar programs.

Government bond yields will fall from all sides. First, the entire U.S. banking system will have to sell their entire inventory of U.S. government debt to repay depositors, alleviating the massive selling pressure in the bond market. Second, the market will begin to price in deflation, as the banking system cannot restore profitability (thereby creating more loans) unless short-term rates fall enough to attract depositors back from competing with repurchase facilities and short-term Treasuries.

I expect that the Federal Reserve will either recognize this outcome early at the upcoming March meeting and begin to cut rates or be forced to pivot in a few months due to a severe economic recession. Since the crisis began, the yield on two-year Treasuries has fallen by more than 100 basis points. The market is calling for deflation supported by the banking system, and the Federal Reserve will ultimately heed the market's call.

As banks become profitable again and can compete with the government to attract depositors back, banks will find themselves in the same position as in 2021. That is, deposits will grow, and banks will suddenly need to start lending. They will begin underwriting loans to businesses and governments at low nominal yields. Again, they will think inflation has not yet appeared, so they will not worry about rising rates in the future. Does this sound familiar?

Then March 2024 arrives. The BTFP program is set to expire. But now, the situation is worse than in 2023. The total size of the bond portfolios underwritten by banks at low interest rates to businesses and governments is larger than it was a year ago. If the Federal Reserve does not extend the program's duration and expand the nominal amount of eligible bonds, we could see the same bank runs we are witnessing now happen again.

Given that the Federal Reserve has no appetite for a free market that allows banks to fail due to poor management decisions, the Federal Reserve will never be able to cancel their deposit guarantees. Long live BTFP.

While I am sure this is abhorrent to all followers of Ayn Rand (like Ken Griffin and Bill Ackman), the continuation of BTFP addresses a very serious problem for the U.S. government. The U.S. Treasury has a lot of bonds to sell, and fewer and fewer people want to own them. I believe BTFP will be expanded so that any eligible securities (primarily Treasuries and mortgages) held on U.S. banks' balance sheets can be exchanged for freshly printed dollars at the one-year interest rate. This gives banks confidence that as their deposit bases grow, they can always purchase government debt in a risk-free manner. Banks no longer have to worry about what will happen to their bonds if rates rise and their depositors want to withdraw their money.

With the rollout of the newly expanded BTFP program, the U.S. government can easily finance larger deficits because banks will buy any bonds for sale. Banks do not care about the price because they know the Federal Reserve supports them. Meanwhile, those concerned with actual returns and price will scoff and not continue to buy trillions of dollars in U.S. government bonds. The Congressional Budget Office estimates that the fiscal deficit will reach $1.4 trillion in 2023. The U.S. is also engaged in wars on multiple fronts: a war against climate change, a war against Russia, and a war against inflation. Wars have inflationary characteristics, so deficits are expected to rise further. But this is not a problem because banks will buy all the bonds that foreigners refuse to purchase.

This allows the U.S. government to run the same growth strategy adopted by Japan, Taiwan, and South Korea. The government implements policies to ensure that savers' savings rates are below the nominal GDP growth rate. The government can then re-industrialize by providing cheap credit to any sector of the economy it wants to stimulate and profit from it. This "profit" can help the U.S. government reduce its debt-to-GDP ratio from 130% to a more manageable level. While everyone may cheer for growth, in reality, the entire public is paying a hidden inflation tax at the rate of [Nominal GDP---government bond yields].

Finally, this resolves a public relations issue. If the investing public believes the Federal Reserve is giving the government a blank check, they may revolt and sell long-term bonds (>10-year maturities). The Federal Reserve would be forced to intervene and fix long-term bond prices, an action that would mark the end of the Western financial system in its current form. The Bank of Japan once faced this issue and implemented a similar program where the central bank provided loans to banks to purchase government bonds. In this case, the bonds never appeared on the central bank's balance sheet; only the loans appeared on the balance sheet, and theoretically, these loans had to be repaid by the banks, but in practice, these loans would roll over indefinitely. The market could be relieved that the central bank would not move towards owning 100% of the government bond market. Long live the free market!

Previous Month's WTI Oil Futures

The general decline in oil and commodity prices indicates that the market believes deflation is imminent. The reason for deflation is that there is almost no credit extending to businesses. Without credit, economic activity declines, and thus the amount of energy required decreases.

The decline in commodity prices helps the Federal Reserve lower interest rates, as inflation rates will fall. The Federal Reserve now has a reason to cut rates.

Capital Outflow from the System

For the Federal Reserve, the most concerning outcome is that people will move capital out of the system. After guaranteeing deposits, the Federal Reserve does not care if you move money from SVB to higher-yielding money market funds. At least your capital is still being used to purchase government debt. But what if, conversely, you purchase an asset that is not controlled by the banking system?

Assets like gold, real estate, and (obviously) Bitcoin are not liabilities on someone else's balance sheet. If the banking system fails, these assets still hold value. However, these assets must be purchased in physical form.

By purchasing exchange-traded funds (ETFs) that track the prices of gold, real estate, or Bitcoin, you are not escaping the malignant effects of inflation. What you are doing is investing in the liabilities of some member of the financial system. You own a claim, but if you try to cash in your chips, you will receive fiat currency paper bills, and all you have done is pay fees to another trustee.

For Western economies that should practice free market capitalism, implementing widespread capital controls is very difficult. For the U.S., it is especially challenging because the world uses the dollar because it has an open capital account. Any explicit prohibition of various ways to exit the system would be seen as a forced implementation of capital controls, making sovereign nations less willing to hold and use dollars.

This is a controversial view. The government will not directly prohibit certain financial assets but may encourage investment vehicles like ETFs. If everyone panics about the inflationary effects of BTFP and pours money into GBTC (Grayscale Bitcoin Trust), this will have no impact on the banking system. You must use dollars to enter and exit that product. You have nowhere to escape.

Be careful what you wish for. A truly U.S.-listed Bitcoin ETF would be a Trojan horse. If such a fund were approved and absorbed a large supply of Bitcoin, it would actually help maintain the status quo rather than provide people with financial freedom.

Also, be wary of those products where you "buy" Bitcoin but cannot withdraw your "Bitcoin" into your own private wallet. If you can only enter and exit that product through the fiat banking system, then you have achieved nothing. You are merely a damned fee provider.

The beauty of Bitcoin is that it is intangible. It has no external form of existence. You can remember the private key to your Bitcoin and transact anytime you want using the internet. Owning large amounts of gold and real estate is heavy and obvious. Ostentatious ways of saving and the associated displays of wealth can easily attract the robbery of other citizens, or worse, your own government might do so.

Clearly, fiat currency has its uses. Play to its strengths, spend fiat, hoard cryptocurrency.

To Da Moon

After my conversation with this hedge fund manager, I noticed how strong my bullish sentiment on Bitcoin is. This is the ultimate game. Yield curve control is in place. BTFP has brought about global unlimited money printing…

The media may also push a narrative that this banking crisis is due to banks accepting fiat deposits from cryptocurrency people. This is ridiculous and makes me laugh out loud. To think that the crypto industry is somehow responsible—banks' job is to handle fiat dollars—accepted fiat dollars from entities related to crypto, followed all banking rules, lent those fiat dollars to the most powerful nation in human history, and then could not repay depositors is absurd. This happened as the central imperial bank raised rates and blew up the banks' bond portfolios.

Instead, cryptocurrency once again proves to be the smoke alarm for the stinky, wasteful, fiat-driven Western financial system. In the uptrend, cryptocurrency indicated that the West printed too much money in the name of the pandemic. In the downtrend, the crypto free market quickly exposed the massive over-leveraged fraudsters. Even the diversified families of FTX did not have enough love to overcome the swift sanctions of the crypto free market. The stench of these detestable individuals (and those they do business with) drove depositors to move their hard-earned money to safer (and more reputable) institutions. In the process, it showed everyone the damage that Federal Reserve policies have inflicted on the U.S. banking system.

For my portfolio, I have basically stopped trading stocks. What’s the point? I usually buy and hold and do not frequently adjust my positions. If I believe what I have written, then I am setting myself up for failure. If there are short-term trading opportunities where I think I can make some quick money and then profitably buy more Bitcoin, then I will do that. Otherwise, I will liquidate most of my stock portfolio and transfer it into cryptocurrency.

If I hold any ETFs related to precious metals or commodities, I will sell them and buy and store commodities directly as much as possible. I know this is not practical for most people, but I just want to illustrate how deep my convictions run.

The only exception to my disdain for stocks is companies related to nuclear energy. The West may scoff, but rising nations are looking for cheap, abundant energy to provide a good life for their citizens. Sooner or later, nuclear energy will create the next higher step in global growth, but individuals cannot store uranium, so I will do nothing with my Cameco position.

I must ensure that my real estate portfolio is diverse across various jurisdictions. You have to live somewhere, and if you can own your housing outright or with as little debt as possible, that is the goal. Similarly, it would be even better if you do not have to be tied to the fiat financial system.

Cryptocurrency is volatile, and most goods and services require payment in fiat. That’s okay. I will hold the cash I need and earn the highest short-term yield possible. Right now, that means investing in dollar money market funds and holding short-term U.S. Treasuries.

My cryptocurrency + long volatility barbell portfolio will remain unchanged. Once I finish rebalancing, I must ensure I adequately protect my downside risk. If I do not have enough risk exposure to those tools that perform well when the government decides to unwind the leverage embedded in the system (rather than continue to pile on more), I must increase my investment in my favorite volatility hedge fund. Beyond that, the only major risk in my overall strategy is if a new energy source is discovered that is significantly denser than hydrocarbons. Of course, such energy already exists; it is called nuclear power. If policymakers are spurred by their citizens to truly build the necessary infrastructure to support a nuclear-powered economy, then all the debt can be repaid through an astonishing burst of economic activity. By that time, I will not be making money on my cryptocurrency or volatility hedge. However, even if there is political will to build this infrastructure, it will take decades to complete. I will have plenty of time to rebalance my portfolio for the nuclear age.

This is the most important financial event since the pandemic. In subsequent articles, I will assess whether the impact of BTFP aligns with my predictions. I realize that my extreme conviction in Bitcoin's upward trajectory may be wrong, but I must judge events based on reality and adjust my portfolio when I find I am wrong.

The ending has long been known. YCC is dead; long live BTFP!