Connecting the Dots

Episode 1- Setting the Macro/Crypto scene

The key topics we cover today:

• Are we reaching the end game for fiat, credit-based financial system?

• Central banks have impossible choices to make.

• What does that mean for crypto?

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The End Game

2022 has been a bruising year for crypto and virtually all asset classes. Massive fiscal stimulus in response to the pandemic, supply chain disruption, a Russian invasion of Ukraine plus central banks keeping policy too low for too long, have combined to create a huge inflation spike. Amidst a growing political backlash, central banks have slammed on the brakes. And hard!

Sharp interest rate hikes, high gas prices, mortgage rates rocketing, plus the dollar reaching its highest levels in 20 years has created the fastest financial tightening perhaps in all recorded history and the impact on “risk assets” has been huge.

Despite the hit to financial assets, the Fed remains steadfast in their commitment to slay the inflation dragon, accepting that may lead to higher unemployment and recession. Panicked by spot inflation, they’ve lost all confidence in their ability to forecast future inflation and are now making policy through the rear view mirror. They will hike until something breaks and already the cracks in the financial system are beginning to appear, whilst every forward looking indicator suggests we’re heading for a deep global slowdown.

So what’s the end game and what does this all mean for crypto?

I came to crypto having had a front row seat to the Great Financial Crisis in 2008. The fiat, credit based system had reached its end goal. However, the short term pain of allowing financial armageddon was too painful a decision for anyone to take. Central banks and governments intervened, printing money and artificially inflating financial assets, which were the collateral underpinning the leverage in the system. Central bank balance sheets exploded higher. Liquidity flowed into financial assets and fiat currencies debased, driving an inequality divide. Asset owners became wealthier. Wage earning workers became poorer. 

There are no fundamental differences in the fiat system today, compared to the one that was bailed out in 2008 and again in response to the Pandemic in 2020. In fact, the debt piles and leverage are higher, central bank balance sheets more inflated. The ability to withstand a prolonged rate hike cycle diminished and we’re seeing that negative impact on financial markets at the moment. Central banks are no longer simply about controlling inflation. They’re a central part to market functioning and liquidity provision. 

Impossible Choices

As central banks attempt to remove the last decade of stimulus to try and control inflation, they risk blowing up the entire financial system. With the cost of living crisis, inflation is the dominant consideration currently. However, we are approaching the point where impossible choices need to be made once more. The lesser of two evils will once again come out on top, to artificially inflate assets and sacrifice fiat currency.

This process began with the Bank of Japan pursuing yield curve control and sacrificing the JPY. The Bank of England have since followed suit as disorderly gilt markets threatened to blow up the pension system and forced “temporary” intervention. GBP was the immediate casualty. The ECB are buying periphery debt as part of their “fragmentation tool” and with Germany no longer running its cheap energy-based surplus, they may soon be forced to support the entire European bond market.

So It's all about the Fed

The one that really matters in all of this is the Fed. With the US dollar as the world's global reserve currency, when the Fed hikes, they suck liquidity out of every corner of the world and crises start to unfold. Worryingly for the Fed, even the US bond market is looking unhinged. As surpluses disappear, demand for treasuries is falling at the same time the Fed embarks on quantitative tightening. UST’s have completely decoupled from long held macro relationships from growth to inflation breakevens.

It increasingly feels close to the point where the Fed are forced to turn liquidity tap back on and artificially inflate collateral once more. Sticky inflation is delaying that moment, but the delay likely forces an even stronger response when it comes.

This is the ultimate long term macro story for crypto playing out. A fiat system reaching its natural end point, artificially saved by the central bank printing press, sacrificing fiat currency as the lesser evil.

 The rationale for a trust-less, decentralised form of money has never looked stronger.

A Fed pivot, WHEN it arrives will fire the starting gun on the next crypto bull market.