Durian’s question to ponder:“Who is buying government bonds?”
Hi dream team,
As stated, I’m on a bit of a writing hiatus until late April given a few other projects. However, given the activity in the crypto markets since my previous post, I was having trouble staying away. Hoping this piece can help push the discussion beyond: “Number go up!”
This week, we explore:
The next act in the power shifts from nation-states to networks
The Triffin Dilemma and social media’s reflexive relationship with inflation
Catching up with Millennials: caught between a controlled yield curve and an unproven libertarian experiment
Banning crypto & grabbing water
Freedom vs. equality and the real problem with crypto
The problem with crypto is not that it is a scam. Or a bubble. Or used in any significant way today to evade taxes and finance terrorism.
The problem with crypto is it presents a viable alternative to monetary monopolies by national governments. A viable alternative to banks and other financial institutions. A viable alternative to intermediated exchange.
The real problem - for politicians, nation-states, and the less tech savvy & affluent within their borders - is, today, holding non-sovereign, algorithmically scarce digital-assets may be a better vehicle to protect one’s future purchasing power than fiat backed by nation-states. The sky-rocketing prices of BTC and ETH are evidence of many reaching a similar conclusion. The shift in power between hierarchy and networks is underway.
“But Pondering,” you plead, “Divorcing monetary sovereignty from nation-states is a bit far fetched don’t you think? I mean think about our collective identities, our hardened, multi-century institutions, the monopoly on violence by the state birthed in the French revolution and solidified through centuries of mass industrialization and high returns to violence on ever grander scales culminating in the global wars of the 20th century?! Surely, you don’t mean to suggest we are heading for a cliché ‘sovereign individual-esk’ world where nations lose control of their own monetary policy to…. distributed algorithms? I mean, sure - the internet has challenged faith in institutions and boosted the relative power of networks and polarized populations, but Pondering… let’s be real, the power of governments has never been more secure. Please stop the hyperbole”
To which I respond: EXACTLY. Which is why this crypto stuff is so wild. Why Act 3 of the internet may be the most dramatic yet.
In a way, the demise of the current financial system was embedded within its own creation. The real question was always: “what comes next?”
The Triffin Dilemma, Social Media & Precarious Scaffolding
For the unfamiliar, Robert Triffin was a 1960s economist who highlighted the paradox of a single nation’s currency serving as the reserve currency for the globe. In short, the inflated international demand for the reserve currency (USD in this case) to conduct trade & host FX reserves will lead to structural trade deficits for the issuer. While an inflated value for the dollar makes imports cheaper, the cost is less competitive exports and mounting deficits. In its effort to supply the world with needed dollars, the US has squeezed many of its own industries offshore, propelled inequality within its borders, and fostered the return of more extreme politics.
In many ways, the deficits of the US are structural in nature. The U.S. now accounts for ~15% of global GDP, but the USD still accounts for >50% of international trade. With a population of ~330m on a globe of ~7.9b, the writing was on the wall from the start. It took until 2021, but the the petro-dollar system is starting to show cracks.
A decade of stimulus, accelerating deficits, and ~US$6+ trillion in COVID relief spending are bringing questions of sustainability to the forefront. Just this week, Bridgewater’s Ray Dalio penned: “Why in the world would you own bonds when… bond markets offer ridiculously low yields?”
The sad reality is real returns on government debt has gone negative - you are literally guaranteed to lose purchasing power holding these assets. International demand for treasuries is drying up at the exact moment governments are accelerating new issuances. With over US$75 trillion in US debts outstanding and rising by the day, buyers are beginning to flinch.
If you are a boomer, the status quo of inflated asset prices & entitlement spending is someone else’s problem. Just a few more kicks of the can…
However, millennials are taking in this macro portrait and quietly asking… : “Does this rickety scaffolding really have another 30 - 40 years? How does this play out?”
Looking at my social media feed, I can’t help but notice the relentless barrage of “money printer go brrrr” memes, a disdain for institutions, and #Bitcoin hashtags burned into the minds of young people as if to say:
“Do you really want to be holding the bag when the trillions in debt, entitlement spending and monetary shenanigans comes due from propping up the asset prices and lifestyle of the boomer generation? Are you really going to sit here and take decades of decreasing purchasing power on the chin as governments inflate away debts that benefitted others?”
I’m not saying it’s right or wrong. I’m just saying its viral.
Twistedly, one of the leading indicators of inflation is… increasing expectations of inflation. Social media algorithms have been finely tuned to spread these exact messages of fear and greed like wild-fire. Small matches have already been lit in many fringe communities online. “Cash is trash” in #fintwits 2021 tag line.
Taking in this increasingly precarious scaffolding, young people have started looking around for an exit. Like a just-in-time life raft, the budding world of cryptocurrencies has emerged as an early favorite.
So here we find our millennial protagonists: squeezed between 1) a rigged financial system and a controlled yield curve likely to destroy their future purchasing power and 2) a risky, unproven libertarian experiment taking on the most powerful institutions on earth.
Rock, hard place.
A Tale of Two Cities
But which one is better?
On the one hand, the existing monetary regime is surprisingly regressive. Artificially depressed rates and cheap debt disadvantage the working class whose wages struggle to keep up with inflation - especially inflation in financial assets - benefitting investors / financiers at the expense of labor. Dovish monetary policy, globalization, and automation are a three-headed monster rampaging through the blue-collar towns of western democracies claiming ever more territory for the expanding “rust belt”.
On the other hand, there is a budding “internet of value” built on distributed systems and cryptography, promising users an alternative to today’s “rigged” system. A system based on transparency, individual sovereignty, and a return to hard money principles with a deflationary currency like Bitcoin at it’s core. A system promising to end the unsustainable fractional reserve banking excess of fiat and the regressive outcomes they encourage.
For incentives we will go through later in the post, I give the new crypto-based financial system a greater chance of success than most realize (while still small). However, I diverge from the crypto utopists - thinking we are likely to trade in one set of challenges for another. Different winners, same game. Meet the new boss, same as the old boss.
Similar to the power-laws of the internet, I imagine a new crypto-centric financial system would be ruthlessly meritocratic - allocating resources to those who truly create value for others in a market-based economy on a global scale. The difference is the value-capture is now native to cyberspace and harder to redistribute for the large swaths within a nation’s borders which will struggle to compete in this brave new world.
Cutting out intermediaries is a double-edged sword. Sure, you can cut out banks, bankers, and big tech from levying high fees and taxes on peer-to-peer transactions; a popular remedy no doubt. However, what happens when more wealth is stored in non-domiciled smart contract platforms or Decentralized Autonomous Organizations (DAOs) - accruing value in the decentralized web, away from the reaches of the nation-state, the primary vehicle of redistribution? I imagine that will be decidedly less popular - especially in developed economies where populations have grown accustomed to transfer payments.
In a world where crypto succeeds as a nation-state resistant store of value (a big if), the most talented, most connected, most tech-savvy individuals globally will thrive to a degree never before seen. Inequality between the “haves” and the “have nots” will yawn further and votes towards ever greater redistribution will be increasingly impotent.
So friends, we find ourselves here. Between a broken, regressive financial system whose only realistic path to paying off its massive debts is devaluing the currency which will only further accelerate the adoption of a new hyper-meritocratic crypto economy which is unlikely to produce outcomes in the interest of the majority which will likely lead to further social unrest…
While early days, the cycle for crypto adoption is beginning to form:
Seeing the mounting Debt / GDP ratios & negative real yields, foreign governments will be less keen to buy new U.S. treasury issuances (feel free to insert ECB or BoJ here)
This lack in demand should be met with an increase in interest rates to entice incremental buyers to fill the void
The US government realizes raising rates will lead to unsustainably large interest payments further compounding the unsustainable debt burden
Instead, the US government will elect to monetize its own debt directly - “i.e. print more money” in the vernacular, controlling the yield curve and devaluing the currency
Investors are unlikely to be excited about holding a devaluing currency and will ditch cash for stocks, gold, property, crypto and other stores of value (preferably beyond the reaches of the state) to protect their purchasing power - further inflating asset values and the gap between the have’s and the have nots
Central governments will strive to combat both inequality and an increasingly dire balance sheet through increases in taxation and capital controls / bans on other stores of value to stem the flight of capital
The devaluing currency, increasing tax burdens, and capital controls will only further encourage more capital flight for those with means (the rich)
A repressive monetary regime would be the perfect storm to push constituents into the crypto-economy -> digital assets with fixed supply, held in pseudonymous digital wallets reached only through memorized seed phrases outside the reaches of the state with the ability to send anywhere in the world at a moment’s notice
I obviously expect nation-states to put up a fight which is why crypto-assets are still sublimely “risky”. Yet, governments will find themselves in a bind. As several have noted, governments can’t actually ban crypto-assets, they can only ban their own constituents from owning them; pushing the innovation (and the financial gains) of the internet’s next iteration to the shores of geopolitical rivals.
The game theory for national leaders is a nightmare.
The Real Problem With Crypto
The next ~10 years will be wild, but it’s impossible to put the genie back in the bottle. Crypto is likely here to stay. Instead of the hourly price updates from resident cheerleaders on twitter, more people should be asking:
What would a crypto-denominated world actually look like?
Many people in emerging markets will be less subject to corrupt politicians and fiscal mismanagement which is still too fresh in the minds of many in Southeast Asia, Latin America, and Africa. No longer would political negligence or corruption destroy citizens’ life savings. Financial access would be equal opportunity.
On the other hand, equal opportunity from quite uneven starting points in a game without a referee to smooth out outcomes. Despite all the talk in DEFI about access to the un / underbanked, Ant, Google, OVO, Mynt, and mPesa have done far more for financial access in emerging markets than DEFI to date. Despite the distribution of ownership to users / early adopters, my sense is that a crypto-denominated world will bring about an even more cut-throat meritocracy than the internet-laced world we inhabit today. The early and tech savvy with swiss bank-accounts in their pocket bouncing from friendly jurisdiction to jurisdiction while left behind nationalists rage against the status quo. Governments progressively stripped of their powers of redistribution to smooth out the unequal gains of a rapidly digitizing world. The majority will find in a world of tech-enabled global markets unencumbered by protectionist policies, they cannot compete.
The real problem with crypto is it just might work.
And then what?
Disclosure: I have been invested in crypto for several years with larger holdings in BTC, ETH, and other Defi bluechips.
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