Hyperinflation is Coming- The Dollar Endgame: PART 1, “A New Rome”

I am getting increasingly worried about the amount of warning signals that are flashing red for hyperinflation- I believe the process has already begun, as I will lay out in this paper. The first stages of hyperinflation begin slowly, and as this is an exponential process, most people will not grasp the true extent of it until it is too late. I know I’m going to gloss over a lot of stuff going over this, sorry about this but I need to fit it all into four posts without giving everyone a 400 page treatise on macro-economics to read. Counter-DDs and opinions welcome. This is going to be a lot longer than a normal DD, but I promise the pay-off is worth it, knowing the history is key to understanding where we are today.

Series (PARTS 1-4) TL/DR: We are at the end of a MASSIVE debt supercycle. This 80-100 year pattern always ends in one of two scenarios- default/restructuring (deflation a la Great Depression) or inflation (in severe cases, hyperinflation (a la Weimar Republic). The United States has been abusing it’s privilege as the World Reserve Currency holder to enforce its political and economic hegemony onto the Third World, specifically by creating massive artificial demand for treasuries/US Dollars, allowing the US to borrow extraordinary amounts of money at extremely low rates for decades, creating a Sword of Damocles that hangs over the global financial system. The massive debt loads have been transferred worldwide, and sovereigns are starting to call our bluff. Systemic risk within the US financial system (from derivatives) has built up to the point that collapse is all but inevitable, and the Federal Reserve has demonstrated it will do whatever it takes to defend legacy finance (banks, broker/dealers, etc) and government solvency, even at the expense of everything else (The US Dollar).

I’ll break this down into four parts. ALL of this is interconnected, so please read these in order:

Part One: The Global Monetary System- “A New Rome” < (YOU ARE HERE)

Part Two: Derivatives, Systemic Risk, & Nitroglycerin- “The Ouroboros” <

Part Three: Banks, Debt Cycles & Avalanches- “The Money Machine” <

Part Four: Financial Gravity & the Fed’s Dilemma- “At World’s End” <

Preface:

Some terms you need to know:

Inflation: Commonly refers to increase in prices (per Keynesian thinking). However, Inflation in the truest sense is inflation (growth) of the money supply- higher prices are just the RESULT of monetary inflation. (Think, in normal terms, prices really only rise/fall, same with temperatures. (ie Housing prices rose today). The word Inflation refers to a growth in multiple directions (quantity and velocity). Deflation means a contraction of the money supply, which results in falling prices.

Dollarization (Weaponization of the Dollar): The process by which the US government, IMF, World Bank, and other elite organizations force countries to adopt dollar systems and therefore create indirect demand for dollars, supporting its value. (Think Petrodollars).

Central Banks: Generally these are banks that control/monitor the monetary policy of the country they reside in. They are usually owned by private financial institutions (large banks/bank holding firms). They utilize open market operations to stabilize and set market rates. They are called the “Lender of Last Resort” as they are supposed to LEND (not bailout/buy assets) to other banks in a crisis and help defend their currency’s value in international forex markets. CBs are beholden to the “dual mandate” of maintaining price stability (low inflation) and a strong job market (low unemployment)

Monetary Policy: The set of tools that central bankers have to adjust how money moves through the financial system. The main tool they use is quantitative tightening/easing, which basically means selling treasuries or buying treasuries, respectively. *A quick note- bond prices and interest rates move inversely to one another, so when Central banks buy bonds (easing), they lower interest rates; and when they sell bonds (tightening), they increase interest rates.

Fiscal Policy: The actions taken by the government (mainly spending and taxing) to influence macroeconomic conditions. Fiscal policy and monetary policy are supposed to be enacted independently, so as not to allow massive mismanagement of the money supply to lead to extreme conditions (aka high inflation/hyperinflation or deflation)

Part One: The Global Monetary System- A New Rome

Prologue:

“In their masterwork tapestry entitled “Allegory of the Prisoner’s Dilemma” (pictured in the title image of this post) the artists Diaz Hope and Roth visually depict a great tower of civilization that rests upon a bedrock of human cooperation and competition across history. The artists force us to confront the fact that after 10,000 years of human civilization we are now at a cross-roads. Today we have the highest living standards in human history that co-exists with an ability to destroy our planet ecologically and ourselves through nuclear war.

We are in the greatest period of stability with the largest probabilistic tail risk ever. The majority of Americans have lived their entire lives without ever experiencing a direct war and this is, by all accounts, rare in the history of humankind. Does this mean we are safe? Or does the risk exist in some other form, transmuted and changed by time and space, unseen by most political pundits who brazenly tout perpetual American dominance across our screens?”

(Artemis Capital Research Paper)

The Bretton Woods Agreement

Money, in and of itself, might have actual value; it can be a shell, a metal coin, or a piece of paper. Its value depends on the importance that people place on it—traditionally, money functions as a medium of exchange, a unit of measurement, and a storehouse for wealth (what is called the three factor definition of money). Money allows people to trade goods and services indirectly, it helps communicate the price of goods (prices written in dollar and cents correspond to a numerical amount in your possession, i.e. in your pocket, purse, or wallet), and it provides individuals with a way to store their wealth in the long-term.

Since the inception of world trade, merchants have attempted to use a single form of money for international settlement. In the 1500s-1700s, the Spanish silver peso (where we derive the $ sign) was the standard- by the 1800s and early 1900s, the British rose to prominence and the Pound (under a gold standard) became the de facto world reserve currency, helping to boost the UK’s military and economic dominance over much of the world. After World War 1, geopolitical power started to shift to the US, and this was cemented in 1944 at Bretton Woods, where the US was designated as the WRC (World Reserve Currency) holder.

In the early fall of 1939, the world had watched in horror as the German blitzkrieg raced through Poland, conquering the entire territory in 35 days. This was no easy task, as the Polish army numbered more than 1,500,000 men, and was thought by military tacticians to be a tough adversary, even for the industrious German war machine. As WWII continued to heat up and country after country fell to the German onslaught, European countries, fretting over possible invasions of their countries and annexation of their gold, started sending massive amounts of their Gold Reserves to the US. At one point, the Federal Reserve held over 50% of all above-ground reserves in the world.

In a global monetary system restrained by a Gold Standard, countries HAVE to have gold reserves in their vaults in order to issue paper currency. The Western European powers all exited the Gold standard via executive acts in the during the dark days of the Great Depression (in Germany’s case, immediately after WW1) and build up to World War II by their respective finance ministers, but the understanding was they would return back to the Gold standard, or at least some form of it, after the chaos had subsided. As WWII wound down, and it became clear that the Allies would win, the Western Powers understood that they would need to come to a new consensus on the creation of a new global monetary and economic system.

Britain, the previous world superpower, was marred by the war, and had seen most of her industrial cities in ruin from the Blitz. France was basically in tatters, with most infrastructure completely obliterated by German and American shelling during various points of the war. The leaders of the Western world looked ahead to a long road of rebuilding and recovery. The new threat of the USSR loomed heavy on the horizon, as the Iron Curtain was already taking shape within the territories re-conquered by the hordes of Red Army. Realizing that it was unsafe to send the gold back from the US, they understood that a post-war economic system would need a new World Reserve Currency. The US was the de-facto choice as it had massive reserves and huge lending capacity due to its untouched infrastructure and incredibly productive economy.

At Bretton Woods, the consortium of nations assented to an agreement whereby the Dollar would become the WRC and the participating nations would synchronize monetary policy to avoid competitive devaluation. In summary, they could still redeem dollars for Gold at a fixed rate of $35 an oz, a hard redemption peg which the U.S would defend. Thus they entered into a quasi- Gold standard, where citizens and private corporations could NOT redeem dollars for Gold (due to the Gold Reserve Act , c. 1934), but sovereign governments (Central banks) could still redeem dollars for gold. Since their currencies (like the Franc and Pound) were pegged to the Dollar, and the Dollar pegged to gold, all countries remained connected indirectly to a gold standard, stabilizing their currency conversion rate to each other and limiting local governments’ ability to print and spend recklessly.

For a few decades, this system worked well enough. US economic growth spurred European rebuilding, and world trade continued to increase. Cracks started to appear during the Guns and Butter era of the 1960’s, when Vietnam War spending and Johnson’s Great Society programs spurred a new era of fiscal profligacy. The US started borrowing massively, and dollars in the form of Treasuries started stacking up in foreign Central Banks’ reserve accounts.

Then-French President Charles De Gaulle did the calculus and realized in 1965 that the US had issued far too many dollars, even considering the massive gold reserves they had, to ever redeem all dollars for gold (remember naked shorting more shares than exist? -same idea here). He laid out this argument in his infamous Criterion Speech and began aggressively redeeming dollars for gold. The global “run on the dollar” had already begun, but the process accelerated after his seminal address, as every large sovereign turned in their dollars for bullion, and the US Treasury was forced to start massively exporting gold. Backing the sovereign government's actions were fiscal and monetary strategists getting more and more worried that the US would not have enough gold to redeem their dollars, and they would be left holding a bag of worthless paper dollars, backed by nothing but promises. The outward trickle of gold quickly became a deluge, and policymakers at all levels of Treasury and the State department started to worry.

Nearing a coming dollar solvency crisis, Richard Nixon announced on August 15th, 1971 that he was closing the gold window, effectively barring all countries from current and future gold redemptions. Money ceased to be based on the gold in the Treasury vaults, and instead was now completely unbacked, based solely on government decree, or fiat. Fixed wage and price controls were created, inflation skyrocketed, and unemployment spiked.

Nixon’s speech was not received as well internationally as it was in the United States. Many in the international community interpreted Nixon’s plan as a unilateral act. In response, the Group of Ten (G-10) industrialized democracies decided on new exchange rates that centered on a devalued dollar in what became known as the Smithsonian Agreement. That plan went into effect in Dec. 1971, but it proved unsuccessful. Beginning in Feb. 1973, speculative market pressure caused the USD to devalue and led to a series of exchange parities.

Amid still-heavy pressure on the dollar in March of that year, the G–10 implemented a strategy that called for six European members to tie their currencies together and jointly float them against the dollar. That decision essentially brought an end to the fixed exchange rate system established by Bretton Woods. This crisis came to be known as the “Nixon Shock” and the DXY (US dollar index) began to fall in global markets.

This crisis came out of the blue for most members of the administration. According to Keynesian economists, stagflation was literally impossible, as it was a violation of the Philips Curve principle, where Unemployment and Inflation were inversely correlated, thus inflation should theoretically be decreasing as the recession worsened and unemployment climbed through 1973-1975.

Phillips Curve Explained:

Low Unemployment>Lots of jobs/high demand for labor.
Thus, more workers are employed, and wages rise>putting more money in more people’s pockets.
These people go out and buy beanie babies, toasters, and bananas (what economist John Maynard Keynes called aggregate demand) and this higher demand leads to higher prices for goods and services. This shows up as inflation.
Consider the opposite- high unemployment>fewer jobs>less money for people
Less demand for goods and services> lower inflation

Keynesian economists treated this curve as a law of nature, rather than a general rule. We see exceptions to this rule everywhere- Argentina is a prime example, where they have persistently high unemployment AND high inflation. This phenomenon is called stagflation, and is evidence of inflationary pressures so strong that they overcome the deflationary force of high unemployment. These economists were utterly blindsided by the emergence of stagflation.

After the closing of the gold window in 1971, the crisis spread, inflation kept climbing, and other sovereigns began contemplating devaluing their currencies as their only peg, the US dollar, was now unmoored and looked to be heading to disaster. US exports started climbing (cheaper dollar, foreigners could now import stuff to their countries), straining export economies and sparking talks of a currency war. Knowing they had to do something to stop the bleeding, the Nixon administration, at the direction of Henry Kissinger, made a secret deal with OPEC, creating what is now called the Petrodollar system. This article summarizes it best:

Petrodollars had been around since the late 1940s, but only with a few suppliers. Petrodollars are U.S. dollars paid to an oil-exporting country for the sale of the commodity. Put simply, the petrodollar system is an exchange of oil for U.S. dollars between countries that buy oil and those that produce it. By forcing the majority of the oil producers in the world to price contracts in dollars, it created artificial demand for dollars, helping to support US dollar value on foreign exchange markets. The petrodollar system creates surpluses for oil producers, which lead to large U.S. dollar reserves for oil exporters, which need to be recycled, meaning they can be channeled into loans or direct investment back in the United States.

It still wasn’t enough. Inflation, like many things, had inertia, and the oil shocks caused by the Yom Kippur War and other geo-political events continued to strain the economy through the 1970’s.

Running out of road, monetary policymakers finally decided to employ the nuclear option. Paul Volcker, the new Federal Reserve Chairman selected in 1979, knew that it was imperative to break the back of inflation to preserve the global economic system. That year, inflation was spiking well above 10%, with no end in sight. He decided to do something about it.

By hiking interest rates aggressively, consumer credit lending slowed, mortgages became more expensive to finance, and corporate debt became more expensive to borrow. Foreign companies that had been dumping US dollar holdings as inflation had risen now had good reason to keep their funds vested in US accounts. When the Petrodollar system, which had started taking shape in ‘73 was completed in March 1979 under the US-Saudi Joint Commission, the dollar finally began to stabilize. The worst of the crisis was over.

Volcker had to keep interest rates elevated well above 8% for most of the decade, to shore up support for the dollar and assure foreign creditors that the Fed would do whatever it takes to defend the value of the dollar in the future. These absurdly high interest rates put a brake to US government borrowing, at least for a few years. Foreign creditors breathed a sigh of relief as they saw that the Fed would go to extreme lengths to preserve the value of the dollar and ensure that Treasury bonds paid back their principal + interest in real terms.

Over the next 40 years, the United States and most of the developed world saw a prolonged period of economic growth and global trade. Fiat money became the norm, and creditors accepted the new paradigm, with it’s new risk of inflation/devaluation (under the gold standard, current account deficits, and thus inflation risk, was self-stabilizing). The Global Monetary system now consisted of free-floating fiat currencies, liberated from the fetters of the gold system.

Dollar Hegemony

Let us say you are the President of a country like Liberia, a small West African nation, looking to enter global trade. You go talk to the International Monetary Fund, whose economists tell you in order to be a modern economy you need to have your own currency. Thus, you need a Central Bank to print your own currency (LD), which will be used as legal tender, enforced by your government. Your Central bank will act as a lender of last resort for all the commercial and investment banks in your country, and will be responsible for stabilizing monetary policy.

But, there’s an issue-the economists tell you that you CANNOT have your Central Bank store up your own currency as the majority of its foreign exchange reserves. Why? Well, if your currency comes under attack in the global Forex markets, you will have to defend it. If your currency trade value is too high, it’s easy to fight- you just print your own currency and buy Euros (EU) or Dollars (USD), flooding the market with your currency and taking other currencies out of the market- “devaluing your currency” . However, if the inverse is true, and your currency is losing value in the market, printing more to flood the market will only make it worse. You need a stable currency, like bullets in the chamber, to utilize to buy your currency at the market rate, to support its value and drive it back up. This form of currency defense is called “defending the peg” (Post-1971, the peg is floating, so it’s more of a range, but it's still referred to loosely as a peg).

This exact phenomenon played out during the Asian Financial Crisis of 1997, a classic case study in global monetary crises. Thailand had grown rapidly as world trade boomed in the 1980s and 90s, and its corporate and real estate sectors took on massive amounts of debt. A massive real estate and financial bubble formed (does this sound familiar)? Soon, the bubble started to pop:

Thailand’s hand was forced, and the Thai Central Bank decided to devalue its currency relative to the US dollar. This development, which followed months of speculative downward pressures on their currency that had substantially depleted Thailand’s official foreign exchange reserves, marked the beginning of a deep financial crisis across much of East Asia. In subsequent months, Thailand’s currency, equity, and property markets weakened further as its difficulties evolved into a twin balance-of-payments and banking crisis. Malaysia, the Philippines, and Indonesia also allowed their currencies to weaken substantially in the face of market pressures, with Indonesia gradually falling into a multifaceted financial and political crisis.

As the president of Liberia, you see what can happen when a country, especially a small third-world country, doesn't have enough dollar reserves to defend its own currency. Rippling currency devaluations, inflation, social and political unrest, widening economic inequality- the beginning of a death spiral of a country if you aren’t careful. So, you tell the IMF that you agree to their terms. They impress upon you that you need to get your bank to buy up some other stable currency to hold as reserves, to defend against this very scenario. As the US dollar is the World Reserve Currency, you’re going to hold it as the majority of your reserve position.

We’ve established the need for a small country to hold another currency on their balance sheet. If ONE small country does this, there is little impact on the US Dollar. However, under the current system, virtually EVERY country has a central bank, and they all use the Dollar as their main reserve currency. This creates MASSIVE buying pressure on Treasuries. Using Liberia as an example, the process works like this:

THIS is what French Finance Minister Valéry Giscard d’Estaing meant when during the 1960’s he had contemptuously called this benefit the US enjoyed le privilège exorbitant, or the “Exorbitant privilege”. He understood that the United States would never face a Balance of Payments (currency) crisis (*AS LONG AS THE USD IS THE WORLD RESERVE CURRENCY*) due to forced buying of Treasuries (from Central Banks) and Dollars (from Petrodollar system). The US could borrow cheaply, spend lavishly, and not pay for it immediately. Instead, the payment for this privilege would build up in the form of debt and dollars overseas, held by foreigners all around the world. One day, the Piper HAS to be paid- but as long as the music is playing, and the punchbowl is out, everyone gets to party, dance & drink to their hearts’ content, and the US can remain the belle of the ball.

Effectively, the US can print money, and get real goods. This means we can import consumer products for cheap, and the inflation we create gets exported to other countries. (ONE of the reasons why developing countries tend to have higher inflation). Another way to explain it:

As it is the WRC, other countries' Central Banks NEED to have US dollars on their balance sheet. Thus, the US has to run persistent current account deficits in order to send out more dollars to the global system, on net, than it receives back. A major byproduct is constant large and increasing trade deficits for the WRC holder (in a fiat money system).

This is what is known as Triffin’s dilemma: the WRC HAS to run constant trade deficits. There are no immediate negative impacts, but in the long run this process is unsustainable, as the WRC country becomes unproductive (ever wonder why US manufacturing left) because the system forces the WRC holder to be a net importer. As world trade grows, the current account deficit/trade deficit grows, and the benefits (more goods to the US) and drawbacks (more dollars build up overseas) increase over time. Eventually the imbalance becomes so great that something snaps, just like it did for the Pound post WWI, where policymakers chose the route of deflation in 1921, creating a Great depression for the UK long before the US ever experienced it.

This is why I laughed out loud when I heard Trump rail against our trade deficits in one of the 2016 presidential debates. He clearly did not understand how our system works, and that this issue was beneficial in the short term, but detrimental in the long term. Our trade deficits were symptoms of our system working exactly as intended. In fact, a large part of the reason why he was elected was the de-industrialization of the American heartland, where loss of economic vitality from manufacturing jobs was leading to rampant drug abuse, depression, and societal decay. I knew this process of deindustrialization would only get worse with time, and nothing he did (short of taking us off the WRC status) would change that. (Not political, other politicians say the same shit. They just don't understand the very system in which we operate).

Fast forward to today- After decades of this process playing out, Foreign Central Banks collectively hold huge amounts of Forex reserves, as you can see below where countries are sized depending on their reserves of foreign currency exchange assets:

The majority of these reserves are held in dollars, mainly in the form of Treasuries, T-bills, and other US government debt. Furthermore, the US Dollar continues to dominate global trade through the SWIFT network (Society for Worldwide Interbank Financial Telecommunication). SWIFT is a payments system used by multinational banks, institutions, and corporations to settle trade worldwide. USD is the preferred payment method within the system, thus forcing other countries to adopt the dollar in international trade. This is one of the results of the petrodollar system we described earlier. Petrodollars originally were exclusively used to refer to oil contracts priced in USD from Saudi Arabia, but over time the name grew to mean any oil contract, transacted by non-US countries, using the US Dollar as the denomination.

When Chile and South Africa trade copper, for example, they have to transact in dollars, because a SWIFT member bank in South Africa will not accept Chilean Pesos as payment, as there is a smaller, less liquid market for it and it doesn't want to take a trading loss when converting to a more usable currency. The contract itself is priced in USD, so if that merchant bank wants to sell it, they can quickly find a buyer. In fact, SWIFT itself published a report in 2014, and found that the USD accounts for almost 80% of all world trade! (see top left)

This process is called dollarization, whereby the dollar is used as the medium of exchange for a contract, in place of some other currency, even between non-US trading partners (Iran and China for example). Dollarization (capital D) of a country occurs when a government switches from managing their own currency to just using the US dollar for trade settlement and tax revenue- like Ecuador, El Salvador, and Panama have done. The US Dollar reserves from the petro-dollar system show up on the balance sheets of these overseas financial institutions; they are called Euro-Dollars, and these USD denominated deposits are not under the jurisdiction of the Treasury or Federal Reserve. If you want to read a brief history of the Euro-dollar market, check out this paper from the Federal Reserve bank of St. Louis here. In 2016, the total value of the Eurodollar Market was estimated to be around 13.83 Trillion.

Through this process, the United States was able to become the largest and most dominant military force in the history of man, able to fight simultaneous two-theater wars with overseas supply lines. The Treasury could borrow and spend, unimpeded by the normal constraints of market discipline that were hoisted on other countries. Despite not declaring war since 1941, the US has been in a state of near-continuous warfare.

At each turn, the US defended this system at all costs, even going so far as to directly invade and occupy the Middle East in the Gulf War in 1991 and the Iraq/Afghanistan War (2001-2021). As a result there are over 800 US military bases around the world, in locales ranging from Turkey to Japan. American institutions like the Senate, Presidency, and Courts were modeled after their Roman antecedents, to the point that the American symbol, the Eagle, is the spitting image of the Roman Aquila adorned on the Standard of the centurions.

Most scholars tout the story of Rome as a tale of triumphalism; of valiant centurions battling in the steppes of Asia, of brilliant generals laying traps for enemy armies, of scheming senators fighting battles of political intrigue, and of a sophisticated and well-functioning empire that harnessed engineering to create marvels such as the Colosseum and the Roman Aqueducts.

More sober historians, however, point out that the story of Rome is one that also echoes a warning through the annals of history. A complex society, with mighty political, legal, and financial institutions, supported by a massive military, fell not to a crushing enemy invasion, but to collapse and decay from within. An elite ruling class, detached from the realities of daily life of the citizens, oversaw an empire with growing income inequality, environmental degradation, political corruption, social deterioration, and economic despair, and did nothing to stop it.

The Roman Treasury, facing insurmountable debts from years of fruitless war, started “clipping coins” an early form of currency debasement that led to the Roman denarii losing 25% of it’s value every year. This eventually led to uprisings in Roman provinces and the Sacking of Rome- the coup de grace, the final nail in the coffin for what had become the decadent Western Roman empire.

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Smooth Brain Overview:

Petrodollars: Oil contracts priced in dollars means foreign companies need to have dollars to buy oil. This creates artificial demand for dollars as companies sell their local currency to buy USD.
Triffin Dillema: As the US is WRC, other countries' Central banks need USDs. US thus runs deficits to push more $ out to the world to satisfy demand. This means cheap goods in the short term, but debt/dollar buildup overseas long term. Because of this, no country can remain WRC holder forever.
Eurodollars: Due to the petrodollar system, USDs build up in overseas bank accounts. These dollars are used by SWIFT for most international payments, and are called Eurodollars (due to the fact that most US dollars after WW2 ended up in Europe). The size of this market is roughly $14T.
Foreign Exchange Reserves: Due to the Triffin Dilemma & structure of WRC system, dollars build up in reserve accounts of foreign central banks. Wanting to earn interest on this cash, CBs invest in treasuries, effectively lending to the US Govt at low interest rate. $4T of these treasuries are held by these CBs, and $2T of these treasuries are held by private institutions.

Conclusion:

If the US loses World Reserve Currency status, two things happen. 1) Foreign central banks start massively dumping their huge Treasury/Dollar debt positions and 2) SWIFT member banks who hold USDs for cross-border payments (EuroDollars) decide to dump them as the currency uses utility and they see the value of their assets decreasing by the day.

This is the one of the many Swords of Damocles hanging over the global financial system. The unraveling of these massive currency positions would truly be catastrophic. Interest rates could effectively jump to +30% or more overnight, creating an immediate solvency crisis for the US Government and most banks, corporations, and state governments who rely on low interest rate borrowing. DXY would be whipsawed violently upwards for a period of time before being forced downward by massive selling pressure from the Eurodollar market. Other currencies would be pulled higher and then lower in volatile moves matching the worst days of the early Nixon crisis. But, this is only part of the story. We will come back to this later.

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Epilogue:

We’ve gone over a brief history of the Bretton Woods system, and it’s transformation to a complete fiat money system starting in 1971. The US as a World Reserve Currency holder is allowed to borrow almost indefinitely without immediate consequence, but this creates massive amounts of US dollar debts overseas. The last time global creditors started to lose faith in the US dollar, we saw massive inflation, unemployment, and stagnation in the US, in a period of rapid demographic and economic growth in the rest of the world. If creditors become worried again, and signs are showing up that they are (more on this in PT4) the results could be catastrophic.

BUY, HODL, BUCKLE UP.

>>>>>>>TO BE CONTINUED >>>>>>> PART TWO

Nothing on this Post constitutes investment advice, performance data or any recommendation that any security, portfolio of securities, investment product, transaction or investment strategy is suitable for any specific person. From reading my Post I cannot assess anything about your personal circumstances, your finances, or your goals and objectives, all of which are unique to you, so any opinions or information contained on this Post are just that – an opinion or information. Please consult a financial professional if you seek advice.

*If you would like to learn more, check out my recommended reading list here

The Dollar Endgame PART 2 “The Ouroboros”

Preface:

Some Terms you need to know:

Derivatives: A derivative is a financial security with a value that is reliant upon or derived from, an underlying asset or group of assets—a benchmark. The derivative itself is a contract between two or more parties, and the derivative derives its price from fluctuations in the underlying asset. The most common underlying assets for derivatives are stocks, bonds, commodities, currencies, interest rates, and market indexes.

Normalized Curve Distribution (Bell Curve): The normal distribution is a continuous probability distribution that is symmetrical on both sides of the mean, so the right side of the center is a mirror image of the left side. The area under the normal distribution curve represents probability and the total area under the curve sums to one. (We’ll go over this more in-depth later).

Value-At-Risk (VaR Distribution): Value at risk (VaR) is a statistic that measures and quantifies the level of financial risk within a firm, portfolio or position over a specific time frame. This metric is most commonly used by investment and commercial banks to determine the extent and occurrence ratio of potential losses in their institutional portfolios. Risk managers use VaR to measure and control the level of risk exposure.

Rehypothecation: Rehypothecation is a practice whereby banks and brokers use, for their own purposes, assets that have been posted as collateral by their clients. Clients who permit rehypothecation of their collateral may be compensated either through a lower cost of borrowing or a rebate on fees.

Exchange-Traded (Listed) Derivative: An exchange-traded derivative is merely a derivative contract that derives its value from an underlying asset that is listed on a trading exchange and guaranteed against default through a clearinghouse. Due to their presence on a trading exchange, ETDs differ from over-the-counter derivatives in terms of their standardized nature, higher liquidity, and ability to be traded on the secondary market.

Over the Counter Derivative: An over the counter (OTC) derivative is a financial contract that does not trade on an asset exchange, and which can be tailored to each party's needs. Over the counter derivatives are instead private contracts that are negotiated between counterparties without going through an exchange or other type of formal intermediaries, although a broker may help arrange the trade.

Part Two: Derivatives, Systemic Risk, and Nitroglycerin- “The Ouroboros”

Prologue:

“The Ouroboros, a Greek word meaning “tail devourer”, is the ancient symbol of a snake consuming its own body in perfect symmetry. The imagery of the Ouroboros evokes the concept of the infinite nature of creation from destruction. The sign appears across cultures and is an important icon in the esoteric tradition of Alchemy. Egyptian mystics first derived the symbol from a real phenomenon in nature. In extreme heat a snake, unable to self-regulate its body temperature, will experience an out-of-control spike in its metabolism. In a state of mania, the snake is unable to differentiate its own tail from its prey, and will attack itself, self-cannibalizing until it perishes. In nature and markets, when randomness self-organizes itself into too perfect symmetry, order becomes the source of chaos, and chaos feeds on itself.”- (Artemis Capital Research Paper-)

Random Walks and Portfolio Insurance

In financial markets, traders have long looked for mathematical relationships between and within assets, to aid in speculation and price prediction. As data aggregation improved, and information became more widely distributed in the 1930s and 1940s, financial analysts quickly realized that the stock market as a whole, as well as individual securities, followed Bell Curve distributions, at least in most time periods. The performance of individual securities on a single day was essentially random, but their overall performance in a time period could be graphed, as seen below:

This flowed logically from the concept of random events that Brownian motion described. In the mid- 1800s, scientist Robert Brown saw that particles in a fluid subdomain bounced around randomly, with their individual movements being essentially unpredictable- these movements were completely random.

Drawing on Brownian motion, mathematicians had created Probability Theory, which could estimate the given probability (not certainty) of a set of outcomes. As an analogy, predicting the result of an individual coin toss accurately every time is essentially impossible, but if you do it 100 times, Probability Theory will tell you that you have a very high probability of 50 heads and 50 tails, or something close to it (45/55 or 53/47 for example). The likelihood of 95 heads and 5 tails, an extreme outlier, would be very close to 0. This is because there is a 50% probability of either heads or tails- and thus the distribution of 100 coin flips should roughly match this probability.

This theory of randomness of prices as it applied to finance came to be known as the Random Walk Theory- and predicted that prices were basically completely unpredictable.

Understanding this concept, traders in the 1960s observed that the probability was great that returns on a single equity security would hover between some set performance range, like -10% and +10%. Rarely did the return hit the extreme ends of the curve. It didn’t matter what the time period was, 1 day, 1 month, or 1 year, the traders always had trouble reliably predicting a single future movement (like predicting heads/tails on a single coin toss), but could reliably say what the probability of variance over time (outcome of 100 coin tosses) would be, and map this mathematical distribution on a bell curve.

These Bell Curve distributions, after being modified for applications in financial markets, came to be known as Value At Risk (VaR) models. Over the course of the 1960s and 1970s, these models came to be widely used in the asset management industry. Essentially what these VaR models could do was provide a statistical technique used to measure the amount of potential loss that could happen in an investment portfolio over a specified period of time. Value at Risk gives the probability of losing more than a given amount in a given portfolio.

You can see from the above that these models have “skinny tails”, that is to say, they predict the likelihood of extreme events (standard deviation of 3 or more) happening as very low, especially on the downside (see above). Outlier events were thus coined “tail risk”, occurrences that only show up on the far tails of the distribution. These models were built using the recorded historical prices of thousands of commodities, equities, and bonds. For earlier markets, they would even plug in estimates created by econometricians (i.e. Corn prices in 1430) to arrive at a large enough data set. With this data, asset managers could feel safe utilizing leverage and complex derivatives in risky investments, as these models told them that the likelihood of severe losses (-30% for example) in a single day was near-zero.

At the same time, Eugene Fama, an American economist freshly minted with a PhD from the University of Chicago, developed his Efficient Markets Hypothesis in early 1970. Drawing on the random walk theory, Fama posited that since stock movements were random, it was impossible to “beat the market”. Current market prices incorporated all available and future information, and thus buying undervalued stocks, or selling at inflated prices, was not feasible. Making consistent profits was impossible- if you made money, you just got “lucky” as the market randomly moved in your favor after you made the trade. The price, therefore, was always “right”.

This further emboldened investors and whetted their risk appetite. Armed with these two theories, they started making statistical algorithms that modeled the stock market, and loaded themselves up with more risk. Starting in the early 1980s, portfolio insurance started to gain traction within the industry. This “insurance” basically was an automated system that short-sold S&P 500 Index futures in case of a market decline.

This concept was invented by Hayne Leland and Mark Rubinstein, who started a business named Leland O’Brien Rubinstein Associates (LOR) in 1980, and was developed into a computer program commonly referred to by the same acronym. They were successful in marketing this product, and by the mid-1980s, hundreds of millions of dollars of Assets Under Management (AUM) from institutions ranging from investment banks to large mutual funds were protected by this new-fangled product.

LOR was a program that dynamically hedged, i.e. would observe market conditions, and understanding it’s own portfolio risk, would actively adjust in real time. Today, dynamic hedging is used by derivative dealers to hedge gamma or vega exposures. Because it involves adjusting a hedge as the underlier moves—often several times a day—it is “dynamic.” The founders of LOR touted it as a program that would actively work to protect a portfolio, a “fire and forget” approach that would allow portfolio managers and traders to focus on alpha-generation rather than worrying about potential losses.

Black Monday- October 19, 1987

Stock markets raced upward during the first half of 1987. By late August, the DJIA (Dow Jones) had gained 44 percent in a matter of seven months, stoking concerns of an asset bubble. In mid-October, a storm cloud of news reports undermined investor confidence and led to additional volatility in markets. The federal government disclosed a larger-than-expected trade deficit and the dollar fell in value. The markets began to unravel, foreshadowing the record losses that would develop a week later.

Beginning on October 14, a number of markets began incurring large daily losses. On October 16, the rolling sell-offs coincided with an event known as “triple witching,” which describes the circumstances when monthly expirations of options and futures contracts occurred on the same day. By the end of the trading day on October 16, which was a Friday, the DJIA had lost 4.6 percent. The weekend trading break offered only a brief reprieve; Treasury Secretary James Baker on Saturday, October 17, publicly threatened to de-value the US dollar in order to narrow the nation’s widening trade deficit. Then the unthinkable happened.

Even before US markets opened for trading on Monday morning, stock markets in and around Asia began plunging. Additional investors moved to liquidate positions, and the number of sell orders vastly outnumbered willing buyers near previous prices, creating a cascade in stock markets. In the most severe case, New Zealand’s stock market fell 60 percent, and would take years to recover. Traders reported racing each other to the pits to sell. Author Scott Patterson describes the scene:

(The Quants, by Scott Patterson, page 51)

Traders on the floor of the NYSE reported seeing ticker numbers spinning so fast that they were unreadable. Liquidity vanished completely from the market. Sell orders flooded in so fast the infrastructure to record them started malfunctioning. At one point, specialists (individual market makers, and at this time were people on the floor representing a firm) simply stopped picking up the phone, which was ringing with dozens of institutions begging them to sell. Dozens of stocks were frozen in time. Those that weren’t were hit with massive volume. At one point, Proctor and Gamble was trading for $0.03. It had ended trading the previous Friday at $6.09. Market makers were trading off the stock prices that were recorded an hour ago, since the infrastructure was so backed up.

In the United States, this collapse quickly came to be known as “Black Monday”, with the DJIA finishing down 508 points, or 22.6 percent. "There is so much psychological togetherness that seems to have worked both on the up side and on the down side,” Andrew Grove, Chief Executive of technology company Intel Corp., said in an interview. “It’s a little like a theater where someone yells 'Fire!’ (and everybody runs for the exit)”.

“It felt really scary,” said Thomas Thrall, a senior professional at the Federal Reserve Bank of Chicago, who was then a trader at the Chicago Mercantile Exchange. “People started to understand the interconnectedness of markets around the globe.” For the first time, investors could watch on live television as a financial crisis spread market to market – in much the same way viruses move through human populations and computer networks.

Black Monday represented a catastrophic rebuttal to the mathematicians and economists who created the Random Walk Theory and Value- At- Risk models. These probability theorists had stated that events like this were improbable- so improbable in fact that their models predicted Black Monday was IMPOSSIBLE. Thus, no one in the market had hedged or expected an event as extreme as this. In fact, some theoreticians started to doubt the validity of the previously iron-clad Efficient Market Hypothesis itself. Patterson continues:

(The Quants, page 53)

Black Monday also represented a fascinating case study in the devastating effects of derivatives on financial markets. The Index Arbitrageurs, buying the S&P 500 futures being sold by portfolio insurance, had raced to short sell the underlying stock to stay net neutral. This was because by owning the S&P 500 futures, they effectively owned a small piece of every stock in the index. To hedge, they had to quickly short the underlying, so that any large loss in the index futures they owned would be offset by a gain on a short position in the individual stocks. However, the S&P 500 index itself was calculated based on the prices of the underlying securities. Thus, after Portfolio insurance sold the arbs futures, the Index arbs short sold billions of dollars worth of stock, the S&P future market tanked, and LOR, seeing the massive volatility and downward pressure on the market, sold more and more futures, which caused the Arbs to short more and more stock. This was the unwelcome discovery of a vicious positive feedback loop, a “shadow risk” that existed beneath the surface of the market, unbeknownst to the investors who traded in it. The Ouroboros had been awakened. These feedback loops, once initiated, continued until the underlying factors have been diminished or until the agents in the system are self-destroyed.

Derivatives and the Alchemy of Risk

Derivatives are financial contracts that derive their value from an underlying security, and have existed for as long as markets have. A futures contract, for example, is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future. The buyer of a futures contract is taking on the obligation to buy and receive the underlying asset when the futures contract expires, and the seller of the futures contract is taking on the obligation to deliver the underlying asset at the expiration date. These contracts have been around for millenia, with the earliest recorded contract dated to 1750 BC in Mesopotamia, or modern-day Iraq.

Say you’re in a casino and you want to make money off a poker game, but you are barred from playing the actual game. So, you grab another patron (Dave) and tell him you’d like to make a bet on the outcome of the game. You really think your friend Allie will win the game, so you’re willing to pony up $100 to bet on her winning. (In this example, the bet you make is the “derivative”. The underlying security’s returns are the results of the poker game.) Seeing your derivative bet, two other people get interested. They don’t want to bet on the game, rather they want to gamble on the outcome of your bet. They create their own bet, weighing probabilities and putting in funds accordingly. This is a second-order derivative. In the modern financial system, since derivatives are basically unregulated due to the Commodities Futures Modernization Act, (especially OTC derivatives or second-order or higher) this process can continue ad infinitum.

When creating a portfolio, most investors worry about their loss exposure. Buying any single equity is risky, and it is reasonable to want to reduce downside risk. This is part of the reason why derivatives were created. Through hedging, traders were able to change their gross exposure into a net exposure. Net exposure underlines the difference (net amount) between a hedge fund’s long positions and its short stock or derivative positions. Once calculated, the net exposure of a fund is usually presented in a percentage, displaying the fund’s risk with regard to market fluctuations.

Let’s break it down- say you are bullish on IBM. You go out and buy $50M of long dated call options (commonly called LEAPS) on IBM. Since you’re afraid of losing money in case IBM misses it’s earnings call, loses revenue, or experiences some other negative event while your position is open, you go and buy $40M of put options with the same expiry date. Thus, your new Net exposure position is only $10M long.

Using this mechanism, traders were able to hedge positions and reduce their theoretical risk. When you buy calls and puts, this net exposure is reduced, and at the same time, your assets increase. In the example above, your gross exposure (the gross value of the derivatives you own) will increase as you own both long calls and long puts.

(Don't get this confused with being long/short or bullish/bearish a stock!! Long position for derivatives simply means YOU OWN the contract, short position means YOU OWE the contract. “Long/Short” is a general term in finance that can mean different things depending on the context!)

Since both these calls and puts have value that you paid for, and represent the right to exercise at strike, they are both recorded as assets on your Balance Sheet. In the example above, you OWN $50M of calls and $40M of puts- your overall derivative gross exposure is $90M. Your net exposure is only $10M. Thus you have $90M of assets (subject to market changes of course) and “net risk” of $10M.

There’s three interrelated ways this goes seriously wrong. One is counterparty risk. A counterparty is someone who takes the opposite side of your trade- so if you are buying, they are the seller, and vice-versa. In derivatives, if the counterparty to your trade fails, i.e. goes bankrupt, the contract will most likely not be honored. This means if you are a hedge fund, and you wrote OTC options, your $90M of calls and puts, if they were written with a single counterparty (like Bear Stearns) will now be worth NOTHING.

This $90M “gross exposure” loss would represent an 800% HIGHER LOSS than the “theoretical” maximum loss of $10M which is your “Net Exposure”. If an options clearinghouse which is the counterparty to all listed options fails, MILLIONS of contracts would be worthless. The TRUE RISK is counterparty risk- this is what the models don’t understand.

Another way this goes wrong is if the underlying fails- the results are equally catastrophic. Going back to the poker game analogy, imagine if the people playing the actual poker game left the table. Now Derivative Bet #1 is worthless, since there’s nothing to bet on. Same goes with Derivative bet #2, and #3, and so on. If the Poker game had $25 in the pot, and each Derivative bet had $100 in each bet, this means that by the poker game ending, $325 worth of value was destroyed, from the elimination of just ONE REAL game worth $25. THIS is the explosive nature of derivatives.

Let’s use the 2008 financial crisis as an example of underlying failure. (W Homeowner goes out and gets a loan (original poker game). The bank then sells that loan to an investment bank who makes a CDO out of it (a bet on the game) which trades on the value of the underlying. Then, another bank comes along and makes a synthetic CDO (a bet on the bet), and then takes out a Credit Default Swap on it (bet on a bet on a bet). This creates insane leverage to the underlying, and horribly dangerous results if the underlying collapses. Dr. Trimbath puts it like this: (Naked, Short and Greedy pg 221 (Ch 19))

A third way this system can blow up is due to cross-collateralization, where one asset is pledged to multiple entities, creating more claims than assets that exist. This process is actually very common in the futures markets- bullion banks, for example, which hold gold and silver, will write between 2-10 futures contracts for every one oz of gold in the vaults.

In the example above, the bullion bank (with the gold) writes 6 futures contracts (assume 1 oz per contract) and sells them to other financial institutions, but only has a single ounce of gold in the vault. They can do this since the vast majority of the futures (~85-90%) never get called in for settlement, and are instead rolled forward (this basically means when the old contract is about to expire, the holder sells it for cash, and then uses this money to buy a new futures contract with a different expiration date).

Thus, the bank/institution writing all these futures never has to actually deliver the underlying- the gold in this case. If all the futures contracts they write are called in at once, then the 1 oz of gold is given to the buyer, and the bank who wrote the contract is on the hook to deliver all 5 oz to the firms that are owed, and is forced to go into the market to purchase it- this is called a “Contract Delivery Squeeze” as outlined in this paper. If the bullion bank fails, all the futures written by it are now null and void, and the firms that weren’t able to take delivery get nothing.

(Side note: Notional Value Explained: Notional value is a term often used to value the underlying asset in a derivatives trade. It can be the total value of a position, how much value a position controls, or an agreed-upon amount in a contract-

The best explanation I’ve seen of this was on a recent post by reddit user u/Criand-- ALL credit to him/her:

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The Market Value is the value of the derivative at its current trading price.

The Notional Value is the value of the derivative if it was at its strike price.

E.g. A CALL Option represents 100 shares of ABC stock with a strike of $50. Perhaps it is trading in the market at $1 per contract right now.

Market Value= 100 shares * $1 per contract = $100
Notional Value= 100 shares* $50 strike price= $5,000

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Nitroglycerin

Imagine you go to the office one day, and see your boss (Anna) sitting there with a bottle of nitroglycerin. You are immediately shocked, and ask Anna what she’s doing. “Are you INSANE?” you say. “That is extremely dangerous!”. She smiles at you and says “Nitroglycerin is stable if not exposed to pressure or heat. It’s safe on my desk, as long as I don’t knock it off, it won’t explode”. Incredulous, you walk away. The next day she brings in another bottle. And another the day after that. Over a year, she brings in hundreds of bottles of nitroglycerin. One day, a poor intern trips on her shoes and knocks one down. The first bottle explodes- Boom. In a few milliseconds, the next one does, and the next, in a vicious chain reaction- BOOM! BOOOM! BOOOOOM!. The entire building is destroyed. THIS is the danger of derivatives.

Systemic Risk

The recent Archegos Capital debacle was a classic example of the destructive power of derivatives. Using contracts like Total Return Swaps, Bill Hwang was able to leverage his fund more than 8x, making bets on the performance of a variety of Chinese and American equities. When the equities lost value, his fund was obliterated- a mere 12.5% drop in the underlying resulted in a complete loss of capital. But, his fund wasn’t the only firm affected- Credit Suisse was his counterparty, and thus lost more than $5.5 Billion, and counting. If derivatives are an explosive bottle, counterparty risk is a fuse- one that always runs to another bottle of Nitroglycerin.

The modern financial system is effectively a complex network of institutions, tied to each other through these complex derivative contracts. GSIBs (Globally Systemic Important Banks) are the largest entities in the system, tied directly to thousands of institutions, and indirectly to hundreds of thousands. Here’s a fascinating map from an IMF White Paper on the GSIBs’ interconnectedness:

The entire derivatives market is HUGE. The BIS estimated the total notional value of the OTC derivatives market to be $640 Trillion in 2019! And that doesn't even include exchange-listed derivatives like most common option contracts. More sober estimates put it somewhere north of $1 Quadrillion. Visual Capitalist has a great graph that demonstrates the monstrosity of this number. Numbers of this size are hard to wrap your head around- this is equivalent to a million billion, or a thousand trillion- for reference, the US economy is around $22 Trillion and the world economy is estimated to be $88 Trillion- thus the entire world economy could fit into the notional derivatives market 11x over and STILL not reach it. Every single bank is exposed, either directly or indirectly, to this market. For example, Deutsche Bank ALONE has over $47 Trillion in Notional gross exposure- TWICE the size of the entire US Economy!

Through the magic of financial engineering, Deutsche is able to create a net exposure of only $22 Billion, equivalent to 0.046% of the notional. Thus, although on paper its risk is extremely small, the actual risk to the firm is enough to wipe it out basically overnight. This is what happened to institutions like AIG in the 2008 crisis - they insured more products than they could ever cover, and when the firms they insured came calling they were quickly forced into bankruptcy, requiring a $182 Billion bailout from the Federal Reserve.

If the hedge funds with derivatives exposure (like Archegos) are the equivalent of an office rigged with nitroglycerin, the banks are stadiums full of 50 gallons drums of this shit- and the DTCC/ICC/OCC are the equivalent of a nuke. Counterparty risk, in the form of fuses, runs between all of them. What happens when enough factors on the system start to apply too much pressure? BOOM.

Why hasn’t anything happened?

This is the question most people ask themselves when they first learn about this. The reason is actually very simple. As long as money keeps flowing into the Casino, the gamblers feel little risk, so no one pulls out. The Fed continues to print money, equity/bond prices continue to rise, and since there’s “no risk” of the underlying falling in value, everyone keeps their money in the pot, and the poker game continues. The profits made from derivatives trading are enormous, and any bank that stopped doing this would quickly lose investors, because they would instantly take their capital out and take it to another bank that actually is profitable. It's all a confidence game- as long as everyone is confident, prices keep rising, and the cash keeps pumping in, the party will continue.

Warren Buffet famously turned down calls to buy Lehman Brothers during the darkest days of the Financial Crisis- he understood a key concept, that derivatives (especially when they make up the majority of your fund are equivalent to Financial Weapons of Mass Destruction, able to destroy entire firms, and indeed entire systems, in one fell swoop.

In the tumultuous month of October 2008, this system was beginning to unravel. The money draining out of the financial system due to bank runs and frozen credit lending started to light fires in multiple financial institutions. The bombs that were Bear Sterns, AIG and Lehman had already blown up, and the fire was spreading through counterparty risk throughout the system. In fact, we were getting dangerously close to hitting the switch on the nuclear warhead- As Timothy Geitner (Pres of New York Fed) put it, “We were a few days away from the ATMs not working”

And the worst part of all of this? Even to this day, Regulators, and indeed even financial industry insiders, are completely blind to the risk. OTC Derivatives are essentially unregulated- NO ONE knows the true size of this market. Worse yet, the traders inside the bank are using optimistic versions of the Efficient Market Hypothesis and VaR models to estimate their risk, which comes out to essentially 0 due to the risk models and net exposure hedging. Thus, they pile on more risk every day, ensuring that this problem continues to grow until the entire system explodes.

Smoothbrain Overview:

Analysts noticed statistical patterns in stocks. Small moves (1%) were much more common than large moves (20%). They created models called Value-at Risk, which predicted extreme losses were not just unlikely, they were virtually IMPOSSIBLE. Thus Fund managers feel more confident, and gamble on riskier and riskier investments. The Financial Services Industry STILL uses these VaR models today.
Eugene Fama creates the Efficient Market Hypothesis. Since prices are “random” they are unpredictable- and also always “right”. Thus there is no way to beat the market, the best thing one can do is leverage up and ride the market up.
Certain market dynamics like index arbitrage, counterparty risk, and shorting (both legit and naked) create positive feedback loops, processes that feed on themselves EXPONENTIALLY (‘The Ouroboros’) to the upside or downside. These processes can lead to extreme dislocations in price movement, like a short squeeze (GME) or a rapid equity market collapse (Black Monday).
Derivatives are created with the goal of reducing risk, and they do, to a certain extent, but they also amplify risk- and create potential losses multiples greater than what the fund managers expected.
Through hedging, traders believe they reduce net exposure and thus overall firm risk. After hedging, they feel safe buying exotic financial products and leveraging the firm even more. They essentially are BLIND to the true exposure of the firm.
The entire financial system is filled to the brim with derivatives- everyone is exposed. The total notional market is estimated to be somewhere around $1 Quadrillion, with some estimates putting it even higher. This represents what Buffet called “A Time Bomb” in the market- as long as money flows in, the party continues. Once it stops, the Weapons of Financial Destruction are unleashed.

Conclusion:

The modern international financial system, unhinged from the fetters of regulation and oversight, has created a derivatives monster whose tendrils reach across the globe. Fed by the incessant money printer and holding the retirement funds of generations, this machine continues to bet, in ever-increasing amounts, in the greatest casino ever created. This monster, as long as it is nourished by cheap credit and ever increasing flows of cash from the Federal Reserve, will continue to grow. This is why the Fed is in the endgame- they KNOW that they cannot turn off the liquidity hose, as they would risk destroying the system in its entirety. They have to convince themselves and the market with constant assurances that inflation will remain low, risk is non-existent, and their balance sheet can continue to grow without consequence. Secretly, they are starting to realize they are in a burning building with no way out.

BUY, HODL, BUCKLE UP.

>>>>>>>TO BE CONTINUED >>>>>>> PART THREE “THE MONEY MACHINE”

Hyperinflation is Coming- The Dollar Endgame: PART 3, “The Money Machine”

Preface:

Fractional Reserve Banking: Fractional reserve banking is a system in which only a fraction of bank deposits are backed by actual cash on hand and available for withdrawal. This is done to theoretically expand the economy by freeing capital for lending.

Debt/Credit Cycles: A credit cycle describes the phases of access to credit by borrowers. Credit cycles first go through periods in which funds are relatively easy to borrow; these periods are characterized by lower interest rates, lowered lending requirements, and an increase in the amount of available credit, which stimulates a general expansion of economic activity. These periods are followed by a contraction in the availability of funds.

Quantitative Easing (QE): Quantitative easing (QE) is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment. Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also expands the central bank's balance sheet.

Quantitative Tightening (QT): This is the inverse of QE- The central bank tightens policy by raising short-term interest rates. Boosting interest rates increases the cost of borrowing and effectively reduces its attractiveness. Tight monetary policy can be implemented via selling assets on the central bank's balance sheet to the market through open market operations (OMO).

Bank Reserves: Bank reserves are the cash minimums that financial institutions must have on hand in order to meet central bank requirements. This is real money that must be kept by the bank in a vault on-site or held in its account at the central bank. Cash reserves requirements are intended to ensure that every bank can meet any large and unexpected demand for withdrawals.

Prologue:

“The global financial markets walk on the razor’s edge between empiricism and what you see is not what you think. The Impossible Object in art is an illustration that highlights the limitations of human perception and is an appropriate construct for our modern capitalist dystopia. The fundamental characteristic of the impossible object is uncertainty of perception. Is it feasible for a real waterfall to flow into itself; or a triangle to twist itself in both directions? Modern financial markets are a game of impossible objects. In a world where global central banks manipulate the cost of risk, the mechanics of price discovery have disengaged from reality resulting in paradoxical expressions of value that should not exist according to efficient market theory. Fear and safety are now interchangeable in a speculative and high stakes game of perception. What you see is not what exists, and what exists cannot be understood” - (Artemis Capital)

Banking and Debt Cycles

The modern banking system can trace its origins to the early days of the Renaissance, in Northern Italy. There, in affluent trading cities such as Florence, Venice, and Genoa, traders dealing solely in finance would set up a bench (called banca in Italian- where the modern word bank comes from) financing voyages, engaging in arbitrage, and funding ship-building for merchants.

Banks of that period dealt almost exclusively in gold and silver coins, and traded these coins freely for foreign coins stamped by a different King. They quickly realized that dealing in physical coins was costly, burdensome, and dangerous, as thieves would often rob money-laden wagons between towns.

So, they came up with an innovative solution. Instead of handing over coins to their customers, they would ask that the customer place their gold or silver in the bank’s vault, which already stored the bank’s own money, and in return the bank would hand them a banknote, or a physical receipt of ownership of the gold. The customer could then take this note and pay for real goods or services someplace else instead of carrying the coins.

The banks quickly saw a loophole- no one was auditing their vaults, and comparing how much gold was there versus how many notes the bank had issued. The financiers immediately began to issue more notes than gold in the vault. This system would work fine as long as every customer had confidence in their banknote and believed that the gold backing their coins was actually there.

But, once the bank started facing financial troubles, and customers showed up to redeem their notes for gold, a bank run would immediately begin- with many clients ending up with worthless pieces of paper after the vaults were emptied. Authorities created extreme punishments for bankers caught issuing more notes than gold in the vault - in some places in Medieval Italy, death penalties were enforced for bankers caught issuing too many notes- in others, life in prison was the punishment.

Our modern financial system is based on the early Italian antecedents. Most people believe that when you deposit funds into the bank, the money stays in your account. In reality, the funds you invest are immediately lent out, re-deposited, and lent out again. This is called Fractional Reserve Banking. Thus, the “money” you see in your bank account is a lie. It isn’t really there.

Let's break down how this works. Say you earn $1000 from a recent paycheck. You go to your bank and deposit these funds. The next day, the bank takes $900 (90%) of the cash you deposited and loans it out, keeping 10% in reserve in case you come to withdraw some of it.

This money is given to Person #1, who takes this loan and buys some paint for his house. The vendor who sold him the paint then takes the $900 received and deposits it in the bank. The bank then repeats the process, loaning out 90% of the money, or $810 to Person #3, who spends/invests it with Person #4, who deposits it again, and the process repeats. Here it is visualized:

All along the way, the bank is able to take the same dollar bills and re-loan it out through multiple transactions (a la rehypothecation), and charge interest on the loans it creates. This is essentially a near- infinite money glitch in the system, and allows banks to make exorbitant profits, like JP Morgan making over $12B in Q4 2020 alone. However, this process also serves to GREATLY increase systemic risk- in the example above, one single $1000 transaction is turned into what APPEARS as $3,439 in bank accounts, but is actually just credit, re-deposited and re-borrowed over and over again.

Here’s another way to visualize it:

Typically, the majority of a banks’ capital provided to businesses will be business loans, lines of credit, or venture financing. These business loans will be put to work to expand factories, build new products, hire workers, or create intellectual property- generally things that expand economic growth.

This effectively means that the vast majority of what we “think” of as money, is not cash, but credit. Most funds in the system, thus, exist in the form of debt.

Another effect of Fractional Reserve banking is a supercharging of the debt cycle. Because banks are allowed to loan and re-loan cash that is deposited, banks are able to create massive amounts of credit, helping to boost economic growth in the boom stage, and worsen economic decline in a bust.

The Debt Cycle is a economic phenomenon that has been observed for centuries- in ancient Israel, for example, the state enforced a debt “jubilee” every fifty years (a long human lifespan) to dissolve all debts, release people from bondage, and restore ancestral lands to the descendants.

There are two main cycles- the long term “super” cycle, which lasts between 50-80 years (longer in countries with higher life expectancy, so most developed countries this is 80 years) and the short term “normal” cycle, which occurs every 8-10 years or so.

The credit cycle undergoes both expansionary and contractionary phases. Let’s take a look at the four phases of a typical credit cycle.

Expansion: Under strong economic conditions, corporate cash flows improve due to strong consumer confidence and the increase in financial institutions’ lending efforts. Easier access to capital markets fosters an ideal environment for business growth and increase in financial leverage for enterprises.

Downturn: The credit cycle downturn is typically due to an economic slowdown or potential recession, which leads to tighter credit standards. Since the credit downturn is often preceded by peak business expansion and high financial leverage, the slow business growth and low earnings experienced by businesses could lead to potential defaults.

Repair: The credit cycle downturn is followed by the repair phase, which simply indicates the emergence from the economic downturn. Here, companies start to focus on strengthening their balance sheets by cutting costs and reducing financial leverage.

Recovery: In the recovery phase, confidence levels start to improve as corporate balance sheets begin to look better with relatively low financial leverage. Financial institutions also tend to start loosening their lending standards.

Look at the US as an example. As you can see below, when we continue through the expansion phase of the credit cycle, companies borrow more debt to invest in new products or services. Once a recession hits, many of these businesses are forced to de-lever (pay back debts) and those which aren’t able to de-lever, go into bankruptcy. (notice we are LONG overdue for a recession and bankruptcy spike)

The Great Depression

The last debt supercycle began cresting in the 1930s. The US appeared to be poised for economic recovery following the stock market crash of 1929, until a series of bank panics in the fall of 1930 turned the recovery into the beginning of the Great Depression.

When the crisis began, over 8,000 commercial banks belonged to the Federal Reserve System, but nearly 16,000 did not. Those nonmember banks operated in an environment similar to that which existed before the Federal Reserve was established in 1914. That environment harbored the causes of banking crises.

One cause was the practice of counting checks in the process of collection as part of banks’ cash reserves. These ‘floating’ checks were counted in the reserves of two banks, the one in which the check was deposited and the one on which the check was drawn. In reality, however, the cash resided in only one bank.

Bankers at the time referred to the reserves composed of float as fictitious reserves (again, rehypothecation anyone?). The quantity of fictitious reserves rose throughout the 1920s and peaked just before the financial crisis in 1930. This meant that the banking system as a whole had fewer cash (or real) reserves available in emergencies.

Another issue was the inability to mobilize bank reserves in times of crisis. Nonmember banks kept a portion of their reserves as cash in their vaults and the bulk of their reserves as deposits in “correspondent banks” in designated cities. Many, but not all, of the ultimate correspondents belonged to the Federal Reserve System.

This reserve pyramid limited country banks’ access to reserves during times of crisis. When a bank needed cash, because its customers were panicking and withdrawing funds en masse, the bank had to turn to its correspondent, which might be faced with requests from many banks simultaneously or might be beset by depositor runs itself.

On November 7, 1930, one of Caldwell’s (a large financial conglomerate that lost millions in stock market speculation) principal subsidiaries, the Bank of Tennessee closed its doors. On November 12 and 17, Caldwell affiliates in Knoxville, Tennessee, and Louisville, Kentucky, also failed.

The failures of these institutions triggered a correspondent bank cascade that forced scores of commercial banks to suspend operations. In communities where these banks closed, depositors panicked and withdrew funds en masse from other banks. Panic spread from town to town. Within a few weeks, hundreds of banks suspended operations. About one-third of these organizations reopened within a few months, but the majority were liquidated (Source). Businesses that relied on loan financing started to collapse, and unemployment started to climb.

What followed was a protracted period of bank runs and panics lasting for years. Contrary to common belief, not all bank runs happened at the same time- some banks experienced one or two runs- others more than that. The Great Depression was a series of panics, rather, that culminated in a near-complete collapse of the banking system and a ban on gold as legal tender by FDR in Executive Order 6102.

In the wake of the crisis, several key financial reforms were made. Among them were the creation of FDIC (Federal Deposit Insurance Corporation) which was created in 1933 to “insure” bank deposits with government funds. This, it was hypothesized, would stop bank runs and restore confidence in the system. Another reform was the creation of the Glass- Steagall Act, a key legal provision that forced commercial and investment banks to remain separate entities.

However, both of these in time would serve to further increase risk, not reduce it. The FDIC, for example, insured $100k (later updated to $250K during 2008) of bank deposits. This was supposedly done for the benefit of the client, but many overlook that it also greatly benefited the bank. When you deposit cash into a bank, it is an asset to you- but to the bank, this is a liability- it represents a cash amount that they will have to pay out to you upon your request. By insuring the deposit, the bank gets essentially free insurance on their liabilities, which allows them to justify taking more leverage.

Glass- Steagall’s separation of banks was an amazing step at reforming the system- sadly, it was repealed in 1999 by Bill Clinton under the Gramm–Leach–Bliley Act (GLBA). Commercial banks are where you deposit funds, get mortgages, small business loans, and personal lines of credit- Investment banks are firms that underwrite financial transactions, create derivatives, and speculate in the market.

By combining the two, banks are essentially allowed to bet with depositors’ money- and if they fail, they can rightly justify to regulators that their collapse would end in financial calamity for millions of working-class depositors who would lose everything since their accounts would be suspended. Thus, they become “Too Big to Fail” and receive Federal Govt bailouts, no matter how reckless they have been.

The Money Illusion

In 2008, we were at the end of a major debt supercycle. The frenzied mortgage lending and securitization in the financial sector, along with massive consumer credit borrowing, had set the U.S. up for a major crisis. In relative terms, we were at a 27% HIGHER total debt to GDP ratio than the Great Depression.

These massive debt loads were coming home to roost, manifesting first as a crisis in subprime but then quickly moving to prime mortgages, corporate debt markets, money markets, and even the consumer credit markets.

But, this didn’t happen. Ben Bernanke, the Chairman of the Federal Reserve, was a self avowed student of the Great Depression- and was determined not to let it happen again. He, along with Treasury Secretary Hank Paulson (Former CEO of Goldman Sachs) and Tim Geitner, created new lending facilities and MBS purchase programs in order to swallow the massive amounts of toxic assets the system had created.

Paulson and Bernanke technically had no legal authority to create these programs, but in a crisis, all caution goes out the window. TARP and other programs authorized by the Treasury bought billions of dollars of MBS, funded by T-bond issuances. This chart shows US Govt Debt as a % of GDP through today: (notice the spike in debt during and after 2008)

The US borrowed heavily- TARP alone was authorized for $700 billion. The Treasury did not have the funds to support this so it issued billions of dollars of T-Bonds. Banks, hedge funds, other governments, and the Fed all bought these bonds en masse.

Remember, only the Treasury has the ability to SPEND, and only the Fed has the ability to LEND/PRINT. The Fed was created as a private institution to “protect” the government from reckless money-printing. The Primary Dealers (banks approved to trade directly with the Treasury) buy government bonds from the US Treasury, and turn around and sell these bonds to the Fed or other third parties. If you’re confused about how the system works, I recommend watching this video on how the financial system functions.

In the equity markets, as we started bottoming in the first quarter of 2009, hedge funds, banks, and family offices began loading up on margin debt again. This renewed confidence in the banking system and overall lending capacity began pushing equity markets back up.

Further stabilizing the markets was the Federal Reserve with their massive Quantitative Easing program. In 2008, the Federal Reserve’s Balance Sheet ballooned- assets grew from $880 Billion pre-crisis, to $2 Trillion immediately after, and eventually over $4T by 2014. Many economists, particularly those with a libertarian bent, such as Peter Schiff, immediately decried this reckless behavior and predicted hyper-inflation as early as 2011.

When the Fed buys assets, it is completely different from any other institution buying. Pension plans or mutual funds use the savings of the investors of the fund. Because that money came either from working, or from other investments, it represents NO net increase in money supply. The money they received HAD to come from someone else, for a good/product/service/asset they created or provided.

However, the Fed has no taxing authority, no savings, no funds to speak of at all- EVERYTHING the Fed buys it purchases through money it PRINTS. Thus, Fed Balance Sheet expansion=money printing. The Fed printed $2T in the two years following 2008.

This rampant money printing rightly worried experts and pundits in the media- but the inflation they feared never came. They were flat out WRONG. Why?

Most of the new money that was printed went directly into the banking system. Lyn Alden describes it brilliantly-

“Leading into the financial crisis, only about 13% of bank reserve assets consisted of cash (3%) and Treasury securities (10%). The rest of their assets were invested in loans and riskier securities. This was also at a time when household debt to GDP reached a record high, as consumers were caught up in the housing bubble.

That over-leveraged bank situation hit a climax into the 2008/2009 crisis, coinciding with record high debt-to-GDP among households, and was the apex of the long-term private (non-federal) debt cycle. When banks are that leveraged with very little cash reserves, even a 3% loss in assets results in insolvency. And that’s what happened; the banking system as a whole hit a peak total loan charge-off rate of over 3%, and it resulted in a widespread banking crisis” (Source).

Thus, the new money went to recapitalize banks and shore up their balance sheets to defend them from bankruptcy- it stayed in untouchable bank reserves, and never entered circulation.

The money that didn’t go to repair bank balance sheets flowed directly into the markets.

There are two different economies- the real economy, and the financial economy. The tidal wave of new money the Fed was creating did not cause inflation (in the traditional sense), because the money did not flow into the real economy- the goods, products and services that everyone consumes on a daily basis. The money instead flowed into the Financial economy- bond markets, stock markets, private equity funds, commodities, Forex markets, etc. (if you’re still confused, please read this article)

When you give a bank $100M, it doesn't go out and buy $100M worth of Big Macs and Kleenex- the bank puts these funds into investments, generally either in the form of loans or in the form of equities or equity derivatives. Thus, the funds that flowed into the banks are stored up almost exclusively in the financial system, or get pushed into loans to consumers.

“Wait a second!”- you say. “The Fed printed money to buy T-Bonds- The Treasury usually spends funds that go into the real economy-- so THAT should have caused inflation, right?”

Yes, this is typically what happens. But, during and after the 2008 financial crisis the majority of new Treasury expenditures went to programs that were stabilizing the financial system (TARP+ TAF+ TLGP+ Others). So, the money that would have been spent by govt agencies in the real economy instead just flowed back to banks and financial institutions.

Typically in a recession the Treasury will increase spending to cushion the blow to workers- and in 2009 they did extend a few unemployment benefits. But, by and large, Congress authorized few benefit programs for workers, and the average time on the benefit decreased after a slight bump in 2009.

Thus, the amount of freshly-printed money that reached the real economy was minimal, and whatever money did reach it largely acted to counteract deflationary forces- it wasn’t enough to actually induce inflation. The government did little to stop foreclosures, or provide aid to small businesses. Unemployment spiked, and due to the Phillips Curve Principle (covered in Pt 1), this put a dampening effect on inflation.

The funds the Federal Reserve had created, therefore, created no inflation in the real economy- instead they flowed to the financial economy and inflated financial assets. This started off the largest and longest bull market run in U.S. Stock market history- easily beating emerging and other developed countries’ equity markets.

Keynesian economists lauded this as an accomplishment- they believed they were creating what is called a “Wealth Effect” - a theory that stated that as people’s financial wealth increased, they would be induced to do more spending and investment- thus, by propping up the stock market, they would stimulate the real economy. This is awfully convenient for the rich- the top 10% own 85% of the equity markets, and thus have seen their wealth balloon by over 186% while growth for everyone else stagnated.

Ironically this theory has it exactly backwards- real economic growth should drive the stock market, not the other way around. But, convinced of their theories, economic policymakers continued to pump ever increasing sums into the financial system.

When you divide stock market performance by the Fed’s Balance sheet, you see that there has been basically NO real growth since 2008.

The entire “rally” we have experienced for the past 12 years has been nothing but an illusion- it is simply the result of vast money inflows into the financial system. Banks and financial institutions will do everything they can to convince you that the high stock market valuations are justified by fundamental growth.

This is wrong- these valuations are NOT justified. Insane levels of money printing and debt leverage have created extremely dislocated equity markets. For example, Square (SQ) has a forward PE ratio of 499.87- it currently doesn't pay a dividend, but let’s assume it paid a 3% dividend payout ratio (which is rare for tech stocks) - if that were the case, it would take 14,996 YEARS for the dividends to pay pack the price of ONE SHARE. (449.87/0.03).

To summarize, see this image from a post I made a month back- all the warning lights are blinking red. The markets are at the extreme end of the range by almost every valuation metric- and no one seems to care.

The markets are slowly being “walked up” every day. Today, the ultimate price insensitive buyer (the Fed) is now plowing $120B a month into Treasuries and MBS, and the Primary Dealers now have to turn around and put their money somewhere. The bond market is already a trap with 2% yields, and 5% inflation. There’s no more profit potential there, so these institutions are forced to buy equities if they want any returns. The Fed is killing whatever is left of price discovery.

Four billion dollars or so a day is being pumped into the system- and going straight to the stock markets.

Further, to stimulate growth in the real economy, policymakers dropped interest rates to near 0% in late 2008 to induce bank lending to get consumers to borrow and spend again. (70% of our economy is consumption due to the factors discussed in Part 1).

This did create massive loan demand- basically every sector of the US economy began borrowing en masse. The Fed was able to “reflate” the bubble and allow the economy to survive on debt financing to “re-invigorate the economy”. Fast-forward to today, and a decade of pinning rates to the zero-bound has us breaking records in terms of debt loads:

Student Loan Debt:

Corporate Debt:

Consumer Credit Card Debt:

Auto Loan Debt:

I could go on and on, but you get the point. Now, the entire system is overleveraged- the cancer has spread, and it has infected virtually every single sector of the economy.

People keep saying that we “kicked the can” of 2008 down the road. This is WRONG. We kicked the can UP THE STAIRS- meaning, we not only delayed the problem, but made sure it would get WORSE, since we borrowed MORE to paper over the old debts and worthless securities the system had created.

A fascinating aspect of our recent financial history is that the bailouts are exponentially growing- this is due to the simple fact that the entity giving the bailout has to have a balance sheet multiples larger than the firm receiving the bailout, and government guarantees of banks induce reckless speculation. For example, to bailout a bank with $10B in mark-to-market losses, you need a bank with a $20 or $30B capital surplus, to absorb the loss and keep the depositors and creditors satisfied that the bank giving the bailout won’t go under.

In 1998, a hedge fund called LTCM was near collapse- it had leveraged itself over 25-1, using complex algorithms made by Nobel Prize winning economists to predict bond prices. They had made massive derivative bets buying Russian bonds (among other things) - and when the Russian government defaulted in August 1998, their positions began to unravel.

The massive debt and derivative exposure they had created was threatening to pull several large banks down with it. The Fed stepped in during September to organize a $3.5 Billion bailout, funded by 12 large banks. According to James Rickards, General Counsel of the LTCM Bailout- the US equity and bond markets were “close to being completely shut down” during the worst of that crisis. (start at 16:30)

In 2008, the entire US financial system was nearing collapse and desperately needed a bailout. A massive bank run had begun. Congress stepped up and provided- in the end spending over $498 Billion of taxpayer funds. However, the Fed also provided a bailout (though QE), eventually buying over $1.7 Trillion of MBS.

Since the Great Financial Crisis, the banking system debt crisis has now become a government debt crisis, and indeed an economic debt crisis- and this debt has spread worldwide. Equity and bond markets have continued to march up, despite fundamentals. This new financial paradigm was rightly termed “The Everything Bubble”

Total (Govt+Private) Global Debt now stands at a staggering 356% of GDP. We’ve never been here before- we are now navigating uncharted waters. The next bailout will have to be bigger- a LOT bigger.

Avalanches

Imagine a snowfield on an alpine slope, above a small town. A few inches of snow falls. Everything is fine. More snow falls. Still nothing happens. A blizzard moves in. A day later, the snowfield reaches critical mass. Then, a disturbance happens- it could be a deer foraging for food, or a hapless skier exploring the backcountry. The snow starts sliding, pushing the snow below it. Positive feedback loops start to engage. The field begins to slide- now an avalanche has begun. The town is wiped out.

The financial crisis was the beginning of a debt avalanche- it’s likely that over 70% of the major banks, mortgage brokers, and other financial institutions would have gone bankrupt, superseding the Great Depression-era record of 30%. Thousands of private and public companies would have gone bankrupt. Real estate and equity markets would have entered a freefall lasting for years, and unemployment would likely have spiked past 30%, bringing back the soup lines not seen since 1936.

Instead, policymakers kicked the can up the stairs- they issued massive amounts of government debt to paper over the 2008 crisis, and incentivized excessive borrowing in the private sector. The fundamental factors that caused the crisis (unregulated derivatives, bank combinations, excessive leverage, lack of oversight) were never resolved. As u/Criand so elegantly puts it, 2008 never ended. Now, with US Government Debt standing at over $31 Trillion, there are only tough choices ahead. We will soon reach a point where the interest payments alone on the debt supersede all US Tax Revenues- when that happens, we will have traveled beyond the event horizon- there will be no coming back. The debt will be IMPOSSIBLE to pay off. (This is according to the government's own projections!)

The US Government continues to borrow- running a staggering $2.1 Trillion deficits for just the first half of 2021- day by day, we are adding snow to the mountains above our village. When will end is anyone’s guess, but borrowing more will only make the end worse.

Smoothbrain Overview:

Through the magic of Fractional Reserve banking, institutions can loan out much more debt than cash that actually exists. This increases systemic risk.
As a result, over 90% of all capital created is in the form of debt. This supercharges debt cycles and can cause massive bank failures.
When debt super-cycles crest, and begin the march downwards, massive deleveraging and defaults begin. If the banking system is weak, bank runs begin. (1930s)
We were hitting another end of the 80 yr debt cycle in 2008 (1929-2008 (79yrs)). We never de-leveraged the system. Instead, we re-leveraged EVERYTHING even MORE.
The Government and the Fed swept in and bailed out the banks. Now the Federal Government is deeply in debt to the tune of $28 Trillion.
The trillions printed by the Fed were almost exclusively routed to the financial system- creating a new bubble in every single asset class, larger and even more widespread than the 2008 bubble.
We never resolved 2008. We only kicked the can up the stairs. The Derivatives monster from Pt 2, along with a massive debt avalanche, will come back with a vengeance.
Almost every sector of the US economy, and indeed the world economy, is now greatly overleveraged. Global Total Debt to GDP broke past 350% during Covid.
Options are running out for policymakers. Debt borrowing and money-printing cannot continue forever.

Conclusion:

The debt crisis will return, but this time, it will be the financial system, US government, and indeed the ENTIRE world economy that needs a bailout- and who has a big enough balance sheet to absorb that? The only answer is the ones with an infinite balance sheet- the Central Banks.

The idea that anyone can borrow forever, or print money forever, with no consequences, defies basic financial logic. Impossible Objects cannot exist forever. History shows deadly consequences for the nations that venture down either path. The United States is no exception.

The Fed has already tried to escape this trap in 2018. It failed. Sovereign creditors are losing faith in the US Treasury, and have been since 2015. The walls are closing in, and the ultimate decision must be made.

The avalanche is coming either way- and we only have two choices. Either we allow ourselves to be buried under a mountain of hyper-deflation, creating a new Great Depression, frozen credit and equity markets, and massive bank failures- or, we burn our way out, using the inferno of money-printing and hyper-inflation.

BUY, HODL, BUCKLE UP.

>>>>>>>TO BE CONTINUED >>>>>>> PART FOUR “AT WORLD’S END”

*If you would like to learn more, check out my recommended reading list here. This is a dummy google account, so feel free to share with friends- none of my personal information is attached. You can also check out a Google docs version of my Endgame Series here. I have a folder with all the Dollar Engame DD here, and another GME DD folder (just collection of PDFs, not my work) here.

Extra Sources:

https://www.bloomberg.com/news/articles/2021-07-01/averting-inflation-crisis-turns-on-something-fed-doesn-t-control

https://www.project-syndicate.org/commentary/stagflation-debt-crisis-2020s-by-nouriel-roubini-2021-06

https://www.epsilontheory.com/im-so-tired-of-the-transitory-inflation-debate/#.YN3H-Dlt1Gc.twitter

Hyperinflation is Coming- The Dollar Endgame: PART 4, “At World’s End”

Preface:

Some Terms you need to know:

Hyperinflation: This is a term to describe rapid, excessive, and out-of-control general price increases in an economy. While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.

Money Velocity: The velocity of money is a measurement of the rate at which money is exchanged in an economy. It is the number of times that money moves from one entity to another. It also refers to how much a unit of currency is used in a given period of time. Simply put, it's the rate at which consumers and businesses in an economy collectively spend money.

The velocity of money is usually measured as a ratio of gross domestic product (GDP) to a country's M1 or M2 money supply.

Monetary Base: The monetary base (or M0) is the total amount of a currency that is either in general circulation in the hands of the public or in the form of commercial bank deposits held in the central bank's reserves. This measure of the money supply is not often cited since it excludes other forms of non-currency money that are prevalent in a modern economy.

Seigniorage: Seigniorage is the difference between the value of currency/money and the cost of producing it. It is essentially the “profit” earned by the government by printing currency. The greater the seigniorage, the more money the government is incentivized to print. Since this money hits government coffers before it circulates in the general economy, it represents “stolen wealth” that is used to fund expenditures. This “profit” has to come from somewhere, so thus it is drawn from the real wages and incomes of the working class people of a country, since their wages/incomes stay constant, but inflation caused by money printing increases the real costs of living.

Currency Pair: A currency pair is the quotation of two different currencies, with the value of one currency being quoted against the other. The first listed currency of a currency pair is called the base currency, and the second currency is called the quote currency. A pair such as EUR/USD which trades at 1.25, for example, means that 1 Euro can buy 1.25 Dollars.

Gresham’s Law: Gresham's law is a monetary principle stating that "bad money drives out good." At the core of Gresham’s law is the concept of good money (money which is undervalued or money that is more stable in value) versus bad money (money which is overvalued or loses value rapidly). The law holds that bad money replaces good money in circulation, since people prefer to dispose of a currency that is falling in value rather than one that retains it; thus in a currency system with two competing currencies, such as Zimbabwe during it’s hyperinflation, the populace prefers to use hyperinflated dollars over US dollars since the Zimbabwean dollars will lose most of their value in just a matter of weeks.

Part Four: Financial Gravity & the Fed’s Dilemma- At World’s End

Prologue:

“Imagine the world economy as an armada of ships passing through a narrow and dangerous strait leading to the sea of prosperity. Navigating the channel is treacherous- err too far to one side and your ship plunges off the waterfall of deflation; but too close to the other and it burns in the hellfire of inflation. The global fleet is tethered by chains of trade and investment so if one ship veers perilously off course it pulls the others with it.

Our only salvation is to hoist our economic sails and harness the winds of innovation and productivity. It is said that de-leveraging is a perilous journey and beneath these dark waters are many a sunken economy of lore. Print too little money and we cascade off the waterfall like the Great Depression of the 1930s... print too much and we burn like the Weimar Republic Germany in the 1920s... fail to harness the trade winds and we sink like Japan in the 1990s.

On cold nights when the moon is full you can watch these ghost ships making their journey back to hell... they appear to warn us that our resolution to avoid one fate may damn us to the other.”

Artemis Capital Research Paper

The Weimar Republic Hyperinflation

On June 28th, 1914, Austrian Archduke Franz Ferdinand and his wife Sophie were assassinated by a Bosnian Serb nationalist named Gavrilo Princep. The assassination set off a rapid chain of events, as Austria-Hungary immediately blamed the Serbian government for the attack, and a complex web of alliances and treaties dragged country after country into the carnage.

As large and powerful Russia supported Serbia, Austria asked for assurances that Germany would step in on its side against Russia and its allies, including France and possibly Great Britain. On July 28, Austria-Hungary declared war on Serbia, and the fragile peace between Europe’s great powers collapsed, beginning the devastating conflict now known as the First World War.

The first month of combat consisted of bold attacks and rapid troop movements on both fronts. In the west, Germany attacked first Belgium and then France. In the east, Russia attacked both Germany and Austria-Hungary. In the south, Austria-Hungary attacked Serbia. Following the Battle Of The Marne (September, 1914), the western front became entrenched in central France and remained that way for the rest of the war. The fronts in the east also gradually locked into place.

In terms of sheer numbers of lives lost or disrupted, the Great War was the most destructive war in history until it was overshadowed by its offspring, the Second World War. By the end, the combatants would estimate 10 million military deaths from all causes, plus 20 million more crippled or severely wounded. Estimates of civilian casualties were harder to make; they died from shells, bombs, disease, hunger, and accidents such as explosions in munitions factories; in some cases, they were executed as spies.

Although both sides launched renewed offensives in 1918 in an all-or-nothing effort to win the war, all efforts failed. The fighting between exhausted, demoralized troops continued to plod along until the Germans lost a number of individual battles and very gradually began to fall back. A deadly outbreak of Influenza, meanwhile, took heavy tolls on soldiers of both sides. Eventually, the governments of both Germany and Austria-Hungary began to lose control as both countries experienced multiple mutinies from within their military structures.

The war ended in the late fall of 1918, after the member countries of the Central Powers signed Armistice Agreements one by one. Germany was the last, signing its armistice on November 11, 1918. As a result of these agreements, Austria-Hungary was broken up into several smaller countries. Germany, under the Treaty Of Versailles, was severely punished with hefty economic reparations, territorial losses, and strict limits on its rights to develop militarily.

World War I was one of the great watersheds of 20th century geopolitical history. It led to the fall of four great imperial dynasties (Germany, Russia, Austria-Hungary, and Turkey), resulted in the Bolshevik Revolution in Russia, and, in its destabilization of European society, laid the groundwork for World War II and the Weimar Hyperinflation.

This destabilization was especially visible in Germany, as soon after the war ended, it was thrown into economic and social disorder. After a series of mutinies by German sailors and soldiers, Kaiser Wilhelm II lost the support of his military and the German people, and he was forced to abdicate on November 9, 1918.

The following day, a provisional government was announced made up of members of the Social Democratic Party (SDP) and the Independent Social Democratic Party of Germany (USDP), shifting power from the military. In December 1918, elections were held for a National Assembly tasked with creating a new parliamentary constitution. On February 6, 1919, the National Assembly met in the town of Weimar and formed the Weimar Coalition. They also elected SDP leader Friedrich Ebert as President of the new Weimar Republic.

As in the case of other wars, governments suspended the gold standard during World War I to increase the money supply and pay for the war. Therefore, as in the case of all post-war eras, many countries faced much higher inflation rates at the end of World War I than they had experienced beforehand.

(When Money Dies, pg. 9)

The German inflation of 1914–1923 had an inconspicuous beginning, a creeping rate of one to two percent. On the first day of the war, the German Reichsbank, like the other central banks of the belligerent powers, suspended redeemability of its notes in order to prevent a run on its gold reserves. (Similar to what Nixon would do for the US several decades later on Aug. 15th, 1971).

Furthermore, it offered assistance to the central government in financing the war effort. Since taxes are always unpopular, the German government preferred to borrow the needed amounts of money rather than raise its taxes substantially. To this end it was readily assisted by the Reichsbank, which discounted (read: purchased) most treasury obligations.

A growing percentage of government debt thus found its way into the vaults of the central bank and an equivalent amount of printing press money into people's cash holdings. In short, the central bank was monetizing (directly printing) the growing government debt, which was being spent into the real economy.

By the end of the war prices had risen some 140 percent, from their figures at the outbreak of war. The German mark had traded around a normal range of 20 marks to the Pound during the early stages of the war, and before that was as low as 5. It ended December 1918 at 43 marks to the Pound.

The U.S. returned to the gold standard in 1919, and other European countries and Japan reinstated the gold parity a couple years later. Considering the limited gold supply of the early 1920s, the European countries and Japan decided on a partial gold standard, where reserves consisted of partly gold and partly other countries’ currencies. This standard is known as the gold exchange standard.

Germany, however, was in a much more difficult position. Devastated by the conflict, she saw her manpower collapse, her raw productive industries destroyed, and her old political establishment upended. Most destructive of all, however, was the Treaty of Versailles.

In January 1919, two months after the fighting in World War I ceased, a conference was convened at Versailles, the former country estate of the French monarchy outside Paris, to work out the terms of a peace treaty to officially end the conflict. Though representatives of nearly 30 nations attended- the peace terms essentially were written by the leaders of the United Kingdom, France and the United States, who along with Italy, formed the “Big Four” that dominated the proceedings.

The defeated countries- Germany and her allies Austria-Hungary, the Ottoman Empire, (now Turkey) and Bulgaria, weren’t even invited to participate. In the end the Allies agreed that they would punish Germany in an attempt to weaken that nation so much that it wouldn’t pose a future threat. The counter-proposals submitted by the Central Powers on the 29th were all rejected. Germany refused to sign. On 17 June the Allies gave Germany five days to decide or have the war resume. Germany’s representatives had no real choice but to accept the terms, and thus assented to the “diktat”.

The terms were harsh, by any standard- The terms of the Treaty required the new German Government to surrender approximately 10 percent of its prewar territory in Europe and all of its overseas possessions. Germany was stripped of massive amounts of land, losing 68,000 km² of territory, including Alsace and Lorraine, which had been annexed in 1870, and 8 million inhabitants. Part of western Prussia was given to Poland, which gained access to the sea through the famous “Polish Corridor”. In addition, it lost most of its ore and agricultural production. Its colonies were confiscated, and its military strength was crippled.

Under the terms of Article 231 of the Treaty, the Germans accepted full responsibility for the war and the liability to pay reparations to the Allies, in an amount to be determined by a Reparations Commission. This last provision would prove to be the most catastrophic for Germany. The reparations figure was hotly contested by all parties- it began as a $5 billion payment in 1919, then $9 billion, and then as the war costs continued to be accounted for, ballooned to $33 billion in 1921 ((all figures in $ value of debt at that time, not adjusted for inflation)). The victors elected to hoist every cost, that of healthcare of wounded French soldiers, of lost Belgian horses, of pensions for British railway workers, and more- onto the shoulders of the German State.

Famous British economist John Maynard Keynes understood that a debt of this size was essentially unpayable, and further antagonized the German people against the Allies- “I believe that the campaign for securing out of Germany the general costs of the war was one of the most serious acts of political unwisdom for which our statesmen have ever been responsible,” he wrote in 1920.

Immediately after the war, the German government embarked upon heavy expenditures for health, education, and welfare. The demands on the Treasury were extremely heavy because of demobilization expenses; the debt of the Armistice, the repair of destroyed infrastructure, and the staggering deficits of the nationalized industries, all added up to massive fiscal deficits that only continued to increase.

(When Money Dies, pg 15)

The wartime inflation of roughly 20% per year had largely been hidden from the public. Under the cloak of military secrecy, the government had been able to conceal the inflation figures, close the stock exchanges, and ban the publication of foreign exchange rates. The frequent shortages and price hikes were chalked up to wartime rationing, and thus many citizens thought that as the war ended and political agreement was finalized in Versailles, the high inflation rates would start to normalize and prices would come down. What they did not understand was that the Treasury by this time was completely underwater in debt and war obligations- they had long since resolved to make up the massive deficits purely through the power of the printing press, electing to expand the money supply rather than default on payments.

(When Money Dies, pg 32)

The cost of living since the outbreak of the war had risen by nearly 12 times (compared with 3 times in the U.S., 4 times in Britain and 7 times in France). The food for a family of four which cost 60 marks a week in April 1919, cost 198 marks by September 1920, and 230 marks by November 1920. Certain items such as lard, ham, tea, and eggs rose to between thirty and forty times the pre-war price. (pg 30). Prices continued to rise across the board.

Throughout the period of the inflation the most popular explanation of the monetary depreciation laid the blame on an unfavorable balance of payments (also known as current account deficits, as covered, in-depth in Part 1) which in turn was blamed on the payment of reparations and other burdens imposed by the Treaty of Versailles. To most German writers and politicians, the government deficits and the paper inflation were not the causes but the consequences of the external depreciation of the mark. The wide popularity of this explanation, which charged the victorious Allies with full responsibility for the German disaster, bore ominous implications for the future- as it provided Hitler with scapegoats on which he could direct the German fury.

As the inflation continued to soar above 50% in late 1920, economists began to uncover a devastating feedback loop that drove consumer behavior. As consumer’s inflation expectations rose, they went out and bought more goods, refusing to leave their cash sitting in bank accounts where it was losing half its value every year. This influx of buying served to increase prices, which confirmed the consumers’ own suspicions of inflation, revealing a hidden feedback loop that was nearly impossible to halt.

The other problem that was quickly realized was the rapidly increasing money velocity. (The velocity of money is a measurement of the rate at which money is exchanged in an economy, measured in how many times the average bill is exchanged a year). Let’s walk through this- If an economy has a total money supply of $1000, but those bills only pass between hands once a year, they can only bid for goods and services ONCE during the year. If those same dollars pass hands (ie transact) 365 times during the year, they can bid those same goods up 365 times during the year, thus increasing overall prices. Low money velocity means that people are saving their money, rather than spending it, and thus asset prices and consumer prices remain low- there is less money available to bid them up.

Money velocity is a second order derivative on top of inflation- it also represents another positive feedback loop. Velocity typically increases in times of inflation and decreases in times of deflation, thus exacerbating moves in either direction (making inflation more severe or deflation more severe).

Data for this time period is extremely scarce, so it was difficult to find good sources that could reliably estimate velocity- one economics professor showed that money velocity started at 8 in 1920, but rapidly increased to 10 in 1921, then 100, then soared above 10,000 in the final stages of the collapse in 1923. A rate this high implies the average single paper mark was changing hands 27 times a day! (The way the Fed calculates money velocity today is EXTREMELY flawed, as we will cover in the coming sections).

Most Germans were oblivious of the ruin that lay in front of them. Frau Esenmenger, a widow in Austria who documented the hyperinflation in detail, went out and used her life savings to buy 20,000 kronen worth of government bonds at the end of the war. When she returned a year later, it already had lost 75% of its value. Several years later, it wouldn’t even buy a loaf of bread. She stormed into the banking hall, asking her banker about her investment from a year prior- she documented this in her diary:

In the large banking hall a great deal of business was being done… All around me animated discussions were in progress concerning the stamping of currency, the issue of new notes, the purchase of foreign money, and so on. I went to see the bank official who advised me. “Well, wasn’t I right?, he said. “If you had purchased Swiss francs a year ago when I suggested, you would not now have lost three fourths of your fortune”. “Lost!” I exclaimed in horror. “Why, you don’t think the currency will recover again?” “Recover!” he laughed. “Just test the promise made on this note and try to get 20 silver kronen in exchange”. “Yes, but mine are government securities”, I replied- “Surely there can’t be anything safer than that?” “My dear lady- where is the State which guaranteed these securities to you? It is dead.”

BUY, HODL, BUCKLE UP.

>>>>>>>TO BE CONTINUED >>>>>>> PART 4.1

I want to caveat the below by stating that I do not think a potential hyperinflation in the U.S. would look the same as Weimar Germany. We have had 100 years of technological and social advancement, and thus it would manifest very differently today. The 1920’s German hyperinflation is a worst-case scenario, but it is vital to understand the history to analyze the similar situation which our nation faces.

Hyperinflation Begins

As 1921 dragged on, the fiscal situation continued to worsen. The German Government faced an impossible situation: they could either choose to hike taxes to over double their current rates (which were already high due to tax hikes authorized during wartime), which would most certainly cause a political revolution in Germany and potential default; or they could continue to print their deficits, and hope that the Allies wouldn’t seize German assets or that the rising cost of living would cause food shortages and riots. They continued down the path of money printing, unaware that they were steering their country ever more rapidly into the abyss.

In March 1921, France occupied German ports, due to increasing frustration on the side of the Allies of the Germans’ inability to pay. The Rhine ports of Duisburg, Ruhrort, and Dusseldorf were seized, which further reduced the ability of exporting businesses to sell their products, driving their shares down on the exchanges. The next month, another devastating blow was dealt as the Commission finalized the determination of Germany’s War reparations. Adam Ferguson continues:

With the political situation becoming more volatile, large banks and wealthy Germans began to sell their marks on the foreign exchange. At the beginning of the negotiations, this had begun as a slight trickle, as most educated Germans believed that the Treasury officials would right the ship, balance the government budget, and be able to pull Germany out of the quagmire. But, as the situation deteriorated through 1920 and 1921, bankers, speculators, merchantmen, and wealthy industrialists all began dumping marks on the exchanges, further driving down the value of the mark and thus increasing the import prices of foreign goods for Germans. By July 1921, the German merchant banks began ordering foreign exchange traders to sell all holdings of paper marks- at any price that was bid.

Soon, the general public joined in. Anyone with any excess wealth held in marks took them to the exchanges to sell and convert to more stable currencies, further adding to the dumping of marks on the exchange and crushing its value in foreign exchange markets. Capital had begun fleeing the country en masse.

Meanwhile, inflation continued to soar. As the Treasury continued to spend, it found that the prices it was paying for goods and services (worker pay, food, oil, coal, steel, etc) kept rising, which in turn increased the amount of money the Treasury itself needed to spend just to keep the government running. This increased demand for new currency fell on the Reichsbank, who readily printed it into existence and handed it to the Treasury- thus representing ANOTHER devastating feedback loop that would lead to an exponentially increasing money supply.

(pg 46)

Furthermore, as seen above, the Tax system could not keep up. The bankers and the wealthy industrialists had already moved the bulk of their wealth overseas or into foreign currencies, and the middle class, squeezed by the ravages of inflation, had no patience for any increase in taxation. Like most industrialized nations, the government collected most taxes on a yearly basis, but with inflation growing past 100% by the winter of 1921, the annual taxes were basically a moot point. If the government charged an individual with a 100 mark tax liability, and he paid it a year later, it would only be worth approximately 16 marks or so- and the longer he deferred it, the less he would have to pay (in real terms).

Other sources of government revenue, such as railway fares, patent fees, coal taxes, and import duties, were fixed at low pre-war levels. The large and complex German bureaucracy made changing these fees extremely difficult, and even when they could adjust these fees, they could never raise them fast enough or often enough to keep up with inflation.

When the government needed taxes the most, the population began a mass program of tax evasion, due to both anger at the current incompetence of the Weimar government and the rapidly rising inflation. Thus, the government had no response but to continue to increase their request for printed notes from the Reichsbank, as all other sources of financing (taxation and borrowing) were slowly being cut off.

(Hyperinflationary Positive Feedback Loop)

European bankers soberly concluded that it was impossible for Germany to continue to pay her payments to the Entente, and sooner or later she would have to declare herself bankrupt. The state of the mark on the foreign exchanges continued to deteriorate. It had somewhat stabilized in mid-August at 310 to the pound, but had sped downwards to over 400 by mid-September, and was still going down. (pg 45).

By October 1921, the state of the budget was sombre. In terms of paper marks, the sum of the governments’ ordinary expenditure plus the reparation payments to the Allies was more than 191 Billion Marks. The revenue from the previous budget and new taxation proposals of July would only amount to 152 Billion Marks. (pg 49, paraphrased).

In November, a buying frenzy had begun. Seeing the steady decline of the mark, throngs of people rushed to stores to buy out their stocks. Cash accounts were emptied at the banks, and safety deposit boxes were stripped of all contents except gold and silver as prices began to skyrocket in terms of paper marks. Store shelves were stripped bare, and black markets of food and manufactured goods quickly developed. British Embassy Councillor Addison observed the scene:

(pg 57).

That same month, mass strikes began across the country. In Berlin for instance, Addison reported that he had to work in his office in semi-darkness due to a strike of municipal electrical workers. This strike was only broken by a promise of wage increases all around, involving an extra expenditure of $400 million marks, pushing the State budget even further underwater. He commented “the impossibility of the working classes to obtain even obvious necessities except at exorbitant prices, coupled with severe winter setting in, might lead to serious trouble.” (pg 58).

The mark, already in serious trouble, dropped to over 1,300 to the pound in late November. Food riots began taking place in Berlin.

With essential goods shortages becoming more and more frequent, people began lining up in queues hours before stores opened. Those who had the means hoarded dozens of pounds of food, saving much of it for their families and selling any extra on the black markets for exorbitant profits, as black market prices were often 30% higher than in-store.

To the anger of the beleaguered Germans, foreigners of all stripes began to pour in and purchase everything off the shelves. French citizens poured in by the thousands, as even the common working man could now afford items in the high-end boutique stores, due to the favorable exchange rates. Europeans from all around wined and dined in the most exclusive restaurants, buying out all the finest entrees and cakes. Workers could only helplessly watch from the windows as the citizens of the victorious nations now rushed in to engorge themselves on cheap German goods.

The first few months of 1922 offered no reprieve. Food prices continued to soar, and theft in stores became commonplace. By the end of March, the prices had soared another 50% compared to the previous December.

Gambling on the stock exchanges became rampant. As capital continued to lose value daily, the opening of the stock exchanges became a national pastime, with hundreds of thousands of Germans, from bellboys to cab drivers, dumping any extra funds into the exchanges in some hope of keeping up with the rapid inflation. The favorites were firms of heavy industry, of steel, coal, or iron, as well as agricultural production or clothing manufacturers- really anything that dealt in real goods. The clearing houses were days behind in settling trades as the volumes were soaring to levels never seen before.

By July 1922, Mr. Seeds, the Consul-General in Munich, wrote to say that his chauffeurs’ weekly expenditure on food alone was now more than 550% more than than a year ago. Rarer items, like butter and marmalade, could not be had for less than 8 times their price the previous year, and could only be found on the black markets, which were outlawed by the Congress.

The foreigners who had bought up entire stores full of goods now set their sights on German real estate. Prices for land were soaring in terms of marks, but even they could not keep up with the rapidly rising exchange rate- this meant that in terms of foreign currency, the price of homes was actually falling. Wealthy French, Italian, British, and Japanese businessmen began buying up swaths of real estate for literal pennies on the dollar.

The wealthy took advantage of the rapid collapse by taking out massive loans to buy assets, as the real value of the debt collapsed due to the rampant inflation. Hugo Stinnes, an industrialist and multi-millionaire, became infamous nationwide, as he built a manufacturing empire which held one-sixth of the country’s total industrial production.

He saw his debt payments for his factories inflated away as the Reichsbank’s printing presses continued to churn out marks in ever increasing quantities during 1922. He justified inflation as a means of guaranteeing full employment- It was, he maintained, the only way whereby “the life of the people could be sustained” (pg 74).

Lord D’Abernon, British Councillor to the Ambassador in Berlin, wrote in his entry for July 10, 1922:

“The whole sky is overcast and gloomy. The fall of the mark continues- today it is at 2,430, or about half the price of a month ago. Prices are rising, and will soon be double the level of June 1, wages and salaries must be adjusted. Adjusted to what?” (pg 81).

In the four weeks of July the index of wholesale prices had risen from 9,000 to 14,000, another monthly rise of over 50%. The Frankfurter Zeitung recorded that wholesale price of goods had gone up by 139 times since before the war; of leather and textiles by 219 times. An egg which had once cost 4 pfennigs now cost 7.20 marks, a 180-fold increase. A bank clerk’s annual salary, would therefore only keep his family alive for about a month.

(pg 85).

The excessive rise in the cost of living put more and more pressure on employers. Government officials were granted a 38% salary increase on August 1, and workers an additional 12 marks an hour- a further burden of 125 Billion marks on the State budget. There were no plans to meet this besides a 50% increase in railway fares and another increase in postal rates, which only provided a fraction of the needed revenue.

To say that the inflation was ravaging the middle classes was an understatement. The German Ministry of Education came out in early 1922 stating that they found the average school child two years behind in development, both physically and intellectually, due to the lack of available bread and milk, as well as the children being pulled out of school to work to provide for their families.

In wealthy neighborhoods, lower- class mothers were seen searching the garbage bins for discarded food, in hopes of finding their children something to eat. The fate of the elderly, was far worse however. Their fixed pensions and savings held in government bonds had been inflated away, so much so that some could not even afford a single apple. With no salary, they had no way of keeping up with the skyrocketing costs of living. Many began to starve and beg in the streets. (pg 87)

Meanwhile, the politicians continued to deny that the printing press was the cause of their woes. Dr. Rathenau, the Minister of Reconstruction, began to claim that a rise in the value of the mark should immediately worry the populace, as any strengthening of the mark against other currencies likely would cause increased bankruptcies across all major industries as debts become comparatively more expensive to pay. The Chancellor echoed this note:

(pg 89- milliards means billions)

It was no surprise that with real wages plummeting, bribery and corruption became rampant. Workers at the patent offices would demand large cash bribes, sometimes of 1,000 marks or more, to file patents, and government officials of all types began adding exorbitant fees which they personally collected instead of sending to the State coffers.

The only people living with any comfort were those living off the country- farmers, ranchers, and the like had the readiest access to real values, and their products, primarily food, continued to rise in price, increasing their profits. Any land debts they owed were evaporating before their eyes- a mortgage of 7 years’ standing had been 399/400ths paid off by inflation alone. The end of August 1922 marked another grisly milestone, as the mark plunged past 9,000 to the pound- more than 3 times its level just two months prior (108).

Those who owned land, houses, manufactured goods, precious metals, and raw materials were the only ones whose wealth remained intact. For all others, the mark’s plunge by this time had destroyed virtually all of their wealth.

On September 9 1922 the financial authorities announced that in the previous ten days 23 billion marks had been printed and distributed, representing 10% of the total circulation of paper in the country. The newspapers recorded, “The daily production of the Federal printing press has now risen to 2.6 Billion paper marks. In the course of this month it will be increased to 4 billion paper marks per day, at which figure it is hoped the shortage of money will definitely be overcome” (pg 111).

In October 1922, the situation continued to worsen. The mark seemed to enter a state of free fall, falling from 9,000 to 13,000 in a matter of weeks. September’s 26-mark litre of milk became October’s 50 mark litre. Butter at 50 marks a pound in April could only be had now for 480. The price of a single egg had also doubled, to 14 marks. At the end of October, the mark had slid again, to over 18,000 to the Pound.

The disparity between the rise of the cost of living and the rise in wages had now become very marked. Whereas the former had gone up by about 1,500 times, the wages of the miner- the best paid worker in Germany- had gone up by barely 200 times. With the mark in Mid-November at 27,000 to the pound, and prices following course, even the highest paid workers were unable to purchase the barest necessities of life. The others- especially those on fixed incomes, suffered accordingly (113-114).

(117).

Social and political unrest continued. Hatred of all foreigners, but especially Jews, became widespread, as the popular explanation was that the Allies and the Jews were collaborating together to manipulate the exchanges and drive the mark ever downwards. The newspapers, goaded on by government officials anxious to drive the public anger away from themselves, propagated and supported these theories.

In the third week of November, there were serious collisions between police and crowds of angry workers across Germany after they demanded a 100% wage increase and threatened to strike. In Dresden there was a fierce outbreak against the cost of living, with provision shops looted and damage estimated at 100 million marks. This was followed by a noisy display of xenophobia in front of the hotels which housed the foreigners- whose presence in the country was commonly supposed to be the cause of the rise in prices. Food riots followed in Braunschweig and in Berlin.

Mr. Seeds’ chauffeur still instinctively regarded the mark as being as good as gold, failing to realize how desperately sick it had become. His records in December reported that milk which had cost him 78 marks a litre in the first week of November cost him 202 marks a month later. Butter had risen from 800 to 2,000 marks a lb, sugar from 90 a lb to 220, eggs from 22 each to 30. Meat of any kind was practically unavailable, as sausage skyrocketed to 1,400 marks per lb.

1923- The Year of the Wheelbarrow

Even more monetary chaos was yet to come. The French, Belgian, and Italian members of the Reparation Commission, with Britain dissenting, decided on January 9th, 1923, that Germany had been in voluntary default on her coal and timber deliveries under the peace treaty. There was then no legal way from preventing Poincare (French Commissioner) from carrying out his threats of invasion. On January 11th, French and Belgium forces crossed the border and seized the Ruhr “for the purposes of securing deliveries”, beginning a formal occupation of the valley. The French Prime Minister warned that sanctions and “coercive measures” would be used if necessary.

(French soldiers entering Buer)

The Ruhr Valley represented the beating industrial heart of Germany, and accounted for the vast majority of her manufacturing power. The populace there, many of which were war veterans with undying patriotism for the fatherland, began a mass campaign of passive resistance, called “Ruhrkampf”. Hardly anyone worked; hardly anything ran. Coal mining was halted. The population there - 2 million workers, 6 million souls- had to be supported by the rest of the country.

The German economy was now called upon to subsidize an open-ended strike, and denied the most important domestic products and raw materials- coal, iron, and steel- and was also robbed of its substantial earnings from the Rhine-Ruhr exports. The Exchequer (Treasury) was itself deprived of all the normal tax revenue from a huge portion of the nations’ industry, as well as the coal tax and railway fares. All railway lines within and out of the Ruhr were shut down, as workers refused to operate them, and in some cases, blew the tracks up (122).

(127).

The significance of the loss of the Ruhr cannot be understated. With her industries no longer producing, and millions out of work, refugees from the Ruhr flooded into the rest of Germany. Goods shortages became even more severe as thousands of farms and factories in the Ruhr were left unattended. Fewer goods being produced meant that prices had to rise even more to account for the shortages.

Hemingway, visiting from France, recorded in March 1923 for the Toronto Daily Star that champagne cost 38,000 marks a bottle, and lunch 3,500 marks.

In March, April, and May of 1923 the government’s income was less than a third of its expenditure. The state of the budget continued to worsen. The Reichsbank, printing out trillions of marks a day, began to run out of ink.

The officials resolved, therefore, to only print the markings on one side of the bill to save ink. They then ordered periodicals and newspapers to cut down issuance so that their ink and paper could be appropriated for use by the printing presses. Between May 1st and may 31st the mark fell from 220,000 to 320,000 to the pound. The 1st of June was celebrated with the issuance of the first five-million mark note (pg 137).

Petty crime, the crime of desperation, was flourishing. Pilfering had of course been rife since the war, but now it began to occur on a larger, commercial scale. Metal plaques on national monuments were removed. The lead was beginning to disappear overnight from roofs. Petrol was siphoned from tanks of motor cars.

Barter was already a usual form of exchange, but now commodities such as brass and fuel were becoming the currency of ordinary purchase and payment. A cinema seat cost a lump of coal. Shirts were priced in potatoes. “The Middle Ages have come back,” a German remarked. (139).

There were stories of shoppers who found that thieves had stolen the baskets and suitcases in which they carried their money- leaving the money itself lying on the ground. Workers who had collected paychecks monthly just a few years before, now demanded daily payment- and they brought wheelbarrows with which to pick up their cash.

(pg 142- A Milliard here means a Billion)

Prices for everything exploded exponentially higher. The announcement of the exchange rates via the radio became commonplace in shops, as shopkeepers wanted to be updated every minute. Shoppers who walked in to buy cheese, for instance, found that the cost had risen from 6,000 marks to 8,000 marks per pound by the time they left the store. Tradesmen could not know how to establish prices, and often simply shut up shop. Cafes began requiring down payments on coffee as the price would double in an hour, and the owners wanted to be sure the customers could pay.

The sickening truth that was beginning to set in was that as prices rose, the demand for money itself rose. With nearly all food prices upwards of 10,000 marks per pound, the country needed billions of marks per day of new notes to satisfy these prices. They were stuck in a vicious cycle that seemed to drive them ever further into the depths of monetary destruction.

During the last days of June 1923, the mark sank from 600,000 to 800,000 to the pound, as the Reichsbank, desperate for foreign currency, was printing marks wholesale and selling them in order to purchase other currencies on the exchange. A month later, the mark would trade at 5,000,000 to the pound.

Companies began to pay workers in shoes, or leather, or anything else they could get their hands on. Many businesses began to refuse accepting marks altogether- unless they had ready means of getting rid of them immediately. The Reichsbank, running out of paper, requested all forms of paper be turned in for use by the presses.

Pay raises became daily occurrences. Those firms and cities that did not comply faced mass rioting and looting of their businesses. The demand for money continued to exponentially increase, with one company in Coblenz reporting that it needed $300 Billion marks in cash on Monday in order to stave off riots from the union workers.

The Reichsbank in early August promised to print locally a trillion marks per day- 2,500 times that which had been printed daily 8 months before. Again the government ordered price increases of 400% for railway fares, and 140,000% increases for income and corporation taxes. A few days later it was proposed to be 600,000% increase. Even if the taxes worked, it would not have reduced the budget imbalance by half (pg 165).

On August 17, Dr. Havenstein, President of the Reichsbank, stated with pride “Today we issue 20 Trillion marks of new money daily… In the next week, the bank will have increased this to 46 Trillion daily. The total money supply at present amounts to $63 Trillion- thus we will be able to issue, in a few days, 66% of the total prior circulation. Before he spoke the mark was trading at 12.5 million to the pound, within 48 hours it collapsed to 22 million to the pound.

The state of the people was desperate. Farmers, seeing the monetary chaos unleashed by the Reichsbank, withheld their produce and meat from the cities. Bakers hoarded their bread, as each passing day they waited to sell, the prices climbed even more.

This created the perverse scenario where farms were filled with food, and barns bursting with produce- but nothing at all to eat in the cities, where mass starvation began. Looting of grocery markets became commonplace, so they shut down. Tens of thousands began dying of starvation. A general state of famine was unfolding across Germany- as recorded by a British businessman:

(pg 199)

The Nazi party, unknown to most before 1922, exploded in popularity. On September 2, 1923, 100,000 demonstrators gathered for a rally at Nuremburg, where Hitler stood and launched a virulent attack upon the government, which was about to surrender Germany’s honour to France. Within a week, sometimes speaking 5 or 6 times a day, Hitler was calling for the installation of a national dictatorship.

The government, hungry for anything that still held value, ordered soldiers to raid cafes in Berlin, forcing customers at gunpoint to hand over all foreign currencies. The soldiers only collected a few thousand dollars worth of money, but the exercise demonstrated not only the futility of the policy, but the desperation of an advanced industrial nation which was unable to find bidders in a foreign market for their marks.

British Councillor to the Ambassador, Addison, recorded on September 9th, 1923 that the mark had collapsed from 300 million to the pound to 500 million just in the last 24 hours. In an act of desperation, everyone, Ministers and the Chancellor included, were hoarding all the food they could, and refused to pay taxes. The only impediment to the distribution of food was the lack of negotiable currency to pay for it.

By late September, the Reichsbank was printing 3.2 Quadrillion marks per week, an astounding amount which only purchased a measly 5.2 million Pounds. Calculating prices became near impossible, as the dizzying numbers were hard to contemplate.

(The cash needed to buy a single loaf of bread, Oct 1923)

The Government’s control of the political, let alone financial situation, was near the breaking point. On September 26th, Stresemann, the Minister of Foreign Affairs, suspended the Weimar Constitution, declared a State of Emergency, and gave executive powers to Herr Gessler, the Defense Minister. The transfer was a formality- Effectively, from then on, for five months, General von Seeckt, Commander in Chief of the Reichswehr (Weimar Army), was the supreme executive power in the land. There were whispers of a military coup in the streets.

On October 15, the marks’ rate against the pound passed 18 billion. Six days later, it was at 80 billion. At the end of the month, the total M1 money supply (bills in circulation) amounted to 2,496,822,909,038,000,000- or 2.49 Quintillion marks. The mark traded Oct 31st at 310 Billion to the pound.

As November started, a new man, Dr. Schacht was appointed as Commissioner of the Currency. The state of the National Budget was appalling. In the previous 10 days, Federal spending had exceeded revenue by 1,000 times. The financial statements of the State included on every page a reminder that all figures were in Quadrillions.

The cost of living index, taking 1914 as 1, had risen from September’s average of 15 million, to 3.6 billion in October, and reached 218 Billion on November 12, 1923.

Dr. Schacht ordered the immediate halt of the printing press on November 15. Havenstein, the President of the Reichsbank, was furious. Schacht recorded that all the unissued paper marks then in the hands of the Reichsbank, would have filled 300 ten-ton railway wagons.

The mark, already in freefall, had too much downward momentum, and thus continued it’s parabolic decline. 12 Trillion to the Pound on November 15- then 18 Trillion to the Pound just 5 days later.

Schacht announced the creation of a new currency- the Rentenmark, which was to be backed by land.

(pg 206)

By November 30, 500 million Rentenmarks went into circulation. This finally did the trick- as there was a fixed issuance of notes, and they had been backed by a scarce commodity like land, the people, exhausted from the chaos of the months before, readily switched to the Rentenmark. Prices stabilized, exchange rates normalized, and food started flowing back into the city markets. The new money was accepted, despite the fact that it was an inconvertible paper currency. It was held and not spent as rapidly.

The exchange rate from the paper mark to the old gold marks was 1,000,000,000,000 to 1- one Trillion old marks for each gold mark. The previous exchange rate before the war had been 4:1. The total old paper mark note circulation (M1 Money Supply) had ended November at 400 Quintillion.

By December, the food shortages had completely resolved, and the political situation stabilized somewhat. The Weimar Republic would exist for another decade, until 1933, when the Nazi Party, led by Hitler, took over the government and permanently suspended the constitution.

Smooth Brain Summary:

Germany entered WW1 due to a complex web of alliances that dragged it into conflict via Austria Hungary declaring war on Serbia in 1914.

Millions of men died, and enormous amounts of infrastructure were destroyed. The German state loaded itself up with debts to pay for the war, and spending continued to increase after the War, setting the nation up for a monetary disaster.

As no financing options were available, the State decided to allow the Reichsbank to print the State deficits, so that they could come up with the money needed to pay reparations payments and keep government services functioning.

Inflation began soaring in 1921, and devastating feedback loops came into effect. German banks began dumping marks on the exchange, and capital began fleeing the country. Social confidence in the mark deteriorated, and money velocity started to accelerate. Inflation reached into the thousands of percent.

Furious that they were being paid in ever more worthless paper marks, the French occupied the German Ruhr river valley in early 1923. This was the last straw, as the Ruhr was the industrial heartland. Goods became even more scarce, and prices raced upwards.

In mid-1923, the mark, already in a hyperinflation, began to go parabolic. Food shortages became common, and riots and political turmoil followed. Radical elements, like Hitler, grew in popularity.

Things were finally stabilized in late November 1923 with a monetary reset- a new currency was introduced, one that was backed by land, and monetary velocity + inflation finally began to fall, prices stabilized. The seeds were sown for the Nazis’ ascent to power a decade later.

Epilogue:

We’ve covered in depth the rapid collapse of the mark and Germany’s descent into the abyss of hyperinflation. The next sections will focus on the United States in the present day, and the dilemma the Fed faces- how to deal with the insurmountable debt levels now permeating the entire American economy and Federal Gov’t- and their ultimate dilemma; whether to destroy the Treasury (by raising rates) or destroy the Dollar (by printing it to oblivion).

As we continue through this series, I want you to reflect on the factors present in Weimar Germany in 1919 before the collapse, compared to the modern U.S. Of course Weimar is not a perfect analogue to the US, we are 100 years more advanced technologically, more socially progressive, and not under threat of military invasion. That being said, there are important similarities.

Factors:

Massive, unpayable government debt
Rapidly increasing Federal deficit spending
Tax evasion, especially by the wealthy
Recently lost a costly war
Exponentially growing money supply
Rising Inflation
Increasing political polarization
Social and moral decay of the upper classes; decline of institutions
Increasing wealth inequality; Mass amounts of homeless veterans
Increasing xenophobia
End of debt cycle + mass bankruptcies of companies
Political turmoil, riots against the establishment
Profiteering by wealthy industrialists to buy up huge swaths of real estate
Banks using backchannels to move capital out of the country
Massive loss of industrial manufacturing (In Germany, due to War/Occupation- in the US, due to China)
Shortages of goods
Evaporation of the Middle Classes
Rapidly rising home + asset prices
Gambling on the stock exchanges (WSB in general, except GME)
Rampant corruption and greed in government offices
Central banks buying massive amounts of government debt
Politicians’ continual denial of the worsening inflation

BUY, HODL, BUCKLE UP.

>>>>>>>TO BE CONTINUED >>>>>>> PART FOUR “AT WORLD’S END”

*If you would like to learn more, check out my recommended reading list here. This is a dummy google account, so feel free to share with friends- none of my personal information is attached. You can also check out a Google docs version of my Endgame Series here. If you want a PDF version, u/zedinstead made copies of Parts 1,2, and 3 in his Superstonk DD library here.

Hyperinflation is Coming- The Dollar Endgame: PART 4.2, “At World’s End”

PART 4.2 “Financial Gravity”

The Panic of 1907 and the Creature from Jekyll Island

As the industrial economy expanded following the Civil War, the weaknesses of the nation’s fractional reserve banking system became more serious. Bank panics or “runs” occurred regularly. Many banks did not keep enough cash on hand to meet customer needs during these periods of heavy demand, and were forced to shut down.

News of one bank running out of cash would often cause a panic at other banks, as worried customers rushed to withdraw money before their bank failed. If a large number of banks were unable to meet the sudden demand for cash, it would sometimes trigger a massive series of bank failures. In 1907, a particularly severe panic ended only when a private individual, the financier J.P. Morgan, used his personal wealth to arrange emergency loans for banks.

The Bank Panic of 1907 occurred during a six-week stretch, starting in October 1907. In the years leading up to the Panic, the U.S. Treasury, led by Secretary Leslie Shaw, engaged in large-scale purchases of government bonds and eliminated requirements that banks hold reserves against their government deposits. This fueled the expansion of the supply of money and credit throughout the country and an increase in stock market speculation, which would eventually precipitate the Panic of 1907.

The role of New York City trust companies played a critical factor in the Panic of 1907. Trust companies were state-chartered intermediaries that competed with other financial institutions. That said, trusts were not a main part of the settlement system and also had a low volume of check-clearing relative to banks.

Consequently, trusts at the time had a low cash-to-deposit ratio relative to national banks—the average trust would have a 5% cash-to-deposit ratio versus 25% for national banks. Since trust-company deposit accounts were demandable in cash, trusts were at risk for runs on deposits just like other financial institutions.

The specific trigger was the bankruptcy of two minor brokerage firms. A failed attempt by speculators Fritz Augustus Heinze and Charles W. Morse to buy up shares of a copper mining firm (using huge margin loans to buy the shares) resulted in a run on investment banks that were associated with them and had financed their speculative attempt to corner the copper market.

This loss of confidence triggered a run on the trust companies that continued to worsen even as banks stabilized. The most prominent trust company to fall was Knickerbocker Trust, which had previously dealt with Heinze. Knickerbocker, New York City's third-largest trust, was refused a loan by banking magnate J..P Morgan and was unable to withstand the run of redemptions and failed in late October.

This undermined the public's confidence in the financial industry in general and accelerated the ongoing bank runs. Initially, the panic was centered in New York City but it eventually spread to other economic centers across America. In many ways, this crisis forebodes the 2008 financial crisis which began with similar circumstances (overleveraged institutions, financial speculation, shadow banks) and had similar results (collapse of financial institutions, emergency programs to save the system).

In an attempt to head off the ensuing series of bank failures, Morgan, along with John D. Rockefeller and Treasury Secretary George Cortelyou, provided liquidity in the form of tens of millions of loans and bank deposits to several New York banks and trusts.

In the following days, JP Morgan would strongarm the New York Banks to provide loans to stock brokerages to maintain stock market liquidity and prevent the closure of the New York Stock Exchange. He later also organized the Tennessee Coal, Iron, and Railroad Company (TC&I) buyout by Morgan-owned U.S. Steel to bail out one of the largest brokerages, which had borrowed heavily using TC&I stock collateral.

A spike in the interest rate on overnight collateral loans, provided by the NYSE, was one of the first signals that trouble was brewing. Specifically, annualized rates spiked from 9.5% to a whopping 70% on the very same day that the Knickerbocker shut down. Two days later, it was at 100%.

The NYSE managed to stay open mainly because of J.P. Morgan, who obtained cash from established financial institutions and industrial behemoths. Morgan then provided it directly to brokers who were willing to take on loans.

After a hold-up of several days, the New York Clearing House Committee got together and developed a panel to promote the insurance of clearinghouse loan certificates. They provided a short-term boost in liquidity and also represented an early version of the window loans provided by the Federal Reserve.

The 1907 financial panic fueled a reform movement. Many Americans had become convinced that the nation needed a central bank to oversee the nation’s money supply and provide an “elastic” currency that could expand and contract in response to fluctuations in the economy’s demand for money and credit. Others did not agree and saw this as a back-door attempt to continually save corrupted banks.

It was clear that a shrewd financier like JP Morgan would not be around forever- bankers grew extremely worried about the next financial crisis. They began to lobby Congress to create a “permanent” solution to bank runs. After several years of negotiation and discussion, Congress established the Federal Reserve System on December 23rd, 1913.

Under a fractional reserve banking system, no bank has enough cash on hand to give out during redemptions. Money deposited in a bank account is very quickly lent out again, with only a fraction (say 10%) being kept on hand to handle withdrawals.

As a run on one bank would ensue, the web of financial obligations that tied the banks together would start pulling other banks down with it. Any loans owed by the bank in crisis would immediately start to be downgraded, and the creditor banks, even if healthy, would see the value of their assets fall as the market started pricing in the default of the collapsing bank.

What was seen in the crisis of 1907 was not only a credit collapse, but a collapse of confidence- the entire banking system was thrown into question, as depositors did not know which bank was solvent and which was not. Similar to the Prisoner's Dilemma, individual depositors, knowing even though leaving the money in the banks would make the system as a whole much safer, took the conservative route and pulled as much money out as they could.

What the banks needed at this time were cash loans- but at the very moment they most desperately needed it, the loans were not available as other banks faced runs as well. Thus, the Fed was created as a “Lender of Last Resort”- it could create bank reserves out of thin air and lend them to banks in order to ensure their solvency.

Many were infuriated by the creation of the Federal Reserve, which they viewed as a perpetual savior to Wall Street and a breeding ground for “Moral Hazard”, an economics term used to describe a situation that occurs when an entity has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs.

With time, their predictions would prove to be correct. With every financial crisis, the Fed’s power has grown, so much so that the institution would not be recognizable today to those who first founded it in the Winter of 1913.

The Fed’s role was inalterably changed during the 1930’s when the U.S. faced its worst banking crisis in history. Coming at the cusp of a major credit downturn combined with a speculative bubble (that it had helped create), the Great Depression saw the collapse of over 10,000 bank and non-bank entities, including shadow banks such as trusts. The Fed did not respond adequately to this crisis; many monetary economists, including Milton Friedman, blame the Fed for not lowering interest rates or lending to failing banks.

Remember from our discussion in Part 3, in our current fractional reserve banking system, most money in the system (~95%) is actually credit. So, when companies/banks/individuals default, the loans are written down, and money is actually destroyed- it is deleted from the ledgers of banks. This is the nasty dual sword of credit- it gives (creates money) in good times, leading to increased revenues, asset values increasing, business growth, employment, etc- BUT, every dollar lent out has to be repaid. These dollars need to be paid back as the economy starts to roll over, and when they aren’t, the money they constituted is eliminated from the system. M3 Money Supply fell an estimated 30% during the Great Depression. (The Fed mysteriously stopped tracking M3 Money Supply in the early days of the Great Financial Crisis).

Thus, the widespread collapse in prices that began in 1929 on Black Monday was not just due to overleveraged speculators on the stock market- if that were the case, it would have just been a equity bear market and perhaps a mild recession (like the 2000 Tech Bubble, where DotCom stocks fell 80%, but the general economy pulled back only slightly).

The continued spiraling drop in prices of everything, from homes, to bread, to oil- was a result of the actual destruction of money that was occurring in the banking system. As credit was destroyed, money was as well- and with fewer dollars chasing the same goods, the dollars became more valuable, and thus it required fewer of them to purchase real goods.

Add onto that the hoarding of cash, which reduced money velocity, and prices fell even further. Businesses that were overleveraged were the first to default, but as prices continued to fall and revenues collapsed, even good businesses with sturdy credit could not find willing lenders. No one was willing to lend for fear of default.

Thus, in 1933, the Federal Deposit Insurance Corporation (FDIC) was created, which insured all deposits of U.S. Commercial Banks up to a limit (now $250k, and now has expanded to include far more than bank deposits). Further, the Fed’s powers were expanded substantially. It had seen small trials of the Open Market Operations in 1907 and again in 1923, and in 1933 took this strategy under its wings, although it did not use it to its full effect as it would in 2008.

Open market operations (OMO) refers to the practice of buying and selling U.S. Treasury securities, along with other securities, on the open market in order to regulate the supply of money that is on reserve in U.S. banks. This supply is what's available to loan out to businesses and consumers. The Fed purchases Treasury securities to increase the supply of money and sells them to reduce the supply of money.

The Fed can thus influence the Price (interest rates) and Quantity (M2 Money Supply) of Money itself- and by doing so, indirectly affect the prices of everything else in an economy.

Again, this practice was originally limited to only U.S. Treasuries, but it would be expanded in future crises to include Mortgage Backed Securities (MBS, 2008), and Corporate Bond ETFs (2020).

During the latter part of the 1930’s, as part of their bid to widen the powers of the Fed, Federal Reserve Governors adopted the “mandate” of ensuring full employment (or as close to it as they can muster), in a bid to shift the overall strategy from solely bank lending to a more holistic monetary policy view. During the inflationary 1970’s, Congress added new stipulations to the Federal Reserve Act of 1913, so that now the Fed aims to follow their Dual Mandate of Price Stability and Full Employment.

In the aftermath of the Great Depression, many monetary scholars envisioned a re-imagined Federal Reserve. The Fed, they argued, should work to eliminate the business cycles all together. Economic cycles have existed for millennia- the Kondratieff Cycle, for example, is an 80 year economic supercycle borne out of technological innovation. Credit cycles have been observed for hundreds of years, and consistently caused spurs in economic growth followed by subsequent recession.

The business cycle is an upwards trending sine wave, where credit creation fuels economic expansion for a time, and then the economy begins to roll over, and all these debts become due, and thus a recession/depression occurs. The cycle has been seen in countries as different as Japan, Afghanistan, the U.S., China, and Brazil- and has even been observed in biblical times (debt Jubilees, Leviticus 25) as well as ancient Egypt, Rome, and Mesopotamia.

Financial Gravity and the Event Horizon

Economics is a social science- it is a blend of both humanities (sociology, psychology) and hard sciences (science, math, statistics). That being said, there are fundamental laws that govern economic systems wherever they prop up. In my personal life, my father has a PhD in Atmospheric Science- he was fascinated by how ice crystals and condensation are formed in clouds, and traveled the world (Chile, Antarctica, Canada) studying cloud physics. As a boy and basically an only child, he instilled a love of science in me- and I still view many things through that prism.

When I explain economic concepts to him, I like to use physics metaphors to get the point across, because this is the world he understands. To me, Debt is a form of financial mass.

One of the emergent properties of mass is gravity, as described by Newton’s equation. The mathematical formula for gravitational force is

The more mass an object has, the greater its gravitational pull, (multiplied by the gravitational constant, G). The distance between two objects in space is represented by r. The gravitational force gets weaker by the square of the distance between two masses.

Debt is very much the same. At first, when debt is added onto an economy, it stimulates growth, as it creates new credit for businesses to build factories, train workers, construct buildings, etc. But, as the debt continues to grow, so do the interest payments- at some point, the debt load is too heavy, and the mass of the economy causes it to fall into itself in a credit contraction- leading to defaults and deflation.

Let’s say you own a company making net income of $100M a year. With a debt load of $1B and an interest rate of 7%, you have to pay $70M a year in interest alone just to keep the creditors off your back. If for some reason the company’s income falls to $50M, or interest rates rise, say to 11%- then you can’t pay your debt. The math doesn't add up.

The reason why debt cycles exist is as fundamental as the laws of physics; when an entity can’t pay its debts, or even cover the interest on the debt- what happens? It defaults. This isn’t a machination of political pundits, or econ professors, or conspiracy theorists- it is simply a law of math.

When this happens across an entire sector, that's when you get deflation, credit contraction, and a downturn in the business cycle.

If an entity can’t pay back their loans, they default- who would want to lend money to an entity that can never pay them back, a la Evergrande? No one.

This is why I compare some economic laws (such as debt) to those of physics- both systems are ruled by math, the fundamental law of the universe. (NOT ALL Economic laws- MANY economic laws are more complex/nuanced or based on human behavior, which doesn't follow perfect logical rules like math does).

Finance at its heart is about numbers, math- and the math doesn't lie. When the numbers don’t add up, and you have more liabilities than you can ever pay back, you default (Lehman Brothers, Bear Stearns, AIG, etc).

“But wait!” You say. “Governments issue debt in their own currency, which they print. Thus they can never default! Problem solved!” Potato, potahto. If they print money to stave off the default, they only devalue their currency- thus, they don’t default in nominal terms (they DO pay back your $1,000 Treasury Bond) but in real terms (that $1,000 buys less stuff due to inflation).

Back to the business cycle- wherever the cycle peaks above the grey dotted line, this is called a positive output gap, and when it is below the line, it is a negative output gap. Post Great Depression, the Fed began to take responsibility for trying to control the business cycle, as they had just seen how destructive a credit bust could be.

Thus, the Fed decided to take on a role of “regulating” the cycle. It would do this by lowering interest rates and easing monetary conditions during a recession, spurring borrowing and lessening the rates of default, to make sure companies can continue to hire and train workers as needed.

During economic booms, they would tighten monetary policy, to prevent the economy from “overheating” by increasing interest rates, thereby tightening monetary conditions and preventing excessive speculation and overleveraging.

They also do this to get interest rates high enough so that they can drop them once again during a crisis, as interest rate policy is one of their most critical tools. (An overheating economy sees excessive credit growth, which often creates inflation- this is why inflation tends to peak before a recession. Just as many have pointed out in this sub, the last time inflation was above 5% was right before the Great Financial Crisis of ‘08)

Don’t believe me? Look at their own tracking of the Federal Funds Rate, the interest rate at which depository institutions trade federal funds (balances held at Federal Reserve Banks) with each other overnight. (the shaded areas indicate a recession)

After every recession begins, they drop interest rates down to mitigate the hit of the downturn. As the economy improves, they are able to raise them back up again. It's a near perfect lagging indicator of a recession.

How long do they keep interest rates down once they are in a recession? No one really knows. The Fed is perpetually caught in a catch-22; if they raise interest rates too soon during a recession, they worsen it or cause a depression.

But, if they keep interest rates low to spur an upturn in the credit cycle (bubble in this case), then they are sowing the seeds for the next crash, as the debt created on the way up must be paid back on the way back down.

When the economy is booming, if they raise interest rates too fast), then they cause debt payments to spike, which means defaults occur, and the economy starts to roll over.

There is no real escape from this conundrum. As you can see, the Fed has been fighting it for the better part of a century to no avail- it keeps reacting to crises in hindsight, never understanding that many times, it is also the one that caused it- Just like a firefighter coming to put out a fire he set an hour before.

Each bubble bursting must be met with the Fed creating a bigger bubble. 1990 sees a mild recession? Time to lower interest rates and (“accidentally”) spur the Tech Bubble. That bursts in 2000? Time to lower interest rates and start a housing bubble. That collapses? Start an Everything Bubble in 2009. Rinse and repeat. (Again, cycle every 8-10 years- March 2020 anyone?) (I’m oversimplifying, there are many other factors that contributed to these bubbles, but low interest rates just adds fuel to the fire).

This process continually creates more debt, more inflated assets, and more risk in the system. Look at the chart above- you’ll notice that the troughs (low interest) get larger and deeper, and the peaks get shorter- with each crisis, they are able to raise the rate to a lower level than before, and have to drop it to a deeper level than before, to get themselves out of it.

Pre 1990, the Fed Funds Rate was at 9.5%. In 2000 it hit a cycle high of 6.5%. Pre 2008 it barely got above 5%, then it was pinned to near zero post Great Financial Crisis until Yellen finally decided to start hiking in late 2015, but even then it took four years to get to a measly 2.4%, and even that could be held for only a couple months.

Why do they keep lowering interest rates, and keeping them lower than before? Simple, just look at a chart of Public Debt to GDP for the United States. As the Fed has continued with this game, debt as a percent of GDP has continually increased, from a starting point of 30% in 1981 to 127% where we sit today. Ever increasing levels of debt means the Federal Government will go bankrupt if interest rates stay at historic norms (6-8%), so the Fed has worked to suppress interest rates to keep the Treasury solvent.

The Fed, with this trend of lower and lower interest rates in their vain attempt to kill the credit cycle, have created a financial black hole- the more they lower rates to get out and stave off default, the more debt is created, piling on more and more mass. This pushes interest rates even lower, which creates more loan demand, and thus more debt, in a devastating feedback loop.

This game will continue until the whole thing collapses under the weight of it’s own gravity. That, or they burn their way out with inflation. (Guess which path they’re currently choosing).

There has been much discussion of a taper, that the Fed will stop printing money to buy securities, and will raise interest rates to “fight inflation”. To me, anyone who believes they will accomplish this is being foolish.

The Fed could barely get interest rates above 2.4% in late 2018/early 2019 before the stock market began to fall into bear market territory and the repo market blew up in September 2019. What makes them think they could get interest rates high enough to matter to fight inflation (above 7%) with Debt to GDP 30% higher than it was in 2019?

See below for a brief overview of all the Fed “Tapers”.

Each time they begin this program, the markets react violently. Addicted to the heroin of easy money and low interest rates, the prisoners of this system (the banks and the US Treasury itself) are up to their eyeballs in debt, and any attempt to offload that debt is vehemently opposed. (See this article for a timeline of the 2013 Taper Tantrum).

Disconnecting the Fed’s liquidity hose results in immediate withdrawal, and must be put back quickly if the Fed wants to avoid a full blown deleveraging event (deflationary spiral). The prisoners demand ever increasing liquidity, more and more QE, and tapers (pull backs in money printing) become ever shorter and fewer.

The inmates are running the asylum.

Bernanke assured everyone during the Financial Crisis that Quantitative Easing “would be temporary, and the tapers would be permanent”. It appears the opposite is true- QE is permanent, and the tapers are temporary. They can only taper for a little while until something else blows up and they are forced to start printing again.

Much like a black hole, in many ways we cannot directly observe the phenomenon, but we can see it’s effects on what surrounds it. The Financial Gravity the Fed has created by incentivizing ever more borrowing has caused more and more distortions in financial markets, pumping junk bonds to absurdly high levels and creating shortages in others (Treasuries, like the Reverse Repo Facility- See my DD here)

The weight of the debt is pulling the economy and markets down, but with constant money printing the Fed hopes to stave off disaster. Much like a Black Hole however, the process is exponential, and the longer the Fed keeps interest rates at the zero bound, the harder it will be to escape and the more money they’ll have to print to get out.

For those of us who follow economics/monetary policy, this exact scenario played out in 2018- the Fed stopped QE, and started tightening/tapering, aka reducing it's balance sheet. (look up Fed Balance sheet on FRED). The markets, a month later, started nosediving. I was actually on Wall St at the time coincidentally (doing interviews, and touring the banks for job offers- never worked there).

I talked to a lot of analysts, they all said that this turbulence was bad, with no more Fed support (QE) the markets were due for a correction, etc. but they also confidently said that the Fed would change its mind and start QE again once things got bad enough. The taper, they said, would not last forever. The markets would make the Fed blink. Sure enough, they were right.

From August to mid December, major equity indexes dropped 20%, putting them in a technical bear market. I was there in late October, and pretty much every day saw heavy selling. December got even worse, and as the selling continued, worry began to spread across financial markets.

Powell stuck to his guns and insisted the balance sheet reduction would continue barring another financial crisis. Here’s a quote from an article on December 19th, 2018.

“Minutes into his press conference on December 19, Powell was asked if the Fed is looking into altering its strategy of undoing quantitative easing by allowing its massive holdings of Treasuries and mortgage-backed securities to mature off the balance sheet.

“I think that the runoff (reduction) of the balance sheet has been smooth and has served its purpose and I don’t see us changing that,” Powell said, adding that interest rates would continue to be the “active tool of monetary policy.” When Janet Yellen kicked off the unwind process at the end of 2017, the Fed outlined its intention to let the roll-off occur on “auto-pilot” with no promise of reverting back to quantitative easing — unless there were a “sufficient” negative shock to the economy.”

Dec 24th, 2018 saw a big drop in the markets, a 400 point loss in the Dow, marking the third Friday in a row of red days in the markets. (See article below).

Again, this entire bear market occurred without an external economic shock or a default by a major US bank- it was purely driven by the fear that the Fed would not restart QE and the Taper would continue.

Not even two weeks later, everything changed. The Fed Chairman, Jerome Powell, came out and recanted his earlier statement of a tapering program “on autopilot”. He said they'd stop tapering soon, and may even begin QE again after they'd "re examined the situation". Markets rebounded, and after QE began again, they started rallying hard. (CNBC Jan 14th, 2019)

(Yes, I know the Fed did not immediately restart QE in Jan 2019, but they signaled an end to the taper program and that they would be "open to restarting QE if the conditions warrant it". This was enough to soothe markets into rallying back to ATHs. They began QE again in September 2019)

Many market observers did not understand the implications of what just happened. What many others grasped, and what I was beginning to suspect, was that this series of events was a major signpost that something was seriously wrong in equity markets.

The markets were completely dependent on Fed liquidity, and the Fed had blown a bubble in literally every single asset class in the financial markets- this bubble was able to be maintained only through constant (and growing) QE, and any taper of these injections resulted in immediate collapse of the bubble.

December 2018 demonstrated that the removal of that liquidity injection (heroin) that the markets were addicted to resulted in rapid downward re-pricing of financial assets. The “wealth effect” the Fed had created was nothing more than an illusion.

Something had changed since 2008. Although the NBER (National Bureau of Economic Research) claimed that we had only experienced a recession, if we use their original terminology we actually had been through a depression. Depressions were originally defined as prolonged periods of economic underperformance, which by all indications we were experiencing. GDP nominally was rising, but much of that could be attributed to increased government spending (component of GDP) and inflation (raw GDP is not adjusted for inflation).

NBER estimates we underperformed GDP potential by around $8.2 Trillion in real growth since ‘08, which would have mostly gone to middle and working class workers in the form of wages. (see here and here).

Although there were no more bank failures after the fall of ‘08, unemployment spread throughout the economy, growth slowed to a standstill, and many left the workforce altogether. As we covered in Part 3, if we divide the performance of the S&P 500 by the Fed’s Balance Sheet since the GFC, the LINE IS FLAT. This means that there has been basically NO REAL growth in stock prices since 2008- with the only rise in prices due to money printing.

The correlation coefficient between central bank quantitative easing and the price of stock indexes is nearly 1. The money printed by the Fed, because of the structure of the Open Market Operations, is plugged directly into the Treasury markets, and from there, flows into equities and derivatives. This has served to primarily enrich the asset owners, financial institutions, and wealthy elites who own the majority of the stock market anyways.

The entire rally has been an illusion, financed by the Fed and maintained through QE. In the black expanse of space, many things are not what they seem.

Smoothbrain Overview

In 1907, a major banking crisis broke out across the United States when overleveraged investment trusts saw their clients default on margin loans. This spurred a general bank run.
Hoping to prevent future panics, Congress created the Federal Reserve, the Lender of Last Resort to all US Commercial Banks (later they would lend to Hedge Funds like LTCM, Investment Banks, and even Insurance Companies)
With each subsequent economic crisis, the role and power of the Fed has grown. Now it commands monetary policy for the World Reserve Currency (USD) and can thus indirectly influence every major global asset market.
The Fed has resolved to reply to every recession with a drop in interest rates to spur credit growth. What this does unfortunately is build up massive amounts of debt over time.
By doing so, they have created a Black Hole for themselves which they are desperately trying to escape (this is why they are set on tapering)
Each dollar of debt that is created puts more strain on the system, as interest rates need to be ever lower to prevent widespread default. Thus the Fed has to move interest rates lower and lower, which incentivizes more debt.
Tapering the balance sheet will quickly result in massive corrections in asset markets as we saw in the fall of 2018. If they chose this route, I expect they will have to reverse course in under a year.
This feedback loop has resulted in interest rates pushing the zero-bound, and will soon be (if not already) in negative territory. To inflate away the debt, the Fed will have to push them even farther down (in real terms)
This results in the ultimate dilemma- to save currencies or save bonds. Ultimately, the Fed will soon have to decide which choice to make.

Conclusion

The Fed is now trapped in a Black Hole of it’s own design. Continually crushed by the weight of the financial debt, the economy and markets themselves keep contracting inwards towards collapse. 2008 was a foreshadowing of what was to come- and in 2018, the system was beginning to unravel again. The Fed, desperate to prevent this, persists in heaping more and more liquidity and debt onto the system, desperately praying that there will be a way out.

Each crisis requires exponentially more stimulus to be used to fight it- $100 Billion for the Tech Bubble. $2.2 Trillion for 2008. $4.1 Trillion (and climbing) for March 2020. The Fed is running out of time.

They will almost undoubtedly try to Taper to escape. Even if they try this, it will fail in time, causing a rapid collapse in asset prices. When it does, they will have to turn back the liquidity hose even more than before, as they try to escape the event horizon, “the point of no return” where not even light itself can run fast enough to flee the massive gravitational pull of the black hole.

What they do not grasp yet is that they have already crossed the event horizon. Only hard choices lie ahead - the only thing on their mind will be avoiding another Great Depression, but to do this they will have to print trillions more.

This will only accelerate worsening inflation, and unleash devastating feedback loops that lurk under the surface of our economy. Many a State has wrecked itself on these shores, but sadly few heed the warnings. As stated in the prologue, “On cold nights when the moon is full you can watch these ghost ships (economies) making their journey back to hell... they appear to warn us that our resolution to avoid one fate, may damn us to the other.”

BUY, HODL, BUCKLE UP.

>>>>>>>TO BE CONTINUED >>>>>>> PART FOUR “AT WORLD’S END”

You can follow me on Twitter @peruvian_bull. All other accounts are impersonators/scam accounts. I will never ask for personal information, nor solicit or offer financial advice.

Hyperinflation is Coming- The Dollar Endgame: PART 4.3, “At World’s End”-

“At World’s End”

PART 4.3 “Economic Warfare & The End of Bretton Woods”

The Dollar as a WMD

Most Americans today walk around aware of the fact that they are a superpower. Military parades, fighter jet flyovers at football games, and clips showing American soldiers engaging enemy combatants are commonplace. However, what most Americans do not know, is the secret mighty Excalibur that the U.S. Government wields in order to achieve most of its ends- the Dollar itself.

Since the end of WWII, many conflicts have been resolved through sanctions and negotiation, at the direction of the United States. In almost every case, the U.S. has used the Treasury and it’s control over the banking system, to effectively choke and strangle powerful opponents without ever firing a single shot.

This system is best described by Joseph Wang, a former Senior Trader at the Federal Reserve’s Open Market Desk, in his book Central Banking 101 (page 98):

“The Eurodollar system is offshore, but ultimately, all dollar banking transactions no matter the origin will have a link to the U.S. banking system. After all, offshore dollars would not really be dollars if they were not fungible with onshore dollars. The U.S. government has authority over the U.S. banking system, and by extension, over the offshore banking system.

This implies that the US government has authority over virtually EVERY dollar transaction done through the banking system in the entire world. Let’s walk through an example to see how this works.

Suppose a bank in Kazakhstan named Kbank has a dollar loan business. Kbank makes a $1000 loan to its client and credits its clients account for $1000. The client then withdraws that $1000 to pay a supplier who banks with a US Bank (named Ubank). Kbank is going to have to settle a payment of $1000 with Ubank.

There are two ways it can do this:

If it has a reserve account at the Fed, then it can send Ubank a wire for $1000 in reserves OR
If it holds its dollars as a bank deposit at a U.S. Commercial Bank, then it will have to ask that commercial bank to send Ubank $1000 in reserves.

In the second case, Kbank’s commercial bank will send $1000 in reserves to Ubank while reducing Kbank’s deposit balance on its books by $1000. In either example, the transaction must go through the U.S. banking system.

The U.S. government, through its control of the U.S. banking system, has the power to shut anyone out of the dollar banking system. If the U.S. government decides that someone should be sanctioned, then that person will not be able to receive or send dollars through banks anywhere in the world.

Banks take these sanctions very seriously because if they are caught violating them, they may also be shut out of the U.S. banking system or SWIFT itself! (Part 1.5 discusses SWIFT). This would be a death sentence to any bank. In June of 2014, BNP Paribas (a French bank) admitted to helping Sudan, Iran and Cuba evade U.S. sanctions and move money through the U.S. banking system. They were forced to pay a breathtaking fine of $9 billion (source).”

See below for some more examples- and ALL of these are banks located outside the US:

Deutsche Bank fined $258m for violating US sanctions

U.S. Indicts Turkish Bank on Charges of Evading Iran Sanctions

Standard Chartered to pay $1.1 billion for sanctions violations

Report: Bahrain bank helped Iran evade sanctions for years

(The list continues on and on. Again, these are ALL FOREIGN BANKS- the US technically has no jurisdiction here! This was elaborated on in a book called “Treasury’s War” by Juan Zarate, a former senior Treasury official and architect of modern financial warfare)

This may not seem a big deal on the surface- these countries are enemies of the United States, right? But this demonstrates how US policy can overrule the policy of sovereign nations such as France. France had no such sanctions against these countries- but the US Treasury Department can effectively force French banks to follow American guidelines!

Imagine if China had this power- and demanded that Canada could not trade with Taiwan, cutting both countries off from the international monetary system if they did so.

To many foreign officials, the US has become drunk with this power, and is using it to tyrannize other countries to follow American policy. (Again, I am not arguing in defense of countries like Iran, which have anti-democratic values, just demonstrating that the US has immense power over even Western countries and can effectively set their foreign policy FOR them)

By sanctioning countries and cutting them out of the US banking system, the US can effectively send them back to the Stone Age. Iran, for example, now has extreme difficulty in settling currency for oil and gas contracts- and has even defaulted to pricing it’s oil in gold in order to receive payment!

Many other countries are chafing under this Dollar Dominant system:

5/22/18- US Sanction power may be reaching its limit, “response to Iran shows global economy won’t be bossed around forever”

“You f***ing Americans”, the message read. “Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians?” - UK banker, 2012

5/28/18- India says it only follows UN sanctions, not unilateral US sanctions on Iran

5/9/18- Australia and Japan still support Iran Deal

6/6/18- Merkel warns of G-7 split over Trump’s “America First”, says World becoming “re-ordered globally”

The US, by controlling the World Reserve Currency (The Dollar), wields immense economic and financial power over most of the globe. However, this power corrupts and corrodes the host over time- and warning signs are beginning to appear signaling that America’s time as global economic hegemon may be coming to an end.

The Unraveling of the Global Monetary System

Before we continue, let us do a quick review of the essential paradox of Global Reserve Currencies- Triffin’s Dilemma, covered in depth in Parts 1 and 1.5. (Again, please go back and read these sections!)

In August 1971, after the closing of the Gold Window, the Dollar was officially off the Gold Standard. In the turmoil that followed, currency markets began to experience rapid volatility and signs of inflation began to appear. Many G10 countries began to worry about the Dollar’s sustainability as a world reserve currency.

In a meeting of the G10 in late 1971 in Rome, US Treasury Secretary Connally famously quipped,

“The Dollar is OUR Currency, but YOUR problem!”.

He was referring to Triffin’s Dilemma, and the unfavorable effects it would have on developing countries while boosting US economic and thus political dominance.

The Triffin dilemma or Triffin paradox is the conflict of economic interests that arises between short-term domestic and long-term international objectives for countries whose currencies serve as global reserve currencies.

Quick recap:

Post WW2, the US Dollar became the World Reserve Currency (WRC), and thus was used as a “safe haven currency” by other central banks, and used as a settlement currency for international trade.
This creates massive artificial demand for US Dollars and Treasuries, since these nations need them for trade and to hold in reserve in case of a crisis in their homeland (Thailand in 1997)
This global demand for US Dollars means the US has to be a Net EXPORTER of Dollars. The opposite side of the trade of Dollars is Goods/Investments, and thus the US has to be a Net IMPORTER of Goods/Investments.
This means the US HAS TO consume more than it produces, and receives more investments than it makes. Over time, this leads to a US surplus of debt and consumption, and a lack of investment and production.
For example, Manufacturing jobs thus get transferred overseas, bolstering the economy of foreign countries (China) and weakening the host country (US).
This loss of manufacturing means wage deflation/stagnation in US as domestic jobs disappear
(Thus contributing to political polarization and economic dispair, rising rates of depression/suicide and drug abuse, homelessness)
The artificial demand for Treasuries also lowers borrowing costs massively, inducing the US government to borrow and spend more than it otherwise would, creating fiscal deficits and unsustainable levels of debt.
Eventually, the United States will reach a breaking point, where the manufacturing base is completely gone, and the debt levels are so high, that foreign creditors will not lend it money any more.
When this happens, the Government’s only recourse is to either slash spending immediately (which will lead to severe recession) or print dollars, which will lead to rampant inflation.
The Endgame is the replacement of the World Reserve Currency with a new one, which can cause horrible inflation, as the old WRC loses demand and all overseas dollars come back to the US to roost.

(Below is a graphic of the results of the US being a WRC holder from the point of view of a developing country, Liberia)

The Trade Deficit was mostly propped up in the 1950s and 1960s as Europe rebuilt after the carnage of WW2 and the US was able to be a manufacturing powerhouse. Global trade was mostly centered around the US, so the US did not need to really export dollars and the ill effects of Triffin’s dilemma. Post 1974, and the entry of the Petrodollar system, and Balance of Trade deteriorated significantly as global trade boomed and the US began to need to constantly export dollars (i.e. import goods / grow trade deficits).

Lyn Alden summarizes the issue perfectly:

“When most other countries run trade deficits, they eventually have a big enough currency devaluation so that their exports become more competitive and importing becomes more expensive, which usually prevents multi-decade extremes from building up.

However, because the petrodollar system creates persistent international demand for the dollar, it means the US trade deficit never is allowed to correct and balance itself out. The trade deficit is held open persistently by the structure of the global monetary system, which creates a permanent imbalance, and is the flaw that eventually, after a long enough timeline, brings the system down.”

For those of us who follow monetary economics closely, omens of the death of the Dollar as WRC are beginning to appear.

We’ll start with Treasuries, the backbone of the Global Financial System.

Remember, foreigners have to recycle their trade surpluses back in USDs in order to settle global trade and hold enough currency reserves in their Central Banks. Historically, they did so by buying US Treasuries, since these are considered “risk free assets” (See Foreign Holdings of Federal Debt, below)

After the 2008 financial crisis, the US Government began borrowing heavily to pay for programs like TARP and increased unemployment benefits. The majority of this borrowing was backstopped by Foreign Creditors, who bought around 70% of the new debt issued (the Fed bought most of the rest).

But, since 2014-2015, Foreign Creditors (Central Banks, FIs) began easing up on their purchases of Treasuries. So much so, in fact, that their holdings began to flatline, and there were no (or very low) net increases for several years. This is surprising given the fact that the trade deficits were still increasing, so the US was still sending out more dollars into the world than it received!

From 2018 to now, Federal Debt ballooned by a whopping $9T ($21T to $30T today), but foreigners only bought a measly 14% (1.3T) of it. Again, a drastic decrease from their buying patterns of prior years.

So, this begs the question- if they aren’t lending the US Government, why? And where are their surplus dollars ending up?

Answer: They’ve stopped lending to the US Government because of increasing worry of default risk. The US has taken on too much debt, and interest rates are too low to provide any sort of return.

They still need to recycle their Dollar Surpluses effectively- one easy way to do this is to buy assets denominated in USD (equities, real estate, etc). So, they have started massively investing in American assets, as reflected by the Net International Investment Position (NIIP), shown below: (Credit to Lyn Alden)

(The Net International Investment Position of a country measures how much foreign assets they own, minus how much of their assets that foreigners own, and the chart above shows it as a percentage of GDP. As of this year, the United States owns $29 trillion in foreign assets, while foreigners own $42 trillion in US assets, including US government bonds, corporate bonds, stocks, and real estate.)

This represents a negative 60% NIIP, and has fueled the creation of a massive stock and real estate bubble. All this massive investment has helped to boost economic growth in the past- however it also creates systemic risk.

With foreigners owning so much of US assets, it means that a large proportion of wealth creation is being siphoned overseas, and doesn't recycle back into American communities. This contributes to wealth inequality globally, and in the US as well.

Further, this creates the potential for a massive “rug-pull” on the American economy. If foreign investors began to lose confidence in the US economy, they could essentially begin a run on the Dollar. This would begin by massive sales of US Treasuries, but could spread to stocks and real estate, causing widespread deflation worse than 2008.

The Fed would then be faced with the grim choice of either letting $42T of US assets be fire-sold into a New Great Depression, or ramp up Quantitative Easing to buy the assets on sale- untold trillions of dollars would need to be printed. This would make the current QE program look like a joke in comparison.

(Again, this is a worse-case scenario; I am not asserting that it will happen, but an event like this could be one of the triggers for much worse inflation, and indeed, potential hyper-inflation.)

Many of these countries do not necessarily want to invest in US assets, especially Treasuries- but they are forced to due to the structure of the system and the fact that there just isn’t any good alternative (for now).

For countries that are geo-political rivals of the US, this system is an extremely potent force to help the US maintain status as an economic superpower. This was put best by Charles Duelfer, quoted in the book Mr. X Interviews Volume II (page 87):

These rivals, particularly Russia, China and Iran, have been hurt the worst by US sanctions and economic warfare. They are also at the forefront in trying to displace the Dollar as WRC in order to strip the United States of it’s “exorbitant privilege” (Part 1.5).

See the below links for reference:

8/14/14- Putin says USD monopoly in global energy trade is damaging economy

11/26/10- Putin: It’s quite possible Russia could join EU currency zone, create currency that would eclipse the USD

6/1/15- Russian Oil Giant Gazprom begins selling oil to China in renminbi (CNY) rather than dollars

6/24/15- China likely to get nod for CNY gold fix soon, could compel foreign suppliers to pay in CNY

9/14/17- China aims for dollar-free oil trade

10/11/17- Saxo Bank: USD reserve status at risk as China begins to de-dollarize

10/14/17- The petrodollar system is being undermined- Barrons

11/20/13- PBOC (Central Bank of China) says no longer in China’s interest to boost FX reserves (aka buy USDs)

9/12/17- US Treasury Sec Mnuchin threatens banning China from “dollar system” (SWIFT)

8/24/17- Saudis may seek funding in CNY (Chinese Yuan)

2/16/16- Chinese general says contain the US by attacking its finances

These countries aren’t alone- as we covered in the beginning, even allies such as the UK, India, Germany, and others are tired of being exploited by this system.

The Exorbitant Privilege created by Triffin’s Dilemma means that these countries have to work hard to produce goods, which are swapped for Dollars (which we can print out of thin air). They then have to exchange these Dollars for US assets instead of investing in their own countries.

We get cheap goods and cheap debt, fueling our overly consumerist culture- while they get more inflation and less investment in their own economies.

The ill-effects of Triffin’s Dilemma are building up and corroding the very system which provides the US with so much economic dominance.

In 2014/2015, on a Net basis, Global Central banks stopped buying US Treasuries. Essentially, they decided to stop funding growing US deficits, which means that now the US is on the hook for any new spending our government incurs. (Credit to Luke Gromen for chart below:)

Since there is no (or very little) new lending coming into the US from Global CBs, we had to source it ourselves. This began with structural changes to Money Market Funds and Bank Capital Requirements (Basel III, Dodd-Frank) that FORCES MMFs and Banks to buy Treasuries for their Balance Sheets. ( Expansion of Government MMFs, covered in my DD on RRPs here)

The amount of funds managed by Government MMFs doubled from $0.8T in 2014 to $2.1T in 2016 and then $3.9T by 2020. These MMFs almost exclusively bought short maturity Treasuries (called T-bills), essentially becoming a new large lender for the US Government.

However, there was only so much money in the money markets for this, so it would only buy a limited amount of time. Beginning in March 2020, the Federal Government began massive fiscal expenditures to prop up the economy and deal with the fallout from Covid-19.

Source- Bianco Research

This time was different- since Global CBs were no longer lending en masse to the US, we had to print the difference. The Fed had to step in and backstop the Treasury. US fiscal deficits, which “hadn’t mattered” for 40 years, now began to matter!

Foreign CBs barely increased their Treasury holdings, and to ensure the US Govt wouldn’t go bankrupt, the Fed had to print trillions of dollars to buy up all the new debt being issued (source).

“That’s not exactly how the “global reserve” currency is supposed to work. It’s like a restaurant chef eating her own cooking more than her customers do. This is what other non-global-reserve countries look like. Within one year, the Fed went from owning half as much Treasuries as foreign central banks combined, to more than them combined.”- Lyn Alden

In 2008, when the Fed did this, the money had stayed in the banking system due to the nature of QE (covered in Part 3.5). However, now it was the US Government and indeed the entire US economy that needed to be bailed out, so that is where the dollars had to flow.

This led to a massive influx of dollars into the real economy, and thus the recipe for a large surge in inflation in the coming years. So far, it looks like we are seeing this play out in real time, as January 2022 CPI came in at a blazing 7.5%!

With fiscal deficits running at $2.8T in 2021, and foreign CBs only financing 14% of it, that means there is $2.4T of Treasuries that need to be bought- the Fed will likely have to print all of it.

Thus, the Fed will likely have to print around $2.4T, every year, for the foreseeable future. Inflationary feedback loops, discussed in Parts 4.0 and 4.1, will kick in, and these figures will grow. The Fed will have to print more and more just to keep the US Govt afloat.

All the borrowing of the past is coming back to bite. Officially, just a few weeks ago, US Debt hit $30 Trillion! This doesn't include the $5T of liabilities that the US Government owes to itself or the staggering $162 Trillion in unfunded liabilities!

(Unfunded liabilities refers to payments that the US has promised to make, such as Social Security, Medicare, Medicaid, pensions. Technically, this isn’t classified as debt, but it is a promise from the US Govt to give future $$- where will this money come from?)

At $30 Trillion, a 1% increase in interest rates means an additional $300B in interest payments annually that must be paid. Who will lend the Treasury this money as the Gov’t continues to dig its own grave, and inflation rates rise above 7%?

Answer: The Lender of Last Resort- the Fed

It is no surprise therefore that cognisant leaders in foreign countries see the writing on the wall and have begun to pull support for USD. Would you want your hard earned taxes being invested in a “reserve asset” that is losing 7.5% of its value (more like 15%) every year, and is projected to lose even more as the debt payments come due?

A 2017 paper published by the Bank of International Settlements called “Triffin: Dilemma or myth?” restates the core issue perfectly (summarized):

The elites understand this issue perfectly- but the reason the system did so well for so long is that the US debt levels were manageable, and there were structural advantages the US had that helped it immensely (deep and liquid bond + stock markets, large population, large % of global trade)

But they also understand that Triffin’s Dilemma is the final nail in the coffin- it has meant that every country has lasted as WRC holder for an average of only 80 years!

To put it another way, the host country (US) has to decide to either not print $$ and import goods, which halts global trade (not enough $$ to settle trade)

It has to decide to run current account deficits (to keep the global economy running) at the expense of burying itself in debt, eventually having to print their way out (which will kill the USD as WRC holder).

This has happened before to Portugal, Spain, Britain- all colonial empires, who saw their might stripped from them as they devalued their currency and lost economic hegemony.

I noted this to a colleague-

“This system also hands China a nuclear option- they now have a massive hoard of over $1T of Treasuries. They have their finger on the button. If they dump them all, they would bring on Armageddon in the bond markets, and force the Fed to print another Trillion or so, perhaps scaring other countries to start dumping their bonds, which would force the Fed to print Trillions more. It would be all out economic warfare.”

He rebutted- “The Chinese wouldn’t do that. It would harm their own economy, that would be tantamount to shooting themselves in the foot”.

I replied- “But their foot is placed against our head”

Smooth Brain Overview

Triffin’s Dilemma creates Artificial Demand for USD, propping up value
US exports Inflation to poorer countries
Move of Manufacturing Base from Importers (US) to Exporters (China)
This creates wage deflation in US- stagnant wages for US workers
Massive build up of Debt in WRC holder (US)
Build up of dollars in overseas bank accounts (Eurodollars)
Increasing levels of debt and inequality in WRC (US) as corporate profits soar and wages flatline
Eventually, the manufacturing base is gone, debt levels are too high, which forces the US to print $$.
This causes global inflation, and foreign countries don’t like seeing their hard earned Yen or Pounds being transferred into a currency being printed to oblivion. They stop lending to the US.
The Fed now has to print even MORE $$ to keep the US Govt afloat.
Inflation problem gets worse. #9 and #10 Repeat in a vicious cycle.
Change of WRC, which causes depression in holder (Britain in late 1920s)

Conclusion

Most Americans today are unaware of the great benefits and might bestowed upon them due to the US being the holder of a WRC. Drunk with power, Presidents from Nixon to Obama have started and continued large scale “forever wars” in Vietnam, Iraq, Afghanistan, and Yemen.

Post Bretton Woods, the US has become an Empire, and essentially created financial colonies in most of the Third World- by forcing them to use US dollars, these countries subordinate their economies to support the value of the dollar, allowing the US to borrow and spend recklessly without immediate consequence.

Further, by using USDs, these countries’ banks are routed through the US banking system and are thus subject to US Foreign policy, even policies that are not supported by the United Nations. The US can essentially extend its jurisdiction over much of the global economy, and cut off trade for those countries who protest.

But this power comes with a cost- by exporting jobs, wages deflate across the US and wealth inequality worsens. Political polarization quickly follows, along with the destabilization and corruption of Institutions.

The drums of Economic Warfare have begun to beat. China and Russia are bristling for conflict. Can the United States survive the onslaught?

The Endgame Approaches. No Empire lasts forever.

BUY, HODL, BUCKLE UP.

>>>>>>>TO BE CONTINUED >>>>>>> PART FOUR “AT WORLD’S END”

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Hyperinflation is Coming- The Dollar Endgame: PART 5.0, “Enter the Dragon”- FINALE

SERIES (Parts 1-4) TL/DR: We are at the end of a MASSIVE debt supercycle. This 80-100 year pattern always ends in one of two scenarios- default/restructuring (deflation a la Great Depression) or inflation (hyperinflation in severe cases (a la Weimar Republic). The United States has been abusing it’s privilege as the World Reserve Currency holder to enforce its political and economic hegemony onto the Third World, specifically by creating massive artificial demand for treasuries/US Dollars, allowing the US to borrow extraordinary amounts of money at extremely low rates for decades, creating a Sword of Damocles that hangs over the global financial system.

The massive debt loads have been transferred worldwide, and sovereigns are starting to call our bluff. Governments papered over the 2008 financial crisis with debt, but never fixed the underlying issues, ensuring that the crisis would return, but with greater ferocity next time. Systemic risk (from derivatives) within the US financial system has built up to the point that collapse is all but inevitable, and the Federal Reserve has demonstrated it will do whatever it takes to defend legacy finance (banks, broker/dealers, etc) and government solvency, even at the expense of everything else (The US Dollar).

I’ll break this down into four parts. ALL of this is interconnected, so please read these in order:

Updated Complete Table of Contents:

“Enter the Dragon”

PART 5.0 “The Monster & the Simulacrum”

“In the 1985 work “Simulacra and Simulation” French philosopher Jean Baudrillard recalls the Borges fable about the cartographers of a great Empire who drew a map of its territories so detailed it was as vast as the Empire itself.

According to Baudrillard as the actual Empire collapses the inhabitants begin to live their lives within the abstraction believing the map to be real (his work inspired the classic film "The Matrix" and the book is prominently displayed in one scene).

The map is accepted as truth and people ignorantly live within a mechanism of their own design and the reality of the Empire is forgotten. This fable is a fitting allegory for our modern financial markets.

Our fiscal well being is now prisoner to financial and monetary engineering of our own design. Central banking strategy does not hide this fact with the goal of creating the optional illusion of economic prosperity through artificially higher asset prices to stimulate the real economy.

While it may be natural to conclude that the real economy is slave to the shadow banking system this is not a correct interpretation of the Baudrillard philosophy-

The higher concept is that our economy IS the shadow banking system… the Empire is gone and we are living ignorantly within the abstraction. The Fed must support the shadow banking oligarchy because without it, the abstraction would fail.” (Artemis Capital)

The Inflation Serpent

To most citizens living in the West, the concept of a collapsing fiat currency seems alien, unfathomable even. They regard it as an unfortunate event reserved only for those wretched souls unlucky enough to reside in third world countries or under brutal dictatorships.

Monetary mismanagement was seen to be a symptom only of the most corrupt countries like Venezuela- those where the elites gained control of the Treasury and printing press and used this lever to steal unimaginable wealth while impoverishing their constituents.

However, the annals of history spin a different tale- in fact, an eventual collapse of fiat currency is the norm, not the exception.

In a study of 775 fiat currencies created over the last 500 years, researchers found that approximately 599 have failed, leaving only 176 remaining in circulation. Approximately 20% of the 775 fiat currencies examined failed due to hyperinflation, 21% were destroyed in war, and 24% percent were reformed through centralized monetary policy. The remainder were either phased out, converted into another currency, or are still around today.

The average lifespan for a pure fiat currency is only 27 years- significantly shorter than a human life.

Double-digit inflation, once deemed an “impossible” event for the United States, is now within a stone’s throw. Powell, desperate to maintain credibility, has embarked on the most aggressive hiking schedule the Fed has ever undertaken. The cracks are starting to widen in the system.

One has to look no further than a simple graph of the M2 Money Supply, a measure that most economists agree best estimates the total money supply of the United States, to see a worrying trend:

The trend is exponential. Through recessions, wars, presidential elections, cultural shifts, and even the Internet age- M2 keeps increasing non-linearly, with a positive second derivative- money supply growth is accelerating.

This hyperbolic growth is indicative of a key underlying feature of the fiat money system: virtually all money is credit. Under a fractional reserve banking system, most money that circulates is loaned into existence, and doesn't exist as real cash- in fact, around 97% of all “money” counted within the banking system is debt, in one form or another. (See Dollar Endgame Part 3)

Debt virtually always has a yield- that yield is called interest, and that interest demands payment. Thus, any fiat money banking system MUST grow money supply at a compounding interest rate, forever, in order to remain stable.

Debt defaulting is thus quite literally the destruction of money- which is why the deflation is widespread, and also why M2 Money Supply shrank by 30% during the Great Depression.

This process repeats ad infinitum, perpetually compounding loan creation and thus money supply, in order to prevent systemic defaults. The system is BUILT for constant inflation.

In the last 50 years, only about 12 quarters have seen reductions in commercial bank credit. That’s less than 5% of the time. The other 95% has seen increases, per data from the St. Louis Fed.

Even without accounting for debt crises, wars, and government defaults, money supply must therefore grow exponentially forever- solely in order to keep the wheels on the bus.

The question is where that money supply goes- and herein lies the key to hyperinflation.

In the aftermath of 2008, the Fed and Treasury worked together to purchase billions of dollars of troubled assets, mortgage backed securities, and Treasury bonds- all in a bid to halt the vicious deleveraging cycle that had frozen credit markets and already sunk two large investment banks.

These programs were the most widespread and ambitious ever- and resulted in trillions of dollars of new money flowing into the financial system. Libertarian candidates and gold bugs such as Peter Schiff, who had rightly forecasted the Great Financial Crisis, now began to call for hyperinflation.

The trillions of printed money, he claimed, would create massive inflation that the government would not be able to tame. U.S. debt would be downgraded and sold, and with the Fed coming to the rescue with trillions more of QE, extreme money supply increases would ensue. An exponential growth curve in inflation was right around the corner.

Gold prices rallied hard, moving from $855 at the start of 2008 to a record high of $1,970 by the end of 2011. The end of the world was upon us, many decried. Occupy Wall Street came out in force.

However, to his great surprise, nothing happened. Inflation remained incredibly tame, and gold retreated from its euphoric highs. Armageddon was averted, or so it seemed.

The issue that was not understood well at the time was that there existed two economies- the financial and the real. The Fed had pumped trillions into the financial economy, and with a global macroeconomic downturn plus foreign central banks buying Treasuries via dollar recycling, all this new money wasn’t entering the real economy.

Instead, it was trapped, circulating in the hands of money market funds, equities traders, bond investors and hedge funds. The S&P 500, which had hit a record low in March of 2009, began a steady rally that would prove to be the strongest and most pronounced bull market in history.

The Fed in the end did achieve extreme inflation- but only in assets.

Without the Treasury incurring significant fiscal deficits this money did not flow out into the markets for goods and services but instead almost exclusively into equity and bond markets.

The great inflationary catastrophe touted by the libertarians and the gold bugs alike never came to pass- their doomsday predictions appeared frenetic, neurotic.

Instead of re-evaluating their arguments under this new framework, the neo-Keynesians, who held the key positions of power with Treasury, the Federal Reserve, and most American Universities (including my own) dismissed their ideas as economic drivel.

The Fed had succeeded in averting disaster- or so they claimed. Bernanke, in all his infinite wisdom, had unleashed the “Wealth Effect”- a crucial behavioral economic theory suggesting that people spend more as the value of their assets rise.

An even more extreme school of thought emerged- the Modern Monetary Theorists- who claimed that Central Banks had essentially discovered a ‘perpetual motion machine’- a tool for unlimited economic growth as a result of zero bound interest rates and infinite QE.

The government could borrow money indefinitely, and traditional metrics like Debt/GDP no longer mattered. Since each respective government could print money in their own currency- they could never default.

The bill would never be paid. Or so they thought.

The American Reckoning

This theory helped justify massive US government borrowing and spending- from Afghanistan, to the War on Drugs, to Entitlement Programs, the Treasury indulged in fiscal largesse never before seen in our nation’s history.

The debt continued to accumulate and compound. With rates pegged at the zero bound, the Treasury could justify rolling the debt continually as the interest costs were minimal.

Politicians now pushed for more and more deficit spending- if it's free to bailout the banks, or start a war- why not build more bridges? What about social programs? New Army bases? Tax cuts for corporations? Subsidies for businesses?

There was no longer any “accepted” economic argument against this- and thus government spending grew and grew, and the deficits continued to expand year after year.

The Treasury would roll the debt by issuing new bonds to pay off maturing ones- a strategy reminiscent of Ponzi schemes.

This debt binge is accelerating- as spending increases, (and tax revenues are constant) the deficit grows, and this deficit is paid by more borrowing. This incurs more interest, and thus more spending to pay that interest, in a deadly feedback loop- what is called a debt spiral.

The shadow threat here that is rarely discussed is Unfunded Liabilities- these are payments the Federal government has promised to make, but has not yet set aside the money for. This includes Social Security, Medicaid, Medicare, Veteran’s benefits, and other funding that is non-discretionary, or in other words, basically non-optional.

Cato Institute estimates that these obligations sum up to $163 Trillion. Other estimates from the Mercatus Center put the figure at between $87T as the lower bound and $222T on the high end.

YES. That is TRILLION with a T.

A Dragon lurks in these shadows.

What makes it worse is that these figures are from 2012- the problem is significantly worse now. The fact of the matter is, no one knows the exact figure- just that it is so large it defies comprehension.

These payments are what is called non-discretionary, or mandatory spending- each Federal agency is obligated to spend the money. They don’t have a choice.

Approximately 70% of all Federal Spending is mandatory.

And the amount of mandatory spending is increasing each year as the Boomers, the second largest generation in US history, retire. Approximately 10,000 of them retire each day- increasing the deficits by hundreds of billions a year.

Furthermore, the only way to cut these programs (via a bill introduced in the House and passed in the Senate) is basically political suicide. AARP and other senior groups are some of the most powerful and wealthy lobbying groups in the US.

If politicians don’t have the stomach to legalize marijuana- an issue that Pew research finds an overwhelming majority of Americans supporting- then why would they nuke their own careers via cutting funding to seniors right as inflation spikes?

Thus, although these obligations are not technically debt, they act as debt instruments in all other respects. The bill must be paid.

In the Fiscal Report for 2022 released by the White House, they estimated that in 2021 and 2022 the Federal deficits would be $3.669T and $1.837T respectively. This amounts to 16.7% and 7.8% of GDP (pg 42).

Astonishingly, they project substantially decreasing deficits for the next decade. Meanwhile the U.S. is slowly grinding towards a severe recession (and then likely depression) as the Fed begins their tightening experiment into 132% Federal Debt to GDP.

Deficits have basically never gone down in a recession, only up- unemployment insurance, food stamp programs, government initiatives; all drive the Treasury to pump out more money into the economy in order to stimulate demand and dampen any deflation.

To add insult to injury, tax receipts collapse during recession- so the income side of the equation is negatively impacted as well. The budget will blow out.

The U.S. 1 yr Treasury Bond is already trading at 4.7%- if we have to refinance our current debt loads at that rate (which we WILL since they have to roll the debt over), the Treasury will be paying $1.46 Trillion in INTEREST ALONE YEARLY on the debt.

That is equivalent to 40% of all Federal Tax receipts in 2021!

In my post Dollar Endgame 4.2, I have tried to make the case that the United States is headed towards an “event horizon”- a point of no return, where the financial gravity of the supermassive debt is so crushing that nothing they do, short of Infinite QE, will allow us to escape.

The terrifying truth is that we are not headed towards this event horizon.

We’re already past it.

As brilliant macro analyst Luke Gromen pointed out in several interviews late last year, if you combine Gross Interest Expense and Entitlements, on a base case, we are already at 110% of tax receipts.

True Interest Expense is now more than total Federal Income. The Federal Government is already bankrupt- the market just doesn't know it yet.

The black hole of debt, financed by the Federal Reserve, has now trapped the largest spending institution in the world- the United States Treasury.

The unholy capture of the Money Printer and the Spender is catastrophic - the final key ingredient for monetary collapse.

This is How Money Dies.

The Dollar Endgame

True monetary collapses are hard to grasp for many in the West who have not experienced extreme inflation. The ever increasing money printing seems strange, alien even. Why must money supply grow exponentially? Why did the Reichsbank continue printing even as hyperinflation took hold in Germany?

What is not understood well are the hidden feedback loops that dwell under the surface of the economy.

The Dragon of Inflation, once awoken, is near impossible to tame.

It all begins with a country walking itself into a situation of severe fiscal mismanagement- this could be the Roman Empire of the early 300s, or the German Empire in 1916, or America in the 1980s- 2020s.

The State, fighting a war, promoting a welfare state, or combating an economic downturn, loads itself with debt burdens too heavy for it to bear.

This might even create temporary illusions of wealth and prosperity. The immediate results are not felt. But the trap is laid.

Over the next few years and even decades, the debt continues to grow. The government programs and spending set up during an emergency are almost impossible to shut down. Politicians are distracted with the issues of the day, and concerns about a borrowing binge take the backseat.

The debt loads begin to reach a critical mass, almost always just as a political upheaval unfolds. Murphy’s Law comes into effect.

Next comes a crisis.

This could be Visigoth tribesmen attacking the border posts in the North, making incursions into Roman lands. Or it could be the Assassination of Archduke Franz Ferdinand in Sarajevo, kicking off a chain of events causing the onset of World War 1.

Or it could be a global pandemic, shutting down 30% of GDP overnight.

Politicians respond as they always had- mass government mobilization, both in the real and financial sense, to address the issue. Promising that their solutions will remedy the problem, a push begins for massive government spending to “solve” economic woes.

They go to fundraise debt to finance the Treasury. But this time is different.

Very few, if any, investors bid. Now they are faced with a difficult question- how to make up for the deficit between the Treasury’s income and its massive projected expenditure. Who’s going to buy the bonds?

With few or no legitimate buyers for their debt, they turn to their only other option- the printing press. Whatever the manner, new money is created and enters the supply.

This time is different. Due to the flood of new liquidity entering the system, widespread inflation occurs. Confounded, the politicians blame everyone and everything BUT the printing as the cause.

Bonds begin to sell off, which causes interest rates to rise. With rates suppressed so low for so long, trillions of dollars of leverage has built up in the system.

No one wants to hold fixed income instruments yielding 1% when inflation is soaring above 8%. It's a guaranteed losing trade. As more and more investors run for the exits in the bond markets, liquidity dries up and volatility spikes.

The MOVE index, a measure of bond market volatility, begins climbing to levels not seen since the 2008 Financial Crisis.

Sovereign bond market liquidity begins to evaporate. Weak links in the system, overleveraged several times on government debt, such as the UK’s pension funds, begin to implode.

The banks and Treasury itself will not survive true deflation- in the US, Yellen is already getting so antsy that she just asked major banks if Treasury should buy back their bonds to “ensure liquidity”!

As yields rise, government borrowing costs spike and their ability to roll their debt becomes extremely impaired. Overleveraged speculators in housing, equity and bond markets begin to liquidate positions and a full blown deleveraging event emerges.

True deflation in a macro environment as indebted as ours would mean rates soaring well above 15-20%, and a collapse in money market funds, equities, bonds, and worst of all, a certain Treasury default as federal tax receipts decline and deficits rise.

A run on the banks would ensue. Without the Fed printing, the major banks, (which have a 0% capital reserve requirement since 3/15/20), would quickly be drained. Insolvency is not the issue here- liquidity is; and without cash reserves a freezing of the interbank credit and repo markets would quickly ensue.

For those who don’t think this is possible, Tim Geitner, NY Fed President during the 2008 Crisis, stated that in the aftermath of Lehman Brothers’ bankruptcy, we were “We were a few days away from the ATMs not working” (start video at 46:07).

As inflation rips higher, the $24T Treasury market, and the $15.5T Corporate bond markets selloff hard. Soon they enter freefall as forced liquidations wipe leverage out of the system. Similar to 2008, credit markets begin to freeze up. Thousands of “zombie corporations”, firms held together only with razor thin margins and huge amounts of near zero yielding debt, begin to default. One study by a Deutsche analyst puts the figure at 25% of companies in the S&P 500.

The Central Banks respond to the crisis as they always have- coming to the rescue with the money printer, like the Bank of England did when they restarted QE, or how the Bank of Japan began “emergency bond buying operations”.

But this time is massive. They have to print more than ever before as the ENTIRE DEBT BASED FINANCIAL SYSTEM UNWINDS.

QE Infinity begins. Trillions of Treasuries, MBS, Corporate bonds, and Bond ETFs are bought up. The only manner in which to prevent the bubble from imploding is by overwhelming the system with freshly printed cash. Everything is no-limit bid.

The tsunami of new money floods into the system and a face ripping rally begins in every major asset class. This is the beginning of the melt-up phase.

The Federal Reserve, within a few months, goes from owning 30% of the Treasury market, to 70% or more. The Bank of Japan is already at 70% ownership of certain JGB issuances, and some bonds haven’t traded for a record number of days in an active market!

The Central Banks EAT the bond market. The “Lender of Last Resort” becomes “The Lender of Only Resort”.

Another step towards hyperinflation. The Dragon crawls out of his lair.

Now the majority or even entirety of the new bond issuances from the Treasury are bought with printed money. Money supply must increase in tandem with federal deficits, fueling further inflation as more new money floods into the system.

The Fed’s liquidity hose is now directly plugged into the veins of the real economy. The heroin of free money now flows in ever increasing amounts towards Main Street.

The same face-ripping rise seen in equities in 2020 and 2021 is now mirrored in the markets for goods and services.

Prices for Food, gas, housing, computers, cars, healthcare, travel, and more explode higher. This sets off several feedback loops- the first of which is the wage-price spiral. As the prices of everything rise, real disposable income falls.

Massive strikes and turnover ensues. Workers refuse to labor for wages that are not keeping up with their expenses. After much consternation, firms are forced to raise wages or see large scale work stoppages.

These higher wages now mean the firm has higher costs, and thus must charge higher prices for goods. This repeats ad infinitum.

The next feedback loop is monetary velocity- the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.

The faster the dollar turns over, the more items it can bid for- and thus the more prices rise. Money velocity increasing is a key feature of a currency beginning to inflate away. In nations experiencing hyperinflation like Venezuela, where money velocity was purported to be over 7,000 annually- or more than 20 times a DAY.

As prices rise steadily, people begin to increase their inflation expectations, which leads to them going out and preemptively buying before the goods become even more expensive. This leads to hoarding and shortages as select items get bought out quickly, and whatever is left is marked up even more. ANOTHER feedback loop.

Inflation now soars to 25%. Treasury deficits increase further as the government is forced to spend more to hire and retain workers, and government subsidies are demanded by every corner of the populace as a way to alleviate the price pressures.

The government budget increases. Any hope of worker’s pensions or banks buying the new debt is dashed as the interest rates remain well below the rate of inflation, and real wages continue to fall. They thus must borrow more as the entire system unwinds.

The Hyperinflationary Feedback loop kicks in, with exponentially increasing borrowing from the Treasury matched by new money supply as the Printer whirrs away.

The Dragon begins his fiery assault.

As the dollar devalues, other central banks continue printing furiously. This phenomenon of being trapped in a debt spiral is not unique to the United States- virtually every major economy is drowning under excessive credit loads, as the average G7 debt load is 135% of GDP.

As the central banks print at different speeds, massive dislocations begin to occur in currency markets. Nations who print faster and with greater debt monetization fall faster than others, but all fiats fall together in unison in real terms.

Global trade becomes extremely difficult. Trade invoices, which usually can take several weeks or even months to settle as the item is shipped across the world, go haywire as currencies move 20% or more against each other in short timeframes. Hedging becomes extremely difficult, as vol premiums rise and illiquidity is widespread.

Amidst the chaos, a group of nations comes together to decide to use a new monetary media- this could be the Special Drawing Right (SDR), a neutral global reserve currency created by the IMF.

It could be a new commodity based money, similar to the old US Dollar pegged to Gold.

Or it could be a peer-to-peer decentralized cryptocurrency with a hard supply limit and secure payment channels.

Whatever the case- it doesn't really matter. The dollar will begin to lose dominance as the World Reserve Currency as the new one arises.

As the old system begins to die, ironically the dollar soars higher on foreign exchange- as there is a $20T global short position on the USD, in the form of leveraged loans, sovereign debt, corporate bonds, and interbank repo agreements.

All this dollar debt creates dollar DEMAND, and if the US is not printing fast enough or importing enough to push dollars out to satisfy demand, banks and institutions will rush to the Forex market to dump their local currency in exchange for dollars.

This drives DXY up even higher, and then forces more firms to dump local currency to cover dollar debt as the debt becomes more expensive, in a vicious feedback loop. This is called the Dollar Milkshake Theory, posited by Brent Johnson of Santiago Capital.

The global Eurodollar Market IS leverage- and as all leverage works, it must be fed with new dollars or risk bankrupting those who owe the debt. The fundamental issue is that this time, it is not banks, hedge funds, or even insurance giants- this is entire countries like Argentina, Vietnam, and Indonesia.

If the Fed does not print to satisfy the demand needed for this Eurodollar market, the Dollar Milkshake will suck almost all global liquidity and capital into the United States, which is a net importer and has largely lost it’s manufacturing base- meanwhile dozens of developing countries and manufacturing firms will go bankrupt and be liquidated, causing a collapse in global supply chains not seen since the Second World War.

This would force inflation to rip above 50% as supply of goods collapses.

Worse yet, what will the Fed do? ALL their choices now make the situation worse.

Many pundits will retort- “Even if we have to print the entire unfunded liability of the US, $160T, that’s 8 times current M2 Money Supply. So we’d see 700% inflation over two years and then it would be over!”

This is a grave misunderstanding of the problem; as the Fed expands money supply and finances Treasury spending, inflation rips higher, forcing the AMOUNT THE TREASURY BORROWS, AND THUS THE AMOUNT THE FED PRINTS in the next fiscal quarter to INCREASE. Thus a 100% increase in money supply can cause a 150% increase in inflation, and on again, and again, ad infinitum.

M2 Money Supply increased 41% since March 5th, 2020 and we saw an 18% realized increase in inflation (not CPI, which is manipulated) and a 58% increase in SPY (at the top). This was with the majority of printed money really going into the financial markets, and only stimulus checks and transfer payments flowing into the real economy.

Now Federal Deficits are increasing, and in the next easing cycle, the Fed will be buying the majority of Treasury bonds.

The next $10T they print, therefore, could cause additional inflation requiring another $15T of printing. This could cause another $25T in money printing; this cycle continues forever, like Weimar Germany discovered.

The $200T or so they need to print can easily multiply into the quadrillions by the time we get there.

The Inflation Dragon consumes all in his path.

Federal Net Outlays are currently around 30% of GDP. Of course, the government has tax receipts that it could use to pay for services, but as prices roar higher, the real value of government tax revenue falls. At the end of the Weimar hyperinflation, tax receipts represented less than 1% of all government spending.

This means that without Treasury spending, literally a third of all economic output would cease.

The holders of dollar debt begin dumping them en masse for assets with real world utility and value- even simple things such as food and gas.

People will be forced to ask themselves- what matters more; the amount of Apple shares they hold or their ability to buy food next month? The option will be clear- and as they sell, massive flows of money will move out of the financial economy and into the real.

This begins the final cascade of money into the marketplace which causes the prices of everything to soar higher. The demand for money grows even larger as prices spike, which causes more Treasury spending, which must be financed by new borrowing, which is printed by the Fed. The final doom loop begins, and money supply explodes exponentially.

Monetary velocity rips higher and eventually pushes inflation into the thousands of percent. Goods begin being re-priced by the day, and then by the hour, as the value of the currency becomes meaningless.

A new money, most likely a cryptocurrency such as Bitcoin, gains widespread adoption- becoming the preferred method and eventually the default payment mechanism. The State continues attempting to force the citizens to use their currency- but by now all trust in the money has broken down. The only thing that works is force, but even the police, military and legal system by now have completely lost confidence.

The Simulacrum breaks down as the masses begin to realize that the entire financial system, and the very currency that underpins it is a lie- an illusion, propped up via complex derivatives, unsustainable debt loads, and easy money financed by the Central Banks.

Similar to Weimar Germany, confidence in the currency finally collapses as the public awakens to a long forgotten truth-

There is no supply cap on fiat currency.

Conclusion:

When asked in 1982 what was the one word that could be used to define the Dollar, Fed Chairman Paul Volcker responded with one word-

“Confidence.”

All fiat money systems, unmoored from the tethers of hard money, are now adrift in a sea of illusion, of make-believe. The only fundamental props to support it are the trust and network effects of the participants.

These are powerful forces, no doubt- and have made it so no fiat currency dies without severe pain inflicted on the masses, most of which are uneducated about the true nature of economics and money.

But the Ships of State have wandered into a maelstrom from which there is no return. Currently, total worldwide debt stands at a gargantuan $300 Trillion, equivalent to 356% of global GDP.

This means that even at low interest rates, interest expense will be higher than GDP- we can never grow our way out of this trap, as many economists hope.

Fiat systems demand ever increasing debt, and ever increasing money printing, until the illusion breaks and the flood of liquidity is finally released into the real economy. Financial and Real economies merge in one final crescendo that dooms the currency to die, as all fiats must.

Day by day, hour by hour, the interest accrues.

The Debt grows larger.

And the Dollar Endgame Approaches.

Hyperinflation is Coming- The Dollar Endgame: PART 5.2, “Enter the Dragon” ADDENDUM

ADDENDUM- Q&A

Hey everyone, I wrote this section as purely a response to the hundreds of questions, comments, and rebuttals I received over this series. They are listed in no particular order, and I do my best to answer each point as concisely and accurately as possible.

Jeffrey Snider- QE is not money printing! QE is the creation of bank reserves which are swapped for commercial bank assets within the financial system. These bank reserves CANNOT be spent in the real world.

Ok, a lot to unpack here. First, in a TECHNICAL sense you are correct- QE does not create money in the form that normal people think of as money. No physical cash is printed and shipped to banks, instead the Fed “prints” by adding entries to their internal SQL ledger and exchanges these new entries for assets. These entries are bank reserves, and like I have already described, are exchanged for assets, mostly Treasuries.

They can’t be immediately “spent” into the real economy- THEY ARE A FORM OF MONEY, but they are trapped exclusively in the financial system, within the markets. Joseph Wang, former Senior trader at the Fed, describes this best, explaining that we have a two tiered money system- the bank reserves trapped at the Fed, and commercial bank deposits that the rest of us can access. These two systems interact and work with each other to provide liquidity and funding.

This doesn't disprove the Dollar Endgame hypothesis- because they can be turned into real economy dollars through the Treasury. This is why high fiscal deficits are the key to extreme inflation- it’s a pairing of the money PRINTER with the money SPENDER.

When the Treasury issues bonds, they receive funds as consideration in the form of commercial bank deposits. These commercial bank deposits CAN be spent in the real economy! Or else what is the point of all this? Why would the government issue debt for money it cannot spend on real world essentials like tanks, bridges, pensions or hospitals?

Through this process, the banking system and Treasury paired together turn Bank Reserves, which can only be held by commercial banks at the Fed, into deposits, and then into funds in the Treasury General Account, which can now be spent in the REAL economy.

The Treasury is the missing link- which is why in 2008 we didn’t see widespread inflation, because the massive tsunami of QE was trapped within the financial system and could not be spent in the real world. We saw inflation in financial assets, but nothing else.

Once the Treasury is underwater and is continually incurring significant fiscal deficits, and the Fed is monetizing these deficits through QE, that is when we see a massive increase in inflation and a resurgence of the vicious feedback loops that propelled countries like Weimar Germany to monetary doom and hyperinflation.

Macro Alf- The true risk is deflation, not inflation. Macro indicators point to a global recession on a scale not seen since 2008. The destruction of aggregate demand will push inflation down to 0 and then below. The Fed will hike us out of inflation.

I am not surprised that many believe this, as all mainstream economists in the late 1960’s believed that stagflation was impossible, or that the dollar could never de-peg from gold. Of course the macro indicators point towards deflation- central banks are hiking rates into 356% global debt to GDP, oncoming recession, energy crises, and war. However, what you and many others completely fail to understand is the entire point of the Central banks.

They DO NOT exist to “maximize” employment.

They DO NOT exist to “minimize” inflation.

They exist to backstop the banks, markets, and most of all, the federal governments via money printing.

They care about “financial stability” more than anything- to them, this means the Treasury has enough cash to roll over its debt, and the banks have enough cash to meet redemptions.

Just look at their actions! Honestly, who cares what they say, state, proclaim, or announce. Everytime there is a financial crisis, they find another excuse, another reason, to turn the money printer back on.

Do you REALLY think that if the Treasury defaults on its debts, and all Treasury bonds enter freefall, that they’re going to sit back and do nothing?

They have printed TRILLIONS for FAR LESS.

Treasuries are the backbone of the global financial system. They are used as collateral in the Eurodollar market, they are held by sovereign wealth funds, used to fund FX swap transactions, and most importantly fund the largest military superpower the world has ever seen.

The Treasury rate is used throughout finance- described as the “risk free rate” ; they are used in almost every valuation metric, including Option Pricing Models, Backsolves, GPCs, DCFs, etc. I would know- this is the industry I work in!

The importance of this asset CANNOT be understated. The Fed will do anything to prevent a deflationary collapse- and they will have to print, as we have already covered, the US Treasury is already bankrupt, deep underwater with $31T of Federal Debt, and $163T of unfunded liabilities.

To prevent a bankruptcy, the Fed will print WHATEVER IT TAKES. This money will be spent in the real economy, as fiscal deficits are at all time highs, and inflation will spike higher, EVEN as the economy contracts while the Fed continues hiking.

Just look at Argentina- they have 83% inflation, and they have 75% interest rates! THEY ARE HIKING AS HARD AS THEY CAN AND IT DOES NOTHING.

It all leads back to a tweet I wrote awhile ago-

So no, the Fed hiking will not lead to widespread deflation- the Treasury will break before that happens, and the system will be flooded with money.

And ironically the higher and faster they hike, the quicker the largest borrowers in the world, the federal governments themselves, become bankrupt.

We are in a macro environment that is more indebted than any other time in human history. The higher they raise rates, the more interest is due on all these debts, and to prevent a collapse greater than the Great Depression, the central banks have to print MORE.

Thus hiking rates ironically really does nothing in the long term to fix the situation. It may slow inflation in the short term but it dooms the central bank to print more in the long run in order to stave off Treasury collapse.

NO WAY OUT

All this inflation is caused by corporate greed. Large companies with monopolies are hiking prices to take advantage of people. It’s all a scam.

Look, I completely understand where this is coming from. A ton of corporations have taken advantage of their market share to hike prices, garner unfair profits, and even fire workers without cause.

This much is true. However, the broad increase in prices of everything, from lumber, to coal, to computers and food, is NOT due to soulless companies- it is due to a 40% rise in M2 money supply financed by the Fed! Milton Friedman said it best- “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

Restaurants, small businesses, real estate, family farms, plumbing companies, and many more distributed industries saw large increases in prices charged to consumers in the last 2 years- this is without major monopolies controlling the majority stake! And for those who would posit that this inflation is “just due to the war in Ukraine” and gas disruptions from Russia, may I remind you that inflation was already at 7.5% per the BLS in January 2022, before the war had even begun!

It’s easy to blame businesses for this phenomenon, and like I stated- there are definitely some firms guilty of price gouging consumers and labeling inflation. But your local small deli store or carpentry shop aren’t raising prices to hurt you, they’re doing so because the price of all their inputs are rising- and thus what they charge to consumers must rise as well.

If deflationary collapse occurs or the government defaults, we can repeat the Bernanke playbook post 2008; just lower interest rates again to 0% to ensure Treasury solvency.

This is a common counterargument. However it falls prey to the exact same conundrum that was discussed earlier- namely how everything the Fed does to avert disaster would make the situation worse, not better.

By lowering interest rates to 0%, this stimulates loan demand and therefore credit creation, which spurs an increase in money supply as the banks lend money into existence. Everyone goes to take out loans, buying cars, houses, food and essentials on credit. Debt burden thus increases in the system overall, making it even harder for the Fed to raise rates in the future.

And this serves to incentivize the Treasury to borrow and spend even more recklessly, as they have the excuse of low interest rates to finance government spending. ALL this does is only slightly delay the inevitable and make the problem worse, not better.

Furthermore, this credit boom increases inflation as new money is created and pumped into the system. So it doesn't even solve that problem.

The fundamental issue, stated again and again, is that the Treasury is underwater and is spending out the wazoo, and as inflation continues to rise, Treasury spending will continue to rise and thus borrowing will increase.

Lastly, let’s talk about the elephant in the room- the bond market!! If the Fed implements Yield Curve Control, similar to what the Bank of Japan did to their market, then they would effectively push bond yields down, but the price would be promising to do infinite QE to buy any bond with a yield above the set amount.

Who wants to buy 0%, or 0.5% bonds, when inflation is 8%? Nobody- so the Fed will have to be the buyer of only resort, which means they will effectively monetize all Federal deficit spending. QE will thus steadily increase for the foreseeable future as the entire bond market gets eaten by the Fed.

Money velocity is insanely low and keeps dropping. The idea that inflation can accelerate with falling velocity is asinine, and thus inflation will subside back to 2% within a year or so.

This is another common argument, especially among those who are educated in economics. At first glance they seem correct, as the chart above from the Fed demonstrates, there appears to have been a massive collapse in money velocity since the late 1990s and especially since COVID.

What they fail to understand is that the manner in which money velocity is calculated is extremely flawed. Instead of using the actual transaction volume of the economy divided by GDP (which would be difficult to do, but could potentially be done with data from Visa and Mastercard as well as ATM txs), they calculate it as

“the ratio of quarterly nominal GDP to the quarterly average of M2 money stock.”

Thus, the denominator is the money supply- and as money supply expands, the equation forces “money velocity” lower and lower. This equation works well enough if you have stable GDP growth and flat or miniscule money supply growth; but it blows out as soon as we see massive money printing like we did in 2008 or 2020. The estimate therefore goes LOWER as money supply INCREASES, which is ironically just the opposite of what happens in reality!

Just take this equation to the real world- if countries like Venezuela who have hyperinflation suddenly use this metric, they would theoretically REDUCE money velocity by printing more money. The velocity there, with money supply growth over 5000% YoY, could easily be infinitely near zero- estimating that 1 Venezuelan bolivar only changes hands every century.

If you go in the streets or talk to the people living under this monetary hellscape, you will see that they spend every dollar the DAY they get paid- as prices will change hour to hour, day to day. They treat their currency like melting ice cubes in the hot tropical sun; they must be used immediately or else be completely wasted. See this documentary for examples.

These kinds of illogical, nonsensical equations can only be thought of in the ivory towers of academia and banking institutions which are protected from the consequences of the real world. None of this works in practice.

So no, money velocity didn’t really fall THAT far in 2020, it just appears that way due to the way it is calculated. Now, did it fall somewhat, maybe 10-20%?? Sure! But that can only be determined by looking at live transaction data on the real economy, not arcane equations made up by the Fed.

So many PHDs and so little common sense….

QE is a net good for the economy. It creates a wealth effect and thus stimulates aggregate demand, increasing prosperity and asset prices for all. The rising tide lifts the boats.

This is another common argument I see from the Neo-Keynesians. Let’s remember first that QE is a completely new experiment- it was not used during the 1800s and early 1900s for example, where America entered the Gilded Age and experienced some of the fastest economic growth in human history. It wasn’t used during the 1950s or 60s, another period of rapid development. So we were able to achieve massive economic growth WITHOUT centralized banking or money printing- in fact, I would argue that on a percent of GDP basis we grew faster during these times and the average worker experienced far more prosperity than now.

It’s only been used at scale post the 2008 financial crisis and into the “lost decade” of the 2010s and 2020s that we are currently experiencing. The thesis was by boosting asset prices we therefore boost the economy; but this is asinine on several levels. First, WHO holds the assets? Recall that the top 10% of Americans hold 84% of all registered stocks on exchanges. They also hold the majority of the land, housing, businesses, and debt instruments. Goosing asset prices higher only directly helps these economic elites- it does little for everyone else.

Besides, this creates the “credit boom” that Mises described- an artificial rise in asset prices solely due to central bank interference. It is not based on true economic productivity.

The Fed creates no new factories, they create no new jobs, no innovations, no startups. Instead they create cheap money which “funds” these things- but as the price of money gets distorted, so do investments, and thus unprofitable and useless projects are built up with debt.

This results in a phenomenon similar to the Chinese “ghost cities”- entire sections of the economy built without need or purpose, and worse, they waste limited commodities and energy to create.

When the debt cycle rolls over, as it always does, the debt must be paid, and the assets that are liquidated are found to be near worthless- a waste of time, energy and resources.

QE therefore harms the real economy and enriches the wealthy at the same time. It cannot be said to be capitalist or socialist; it is simply plutocracy and kleptocracy; crony capitalism where the wealthy steal from the poor and foot them with the bill.

Even if inflation gets a bit high, it won’t and can’t get worse. The system will be fine, and the Fed hikes will cure the situation. It’ll be rocky for a little bit, similar to the stagflation of the 1970s, but we’ll get through this and in a few years it’ll be back to 2%, no problem.

The issue with this argument is one of scale. Sure, in the late 1970s and early 1980s, the Fed, under the reign of Volcker, was able to hike rates to the 20% range, but debt to GDP at the time was 30%- not the mammoth 132% we have now.

Besides, this doesn't take into effect the slippage that will occur in bond markets- as the Fed continues to hike, bonds will selloff hard, racing ahead of the Fed and moving rates much higher, much faster than the Fed anticipates. With $31T of Federal debt, this means interest expense will spike; thus the Treasury must borrow MORE to rollover existing debt and in doing so lock in higher coupon payments, OR they must ask the Fed to pin interest rates LOW, in a policy called Yield Curve Control, but this requires infinite QE as every time the yields peek their head above the target interest rate, the central bank must print as much money as needed to buy bonds, forcing rates back down to the target.

The Bank of Japan is currently experimenting with this policy, and it is creating an emerging markets currency crisis for them.

Besides, this ignores the basic feedback loops that take place once inflation rises above 2 or 3%- first, the inflation expectations loop, where people frontload purchases, driving up prices.

Next is the Treasury feedback loop- more inflation means deficit spending increases, which means more government borrowing, which means more QE, which means more inflation.

After that is money velocity- as inflation increases and people lose faith in the currency the speed of transacting in the money starts to increase. This increases inflation as the dollars get turned over faster, and are able to bid more products within a given timeframe (say a month or a year)

Next is the wage price spiral, where prices rise, forcing workers to strike or demand higher pay, which is usually eventually given, which increases business costs, which forces higher prices, repeating the feedback loop.

Long story short, once the inflation genie is out of the bottle, it is very hard to put back- and it usually begins to grow a life of it’s own. These processes feed on each other exponentially.

Worse yet, like already stated, there is $31T of federal debt, $20T or so of Eurodollar debt overseas, and $166T of unfunded liabilities owed by the US government - all debts which must be paid in dollars, which must either be paid through taxation or the printing press. Passing new tax laws during an economic downturn is essentially political suicide, so the printing press is the likeliest answer here.

The REAL risk for hyperinflation lies in the international community finding another World Reserve Currency - if this happens, either slowly or over time, the global DEMAND for dollars switches into global SUPPLY of dollars as USD positions are liquidated in favor of the new global reserve currency.

The dollars are now dumped for real goods and services- and the strong tailwind of demand becomes a headwind of supply as USDs flood back into America, bidding up prices of land, food, manufactured goods etc. The scramble becomes a stampede and the entire system unwinds as trillions of dollars flow back to the States, causing a massive whiplash in inflation and further pushing the US Treasury into deficit spending, thus causing more money creation, and more inflation, in a vicious feedback loop.

Again, this process may take years to play out- but no reserve currency has lasted forever, and the inherent structural defects explained by Triffin’s Dilemma cannot resolve themselves. All currencies come to an end.

What would the effect of a CBDC (Central Bank Digital Currency) be? Would it be able to be used to “reset” the system?

I am being completely honest and transparent when I say this- CBDCs must be resisted AT ALL COSTS. Most people are completely blind to the level of Orwellian control that this sort of technology would implement over the populace.

Remember, Keynesian economic theory rests on stimulating spending and consumption, and utilizing government deficits and central bank money printing to pull economies out of depressions. It arose from a need to get the US and Britain out of their 1930’s economic contraction and into a strong economic position in order to fight World War II. The Keynesians believed the best way to stimulate spending would be to cause inflation, as this would force people with “hoards of cash under their mattress” to go out and spend these funds before they lost more value.

There was no way to centrally force people to spend- they could just increase money supply and pump that money into the economy by government spending in order to hike inflation up and as a second order effect, produce higher spending patterns.

They’ve always wanted more control over spending- and a CBDC would get them there. With a CBDC, they would eliminate the need to have banks, credit unions or trust companies- you would essentially just make a direct account with the Fed. The Fed would be able to create new policies, written in code, that would enforce certain actions on your deposits.

They could program in a 1% weekly negative interest rate- the balance would decline by 1% a week in perpetuity, and thus you would be forced to spend or invest it unless you wanted to see your money disappear.

They could enforce taxes directly to your account. You buy cigarettes? That’s unhealthy and against their guidelines. $15 taken. Alcohol? Doesn't promote work ethic- $10. New car? That’s bad for the environment. $1900.

They could even ban travel, remove the ability to buy firearms or food, and reduce your ability to use healthcare services.

The issue is not whether these things are good or bad- there are arguments to be made for reducing consumption, buying used cars, reducing environmental waste, etc.

The issue is that to force these policies on the people via a CBDC would grant the Fed and Treasury virtually unlimited, Orwellian power to control and command almost every aspect of a citizen’s life. Freedom of speech would now be an afterthought- who cares about the protest if no one can buy a bus ticket, Uber, or gas to get there??

And the worst thing is these extreme neo-keynesian economists ACTUALLY THINK this would be a good thing! “Think of all the policies we could implement! We could ban smoking, we could reduce travel, we could lower CO2 emissions directly! We could even eliminate the IRS as we can tax people directly from their bank account!”

In my opinion, the economists who support these kinds of policies are nothing but grifters, frauds and cronies of the lowest sort- those willing to force total financial control on the populace so that their “theories” can be tried in real time, on real people.

Furthermore, I think it would be incredibly difficult for them to “reset” the system. Monetary resets have happened before, but usually they occur only under the most difficult and strenuous of circumstances, and involve an issuance of a new currency that is some fraction of the old one- for example, in Peru, due to the bad state of economy and hyperinflation in the late 1980s, the government was forced to abandon the inti and introduce the sol as the country's new currency.

The new currency was put into use on July 1, 1991, by Law No. 25,295, to replace the inti at a rate of 1 sol to 1,000,000 intis. Coins denominated in the new unit were introduced on October 1, 1991, and the first banknotes on November 13, 1991. The new currency was basically a reverse stock split of the old currency- and if a monetary “reset” occurred in this manner, the only intended effect would be to boost confidence in the currency and thus shore up bank deposits, slow down monetary velocity, and reduce inflation.

The “reset” would likely hurt the working class the most- as some wealthy government elites would know about it beforehand, they would sell their assets for another currency, wait until the conversion, and then re-buy the assets with the new currency. The old currency, the Inti, quickly became completely useless as everyone switches to the new system.

I’ll be honest, I’m not exactly sure what a CBDC “reset” would look like, as it has never been tried before. I think the main issue is the debt- does the debt get converted as well? If so, then the problem may not be really solved. If you convert the debt at 10:1 and the currency at 10:1, what has really changed?

Nothing- and therefore likely what they would do is apply a different conversion rate to debt to de-lever the system and wipe at least some of it out. But this is all speculation.

(You didn’t hear this from me, but there has already been a covert war on cash and ATMs from the CIA, look up Operation Choke Point).

CBDCs must be resisted. At all costs.

Just cut government spending down to zero, or close to it! This would solve the issue.

This is another common counterargument- the hyperinflationary feedback loop rests on government deficit spending, which increases during inflation, resulting in more borrowing, and thus more money printing, and thus more inflation.

If we cut government spending enough to drastically reduce deficits, we would essentially be gutting our own economy, and very quickly bring on a Great Depression. The only “tool” that we have to escape a Great Depression quickly IS government spending, and thus we would be in for a long, hard downturn with severe unemployment and price collapse.

Remember the equation for GDP:

Government spending is part of the value add of the formula FOR GDP. Thus, if we reduce government spending, all else being equal, we REDUCE GDP.

According to data from the St. Louis Fed, Federal Net Outlays are currently 29% of GDP, in 2021 data. Thus, if we were to severely slash government spending, we would see a reduction of 25% or so. To get rid of the deficits, we would have to slash so much spending that we would basically immediately see a collapse of 15.96% of GDP within a few weeks.

As all things do in economics, this would have immediate knock- on effects. Government contractors, like Boeing, Lockheed Martin, or Raytheon would quickly lose huge revenue streams. Massive layoffs would occur across defense, infrastructure, social services, and more- and within a few months GDP would drop another 10% or so.

This would spur on a deflationary wave similar to the Great Depression. Unemployment would soar- bringing all the issues with it, the soup lines, homelessness, crime, collapsing house and business values, and political upheaval. If the FDIC did not step in to print enough money to shore up the banks, there would be widespread bank runs as the capital reserve requirement for banks is 0%- and most banks only hold 2-5% of reserves in cash to pay out to consumers who want to redeem their deposits.

In my opinion, all this is besides the point- the government will NEVER cut spending this much, and create this severe of a depression, to stave off a crisis they believe cannot occur.

Firstly, most government spending is mandatory- per the Government Accountability Office, 70% of federal outlays are already earmarked and must be spent. To reduce the size of these programs would basically require an act of Congress, a bill passing through the House and Senate and signed by the President.

The other 30% of discretional spending is very hard to cut as well- lobbyists, corporations, citizen’s rights groups, unions, and other powerful interests will do anything in their power to ensure that the money continues to flow into their coffers.

Besides, some of these programs are good, or at least appear good! Imagine the political backlash if a House Rep proposes to cut food stamp benefits, or funding for the DEA, or National Parks Service.

Remember who runs our country- and these people will do virtually anything to prevent the money spigot from turning off. They do not believe, or maybe don’t even care, if extreme inflation comes. They are benefiting from the structure of the current system- why would they change it?

Delete all the debt!

The basic equation learned in first year finance and accounting programs is this:

Thus, for every asset there is a liability or equity. If you destroy one side of the equation, the liability side, you simultaneously destroy the other side of the equation, on someone else’s balance sheet!

Treasury bonds are debt, and a LOT of them are held by Boomers in retirement accounts. Even if we could go in and somehow “delete” the bonds and annul the coupon payments, this would be tantamount to deleting assets of these retirees- and what will they have to retire with then? The retirement accounts would lose trillions of dollars worth of value!

There is no easy way out of this trap. Remember, in a debt based monetary system, most money is actually credit- the only “real” money that is not someone else’s liability is cash, but his makes up for less than 3% of total money supply. Imagine if we had a 97% reduction in money supply within a few months- the pure economic catastrophe that would occur is unimaginable.

Besides, remember debt based instruments, like Treasury bonds, are literally the collateral that holds this whole system up. There is $2.2T in reverse repo secured by Treasuries, and most of the Eurodollar market, as well as the interbank repo market (which blew up in September 2019, spurring a Fed rescue). Wiping out the debt would also wipe out the collateral which underlies the entire financial system.

It’s all intricately linked together, like a wired bomb- remove any connection, and the whole thing can blow. That’s not to say that this would be impossible, just that it is very unlikely to be taken as a serious response to the crisis.

What if you’re wrong? These predictions are extreme, and others have predicted this before. It didn’t happen.

I don’t think I’m wrong, but even if I am, I think the bull case is a worse version of the 1970s stagflation. Inflation is already at 8%, via official CPI data (realized inflation is already like 16%, per ShadowStats)

Stagflation is an economic condition whereby the economy contracts while inflation remains elevated. Layoffs are already becoming widespread, especially in the tech, car and mortgage industries, which have the most sensitivity to rising interest rates.

Oil prices are exacerbating the inflation situation- energy is the input to virtually every single moving part of our economy, and thus higher energy prices means higher and more sustained inflation rates.

We are having record inflation while the US is draining the Strategic Petroleum Reserve (SPR) and while China is offline. In a Macrovoices interview in October, Louis Vincent Gave laid out the case that when China comes back online, they will require an additional 1.5M barrels per day of oil, which will likely shoot prices back above the $120 level, from the $80 or so they are at now. This could shoot inflation easily above 10%.

Payrolls have been stronger than expected, but I believe this is mainly due to declines in full time positions and increases in part time positions. The US economy will fare relatively well compared to other countries given the built in demand for the dollar, but in my opinion if the Fed continues hiking we will see a severe recession, and eventually depression if they go high enough.

Tax the rich at 100% and that will cure the issue

If we tax all the billionaires at 100% we would acquire roughly $4.18T worth of assets. However, there is a gargantuan $31T of debt and $160T to $222T of unfunded liabilities. This would be a drop in the bucket.

Furthermore, a LOT of the assets are illiquid, hard to value, or dependent on market conditions. If the Treasury somehow acquired 20% of Tesla, for example, they could only sell small amounts slowly so that they do not crush the market and shoot themselves in the foot.

Even if we take it at face value, $4.18T would only pay for about 8 months of Federal spending (using 2021 figures). The issue is just too big for even the wealthiest to handle.

The politicians have dug us a hole so deep that it is impossible to get out.

Do you still believe in MOASS? How high can the price go?

Yes, I still believe in MOASS and I still hold GME. I don’t write about it as I believe other people have done better research and I honestly don’t have anything to add.

I don’t know how high the price can go. Anyone who tells you that is lying. I can’t tell the future and there is no mathematical model to accurately predict the price action.

I’ve DRSed all but 5 shares. I’ll move those soon.

Other than GME, what can I buy? What can I do?

First, educate yourself. I’ve included reading lists for every section, highly recommend you start there. Also check out podcasts such as macrovoices, planet money, and bankless.

Next, I am NOT going to give individualized financial advice- just generally share what’s done well in the past. I highly recommend you go talk to a financial advisor and just tell them you are worried about inflation staying above 10% for the next 5 years or so, and ask them what they think are wise investments.

I think real estate will do well, but you have to be extremely careful with payments, make sure you can cover them and then some so you don’t get your house repossessed.

I think equities on the whole will do well, until the very end when the money truly dies and inflation reaches thousands of percent. IF that happens, then real tangible assets (farmland, food, gas, water, bullets) will gain tons of value. If Bitcoin isn’t used as a medium of exchange, then we would likely go back to a barter system. Again, I don’t see this happening- I think we would switch to a new money before the worst of the hyperinflation hits us.

Equities are closer to the money printer than almost anything else and as bonds melt down and become monetized, institutional money will flow to them. A certain stonk of a “dying brick and mortar” will likely do better than all others.

I also believe MOASS will happen before any extreme inflation event occurs. In my opinion, hyperinflation would be 3-5 years out (more likely closer to 5 years) IF THE FED takes the route I think they will take. At current rates of DRS, we will likely reach 100% DRS long before that.

Will that cause MOASS? I don’t know. It’s never been done before, to my knowledge. But why don’t we find out?

Many have asked me if it’s wise to take on debt to buy assets. Overall, I would say it is, but you need to be very careful. If your primary income is a job, remember that inflation rates almost always rise faster than wages- so you need to expect your real income to fall. If you can switch jobs faster, or you are in a highly paid, high demand industry then you will likely be fine, but this is something to watch out for.

If you own a business that will do well in inflation, then you can be more aggressive. However, with all of this you need to understand the caveat- the Fed can still choose deflation. I think this is highly unlikely, but it is possible, so you need to be prepared for it. If I were looking to invest in real estate/assets right now, I would save up cash and wait for the Fed to officially pivot back into QE to buy. The market could trend downwards for some time until the Fed pivots.

The one thing I personally would stay away from generally is bonds. Inflation linked bonds, if high enough yield and short enough timeframe (less than a year) might be OK, but almost all other bonds will lose value in real terms as inflation stays elevated.

Deflation is the easy way out. The people in charge will see the inflationary crisis coming and opt for a de-leveraging of the system instead.

Again, I wish i could say I believed this would be the case. First thing you have to understand, a deflationary crisis would be better and worse than an inflationary crisis in different ways. We would see a complete collapse of the asset bubbles in stocks, bonds, real estate, technology, crypto, art, and more as the leverage in the system unwinds. There would be massive layoffs as government subsidized industries grind to a halt, and a collapse in GDP as huge parts of the federal government, defense and infrastructure sectors, and transfer payments like social security completely turn off.

The public backlash from this would be incredible- a new Occupy Wall Street, and severe protests from people across the political spectrum over the defaulted promises of the government.

Unemployment could easily soar to 20% or more. Bread and soup lines, homelessness, crime, and more would proliferate. Bank runs would occur, and if the FDIC did not get Treasury or Fed backing, their cash on hand would run out and bank deposits would no longer be insured. Your money in the bank would become worthless.

Money market funds, hedge funds, pension funds- all would collapse. Only those who hold physical cash would fare well; as prices of everything enter freefall, they could rush in and buy distressed assets at bargain prices.

Overall, would this be better for the working class than hyperinflation? Probably. Most debts, including credit card, auto loans, student loans, and mortgages would default, and the banks, unable to collect the tsunami of assets that they are “owed” as collateral, would likely fail.

The system only works on the margins- if a few people default on mortgages, the banks can repossess their homes and sell them. What if the majority default? Police would likely not be willing to go door to door through entire neighborhoods and kick residents out for a greedy bank that overlevered itself and will fail without these assets.

Besides, remember who RUNS the system- the wealthy, by and large. They own most of the assets; the land, the casinos, the businesses, the stocks, bonds, and derivatives. The system unwinding and asset prices collapsing means a collapse of THEIR wealth more than anyone else’s. The notion that they would opt for this depressionary outcome rather than an inflationary one, which is comparatively better for them, is asinine.

What will replace the Dollar as World Reserve Currency?

This is an incredibly difficult question to answer, as there is great uncertainty surrounding how the major powers will react to an unwind of the Dollar-centric global monetary system. The last few times we had a transition to a new WRC, there was a clear rising global superpower that could take on the mantle and conduct enough trade to keep the system running.

For example, the most recent transition occurred from 1929-1944 took a decade and half, and required serious damage to the former global superpower, Great Britain. Pulling every resource to slow the German onslaught in the early stages of World War II, Churchill was increasingly worried of the potential of a mass invasion of the home island, and thus began shipping British gold to the United States to be stored with the Fed and Treasury for safekeeping.

Other Allied nations, such as France, followed suit. Hundreds of tons of gold flowed west- and by the end of the war the US had 50% of the above ground gold in the world. Standing virtually untouched by the ravages of war, while Europe and Asia lay devastated, America superceded Great Britain in terms of military and economic strength.

She was now able to lay the terms of global trade- with the only Navy large enough to protect vital trade routes from state actors and pirates, the US could now force her own terms on the world, and these terms were cemented in the Bretton Woods agreement in 1944.

The Dollar would now be the new World Reserve Currency- and instead of holding gold and trading gold certificates, they would hold US Dollars, which would be redeemable for gold.

This system worked because there was one superpower with sufficient might to enforce it- but after a breakdown in our current monetary system, there is no single nation that can become WRC holder.

China has a closed capital account- they don’t really allow free movement of capital out of the country, which has to be done if you want to have a WRC. India does not have a Navy large enough to enforce trade. Russia is a massive commodities powerhouse, but has a declining population, crumbling infrastructure, and as we have seen in Ukraine, a military that is far more of a paper tiger than most analysts had predicted.

There is no unipolar world in our future- only a multipolar one, with various regional powers vying for control. In this sort of a system, the new reserve currency would have to be a neutral one. There are several different options.

The first is something called the Special Drawing Right, or SDR. The International Monetary Fund’s website describes it like this: “The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. The SDR was created as a supplementary international reserve asset in the context of the Bretton Woods fixed exchange rate system. The collapse of the Bretton Woods system in 1973 and the shift of major currencies to floating exchange rate regimes lessened the reliance on the SDR as a global reserve asset. Nonetheless, SDR allocations can play a role in providing liquidity and supplementing member countries’ official reserves, as was the case amid the global financial crisis.

The SDR serves as the unit of account of the IMF and other international organizations.

The SDR is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. SDRs can be exchanged for these currencies.

The value of the SDR is based on a basket of five currencies—the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.”

This is a neutral reserve currency, already created and managed by the IMF, and used to a small degree in global reserve transactions between central banks. However, as many point out, the IMF is a clearly Westernized organization, controlled mostly by the United States, and thus is not truly neutral- oppositional countries like Russia and China would still dislike an SDR based world, although there are some benefits.

Namely, each country would be able to continue to use, issue, and control their own local currency, using SDRs instead for global trade and converting back to their own currency when needed. However, given that SDRs would be cleared through the IMF, there is still the potential for economic warfare in the same manner that was imposed on Russia in the early stages of the Ukraine invasion- a complete freeze and seizure of reserves, rendering the asset virtually useless. It may be easy to get Western countries to agree to this new system, but others will likely be wary.

The second option is a return to a semi floating gold standard- each country re-backs their currencies to gold and opts for floating exchange rates between currencies, and in order to ensure smooth functioning, everyone must allow free trade and redemption of gold, even between antagonistic member states.

Brent Johnson of Santiago Capital put together this great table- illustrating the price at which gold would have to be to re-back their monetary supply. To back M2 Money Supply in the US, gold would have to be priced at around $82k an ounce, whereas Russia could achieve the same backing for just $11k an ounce.

This is what would be called a floating gold exchange standard- where each country would store gold as reserves and use it for redemptions of their own currency. Russia and China are preparing for a system like this, evidenced by their massive dumplings of US Treasury positions and steady acquisitions of gold for their central bank vaults.

However, although this system worked *somewhat* well in the past, I simply do not believe we will return to it. This is due to multiple factors, but the largest being the inconvenience, difficulty, and trust required to continually move gold between central banks, banks, and individuals, along with the frequent bank runs that will occur on banks that over issue currency without sufficient gold to back it.

Gold is money, in all ways but one- it is difficult to use for small transactions. You can’t take an ounce of gold to the store to buy groceries, and shaving small pieces off a nugget to pay for goods isn’t something that is likely to happen in our 21st century, digitized world. Therefore, the SAME THING that happened last time will happen again-

They will re-back the currency 1:1 with gold. They’ll issue paper banknotes as claims against the gold. Once enough time has passed, they will slowly start to increase the supply of banknotes. 1.5:1, then 2:1, then 3:1. Once everyone finally realizes again that the currency has been inflated, and their value has been stolen, they can re-value the price of a gold to a new higher price and restart the process all over again.

The fundamental issue is trust- we have to give over large portions of gold to centralized entities for convenience and payment facilitation, but we have to TRUST that they will not print more paper currency than what can be backed.

This leads me to the third major option for what I believe can be a new World Reserve Currency- Bitcoin.

Bitcoin is a peer to peer, decentralized cryptocurrency that can send and receive value without a single trusted third party. Instead, Bitcoin relies on a network of nodes and miners to confirm and validate transactions, and then to record them in a block, which is appended to the most recent block- thus creating a “blockchain”.

Bitcoin has proven to be the most resilient, longstanding, anti fragile, and robust cryptocurrency to date, since it’s inception in 2009. Bitcoin mining is a distributed consensus system that is used to confirm pending transactions by including them in the block chain. It enforces a chronological order in the block chain, protects the neutrality of the network, and allows different computers to agree on the state of the system. To be confirmed, transactions must be packed in a block that fits very strict cryptographic rules that will be verified by the network. These rules prevent previous blocks from being modified because doing so would invalidate all the subsequent blocks.

Total computational power of the network has steadily increased since inception, making the network more and more secure over time- and although Bitcoin is slow to adapt and change, and perhaps even behind in smart contract development, many extoll this as a virtue. Any monetary network that has the properties of hard money, such as gold, must also be resistant to change, even “good” change as almost all changes are tradeoffs and create winners and losers.

If Bitcoin did eventually become the new World Reserve Currency, it’s value would be incalculable. There can only ever be 21 million Bitcoins- and divide the entire global GDP, asset base, and consumer goods by this figure and you see astronomical figures for a single Bitcoin. Imagine reducing the entire global money supply to $21M- a house could cost $0.50, a car 2c, a sandwich thousandths of a penny.

This is not a Bitcoin paper- there are authors much more intelligent than I with writings already in this area, such as Saifedean Ammous’ “Bitcoin Standard”.

However, I would recommend looking further into it. For all the Ethereum maxis out here, I also am not saying that Ether is worthless, or has no intrinsic value. From a pure monetary economics standpoint, Bitcoin is a harder money- harder to change and more difficult to update; and thus is much more likely to be used as a global reserve currency than Ethereum is.

This is not to say that ETH will not play a role, or cannot be used as collateral, or utilized for purchase of digital assets, NFTs, and the like; similar to how silver and copper were used under a gold standard.

It is just to say that for most countries, inexperienced in crypto and wary of control of monetary systems by powerful interests like the United States, are unlikely to choose systems wrapped with complexity and hard-to-grasp concepts. They are more likely to choose cryptocurrencies with robust protocols, (relatively) simple operations, hard supply caps, and a proven network effect- and Bitcoin has all of these.

Bitcoin’s second layer, the Lightning Network, which will be used to facilitate the daily payments that make up 99% of the transactions in the financial system, is steadily growing.

Lightning wallets are getting easier, cheaper, and more convenient to use by the day. Although there is not enough throughput on the base chain to support a global payment network, there is potentially on Lightning. Base chain transactions can be used for large purchases, like bank transfers or movement of funds for a land purchase, while the second layer can be used for shopping, ecommerce, microloans, etc.

Several countries have already adopted Bitcoin as legal tender and are implementing Lightning wallets as payment options for small businesses.

(The above statements are my opinion, and are thus subject to change. I am far from an expert on cryptocurrencies, Bitcoin or otherwise. I recommend doing your own research before you invest any funds into any token)

Ok, so you’re a BTC maxi? You hate ETH?

Woah, slow down there. I’m not like other people in this space, as you can see I am a very anti-establishment thinker and I don’t like getting lumped in with large groups I don’t necessarily agree with.

I still hold ETH, and LRC for that matter. I think these tokens DO have utility. The question that gets posed to me is will crypto surpass the dollar as a World Reserve Currency; and for this argument BTC is the clear winner.

Think of the Treasury market- the financial system needs a reserve asset, which can be used as collateral and/or sold during times of stress to cover obligations. Bitcoin has the best chance of becoming that. Corporations could hold BTC on their balance sheet as a reserve asset, like T-bills, and ALSO hold ETH for facilitation of smart contract payments.

Large banks, corporations do not care *yet* about smart contracts. They’ve invested in the space, but mostly around other L1 projects to my knowledge and not the actual smart contract development that’s taking place.

ETH’s smart contracts allow for the development of Dapps, decentralized applications where people can loan and borrow funds, swap tokens, and even get insurance without a single third party, instead a software protocol is the agent and enforcer of terms. These smart contracts can add incredible utility, but also as we’ve seen produce vulnerabilities that can be exploited. A simple cursory google search can produce dozens of results of examples of hacks.

Furthermore, ETH does not have a hard money supply. Although it is now deflationary money, this was not always the case. The fact that the rate of issuance and burn can be changed makes it a less hard money than Bitcoin- hardness here refers to the difficulty of changing the supply.

Overall, when extremely conservative institutions like nation states and banks look at using crypto for a reserve currency, in my opinion, Bitcoin will be preferred over other cryptos.

I highly recommend you read An Economic Analysis of Ethereum by Lyn Alden for more understanding. She lays it out in a concise, simple manner.

I’m not going to say anything more as I don’t want to get dragged into the crypto flame wars. To add onto that, I am a relatively new entrant into crypto, I am not an expert by any means. Please, please do your own research.

Hyperinflation can’t happen here. It’s never occurred in a developed country, especially one like the US.

This is another common retort. Almost everyone in the West suffers from recency bias; our monetary system has been stable the last 50 years- why can’t it be stable for the next 50, or 100?

Stability has only been achieved through the creation of a system that has built in demand for dollars- and anytime systemic risk has popped up through a crisis, we have kicked the can up the stairs by papering over the crisis with more debt. At a certain point the debt becomes far too unsustainable and the entire system either melts down or up.

Secondly, you’re wrong- this has occurred before in American history. The Richmond Fed posted this research paper explaining the basic process by which the Confederacy, the Southern antagonists during the Civil War, began turning to the printing press to finance the heavy costs of war against the North. The South was mostly agrarian, and lacked the industrial and financial centers of their counterpart. Thus, they were unable to borrow the massive sums needed to finance their war effort, and worse still, they lacked the centralized power to crack down on member states to cough up enough resources to fully pay for the war.

The early stages of the war saw rampant inflation as the Confederate government readily printed more to fund the rapidly rising war costs. However, it was not until the later stages of the war, where significant Union victories and destruction of Confederate infrastructure really began to damage public confidence in the currency. Although the money supply had grown by 2000x, prices climbed above 9,000x their 1861 levels as monetary velocity exploded and suspicions regarding the South’s defeat grew to be widespread. In such a world, Southerners knew their newfangled money would become worthless.

Our founding Fathers warned against banks and centralized control of money supply. Andrew Jackson went so far as to claim that bankers were those who “gambled on the breadstuffs of the country, and when they won, took the profits, but when they lost, charged it to the bank”. He spitefully called them “a den of vipers and thieves”.

Jefferson went even further-

There were only two ways he believed that a nation could be enslaved- by sword or by debt. When these debts finally come due, the unfortunate government response is to print any cash necessary to stave off default. It was stealing from the future, from the prosperity of our children- and the most immoral of ventures.

Thomas Jefferson was afraid that a national bank would create a financial monopoly that might undermine state banks and adopt policies that favored financiers and merchants, who tended to be creditors, over plantation owners and family farmers, who tended to be debtors.

Jefferson also argued that the Constitution did not grant the government the authority to establish corporations, including a national bank. Despite the opposing voices, Hamilton’s bill cleared both the House and the Senate after much debate. President Washington signed the bill into law in February 1791.

The National Bank acted as the federal government’s fiscal agent, collecting tax revenues, securing the government’s funds, making loans to the government, transferring government deposits through the bank’s branch network, and paying the government’s bills. The bank also managed the U.S. Treasury’s interest payments to European investors in U.S. government securities.

Although the U.S. government, the largest shareholder, did not directly manage the bank, it did garner a portion of the bank’s profits. The Treasury secretary had the authority to inspect the bank’s books, require statements of the bank’s condition as frequently as once each week, and remove the government’s deposits at any time for any reason. To avoid inflation and the appearance of impropriety, the Bank was forbidden from buying U.S. government bonds.

The Federal Reserve’s current program is one almost exclusively of purchasing Treasury bonds- and manipulating market interest rates through the fixing of the Funds rate, “Dot Plot” estimations, and forward guidance.

The current iteration is a perversion of even what a central bank in Jefferson’s time was created to do. Any illusion of separation of money and state is gone, and the Fed, owned by private corporations, exists solely to uphold the banking system and the governmental apparatus that protects it.

Over two hundred years ago, Jefferson issued a dire warning. The truth was obfuscated with decades of faulty economic theory and QE pumping financial assets.

We never listened. Now we must deal with the tyrannical, rent-seeking banking apparatus that has an iron grip over politics, economics and trade.

The Revolution will not be televised.