Digital Dollar, Debt, and Secular Inflation
There has been much talk surrounding the inflation vs. deflation argument, and I understand both views. Many of the arguments I see on Twitter seem to hinge on the meaning of the word "inflation" itself. So let me take the Socratic approach and first define the word in a way that we can hopefully agree upon, at least for this purposes of this article.
Inflation is when the cost of goods and services you use daily goes up over time. We don't need to think about the "broad expansion of M2" or any technical jargon used by self-proclaimed erudite economists. No, we simply need to think, "will this cheeseburger, this car, this house, this stick of gum cost more in the future than it does today." Secondly and most importantly, will the dollars in my savings account be able to buy the same amount of "stuff" in the future as they do today?
Now that we have a foundation upon which to build, we need to understand debt. I talked about this ad nauseam in my last article, so I will not go into depth here. However, there are a few key points to keep in mind.
If the U.S. government were a corporation, we would try and find traditional ways to value it, correct? A perfectly reasonable first step would be to analyze its assets and liabilities. Corporation (U.S GOV) has 3.3T dollars in revenue and 27T in debt. The U.S government services this debt by selling treasuries and collecting taxes. When you do the math, it would seem treasuries are selling at 9x revenue. We must also remember the Government's other liabilities, namely pension and entitlements. The estimates for pension + entitlement are around 110-200T, divided by an income of 3.3T, and treasuries are now trading anywhere between 33x - 60x revenue. If the U.S Government was a corporation, would you purchase it’s bonds? It seems to me this corporation could go bust at any moment, and therefore I wouldn’t touch its debt with a ten foot pole. This is partially why foreign nations have stopped buying U.S Treasuries.
*Note: As I write, the Government is voting on passing another 1.9T dollar stimulus package and TIPS are hitting highs last seen in 2014. Investors are hedging the depreciation of the dollar.
We will return to the debt problem because it profoundly impacts inflation and what actions the Fed takes to control this phenomenon. For now, let's shift gears to inflation.
There are three things that contribute to inflation according to to Russell Napier, the quantity of money, where that money currently sits, and who is creating that money. The Fed is creating money, and right now, it sits mostly on the balance sheets of large banks as reserves, although it is quickly making its way to main-street.
Chart Source: Lyn Alden
The third factor, the creation of money, is actually the most interesting part, let me explain. We would like to believe the Fed governs monetary policy, but that could be only a matter of perspective. If the Government mandates banks to make loans by guaranteeing the principle, they have effectively created money out of thin air. In this way, most of the world's money supply is created by commercial banks. What's important and scary about this style of monetary policy is that the Government can steer credit exactly where they want it to flow.
The total amount of dollars in existence is 25% up YoY, Yen is up 9% YoY, and the Pound is up 10% YoY, but where is all this money going? It seems a massive amount is going to buy up treasuries that foreign nations are no longer buying. This needs to happen, because its how we service our 27T dollar debt.
Capital is also seeping into markets; the S&P has hit an all-time high since the March 2020 crash, Bitcoin has had a meteoric rise, and real estate prices are exploding. This could have something to do with service industry being unavailable due to lockdowns. However, I think an undercurrent of fear coupled with low interest rates are inspiring a risk on scenario.
We have seen this type of mania happen before. When Government engages in aggressive monetary policy to pump money into the real economy while at the same time engaging in massive QE, assets rise. People understand on a fundamental level that their dollars are less scarce and therefore less valuable; more tangibly, they see daily necessities such as food price increase. When this happens, people need to store their dollars in an asset that holds value. This in the past has been Gold, or during the 1920s, industrial stocks.
"Speculation on the stock exchange has spread to all ranks of the population and shares rise like air balloons to limitless heights. My banker congratulates me on every new rise, but he does not dispel the secret uneasiness which my growing wealth arouses in me. It already amounts to millions."
“Gambling on the stock exchange had become the fashion — the only way to avoid losing all ones money and perhaps to add to it. Many new bankers were giving people advice, the flight from the krone governing all transactions. ‘Meanwhile,’ Frau Eisenmenger wrote, a large numbers of unemployed, their passions fermented by the Communists, are seething with discontent … a mob has attempted to set the Parliament building on fire.”
-When Money Dies: The Nightmare of Deficit Spending, Devaluation and Hyperinflation in Weimar Germany
by Adam Fergusson
So we print a bunch of money to service our debt, but this leads to inflation. If inflation runs too hot for too long, the dollar becomes worthless. How does the Fed control this? One option would be to raise the rates. This slows the flow of money and generally works well in restraining inflation. Currently this poses a problem. Raising the rates slows growth, and fewer dollars means a stronger dollar; a strong dollar forces countries with large amounts of dollar-denominated debt to capitulate, sell their treasuries, and sometimes default. These defaulting countries are the same countries financing our 27T dollar deficit we talked about above. So you see the conundrum, we cannot print more money, but neither can we raise interest rates. So what is the solution?
Financial Repression
I was listening to a podcast recently, and they started to speak about what happens when governments interfere with free markets. They called it financial repression. As I understand it, financial repression is yield curve control (YCC). For our purposes, yield curve control simply means manipulating interest rates out into the future. There are a few ways to achieve this, print money, quantitatively control the credit, rent control, high transaction taxes. Sounds familiar, right? Just think of everything the Biden administration is doing or has proposed to do. It checks all the boxes.
When you cap the yield curve, you are destroying one of the most crucial pricing mechanisms in the world, that of long term interest rates. At its core, we are destroying free markets, and that never ends well. It would seem we do not operate a market economy but rather a command economy. Or, as Russell puts it, capitalism with a bit of Chinese spice. This is a crucial point to remember, and I am about to explain why.
We are assumably engaging in the practice of YCC to keep inflation at its target and our debt under control. It has worked out well thus far, right? *pause for laughter*. If inflation continues to run wild despite our best efforts, and we can't raise rates for the reasons we discussed above, what do we do? Raising rates would be our only choice in a free market economy, but we have now established what we live in is more akin to a command economy, so there is another option.
Post WW2, France saw unprecedented inflation. In response, the Government did not raise rates but instead started to control bank credit growth, meaning they steered who credit was going too and how much they received, surprisingly it worked. France still saw inflation through the '50s and '60s, but it was relatively muted compared to what it could have been. Another notable government credit control moment in history occurred in 1980's Japan. The Government used banks to create an artificial real estate bubble. The bursting of that bubble would result in an unopposed regime and monetary change, fascinating story, if you are interested you should watch the documentary Princes of the Yen.
So by controlling the supply of bank credit, you can control inflation. Again, it doesn't work as well as raising rates, but it works to a certain extent. However, as mentioned above, there is a big problem with allowing governments to steer credit wherever they want. With that type of control, the Government can push credit to whichever industry or individual they deem appropriate. This inevitably leads to corruption and massive bubbles bursting. Volcker was not a fan of this type of money creation/inflation repression, but it seems to be back on the menu.
Digital Wallets
Currently, the way we control the yield curve is by printing money and buying bonds ourselves. However, if we keep having our central bank print money, we risk pushing inflation too far. So we will have to control the amount of credit and to whom it is assigned, but even that won't be enough. The amount of debt is simply too large at this point and we will need more funding.
This will come with the implementation of negative interest rates. We already see this all over the world. In fact, the ECB just told the BOE to prepare for the possibility of negative rates. You might be thinking, who would ever loan their money to the Government and receive -1%. Well, most people wouldn't, especially if inflation is running hot at 4%. Unfortunately, most people hold their money in "savings" institutions, banks regulated by the Federal Government. It would not be out of the realm of possibilities to pass legislation saying banks now have to invest in negative-yielding bonds, and with the flick of the pen it becomes reality. Your savings account is now effectively earning a negative yield every single year. This accomplishes their goal, it provides liquidity for our Government to service the mountain of debt they have created without tapping the central bank for more cash.
Before you write that off as a crazy, @wmiddelkoop just posted this photo on twitter. Negative Interest Rates #ABNbank for Dutch Savings Account.
Now let us take this a step further. What if, by that time, we live in a completely cashless society? What if they give us all an app called a "Fed Wallet," and in that wallet we are given "Fed dollars." How much easier would it be to implement a negative savings rate. Remember earlier when we talked about financial repression and how that that works: print money, quantitatively control credit, rent control, high transaction taxes. These things would be straightforward to implement if people could not pull their money out of the bank in cash and hide it. All the exits would be blocked, and they could move our money around in ones and zeros with a keystroke.
This is not a some SciFi fantasy. Its already in the works. Read article on Fed Wallet here. Second article here: Federal Reserve Digital Dollar.
This bill offers a definition for digital dollars as well as for a digital dollar wallet, and provides the provision for a pass-through digital dollar wallet with the mandate for all member banks to open and maintain digital dollar wallets for all persons, including those eligible to receive the stimulus.
Arbiter of Truth
The Government is expanding the money supply at an exponential rate. Their broken inflation metric (CPI) will tell you we are encroaching on 2% inflation, but when you look at the aggressive increase in commodity prices, inflation is more likely 4%. When do we start asking, is this acceptable? Is devaluing our currency, our savings, by 4% a year acceptable; is 2% even acceptable?
The U.S government is in a tight spot. They are backed into a corner and will be forced to take drastic actions. You simply cannot destroy debt. You have to deal with it someday. Along with the federal reserve, our Government will try to inflate the debt away and, if need be implement negative rates. The question becomes how far can they push the people before everyone starts looking for exits?
The only exit I see is Bitcoin (and gold to a lesser extent.) It's utterly independent of any nation or corporation, and most importantly, it is deflationary, meaning its new supply goes to zero over time. Bitcoin could be problematic for governments who choose to not work with it. If people wake up and realize their money is not only heavily taxed, but it is also sitting in a negative-yielding savings account, they will flee to the safety of Bitcoin. If Governments see a massive outflow of capital to the safety of Bitcoin (something they cannot stop,) it might force them to back off on the negative rates, or at least keep them within "reason." In this way, Bitcoin acts as an arbiter of truth, so to speak, it keeps the Government as honest as possible.
Finally, let us say that negative rates never show up, it is still essential to look at Bitcoin with a low time preference. The most basic question to ask oneself is, over the next 10-30 years will the dollar depreciate relative to Bitcoin? That is the only thing that matters, and all the evidence seems to be screaming a resounding yes.
_Variant
Twitter: @researchvariant
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