Arthur Hayes' Latest Article: The Monetary Policy Game Between China, the U.S., and Japan Presses the Start Button for the Crypto Bull Market
Timing is key.Original Title: 《 The Easy Button 》
Author: Arthur Hayes
Compiler: Deep Tide TechFlow
Introduction: Arthur delves into how global elites use policy tools to maintain the status quo, despite the pain these tools may bring now or in the future. His core argument is that the USD/JPY exchange rate is one of the most important global economic variables, exploring the complex interactions of monetary policy between Japan, the United States, and China, and their profound impacts on the global economy.
Global elites have various policy tools to maintain the status quo, which may bring pain now or in the future. I am skeptical and believe that the sole goal of both elected and unelected bureaucrats is to maintain power. Therefore, the easy button is always prioritized. Tough choices and strong measures are best left for the next administration.
It would take a series of very long articles to fully explain why the USD/JPY exchange rate is the most important global economic variable. This is my third attempt to describe the chain of events that led us into the cryptocurrency paradise. Rather than providing a complete and comprehensive picture first, I will, like them, give readers an easy button. If decision-makers abandon this tool, then I know that longer, harder, and more protracted corrective actions will be taken. By then, I can provide you with a more complete explanation of the sequence of monetary events and the relevant historical perspectives.
When I read the two recent "Solid Ground" newsletters by Russell Napier, the real "oh, they are really screwed" moment arrived. These newsletters describe the dilemma faced by the monetary elites managing Japan and America during peacetime. The most recent newsletter, published on May 12, describes the easy buttons available to the Bank of Japan (BOJ), the Federal Reserve (Fed), and the U.S. Treasury.
It's very simple: the Fed, at the direction of the Treasury, can legally exchange unlimited amounts of dollars and yen with the Bank of Japan at any time and place. The Bank of Japan and the Ministry of Finance (MOF) can use these dollars to manipulate the exchange rate by purchasing yen. This strengthens the yen and avoids the following situations:
The Bank of Japan raises interest rates, forcing regulated pools of funds such as banks, insurance companies, and pension funds to buy Japanese government bonds (JGB) at high prices and low yields.
To purchase these high-priced Japanese government bonds, these funds must sell their U.S. Treasuries (UST) to raise dollars to buy yen and repatriate them.
The Ministry of Finance sells U.S. Treasuries to raise dollars to buy yen.
If Japanese companies—the largest holders of U.S. Treasuries—do not become forced sellers, this helps the Treasury continue to fund a profligate federal government at negative real interest rates. Otherwise, the Treasury would have to initiate yield curve control (YCC). This is the ultimate destination, but it must be delayed as long as possible due to obvious inflation and potential stagflation effects.
Seppuku
Who is the largest holder of Japanese government bonds? The Bank of Japan.
Who is responsible for Japan's monetary policy? The Bank of Japan.
What happens to bonds when interest rates rise? Prices fall.
If interest rates rise, who suffers the most? The Bank of Japan.
If the Bank of Japan raises interest rates, it would be committing seppuku. Given its strong self-preservation instinct, the institution will not raise rates unless there is a solution to share the losses with other financial participants.
If the Bank of Japan does not raise interest rates and the Fed does not lower rates, the interest rate differential between the dollar and yen remains. Because the yield on the dollar is higher than that of the yen, investors will continue to sell yen.
China is Unhappy
China and Japan are direct export competitors. In many industries, the quality of Chinese goods is comparable to that of Japanese goods. Therefore, the only thing that matters is price. If the RMB/JPY exchange rate rises (a weaker yen against a stronger RMB), China's export competitiveness will be affected.
China will not like this RMB/JPY exchange rate chart.
China wants to escape deflation by manufacturing and exporting more goods.
Real estate = bad
Manufacturing = good
This is where cheap bank credit will flow.
As you can see, China and Japan are evenly matched in the emerging passenger car export market. I use this as an example of global export competition. Given the number of cars purchased each year, this is the most important export market. Additionally, the global south is young and growing, and their per capita car ownership will increase in the coming years.
If the yen continues to depreciate, China will respond by depreciating the RMB.
The People's Bank of China (PBOC) has essentially pegged the RMB to the dollar since 1994, with a slight tendency to strengthen. This is what the USDCNY chart shows. This situation is about to change.
China must implicitly depreciate the RMB by creating more onshore RMB credit and explicitly depreciate the RMB through a higher USDCNY value to ensure exports can outprice Japan. China must do this to counter the deflationary collapse caused by the bursting of the real estate bubble.
The GDP deflator converts nominal GDP into real GDP. A negative number means prices are falling, which is not good for a debt-based economy. Because banks issue credit against collateral, when asset prices fall, debt repayment becomes an issue, and prices will also fall. This is deadly, which is why China and all other global economies need inflation to function.
Creating the required inflation is easy; just print more money. However, China's money printing machine is not operating at full capacity. Credit, as always, is created by the commercial banking system.
These BCA research charts clearly show negative credit impulses, indicating insufficient credit money creation.
Spending by local and central governments is also insufficient to end deflation.
Real interest rates are positive. The growth of the money supply is declining, but its price is rising. Very bad.
China must create more credit through government spending or lending to businesses. So far, China has not launched a heavy stimulus plan like in 2009 and 2015. I believe this is due to valid concerns that these domestic money creation policies will negatively impact the exchange rate, and at least for now, they want to maintain stability against the dollar.
To create the above chart, I divided China's M2 (RMB money supply) by reported foreign exchange reserves. At the peak in 2008, the RMB had 30% of its foreign exchange reserves backed, primarily by U.S. Treasuries and other dollar assets. Currently, the RMB has only 8% of its foreign exchange reserves backed, the lowest level since data has been available.
If China increases credit creation, the money supply will further increase. This increases the pressure on the RMB to float dirty against the dollar. I believe that for domestic and diplomatic political reasons, China wants to maintain stability in the USD/RMB exchange rate.
Domestically, China does not want to exacerbate capital outflows through a massive depreciation of the RMB. Additionally, this increases import costs. China imports food and energy. When these costs rise too quickly, social unrest is not far behind. Any Marxist, especially Chinese Marxists, learns from revolutionary history that inflation rates for food and energy must never be allowed to spiral out of control.
A key factor of concern for China is the response of America during peacetime to the depreciation of the RMB. I will discuss this in detail later, but the depreciation of the RMB makes Chinese goods cheaper, reducing the incentive for American factories to return. Why would they build expensive factories and hire expensive skilled workers (if they can find them) when their final products still cannot compete with Chinese goods on price? Unless the U.S. government provides massive corporate welfare, American manufacturing companies will continue to produce products abroad.
Rust Belt
Biden's states that have lost manufacturing bases over the past 30 years have been hit hard. If China depreciates the RMB, jobs will continue to be lost. If Biden does not win these states, he will lose the election. Trump's victory in 2016 came from winning these rust belt states that held anti-China sentiments.
Some readers may think that Biden's aides finally understand; anti-China rhetoric and actions are more frequent from the Biden administration. In fact, Biden has just announced another increase in tariffs on Chinese-origin goods, such as electric vehicles.
My counterargument is that Chinese goods do not always ship directly from China. If products are cheap enough, China will first export to a U.S.-friendly country before ultimately entering the U.S. Then, these goods are considered to come from another country, not China.
This is a chart of China's exports to Mexico (white), Vietnam (yellow), and the United States (green). Trump's term began in 2017, which is the starting date for this index, valued at 100. Trade between China and Mexico grew by 154%, trade with Vietnam grew by 203%, but trade with the U.S. only grew by 8%. Clearly, the trade value with the U.S. is far higher than with Mexico and Vietnam, but it is evident that China is using these two countries as transit points for goods entering the U.S.
If the quality of the goods is high and the price is low, they will enter the U.S. While politicians may loudly impose punitive tariffs on "dumped" goods, China can easily shift the export destination. Countries like Vietnam and Mexico are happy to earn a small commission by allowing goods to pass through their borders into the U.S.
Biden must win these battleground states to stop Trump. Biden cannot afford a depreciation of the RMB before the election. China will use this fear of electoral defeat to achieve its objectives.
Chinese Threat
In recent quarters, Secretary of State Blinken and Treasury Secretary Yellen have visited Beijing multiple times. I imagine the real core of the conversation revolves around the threat from China.
If the U.S. does not allow Japan to strengthen the yen, China will respond by depreciating the RMB against the dollar and exporting its deflation to the world. Deflation is exported through cheap goods produced in large quantities.
China is also pressuring Yellen to implement a weak dollar policy to increase the global supply of dollars by any necessary means. This allows China to re-stimulate its economy again, as the speed of RMB credit creation will match that of the dollar on a relative basis.
In return, China will maintain stability in the USD/RMB exchange rate. The RMB will not depreciate against the dollar. Perhaps China will even agree to limit the quantity of products it exports to the U.S. to help American companies bring back production.
If Yellen and Blinken hesitate in the face of this threat, I would propose a nuclear currency option.
It is estimated that China has hoarded over 31,000 tons of gold. This is the total of government and private holdings. The party essentially owns everything in China, so I combine government and private holdings. At today's prices, this gold is worth about $2.34 trillion. The RMB is implicitly backed by 6% gold. I divide the reported RMB money supply by the value of all gold in China.
As mentioned earlier, China's foreign exchange reserves/M2 ratio is 8%. The RMB is roughly proportionately backed by dollars and gold.
My threat would be to announce a floating RMB against gold. China could achieve this by:
Quickly exchanging U.S. Treasuries for gold. At some point, the U.S. may freeze Chinese assets or limit China's ability to sell its approximately $1 trillion in U.S. Treasuries. But I believe China can quickly sell hundreds of billions of dollars in U.S. Treasuries at a discount price before U.S. politicians react.
Instruct any state-owned enterprises holding U.S. stocks or U.S. Treasuries to also sell and buy gold.
Announce that the RMB will be pegged to gold at a depreciation of 20% to 30% from current levels. The price of gold in RMB terms will rise (XAUCNY will increase).
There is a premium for gold on the Shanghai Futures Exchange (SFE) relative to the London Bullion Market Association (LBMA) fixing price. This leads traders to deliver gold in London through long futures contracts and deliver in Shanghai through short futures contracts, thus arbitraging. This will transport gold from the West to the East.
As global gold prices rise and physical gold inventories in LBMA member warehouses decrease, one or more major Western financial institutions may go bankrupt due to a lack of physical gold. It is rumored that Western financial institutions are naked shorting gold in the paper derivatives market. This would be an upgraded version of "GameStop," as it could lead to the collapse of the entire Western financial system due to embedded leverage.
The Fed would be forced to print money to save the banking system, increasing the supply of dollars. This would help strengthen the RMB against the dollar.
After reading these hypothetical scenarios, readers may wonder why I believe the U.S. can influence Japan's monetary policy. The key assumption is that by threatening the U.S., China can persuade the U.S. to instruct Japan to strengthen the yen.
In the 1970s and 1980s, Japan often agreed to strengthen the yen to reduce its export competitiveness relative to the U.S. and Western Europe (mainly Germany).
The above chart shows the USD/JPY exchange rate. In the early 1970s, the USD/JPY was 350; imagine how cheap Japanese goods were for inflationary Americans at that time.
Yellen is fully capable of politely suggesting to Japanese companies to strengthen the yen this time to prevent Chinese retaliation.
If Japan cooperates, what would they do? Let me explain why Japan cannot strengthen the yen by instructing the Bank of Japan to raise interest rates and end its quantitative easing policy.
Japanese Debt Math
I want to quickly explain why if the Bank of Japan raises interest rates, they would melt faster than Sam Bankman-Fried on the witness stand.
The Bank of Japan owns over 50% of all outstanding Japanese government bonds. They have essentially fixed the prices of 10-year or shorter bonds. What they really care about is the yield on 10-year Japanese government bonds, as this is the reference rate for many fixed-income products (corporate loans, mortgages, etc.). Assume their entire portfolio consists of 10-year Japanese government bonds.
Currently, the latest price for the 10-year Japanese government bond #374 is 98.682, with a yield of 0.954%. Assume the Bank of Japan raises the policy rate to match the current yield of 4.48% on 10-year U.S. Treasuries. At that point, the price of Japanese government bonds would be 70.951, a decline of 28% (I used Bloomberg's
Losing so much money would be fatal for the Bank of Japan's credibility with yen holders. The Bank of Japan only holds $32.25 billion in equity capital. Even extreme traders in cryptocurrency would not trade with as much leverage as the Bank of Japan. Seeing these losses, what would you do if you held yen or yen-denominated assets? Sell or hedge. In any case, the USD/JPY would quickly rise above 200, faster than Su Zhu and Kyle Davis fleeing the British Virgin Islands court-appointed liquidator.
If the Bank of Japan really had to raise interest rates to narrow the USD/JPY spread, they would first force domestic regulated pools of funds (banks, insurance companies, and pension funds) to buy Japanese government bonds. To do this, these entities would sell their foreign dollar assets, primarily U.S. Treasuries and U.S. stocks, using those dollars to buy yen and then purchase the Bank of Japan's high-priced Japanese government bonds with negative real yields.
From an accounting perspective, as long as these institutions hold to maturity, they would not mark to market their Japanese government bond portfolios and report huge losses. However, their clients, the people whose funds they manage, would be financially suppressed to save the Bank of Japan.
From the perspective of peacetime America, this is a bad outcome, as the Japanese private sector would sell trillions of dollars of U.S. Treasuries and U.S. stocks.
Whatever solution Yellen proposes to strengthen the yen cannot require the Bank of Japan to raise interest rates.
Easy Button
As mentioned above, there is a way to weaken the dollar, allowing China to re-stimulate its economy and strengthen the yen without needing to sell U.S. Treasuries. I will discuss how to solve this problem through unlimited USD/JPY currency swaps.
To weaken the dollar, its supply must be increased. Imagine Japan needs $1 trillion in firepower to strengthen the yen from 156 to 100 overnight. The Fed exchanges $1 trillion for an equal amount of yen. The Fed prints dollars, and the Bank of Japan prints yen. For each central bank, this costs nothing, as they have their respective domestic currency printing presses.
These dollars exit the Bank of Japan's balance sheet because the Japanese Treasury must buy yen in the open market. The Fed has no use for yen, so it remains on the Fed's balance sheet. When a currency is created but remains on the central bank's balance sheet, it has been sterilized. The Fed sterilizes the yen, but the Bank of Japan releases $1 trillion into the global money market. Therefore, the dollar depreciates against all other currencies due to the increase in supply.
As the dollar depreciates, China can create more onshore RMB credit to counter the adverse effects of deflation. If China wants to maintain the USD/RMB exchange rate at 7.22, it can create an additional 7.22 trillion RMB ($1 trillion * 7.22 USD/RMB) in domestic credit.
The RMB/JPY exchange rate falls, which is a depreciation for China but an appreciation from Japan's perspective. The global supply of RMB increases, while the supply of yen decreases as the Japanese Treasury buys yen with dollars. Now, the yen is fairly priced against the RMB on a purchasing power parity basis.
Any dollar-denominated asset price rises. This is good for U.S. stocks and the U.S. government, as it generates capital gains tax on profits. This is good for Japanese companies, as they collectively own over $3 trillion in dollar assets. Cryptocurrencies soar as there is more dollar and RMB liquidity in the system.
Domestic inflation in Japan decreases because the cost of imported energy falls due to the strengthening yen. However, exports will be affected due to the stronger currency.
Everyone benefits, some more than others, but this helps maintain the integrity of the global dollar system before the U.S. presidential election. No country needs to make painful choices that negatively impact its domestic political standing.
To understand the risks of U.S. involvement in such actions, first, I need to draw an equation between yield curve control (YCC) and this USD/JPY swap scheme.
Same but Different
What is YCC?
It occurs when a central bank is willing to print unlimited amounts of money to buy bonds to fix prices and yields at politically appropriate levels. Due to YCC, the money supply increases, leading to currency depreciation.
What is the USD/JPY swap arrangement?
The Fed is prepared to print unlimited amounts of dollars so that the Bank of Japan can delay raising interest rates and avoid selling U.S. Treasuries.
The result of both policies is the same; that is, U.S. Treasury yields are lower than they would otherwise be. Additionally, as supply increases, the dollar will depreciate.
The swap line is politically better because it happens in the shadows. Most civilians, even the elite, do not understand how these tools work or their position on the Fed's balance sheet. It also does not require consultation with the U.S. Congress, as the Fed obtained these powers decades ago.
YCC is more visible and will certainly provoke fierce opposition from citizens who are concerned and outraged.
Risks
The risk is that the dollar depreciates too much. Once the market equates the USD/JPY swap line with YCC, the dollar will plummet to the bottom. When the swaps are unwound, it will signify the end of the dollar reserve system.
Given that the market will take many years to force such an unwinding, the politicians supporting it today will back the expansion of the USD/JPY swap line.
Stay Alert
How do you monitor whether I am right or wrong?
Monitor the USD/JPY exchange rate more closely than Solana developers monitor uptime. In fact, pay even closer attention to…
The USD/JPY spread issue has not been resolved. Therefore, regardless of intervention measures, the yen will continue to weaken. After each intervention, open this webpage and monitor the scale of the USD/JPY swap line. On Bloomberg, monitor the FESLTOTL index. If it starts to increase significantly, I mean in the billions of dollars, then you know this is the path chosen by the elites.
At this point, add the scale of the dollar swap line to your dollar liquidity index. Sit back and watch cryptocurrencies rise in fiat terms.
Errors
I may have two erroneous paths.
The Bank of Japan changes its weak yen policy by significantly raising interest rates and indicates it will continue. By significant, I mean 2% or more. A mere 0.25% rate hike will not cut the 5.4% spread between the dollar and yen.
The yen continues to weaken, and both the U.S. and Japan do nothing. China retaliates by depreciating the RMB against the dollar or pegging it to gold.
If either of the above scenarios occurs, it will ultimately lead to some form of YCC in the U.S., but the road to YCC is complex. I have a theory about the sequence of events from here to there, and if necessary, I will publish a series of articles about this journey.
Timing is Key
The market knows the yen is too weak. I believe the pace of yen depreciation will accelerate in the fall. This will put pressure on the U.S., Japan, and China to take action. The U.S. election is a key driving factor for the Biden administration to come up with solutions.
I believe a rise in the USD/JPY to 200 is sufficient to have the Chemical Brothers play "Push the Button."
This is a simplified version of how all cryptocurrency traders must constantly monitor the USD/JPY. I believe the clowns managing peacetime America will choose the easy way. It is simply the politically rational choice.
If my theory comes to fruition, any institutional investor can easily purchase a Bitcoin ETF listed in the U.S. Bitcoin is the best-performing asset in the face of global fiat currency depreciation, and they know it. When dealing with the weak yen issue, I will mathematically estimate how the inflow of funds into the Bitcoin complex will drive the price up to $1 million or even higher. Keep your imagination alive, stay optimistic, and now is not the time to be timid.
