Arthur Hayes's new article: The crypto market may break free from the downturn in September, and the next stop for BTC is 1 million dollars

Author: ARTHUR HAYES

Compilation: Deep Tide TechFlow

(Any opinions expressed here are solely those of the author and should not be taken as the basis for investment decisions, nor should they be interpreted as recommendations or advice to engage in investment trading.)

Water, water, everywhere,
All the boards did shrink;
Water, water, everywhere,
Nor any drop to drink.
------ Coleridge, "The Rime of the Ancient Mariner"

I love specialty coffee, but my attempts to brew coffee at home always fail. I spend a decent amount of money on coffee beans, yet my coffee is always worse than what I get at the café. To improve my brewing, I started paying more attention to details. I overlooked one crucial detail: the quality of the water.

Water is essential for coffee quality. Recently, an article in issue 35 of Standart struck me deeply.

During my time as a barista, I had a similar realization when I learned that over 98% of the components in a cup of coffee and about 90% of espresso are water.

This awareness often comes late, perhaps because the idea of spending money on new machines to improve coffee is more appealing. "Ah, you have a cone grinder! That's why your coffee is murky. Switch to a flat burr!" But what if the problem isn't in the ingredients? What if focusing on the solvent itself could solve our coffee issues? ------ Lance Hedrick, "On Water Chemistry"

My next step is to understand the author's advice and order a home distiller. I know a local coffee shop sells mineral concentrates that can be added to water, which will provide the perfect base for my coffee to highlight the flavors of their roasted beans. By this winter, my morning coffee should be delicious… I hope so. I pray for my adventurous friends who will taste my "black gold" coffee before climbing Mount Shasta.

Quality water is crucial for brewing delicious coffee. Turning to investments, water or liquidity is also important for accumulating Bitcoin (sats). This is a recurring theme in all my writings. Yet we often forget its significance, focusing instead on the small things we think will impact our ability to make money.

If you can identify how, where, why, and when fiat currency liquidity is created, it becomes difficult to lose money when investing. Unless you are Sue Zhu or Kyle Davies. If financial assets are priced in U.S. dollars and U.S. Treasury securities (UST), it can be inferred that the quantity of global currency and dollar debt is the most critical variable.

We need to focus not on the Federal Reserve (Fed), but on the U.S. Treasury. This will help us determine the specifics of the increase or decrease in fiat currency liquidity under Pax Americana.

We need to return to the concept of "fiscal dominance" to understand why U.S. Treasury Secretary Yellen has made Fed Chair Powell her "beta cuck towel bitch boy." Please read my article titled Kite or Board for a deeper discussion. During periods of fiscal dominance, the necessity of funding the state outweighs any concerns the central bank may have about inflation. This means that bank credit, as well as nominal GDP growth, must remain high, even if it leads to inflation persistently exceeding target levels.

Time and compounding determine when power shifts from the central bank to the Treasury. When the debt-to-GDP ratio exceeds 100%, debt grows mathematically at a much faster rate than economic growth. Beyond this event horizon, the institution controlling the debt supply is crowned emperor. This is because the Treasury decides when, how much, and when debt will be issued. Furthermore, as the government now relies on debt-driven growth to maintain the status quo, it will eventually instruct the central bank to use its printing press to cash the Treasury's checks. The independence of the central bank becomes irrelevant!

The outbreak of COVID and the U.S. government's measures to keep people at home, along with the issuance of stimulus checks in exchange for their compliance, caused the debt-to-GDP ratio to quickly exceed 100%. The transformation from "grandma" to "bad girl" Yellen was just a matter of time.

Before the U.S. enters a full-blown hyperinflation scenario, Yellen has a straightforward way to create more credit and drive asset markets. The Fed's balance sheet has two sterilized pools of funds that, if released into the market, would promote bank credit growth and push up asset prices. The first pool is the reverse repurchase agreement (RRP) fund. I have discussed this fund in detail, where money market funds (MMFs) park cash at the Fed overnight and earn interest. The second pool is bank reserves, for which the Fed pays interest in a similar manner.

When funds are on the Fed's balance sheet, they cannot be re-mortgaged into the financial market to generate broad money or credit growth. By providing reserves interest and reverse repo interest incentives to banks and money market funds respectively, the Fed's quantitative easing (QE) program has created inflation in financial asset prices rather than leading to rapid growth in bank credit. If QE were not sterilized in this way, bank credit would flow into the real economy, increasing output and inflation in goods/services. Given the current total debt of Pax Americana, strong nominal GDP growth coupled with inflation in goods/services/wages is precisely what the government needs to increase tax revenue and reduce leverage. Thus, "bad girl" Yellen steps in to correct the situation.

Yellen is indifferent to inflation. Her goal is to create nominal economic growth so that tax revenues rise and the U.S. debt-to-GDP ratio decreases. Given that no party or its supporters are committed to cutting spending, deficits will persist for the foreseeable future. Moreover, due to the scale of the federal deficit being the largest in peacetime history, she must utilize all available tools to finance the government. Specifically, this means transferring as much money as possible from the Fed's balance sheet into the real economy.

Yellen needs to give banks and money market funds what they want. They want a cash-like instrument with no credit and minimal interest rate risk to replace the yield cash they hold at the Fed. Treasury bills (T-bills) with maturities of less than one year, yielding slightly more than the interest on reserve balances (IORB) or the reverse repo rate (RRP), are the perfect substitute. T-bills are assets that can be leveraged in the market, generating credit and asset price growth.

Can Yellen issue $3.6 trillion in T-bills? Of course. The federal government is running a $2 trillion annual deficit that must be financed through debt securities issued by the Treasury.

However, Yellen or whoever succeeds her in January 2025 does not necessarily have to issue T-bills to finance the government. She could sell long-term Treasuries that are less liquid and have higher interest rate risk. These securities are not cash equivalents. Moreover, due to the shape of the yield curve, the yields on long-term debt securities are lower than those on T-bills. The profit motive for banks and money market funds makes it unlikely they will exchange anything other than T-bills for the funds held at the Fed.

So why should we crypto traders care about the flow of funds between the Fed's balance sheet and the broader financial system? Take a look at this beautiful chart.

As the reverse repo program (white line) retreats from its highs, Bitcoin (gold) rebounds from its lows. As you can see, this is a close relationship. When funds leave the Fed's balance sheet, it increases liquidity, which leads to rising prices for limited financial assets like Bitcoin.

Why does this happen? Let's consult the Treasury Borrowing Advisory Committee (TBAC). In its latest report, TBAC clearly outlines the relationship between increased T-bill issuance and the funds held by money market funds (MMFs) in the RRP.

Large overnight reverse repo balances may indicate strong demand for T-bills. During 2023-24, overnight reverse repo funds have almost moved one-for-one into T-bills. This rotation has facilitated the smooth absorption of record T-bill issuance. ------ Slide 17, TBAC July 31, 2024

As long as T-bill yields are slightly higher than the reverse repo rate, money market funds will shift cash into T-bills—currently, the yield on one-month T-bills is about 0.05% higher than the funds in the RRP.

The next question is whether bad girl Yellen can guide the remaining $300 billion to $400 billion in funds from the RRP into T-bills. If you doubt bad girl Yellen, you might face sanctions! Just ask those poor souls from developing countries what happens when you lose the opportunity to obtain dollars to buy basic necessities like food, energy, and medicine.

In the recent Q3 2024 Quarterly Financing Announcement (QRA), the Treasury stated it would issue $271 billion in T-bills by the end of this year. That's good, but there is still money in the RRP. Can she do more?

Let me quickly talk about the Treasury's buyback program. Through this program, the Treasury repurchases illiquid non-T-bill debt securities. The Treasury can fund purchases by reducing its General Account (TGA) or issuing T-bills. If the Treasury increases T-bill supply while reducing other types of debt supply, it will net increase liquidity. Funds will leave the RRP, which is positive for dollar liquidity, and as the supply of other types of Treasuries decreases, holders will turn to the risk curve to replace these financial assets.

The latest buyback plan as of November 2024 totals $30 billion in non-T-bill purchases. This is equivalent to reissuing $30 billion in T-bills, bringing the total outflow from the RRP to $301 billion.

This is a robust liquidity injection. But how powerful is bad girl Yellen? How much does she hope for the minority American presidential candidate Kamala Harris to win? I call her "minority" because Harris changes her phenotype affiliation based on her audience in different contexts. This is her unique ability. I support her!

The Treasury can inject massive liquidity by reducing the TGA from about $750 billion to zero. They can do this because the debt ceiling will take effect on January 1, 2025, and by law, the Treasury can spend the TGA to avoid or delay a government shutdown.

Bad girl Yellen will inject at least $301 billion, potentially up to $1.05 trillion, before the end of the year. Boom! This will create a brilliant bull market covering all types of risk assets, including cryptocurrencies, just in time for the elections. If Harris still can't beat that orange guy, then I think she needs to turn into a white male. I believe she has that superpower within her/his capabilities.

Grenade

Injecting $2.5 trillion into the financial markets through the reverse repo program (RRP) over the past 18 months is quite impressive. But there is still a huge pile of dormant liquidity eager to be released. Can Yellen's successor create a situation post-2025 that draws funds from the bank reserves held at the Fed and injects them into the broader economy?

During periods of fiscal dominance, anything is possible. But how?

Profitable banks will exchange one yield cash-like instrument for another in terms of capital adequacy, as long as regulators treat them the same and the latter has a higher yield. Currently, T-bill yields are lower than the reserve balances held by the Fed, so banks are not buying T-bills.

But what happens next year when reverse repos are nearly zero, and the Treasury continues to flood the market with T-bills? Sufficient supply and money market funds (MMFs) unable to purchase T-bills with funds parked in reverse repos means prices must fall, and yields will rise. Once T-bill yields exceed the excess reserve rate by a few basis points, banks will use their reserves to buy T-bills in large quantities.

Yellen's successor—I would bet it's Jamie Dimon—will not be able to resist the ability to continue dumping T-bills into the market for the political benefit of the ruling party. Another $3.3 trillion in bank reserve liquidity is waiting to be injected into the financial markets. Join me in shouting: T-bills, baby, T-bills!

I believe TBAC is quietly hinting at this possibility. Here’s another excerpt from a previous report, with my comments marked in [bold]:

Looking ahead, many factors may need further study to consider the future share of T-bill issuance:

[TBAC hopes the Treasury considers the future and how large T-bill issuance should be. Throughout the report, they advocate that T-bill issuance should remain around 20% of total net debt . I believe they are trying to indicate what would lead to this ratio increasing and why banks would become the primary buyers of these T-bills.] ------ TBAC July 31, 2024, Slide 26

The evolution of the banking regulatory environment and ongoing assessments (including liquidity and capital reforms, etc.), as well as the impact of banks and dealers meaningfully participating in the primary Treasury market to intermediate and warehouse (anticipated) future U.S. Treasury maturities and supply.

[Banks do not want to hold more long-term notes or bonds that attract stricter collateral requirements. They are quietly indicating that they will no longer purchase long-term debt because it harms their profitability and is too risky. If primary dealers strike, the Treasury is in trouble, because who else has the balance sheet to absorb massive debt auctions?]

The evolution of market structure and its impact on Treasury market resilience initiatives, including:

• SEC's central clearing rules, which will require a large amount of margin to be posted in covered clearinghouses.

• [If the Treasury market shifts to exchanges, this will require dealers to post billions of dollars in additional collateral. They cannot bear such costs, resulting in decreased participation.]

• Future (anticipated) U.S. Treasury auction sizes and predictability in cash management and benchmark T-bill issuance.

• [If the deficit remains so large, the amount of debt issued may increase significantly. Therefore, the role of T-bills as a "buffer" will become increasingly important. This means higher T-bill issuance will be needed.]

• Future money fund reforms and potential structural demand for T-bills.

• [If money market funds return to the market after fully drawing down reverse repos, T-bill issuance will exceed 20%.] ------ TBAC July 31, 2024, Slide 26

Banks have effectively struck and are no longer purchasing long-term Treasuries. Bad girl Yellen and Powell nearly caused the banking system to collapse by filling banks with Treasuries and then raising rates from 2022 to 2023… Rest in peace, Silvergate Bank, Silicon Valley Bank, and Signature Bank. The remaining banks do not want to take risks and see what happens if they greedily buy high-priced Treasuries again.

For example: Since October 2023, U.S. commercial banks have purchased only 15% of non-T-bill Treasury securities. This is very bad for Yellen because she needs banks to step up when the Fed and foreigners exit. I believe as long as banks buy T-bills, they will be happy to fulfill their responsibilities since T-bills have risk characteristics similar to bank reserves but with higher yields.

Widowmaker

The move from 160 to 142 in the USD-JPY currency pair has triggered a violent reaction in global financial markets. Many were reminded last week to sell whatever they could. That moment was textbook correlation. The USD-JPY will hit 100, but the next wave will be driven by the repatriation of foreign capital by Japan Inc., not just by hedge fund investors unwinding their yen carry trades. They will sell U.S. Treasuries and U.S. stocks (mainly large tech stocks like NVIDIA, Microsoft, Google).

The Bank of Japan attempted to raise interest rates, and global markets reacted violently. They compromised and announced that raising rates was off the table. From the perspective of fiat currency liquidity, the worst-case scenario is that the yen trades sideways, with no new low-cost yen positions being established. As the threat of yen carry trades fades, bad girl Yellen's market intervention comes back into focus.

Dehydration

Without water, you will die. Without liquidity, you will face collapse.

Why has the cryptocurrency risk market been flat or declining since April of this year? Most tax revenues were generated in April, leading the Treasury to reduce borrowing. We can see that the number of T-bills issued between April and June decreased.

Due to the net decrease in T-bills, liquidity in the market has been removed. Even if overall government borrowing increases, the net decrease in cash-like instruments provided by the Treasury will lead to reduced liquidity. Thus, cash remains trapped on the Fed's balance sheet, in the reverse repo program (RRP), unable to drive up financial asset prices.

This chart of Bitcoin (gold) versus RRP (white) clearly shows that from January to April, when T-bills were net issued, RRP declined and Bitcoin rose. From April to July, when T-bills were net withdrawn from the market, RRP increased, and Bitcoin traded sideways, accompanied by several sharp declines. I stopped on July 1 because I wanted to show the interaction before the USD-JPY fell sharply from 162 to 142, leading to a broad sell-off in risk assets.

Thus, according to bad girl Yellen, we know that there will be a net issuance of $301 billion in T-bills between now and the end of the year. If this relationship holds, Bitcoin will quickly recover from the sell-off caused by the yen's appreciation. Bitcoin's next target is $100,000.

When is Altcoin Season?

Altcoins are the high Beta play on Bitcoin in crypto. But in this cycle, Bitcoin and Ethereum now have structural buying in the U.S.-listed exchange-traded funds (ETFs). Although Bitcoin and Ethereum have pulled back since April, they have escaped the brutal fate of the altcoin market. Altcoin season will only return after Bitcoin and Ethereum break through $70,000 and $4,000, respectively. Solana will also exceed $250, but given its relative market cap, Solana's rise will have far less impact on the overall crypto market's wealth effect than Bitcoin and Ethereum. By the end of the year, the rebound in Bitcoin and Ethereum driven by dollar liquidity will lay a solid foundation for the return of the sexy altcoin party.

Trading Setup

As T-bill issuance and buyback programs run in the background, liquidity conditions will improve. If Harris wavers and needs more firepower to push the stock market up, Yellen will reduce TGA funding. In any case, I expect cryptocurrencies to begin breaking out of their downward trajectory in September. Therefore, I will use this soft period at the end of summer in the Northern Hemisphere to increase my investment in crypto risk.

The U.S. elections will be held in early November. Yellen will peak in manipulation in October. There is no better liquidity moment this year. Therefore, I will seize the opportunity. I will not liquidate my entire crypto portfolio but will take profits on more speculative momentum trades and park capital in staked Ethena USD (sUSDe). A rise in the crypto market increases the chances of Trump winning. Trump's odds peaked after the assassination attempt and Slow Joe's disastrous debate performance; Kamala Harris is a top-tier political puppet, but she is not an octogenarian vegetable. That is exactly what she needs to defeat Trump. Elections are a coin toss, and I prefer to watch the chaos from the sidelines and re-enter the market after the U.S. debt ceiling is raised. I expect this to happen between January and February.

Once the farce of the U.S. debt ceiling ends, liquidity will flood from the Treasury and the Fed to normalize the markets. Then, the real bull market will begin. A million-dollar Bitcoin remains my base prediction.

P.S.: Once bad girl Yellen and towel boy Powell team up, China will finally unleash its long-awaited fiscal stimulus. The mid-2025 U.S.-China crypto bull market will be glorious.