Moderator: Michael, Blockworks Macro
Presenter: Arthur Hayes, CIO, Maelstrom Foundation
Finishing & Compilation: Deep Tide TechFlow
On today’s episode, Arthur Hayes, CIO of the Maelstrom Fund, discusses the bursting of the sovereign debt bubble as bonds continue to see one of the largest sell-offs in U.S. history, the dreaded steepening of the bear market and its impact on bank balance sheets, market liquidity.
How can cryptocurrencies act as a safe haven in times of financial crisis?
Impact of high global debt
The nature of debt: Arthur likens debt to time travel, borrowing from the future to fund today’s activities, based on the expectation that the output of those activities will exceed the cost of debt, in a way that is theoretically a means of using potential future growth to drive current economic development.
Arthur notes that debt structures are often based on the fact that more people will be engaged in economic activity in the future, creating wealth and income to pay off those debts. If there is a decline in population growth, then this basic assumption will be challenged. In the case of slower or negative population growth, there are fewer participants in economic activity, while the debt burden remains, and the remainder must bear more of the repayment responsibility, especially in developed countries.
Arthur criticized the practice that had been trying to eliminate the business cycle since the end of World War II. He argues that this approach, which attempts to smooth out the natural ebb and flow of the economy through debt financing to avoid a recession and promote stable growth, has led to an unsustainable situation where the global debt-to-GDP ratio is around 360%, making managing interest on these debts a significant challenge.
Arthur stressed that when debt grows to such a high level, the economy has to invest a lot of resources just to repay the interest, which reduces the amount of money available for other productive investments. This high debt burden limits the fiscal space of governments, and they must allocate a significant portion of their budget to debt servicing rather than investing in education, infrastructure, or other growth-boosting measures.
**The bear market is steepening, and U.S. bonds are not fragrant? **
Definition: Bear market steepening refers to a situation in which long-term interest rates rise relative to short-term interest rates, which is seen as a negative signal in the bond market.
Arthur compared the performance of the Long-Term U.S. Treasury ETF (TLT) against Bitcoin. Since Russia’s invasion of Ukraine on February 24, 2022, Bitcoin has risen by about 50%, while TLT has fallen by about 17%. From October 7, 2022 to the present, Bitcoin is up about 24-25%, while Treasuries are down 3%.
Arthur points out that the traditional investment strategy, which is to invest in U.S. assets when the market is unstable. And now, investors are starting to seek a global asset like Bitcoin because it is not directly controlled by a certain country’s government like traditional assets, it is virtual and not directly seen and touched like physical assets. Investors are beginning to lose interest in U.S. Treasuries, fearing that the U.S. government’s involvement in global military operations will not sustain its economic commitments to retirees.
Arthur satirized investors who still buy Treasuries, even though the performance of the US 30-year Treasury has fallen by 50% over the past three years. He predicts that when these investors realize that bonds are no longer able to reduce the overall volatility of their portfolios, they will have to look for other avenues to invest.
Arthur believes that as investors become more aware of the changing relationship in the market, they will seek fixed supply of assets such as Bitcoin and gold, and this shift will drive the price of these assets up because of the huge global bond market. If investors start questioning the ability of bonds as a way to reduce portfolio volatility and whether the government can maintain the purchasing power of the bond market on energy, the demand for Bitcoin, tech stocks, and other assets could increase significantly.
Policymaker’s dilemma
Arthur mentioned that the Bond Market Volatility Index (MOVE Index) is often used to measure market instability, and when the index rises, it reflects an increase in market nervousness, and in order to reduce market unease and prevent further turmoil, the US Federal Reserve Bank or the US Treasury may step in to the market and take steps to stabilize the situation.
He noted that while rising long-term interest rates are often seen as good for banks, in reality, banks were induced to buy large amounts of US Treasuries between 2020 and 2022, and now the value of these bonds has fallen, leaving banks effectively insolvent, unable to lend and therefore unable to make money.
Arthur referred to a conversation he had with a volatility fund manager who mentioned that Bank of America disclosed a large number of unrealized held-to-maturity losses in its quarterly reports. These losses, although not reflected in the income statement, have actually affected the capital adequacy ratio of banks.
Arthur stressed that there are problems with the U.S. banking system, and signals from the market suggest that if the bank stock index falls below the level of March, it means that more banks are facing the same problems. As the interest rate curve accelerates, we are likely to see more pressure.
Arthur hypothesized that there would be a moment when a market participant or investor chose a bank and found that it owned a large amount of commercial property that had depreciated and had not incurred losses. When this happens, it can lead to banks being forced to sell these assets to balance their books, and if banks can’t figure it out on their own, they need money from the FDIC and U.S. taxpayers to step in to help them overcome their financial woes.
Arthur raised a key decision point as to whether there would be a comprehensive safeguard mechanism that would not only protect bank depositors’ deposits and ensure they wouldn’t lose them due to the bank’s problems, but could also extend to support various types of debt.
Arthur points out that the owners of financial assets are mainly the top 1% of society, who benefit from them, while the costs are borne by society as a whole. This has led to class divisions and social injustice, as well as the problem of inflation, which can manifest itself in different ways in different places.
Arthur mentioned that governments and central banks are likely to continue to print money and intervene in the market, especially as financial institutions face difficulties. He noted that while money can be printed, energy cannot be printed, which could lead to higher energy prices and become a persistent factor in inflation.
Arthur argues that inflation statistics are manipulated by governments and that everyone’s consumption basket is different, so everyone’s inflation rate is different. The real interest rate should be determined using the nominal GDP growth rate minus the yield on government bonds, which reflects the real level of economic activity.
Arthur points out that the United States was able to successfully implement the strategy of financial repression in the 40s and 50s of the 20th century because the United States was the only major producer in the world at that time. But in today’s globalized economy, this strategy may no longer work.
Debt, Global Competition and Asset Market Performance
Arthur noted that in 2023, every country is producing goods, there are workers who need jobs, and these workers want the government to deliver on its promise to bring jobs. Arthur mentioned that the current global trade imbalance, especially with the United States as a net debtor and Germany, China and Japan as net creditors, is not sustainable.
Arthur noted that the U.S. government’s monetary policies, such as the CHIPS Act and the Inflation Reduction Act, which are designed to encourage domestic production of goods in the U.S. through money printing, pose a direct threat to China, the European Union, and Japan. He quotes the phrase “Trade Wars Are The Mirror Image of Currency Wars”, which can lead to currency wars and ultimately real conflicts.
Arthur emphasized that over the past two decades, the U.S. government’s military interventions and operations in Afghanistan, Iraq, and Syria have been enormous, totaling trillions of dollars, and that these massive military expenditures have had an impact on the current state of the U.S. economy.
Arthur pointed out that central banks around the world need to issue debt, but the question is who buys it, and the ultimate “baggage” may be borne by ordinary citizens around the world. He predicted what the current market may see: yields on long-term bonds will rise, gold and bitcoin prices will rise, and the stock market trend will decline.
Arthur believes that ETFs could raise the price of Bitcoin’s fiat currency and could also centralize ownership of Bitcoin, a concern that runs counter to its spirit of decentralization. Arthur emphasized that cryptocurrencies offer a way to escape from the unsustainable traditional financial system. As more fiat currencies flow into the market while the supply of Bitcoin and other major cryptocurrencies remains the same or becomes deflationary, this scarcity causes the value of cryptocurrencies to rise relative to regular currencies.
Arthur argues that the value of money is not in its quantity, but in how much energy it can buy. He stressed that no matter what kind of currency it is, even Bitcoin, what matters is how much energy it can buy. Energy is a resource that cannot be printed, and if we continue to print everything else, not energy, then energy prices will continue to rise and become a sticky component of inflation that persists.
BTC’s Playbook in the Current Economic Environment
Arthur mentioned that in 2021, Bitcoin performed similarly to tech stocks, both of which reacted similarly to market volatility and macroeconomic factors.
But in recent months, bitcoin’s behavior has diverged, and against the performance of tech stocks, bitcoin has begun to behave more like gold. This shift means that Bitcoin is starting to be seen as a more stable store of value, rather than being tied to risky tech stocks as it was before.
Arthur sees the Bitcoin price as a combination of fiat money, liquidity, and technology. When the focus is on Bitcoin’s technology as a decentralized peer-to-peer currency, coupled with the liquidity of fiat currencies, it can lead to a huge bull run.
Arthur further noted that when global fiat currency liquidity increases (e.g., through quantitative easing by central banks), this additional liquidity tends to find investment channels, and Bitcoin is an attractive investment target due to its limited supply and decentralized nature.
Arthur mentioned that when the market’s focus is on Bitcoin’s technical superiority, and when it is accompanied by an increase in fiat liquidity, this combination can trigger a huge bull run.
Arthur mentioned that large institutional investors like BlackRock can have an impact on the Bitcoin market, which could have a significant impact on the future of Bitcoin if these institutions control a large number of Bitcoin and mining operations. He proposes a scenario where institutions such as BlackRock absorb a large amount of bitcoin in circulation through ETFs, which could cause bitcoins to become less liquid because those bitcoins will be locked up in ETFs instead of being traded freely.
Arthur is concerned that if these institutions become major shareholders in Bitcoin mining operations, they may not support upgrades to the Bitcoin network, which may include enhanced privacy or encryption to ensure Bitcoin as a solid cryptocurrency asset.
He believes that the participation of institutional investors is a double-edged sword. On the one hand, they can bring a lot of money and credibility to the Bitcoin market, but on the other hand, they can have a negative impact on Bitcoin’s decentralization and free liquidity. Arthur noted that if the majority of Bitcoin’s supply is controlled by these institutions, then Bitcoin’s very nature as a decentralized, freely tradable asset could be threatened.
Regarding market cycles, Arthur believes that the usual sequence is to start with Bitcoin, then move to major other cryptocurrencies such as Ethereum, and finally riskier assets. He pointed out that each cycle brings new “new things” to attract the attention of the market, and although the Maelstrom Fund is involved in these cycles, it is very challenging to get consumers to embrace new things and change their behavioural patterns that they have been accustomed to for a long time.
