Arthur Hayes's new article: The global economy is at the turning point of an inflation cycle, and holding cryptocurrencies is the best way to preserve value

Original Title: 《Zoom Out》

Author: Arthur Hayes

Translation: 深潮TechFlow

Some people might say:

• "The cryptocurrency bull market is over."

• "I need to launch my token now because we are in the downward phase of the bull market."

• "Why hasn't Bitcoin risen along with the large American tech companies in the Nasdaq 100 index?"

This comparison chart of the Nasdaq 100 index (white) and Bitcoin (gold) shows that the two assets have moved in tandem, but Bitcoin has stagnated since reaching an all-time high earlier this year.

This chart of the Nasdaq 100 (white) and Bitcoin (gold) shows that their trends are consistent, but Bitcoin has stalled after hitting an all-time high earlier this year.

But the same people might also say the following:

• "The world is shifting from a unipolar US-dominated global order to a multipolar world order that includes leaders from China, Brazil, Russia, and others."

• "To fund government deficits, savers must be financially repressed, and central banks must print more money."

• "World War III has already begun, and war leads to inflation."

Some opinions about the current Bitcoin bull market phase, along with their views on geopolitics and the global monetary situation, confirm my belief that we are at a turning point—transitioning from one geopolitical and monetary global arrangement to another. While I don't know which country will ultimately dominate or what the trade and financial architecture will look like, I have a general idea of its shape.

I want to step back from the current tumultuous cryptocurrency capital markets and focus on the broader cyclical trend reversal we are experiencing.

I want to analyze three major cycles from the Great Depression of the 1930s to the present. This will focus on the American utopia, as the entire global economy is a derivative of the financial policies of the dominant empire. Unlike Russia in 1917 and China in 1949, the American utopia did not undergo a political revolution due to the two world wars. Most importantly, for the purposes of this analysis, the American utopia is relatively the best place to hold capital. It has the deepest stock and bond markets, as well as the largest consumer market. Whatever the US does, the rest of the world tends to follow and react, leading to good or bad outcomes relative to the flag on your passport. Therefore, understanding and predicting the next major cycle is crucial.

Historically, there have been two types of periods: local periods and global periods. In local periods, governments financially repress savers to fund past and present wars. In global periods, financial controls are relaxed, and global trade is promoted. Local periods are inflationary, while global periods are deflationary. Any macro theorist you follow will have a similar classification to describe the major cycles of history from the 20th century onward.

The purpose of this history lesson is to make wise investments throughout the cycles. In a typical 80-year lifespan, due to the stem cells I’ve injected, I might expect to gain more time; you can expect to experience an average of two major cycles. I categorize our investment options into three types:

If you believe in the system but not in the people managing it, you invest in stones.

If you believe in the system and in the people managing it, you invest in government bonds.

If you believe in neither the system nor the people managing it, you invest in gold or other assets that do not require the existence of any state remnants, such as Bitcoin. Stocks are a legal fiction maintained by courts that can dispatch armed personnel to enforce compliance. Thus, stocks require a strong state to exist and maintain value over the long term.

In a local inflationary period, I should hold gold and abandon stocks and bonds.

In a global deflationary period, I should hold stocks and abandon gold and bonds.

Government bonds generally do not retain value over the long term unless I can utilize them at low or no cost indefinitely, or regulators force me to hold them. This is mainly because it is too tempting for politicians to fund their political goals by printing money rather than resorting to unpopular direct taxation.

Before describing the cycles of the last century, I want to highlight a few key dates.

• April 5, 1933: On this day, President Franklin D. Roosevelt signed an executive order prohibiting private ownership of gold. Subsequently, he violated the US commitment under the gold standard by devaluing the dollar against gold from $20 to $35.

• December 31, 1974: On this day, President Gerald Ford restored the right of Americans to privately own gold.

• October 1979: Federal Reserve Chairman Paul Volcker changed US monetary policy to target credit volume rather than interest rate levels. He then curtailed inflation by restricting credit. In the third quarter of 1981, the yield on 10-year US Treasury bonds reached 15%, a historic high, while bond prices hit a historic low.

• January 20, 1980: Ronald Reagan was sworn in as President of the United States. He subsequently actively relaxed regulations on the financial services industry. Other significant changes in financial regulation included making capital gains tax treatment for stock options more favorable and repealing the Glass-Steagall Act.

• November 25, 2008: The Federal Reserve began printing money under its quantitative easing (QE) program to address the global financial crisis triggered by subprime mortgage losses on financial institutions' balance sheets.

• January 3, 2009: Satoshi Nakamoto's Bitcoin blockchain released the genesis block. I believe our Lord and Savior is here, rescuing humanity from state control by creating a digital cryptocurrency that can compete with fiat currency.

1933 - 1980 The American Peaceful Ascendancy Cycle

Compared to other countries, the US emerged from wars unscathed. Considering the casualties and property losses, World War II was less deadly and destructive than the 19th-century Civil War. While Europe and Asia lay in ruins, American industry rebuilt the world and reaped enormous rewards.

Despite the smooth progress of war for the US, it still needed to pay for the war through financial repression. Starting in 1933, the US prohibited gold ownership. By the end of the 1940s, the Federal Reserve merged with the US Treasury. This allowed the government to control the yield curve, enabling it to borrow at rates below the market because the Federal Reserve printed money to buy bonds. To ensure that savers could not escape, bank deposit interest rates were capped. The government used the saved marginal dollars to pay for World War II and the Cold War with the Soviet Union.

If gold and fixed-income securities that at least paid interest at the inflation rate were outlawed, what could savers do to beat inflation? The stock market was the only way out.

From April 1, 1933, to December 30, 1974, the comparison of the S&P 500 index (white) and the gold (gold) index (100)

Even after President Nixon abolished the gold standard in 1971, gold rose, yet its returns still did not surpass those of stocks.

But what happened when capital could freely bet against the system and the government again?

From December 31, 1974, to October 1, 1979, the comparison of the S&P 500 index (white) and the gold (gold) index (100)

During this period, gold outperformed stocks. I stopped comparing in October 1979 because Volcker announced that the Federal Reserve would significantly tighten credit, restoring confidence in the dollar.

1980-2008 The Pinnacle Global Cycle of American Governance

As confidence grew that the US could and would defeat the Soviet Union, the political winds shifted. It was time to transition from a wartime economy, deregulate finance and other sectors, and invigorate the markets.

Under the new petrodollar monetary framework, the dollar was backed by oil sales surpluses from Middle Eastern oil-producing countries like Saudi Arabia. To maintain the dollar's purchasing power, it was necessary to raise interest rates to suppress economic activity and thus curb inflation. Volcker did just that, allowing interest rates to soar while the economy declined.

The early 1980s marked the beginning of the next cycle, during which the US, as the sole superpower, spread its wings in global trade, and the dollar strengthened due to monetary conservatism. Unsurprisingly, gold performed poorly compared to stocks.

From October 1, 1979, to November 25, 2008, the comparison of the S&P 500 index (white) and the gold (gold) index (100)

Apart from bombing some Middle Eastern countries back to the Stone Age, the US has not faced any wars against peer or near-peer militaries. Even after the US wasted over $10 trillion fighting cave dwellers in Afghanistan, cave dwellers in Syria, and guerrilla insurgents in Iraq and failing, confidence in the system and government remained unshaken. After Jesus seized glory a millennium ago, the Almighty is about to wreak havoc on America again.

2008 to Present: The Comparison of the American Utopia and the Medieval Native Cycle

Faced with another deflationary economic collapse, the American Utopia Association once again defaulted and devalued. This time, the Federal Reserve did not prohibit private ownership of gold and then devalue the dollar against gold; instead, it decided to print money and buy government bonds, calling it quantitative easing. In both cases, the amount of dollar-based credit rapidly expanded to "save" the economy.

The proxy wars between major political factions erupted once again. A significant turning point was Russia's invasion of Georgia in 2008, a response to NATO's intention to allow Georgia to join the alliance. For the Russian elite led by President Putin, preventing a nuclear-armed NATO from advancing and encircling Russia has always been a top priority.

Currently, intense proxy wars have erupted between the West (the American Utopia and its vassals) and the Eurasian continent (Russia, China, Iran) in Ukraine and the Levant (Israel, Jordan, Syria, and Lebanon). Any of these conflicts could escalate into nuclear war between the two sides. In response to the seemingly unstoppable war process, countries are turning inward, ensuring that all aspects of their national economies are prepared to support the war.

For this analysis, this means that savers will be asked to fund the nation's wartime expenditures. They will be financially repressed. The banking system will allocate most credit according to the state's directives to achieve certain political goals.

The American Utopia Association once again defaulted on the dollar to prevent a deflationary depression similar to the Great Depression of 1930. Subsequently, the US set up trade protectionist barriers as it did from 1930 to 1940. All nation-states are looking out for themselves, which can only mean experiencing severe inflation while undergoing financial repression.

From November 25, 2008, to the present, the comparison of the S&P 500 index (white) against gold (gold) and Bitcoin (green) with an index of 100

This time, as the Federal Reserve devalues the dollar, capital can freely exit the system. The issue is that at the beginning of the current local cycle, Bitcoin offers another stateless currency. The main difference between Bitcoin and gold is that, in Lynn Alden's words, Bitcoin's ledger is maintained through a cryptographic blockchain, allowing currency to flow at the speed of light. In contrast, gold's ledger is maintained by nature, with its movement speed only comparable to the actual speed at which humans transfer gold. Compared to digital fiat currency, which also moves at the speed of light but can be printed infinitely by governments, Bitcoin is superior, while gold falls short. This is why Bitcoin has somewhat overshadowed gold from 2009 to now.

Bitcoin's performance has far outstripped gold, to the extent that you cannot see the difference in returns between gold and stocks on this chart. Thus, gold's performance has lagged behind stocks by nearly 300%.

The End of Quantitative Easing

While I believe my background and description of the past 100 years of financial history are incredible, this does not eliminate concerns about the current bull market ending. We know we are in an inflationary period, and Bitcoin has done what it should: outperforming stocks and fiat currency depreciation. However, timing is everything. If you bought Bitcoin at the recent historical high, you might feel like a beta version of a cuckold, as you inferred past results into an uncertain future. That said, if we believe inflation will persist and war (whether cold, hot, or proxy) is imminent, what insights do the past provide for the future?

Governments have consistently repressed domestic savers to fund wars and the winners of past cycles while maintaining system stability. In this modern nation-state and large integrated commercial banking system, the primary way governments fund themselves and key industries is by controlling how banks allocate credit.

The problem with quantitative easing policies is that the market will funnel free money and credit into businesses that do not produce the actual products needed for a wartime economy. The American Utopia Association is the best example of this phenomenon. Volcker ushered in the era of omnipotent central banks. Central bankers create bank reserves by purchasing bonds, thereby lowering costs and increasing credit limits.

In private capital markets, the allocation of credit is aimed at maximizing shareholder returns. The simplest way to boost stock prices is to reduce float through buybacks. Companies that can access cheap credit will borrow money to repurchase shares. They will not borrow money to increase capacity or improve technology. Improving business to hope for more revenue is challenging and does not guarantee a boost in stock prices. But mathematically, reducing float can raise stock prices, and since 2008, large-cap companies that have received substantial cheap credit have been doing just that.

(See source)

Another easily achievable goal is to increase profit margins. Therefore, companies have not used stock prices to build new capacity or invest in better technology but have lowered labor costs by shifting jobs to China and other low-cost countries. American manufacturing has become so fragile that it cannot produce enough ammunition to respond to Russia's fighting in Ukraine. Moreover, China has a clear advantage in manufacturing goods, to the extent that the US Department of Defense's supply chain is filled with critical components produced by Chinese companies. Most of these Chinese companies are state-owned enterprises. Quantitative easing (QE), combined with shareholder-centric capitalism, has made American military "giants" reliant on the "strategic competitor" of the state (their words, not mine), China. How ironic! The way the American Utopia Association and the Western collective allocate credit will resemble that of China, Japan, and South Korea. Either the state directly instructs banks to lend to this or that industry/company, or banks are forced to purchase government bonds at yields below the market, allowing the state to subsidize and grant tax breaks to the "right" companies. In either case, the return on capital or savings will be lower than nominal growth and inflation. Assuming there are no capital controls, the only way out is to purchase value storage outside the system, such as Bitcoin.

For those obsessed with watching the changes in major central banks' balance sheets and believing that the pace of credit growth is insufficient to drive cryptocurrency prices up again, you must now obsess over the credit limits created by commercial banks. Banks achieve this by lending to non-financial enterprises. Fiscal deficits also generate credit because deficits must be funded by borrowing in the sovereign debt market, and banks dutifully purchase this debt.

In short, in past cycles, we monitored the size of central bank balance sheets. In this cycle, we must monitor the total fiscal deficit and non-financial bank credit amount.

Trading Strategy

Why am I confident that Bitcoin will regain its magic? Why am I confident that we are in a new localized, nation-state-prioritized inflation cycle?

Look at this information:

According to a federal agency's forecast, the US budget deficit is expected to soar to $1.915 trillion in fiscal year 2024, exceeding last year's $1.695 trillion and reaching the highest level outside the COVID-19 era. The agency attributed its earlier prediction increase of 27% to rising expenditures.

For those worried that "slow" Biden won't keep the economy running with more spending before the election, this is the answer.

The Atlanta Fed forecasts a staggering +2.7% real GDP growth for the third quarter of 2024.

For those concerned that the American governance will fall into recession, it is mathematically extremely difficult to experience a recession when the government spends $2 trillion beyond tax revenues. This amounts to 7.3% of 2023 GDP. For context, US GDP fell by 0.1% in 2008 and by 2.5% during the global financial crisis in 2009. If another global financial crisis similar to the last one occurs this year, the decline in private economic growth will still not exceed the amount of government spending. There will be no recession. This does not mean that many ordinary people will not fall into severe financial distress, but the American governance will continue to move forward.

I point this out because I believe fiscal and monetary conditions are loose, and will continue to remain loose, therefore, holding cryptocurrencies is the best way to preserve value. I am convinced that today's situation is similar to that of the 1930s to the 1970s, which means that, given I can still freely transfer from fiat to cryptocurrency, I should do so, as the devaluation resulting from the expansion and concentration of credit allocation through the banking system is imminent.