Arthur Hayes: The next few months are a golden opportunity to increase positions

Original Title: 《Left Curve》

Author: Arthur Hayes

Compiled by: Tao Zhu

Some of you think you are the masters of the universe now because you bought Solana for under $10 and sold it for $200. Others did the smart thing by selling fiat for cryptocurrency during the bear market from 2021 to 2023, but reduced their positions as prices soared in the first quarter of this year. If you exchanged junk coins for Bitcoin, you got a pass. Bitcoin is the hardest currency to create in history.

Bull markets do not come around often; it is ironic when you make the right decisions but do not maximize your profit potential. Too many of us try to reason through bull markets. As long as the bull market continues, they buy, hold, and buy again.

Sometimes I find myself thinking like a loser. When I do, I have to remind myself of the overarching macro theme that the entire retail and institutional investment community has begun to believe. That is, all major economic blocs (the U.S., China, the EU, and Japan) are devaluing their currencies to reduce the leverage on government balance sheets. Now, TradFi can profit directly from this narrative through U.S. and the soon-to-be-launched U.K. and Hong Kong spot Bitcoin ETFs, urging clients to use these crypto derivatives to maintain the purchasing power of their wealth.

I want to quickly explain the fundamental reason for the significant rise of cryptocurrencies relative to fiat currencies. Of course, this narrative will eventually lose its potency, but that time is not now. At this moment, I will suppress the impulse to take chips off the table.

As we exit the soft window I predict due to the U.S. tax deadline on April 15 and the Bitcoin halving, I want to remind readers why the bull market will continue and prices will become even more absurd. There are very few things in the market that can get you from here (Bitcoin from zero in 2009 to $70,000 in 2024) to there (Bitcoin to $1,000,000). However, as the sovereign debt bubble begins to burst, the macro environment that drives Bitcoin higher due to a surge in fiat liquidity will only become more apparent.

Nominal GDP

What is the purpose of government? Governments provide public goods such as roads, education, healthcare, and social order. Clearly, this is the wish list of many governments, but they deliver death and despair… but I digress. In return for these services, we citizens pay taxes. A balanced-budget government provides as many services as possible under a certain amount of tax revenue.

However, sometimes the government borrows money to do things it believes will generate long-term positive value without raising taxes.

For example:

Building expensive hydroelectric dams. The government does not raise taxes but issues bonds to pay for the dam's costs. It hopes the economic return from the dam will meet or exceed the bond's yield. The government attracts citizens to invest in the future by paying close to the yield that the dam will create in economic growth. If, ten years later, the dam will generate 10% economic growth, then the government bond yield must be at least 10% to attract investors. If the government pays less than 10%, then its profits come at the expense of the public's interest. If the government pays more than 10%, then the public's profits are borne by the government.

Let’s zoom out a bit and discuss the economy from a macro perspective. The economic growth rate of a specific nation-state is its nominal GDP, composed of inflation and real growth. If the government wants to drive nominal GDP growth through budget deficits, it is natural and logical for investors to expect returns equal to the nominal GDP growth rate.

While it is natural for investors to expect returns equivalent to nominal GDP growth, politicians prefer to pay returns below this figure. If politicians can create a situation where government debt yields are below nominal GDP growth rates, they can spend money faster than Sam Bankman-Fried in effective altruism charity. The best part is that there is no need to raise taxes to pay for this spending.

How do politicians create such a utopia? They economically suppress savers through the TradFi banking system. The simplest way to ensure that government bond yields are below nominal GDP growth is to instruct the central bank to print money and buy government bonds, artificially lowering bond yields. Then, banks are told that government bonds are the only "appropriate" investment for the public. In this way, the public's savings are secretly funneled into low-yield government debt.

The problem with artificially lowering government bond yields is that it promotes misallocation of investment. The first projects are often worthwhile. However, as politicians strive to create growth for re-election, the quality of projects declines. At this point, the growth of government debt outpaces the growth of nominal GDP. Politicians now face tough decisions. Today, they must recognize misallocation losses through severe financial crises or tomorrow through low growth or even zero growth. Typically, politicians choose long periods of economic stagnation because the future occurs after they leave office.

A good example of misallocated investment is green energy projects, which can only be realized through government subsidies. After years of generous subsidies, some projects fail to achieve returns on invested capital or have excessively high actual costs for consumers. It is predictable that once government support is withdrawn, demand will weaken, and projects will stagnate.

During economic downturns, when the central bank presses the "Brrrr" button harder than Lord Ashdrake presses the "sell" button, bond yields become even more distorted. Government bond yields remain below nominal GDP growth, allowing the government's debt burden to be offset by inflation.

Yield

The key task for investors is to understand when government bonds are a good investment. The simplest way is to compare the year-on-year growth rate of nominal GDP with the yield on 10-year government bonds. The yield on 10-year bonds should serve as a market signal to inform us about expected future nominal growth.

Real yield = 10-year government bond yield - nominal GDP growth rate

When the real yield is positive, government bonds are a decent investment. The government is usually the most credible borrower.

When the real yield is negative, government bonds are a poor investment. The trick for investors is to look for assets outside the banking system that grow faster than inflation.

All four major economies have implemented policies that economically suppress savers and lead to negative real yields. China, the EU, and Japan have all ultimately taken cues from U.S. monetary policy. Therefore, I will focus on the past and future monetary and fiscal conditions in the U.S. As U.S. engineers relax financial conditions, the rest of the world will follow suit.

The chart shows real yields in white (the .USNOM index) and the Federal Reserve (Fed) balance sheet in yellow. I start from 2009 because that was the year Bitcoin's genesis block was launched.

As you can see, after the deflationary shock of the 2008 global financial crisis, real yields turned negative. Due to the deflationary shock of the pandemic, this index briefly turned positive again.

Deflationary shocks refer to the spike in real yields due to a sharp decline in economic activity.

Except for 2009 and 2020, government bonds have been poor investments compared to stocks, real estate, cryptocurrencies, and others. Bond investors have only been able to perform well by trading with crazy leverage. For the hedge fund puppet readers, this is the essence of risk parity.

This unnatural state occurs because the Federal Reserve expands its balance sheet by purchasing government bonds with printed money, a process known as quantitative easing (QE).

During this period, the negative real yield safety valve has been Bitcoin (in yellow). Bitcoin rises non-linearly on a logarithmic chart. The rise of Bitcoin is purely a function of a limited-quantity asset priced in depreciating fiat dollars.

This explains the past, but markets are forward-looking. Why should you continue your cryptocurrency investments and feel confident that this bull market has just begun?

Free Shit

Everyone wants to get something for nothing. Obviously, the universe will never provide anything so cheap, but that does not stop politicians from promising benefits without raising tax rates. Support for any politician, whether at the ballot box in democratic countries or implicit support in more authoritarian regimes, stems from their ability to create economic growth. Once simple and obvious growth-supporting policies are enacted, politicians will turn on the printing presses, funneling money into their favored constituencies at the expense of the public good.

As long as the government borrows at negative real yields, politicians can offer free stuff to their supporters. Therefore, the higher the partisanship and polarization of nation-states, the more motivated the ruling party is to increase their chances of re-election by spending money they do not have.

2024 is a pivotal year for the world, with many major powers holding presidential elections. The U.S. election is crucial globally, as the ruling Democratic Party will do everything possible to retain power (the suspicious actions they have taken against the Republican Party since the orange man "lost" the last election prove this). A significant portion of Americans believes that the Democrats somewhat deceived Trump into losing. Regardless of whether you believe this is true, the fact that a large portion of people hold this view ensures that the stakes for this election are very high. As I mentioned earlier, the peaceful fiscal and monetary policies under U.S. governance will be emulated by China, the EU, and Japan, which is why it is important to pay attention to the election.

The above chart from BCA Research shows the political polarization of the U.S. over time. As you can see, voters have never been this polarized since the late 19th century. From an electoral perspective, this makes it a winner-takes-all situation. The Democrats know that if they lose, the Republicans will reverse many of their policies. The next question is, what is the easiest way to ensure re-election?

This is stupid economics. Voters who have not yet decided the winner of the election base their decisions on their views of the economy. As shown in the chart above, if the public perceives the economy to be in recession during the election year, the incumbent president's chances of re-election will drop from 67% to 33%. How can a ruling party that controls monetary and fiscal policy ensure that a recession does not occur?

Nominal GDP growth is directly influenced by government spending. From this Bianco Research chart, it can be seen that U.S. government spending accounts for 23% of nominal GDP. This means that the ruling party can print GDP at will as long as they are willing to borrow enough money to meet the desired level of spending.

The Chinese government decides the GDP growth rate every year. Then, the banking system creates enough credit to drive economic activity to the desired level. For many Western-trained economists, the "strength" of the U.S. economy is perplexing because many key economic variables they monitor indicate that a recession is imminent. But as long as the ruling party can borrow at negative interest rates, it can create the economic growth needed to remain in power.

This is why the Democratic Party, led by President Biden, will go to great lengths to increase government spending. Then, U.S. Treasury Secretary Janet Yellen and her Fed Chair Jerome Powell need to ensure that U.S. Treasury yields remain significantly below nominal GDP growth. I do not know what kind of euphemism they will create for printing money to ensure that negative real yields persist, but I believe they will take the necessary steps to keep their boss and his party in power.

However, the orange man may win. What will happen to government spending in that case?

The above chart estimates the deficits during Biden or Trump’s presidency since 2024. As you can see, Trump's spending is expected to be even higher than Slow Joe's. Trump is seeking another round of tax cuts, which will further expand the deficit. Regardless of which elderly clown is chosen, rest assured that government spending will not decrease.

The Congressional Budget Office (CBO) predicts large deficits based on current and assumed future political environments. Fundamentally, if politicians can create 6% growth by borrowing at 4%, why would they stop spending?

As mentioned above, the political situation in the U.S. gives me confidence in the development of the printing press. If you think what the American monetary and political elite have done to "solve" the 2008 global financial crisis and the pandemic is absurd, then you have not seen anything yet.

The wars outside the peace of America continue primarily on the Ukraine/Russia and Israel/Iran battlefields. As expected, war hawks from both parties are satisfied to continue funding their proxies with borrowed billions in cash. As conflicts escalate and more countries become embroiled in the chaos, costs will only increase.

Conclusion

As we enter the summer in the Northern Hemisphere, decision-makers will have a chance to catch their breath from reality, and the volatility of cryptocurrencies will decrease. This is the best time to slowly increase positions by taking advantage of the recent cryptocurrency downturn. I have a list of junk coins that were hit hard last week. I will discuss them in upcoming articles. There will be many token releases, but they will not be as popular as those released in the first quarter. This provides a great entry point for those who are not pre-sale investors. No matter how exciting the taste of cryptocurrency risk may be, the coming months will offer a golden opportunity to increase positions.

Your intuition is correct that as politicians spend money on handouts and wars, printing will accelerate. Do not underestimate the desire of the current elite to remain in power. If real interest rates turn positive, reassess your beliefs about cryptocurrencies.