US dollar liquidity will usher in the biggest bull market in history

Treasury Secretary Janet Yellen, the real number two in the US peace, can unilaterally remove individuals, companies, or entire countries from the US dollar global financial system if she wants. Considering that having US dollars is essential for most people to buy primary energy (oil and gas) and food, removal from the US-ruled peace financial system is tantamount to a death sentence. She calls it sanctions, some call it a death sentence.

From a financial perspective, she is responsible for the rules and regulations that govern how the fiat financial system operates. Since credit makes the world go round, and this credit comes from banks and other financial companies, her will has a major impact on the structure of the global economy.

Her most important responsibility is to ensure that the U.S. government is funded. When the U.S. government spends more than it collects in taxes, she is called upon to issue debt in a judicious way. Her role is even more important given the size of the U.S. government's recent deficits.

Yellen publicly supports Slow Joe, but privately she is busy making sure the empire can issue bonds at affordable prices to feed the kids. Who are the kids? Baby boomers are getting older, sicker, and needing more and more health care products and other benefits. The military-industrial complex needs an ever-expanding defense budget to produce more bullets and bombs. Interest needs to be paid to wealthy savers so that promises to debt holders can be honored.

Yellen may be a bad person, but the market doesn't buy it. The yields on long-term Treasury bonds (maturity > 10 years) are rising faster than those on short-term Treasury bonds (maturity < 2 years). This creates a fatal problem for the financial system, known as "bear market steepening". I wrote about why this is so harmful to the banking system in my previous article The Periphery.

She needs to devise a solution that buys the economy time. So here is Yellen’s to-do list:

- Inject liquidity into the system, allowing stocks to rise. When stocks rise, capital gains taxes go up, which helps pay some bills.

- Trick the market into thinking the Fed will cut rates, thereby removing selling pressure on the stocks of banks that are not “too big to fail” (TBTF), which are insolvent.

- Mislead the market into thinking the Fed will cut interest rates, thereby creating demand for long-term debt.

- Ensure that the liquidity injection is not so large that it causes a spike in oil prices due to a weaker dollar.

The Fed kept interest rates unchanged at its most recent meeting and indicated a further pause in rate hikes as it continues to assess the impact of rate hikes so far. Meanwhile, Yellen said the U.S. Treasury will increase its issuance of short-term bills, which is what money market funds (MMFs) want. MMFs will continue to draw funds from the Fed's reverse repurchase program (RRP) and purchase Treasury bonds, which is a net liquidity injection into the market.

The rest of this article will focus on my argument, explaining why I think the above policies will lead to the following outcomes:

1. Inject $1 trillion of net liquidity into global financial markets, equivalent to the current size of the RRP.

(A) This liquidity injection will drive gains in U.S. stocks, cryptocurrencies, gold, and other fixed-supply financial assets.

(B) All other major central banks such as the People’s Bank of China (PBOC), the Bank of Japan (BOJ), and the European Central Bank (ECB) will also print money because now that monetary conditions in the United States are easing, they can print money without weakening their currencies.

2. The market believes that the US Treasury yield curve will steepen in a bull market.

(A) It would prevent the market from selling off all non-TBTF bank stocks.

3. Once the RPP is exhausted at the end of 2024, the doomsday of the U.S. Treasury market will be repeated.

This is one of the most important images to understand the power dynamics at the top of the empire. Slow Joe and Yellen instructing "Powell" to fight inflation at all costs

The problem with raising interest rates to a level that restricts the economy is that it will destroy the banking system. So the Fed plays a game where it pretends to fight inflation but is always looking for a way to justify pausing its monetary tightening program. The easiest (and most dishonest) way for them to achieve this is to make up misleading statistics about the level of inflation.

The inflation numbers that the government reports are bullshit. It is in the government's interest to downplay inflation and convince citizens that their eyes are deceiving them at the checkout counter. The price shock you feel when you buy a loaf of bread is not credible because the government tells you that inflation does not exist. To do this, bureaucrats create these representative baskets of goods to downplay the impact of rising food and energy prices. The misleading inflation statistics are calculated based on the price changes of this basket of currencies.

The Fed didn't like the high Consumer Price Index (CPI), which includes food to fill our bellies and gasoline to drive our chariots, so that led them to do some fancy math. Magically, this led to the creation of the Core CPI, or as they like to call it, "core inflation." The Core CPI excludes food and energy. But the Core CPI was too high, so the Fed asked staff to remove the non-transitory elements of the Core CPI to get a better (i.e., lower) measure of inflation. After doing more magical math, they created the Multivariate Core Trend Indicator.

The problem is that all of these manipulated inflation measures are above the Fed's 2% target. Worse, they appear to have bottomed out. If the Fed was really fighting inflation, then they should continue to raise rates until their fuzzy inflation measures hit 2%. But suddenly, Powell said in his September press conference that the Fed would pause to see the effects of its rate hikes.

My suspicion is that Powell was prodded a little by Yellen and told to expect him to pause again and signal to the market that the Fed is on hold until further notice. A slick policy response, is what I think.

The market wants to believe that a recession is coming next year. A recession means the Fed has to cut rates to ensure that the dreaded deflation doesn’t happen. Deflation is the result of falling prices as a result of falling economic activity. Deflation is bad for the filthy fiat system because the assets (collateral) backing the debt are worth less. This creates losses for the creditors (aka the banks and the wealthy). So the Fed cuts rates.

As I explained in my last article, as economic forecasts weaken, the market will buy long-term US Treasuries. This, combined with the general decline in interest rates caused by the Fed's policies, means that holders of long-term debt will profit. As a result, the yield curve will eventually steepen.

The market will take the lead and buy more long-term bonds instead of short-term bonds. This is because long-term bonds are more profitable than short-term bonds when interest rates fall. The result? The bear market steepening stops, the curve inverts more, and then when the recession arrives in 2024, the bull market curve steepens. The Fed achieved all this with just two pauses at its September and November meetings and a forward-looking negative outlook for the economy. This is a win for Powell and Yellen because no rate cuts were needed to achieve a positive market reaction.

I'll use a few simple graphs to illustrate this process. The longer the arrow, the greater the amplitude.

Figure 1: This is the bear market steepening curve. The curve begins to invert, yields rise across the curve, and long-term rates rise faster than short-term rates.

Figure 2: This is the ultimate yield curve. As the bear market steepening intensifies, at higher rates you get a positively sloped yield curve. This is the worst possible outcome for bondholders and the banking system. Bad girl Yellen must do everything in her power to prevent this from happening.

Figure 3: If Yellen’s Strategy Succeeds and the Market Buys More Long-Term Bonds Than Short-Term Bonds, the Curve Will Invert Again.

Figure 4: This is the final yield curve. The curve has inverted again, which is unnatural. The market is expecting a recession, which is why the long end of the yield curve is lower than the short end.

Chart 5: A recession is coming, or some TradFi companies go bankrupt, and the Fed cuts rates, causing short-term rates to fall and long-term rates to remain unchanged. This will steepen the curve .

Figure 6: This is the final yield curve. After all these phase shifts, the curve is steeper. The curve is positively sloped, which is natural, and the overall level of interest rates has fallen. This is the best possible scenario for bondholders and the banking system.

Bank rescued

The immediate impact of the re-inversion of the yield curve and the eventual steepening of the bull market is a decline in the unrealized losses on U.S. Treasuries held to maturity on banks’ balance sheets.

Bank of America (BAC) reported unrealized losses of $132 billion in the HTM asset class in the third quarter of 2023. BAC has $194 billion in Tier 1 common equity capital and $1.632 trillion in total risk-weighted assets (RWA). When you recalculate BAC's capital adequacy ratio (equity/RWA), by subtracting equity for unrealized losses, it drops to 3.8%, well below the regulatory minimum. If these losses were recognized, BAC would go into receivership like Silicon Valley Bank, Signature Bank, First Republic, etc. The higher the long-term Treasury yield, the bigger the shortfall. Clearly, this is impossible. One rule for them, another for us.

The banking system is choking on all the government debt they accumulated in 2020-2022 at record high prices and low yields. BAC is effectively a state-owned bank due to its TBTF designation. But the rest of the non-TBTF U.S. banking system is insolvent due to unrealized losses on Treasury and commercial real estate loans.

If Yellen can design a policy that causes bond prices to rise and yields to fall, then holders of bank stocks will have no reason to sell. This portends an inevitable future: the balance sheet of the entire US banking system will enter the books of the US Treasury. This will be extremely bad news for the credibility of the US government, because the government will have to print money to guarantee that banks will honor deposit withdrawals. In this case, no one will be willing to buy long-term US Treasury bonds.

Are there any consequences?

The challenge is that if the Fed cuts rates, the dollar will likely depreciate significantly. This will put extreme upward pressure on oil prices, since oil is priced in dollars. While the mainstream financial media and intellectually bankrupt cheerleaders like Paul Krugman try to deceive the public into believing that inflation doesn't exist, any experienced politician knows that if gas prices go up on Election Day, you're screwed. That's why cutting rates at this critical moment - when the Middle East is on the brink of war - would be political suicide. Oil prices could very well be close to $200 by Election Day next year.

Of course if you exclude all the things people need to live and make a living, inflation doesn't exist. What a damn puppet.

But what if inflation has bottomed out and the Fed pauses on rate hikes as inflation accelerates? That is a possible outcome, but I believe any discontent over rising inflation would be overwhelmed by the strong U.S. economy.

Strong economy

I don’t see a recession in 2024. To understand why, let’s go back to the first principles of what drives GDP growth.

GDP growth = private sector spending (including net exports and investment) + net government spending

Net government spending = government spending - tax revenue

When the government spends net money through a deficit, it generates a net increase in GDP growth. This makes sense conceptually - the government spends money to buy things and pay its employees. However, the government pulls resources out of the economy through taxes. Therefore, if the government spends more than it taxes, it generates a net stimulus to the economy.

If the government runs a large deficit, it means that nominal GDP will grow unless the private sector shrinks by an equal amount. Government spending—or any spending for that matter—has a multiplier effect. Let’s take an example that Slow Joe gave to the American public in his recent speech to illustrate the various conflicts in which the Empire has been involved.

The US government will increase defense spending. There will be many Americans making bullets and bombs to kill all the terrorists and more civilians around the empire. I am fine with that as long as each terrorist kills no more than 10 civilians. That is a "fair" ratio. Those Americans will spend their hard-earned money in their own communities. There will be office buildings, restaurants, bars, etc., all built for the workers in the defense industry. This is the multiplier effect of government spending because it encourages private sector activity.

Given this, it is hard to imagine that the private sector could shrink enough to offset the net gains in GDP growth contributed by the government. In the latest Q3 2023 data dump, US nominal GDP grew 6.3% and the annual deficit was close to 8%. If CPI inflation is below 6.3%, then everyone wins because real GDP growth is positive. Why would voters be upset about this situation? With CPI inflation at 3, it will take many quarters for inflation to reach a level that, in the minds of voters, exceeds the US economy.

The deficit is expected to be between 7% and 10% in 2024. The US economy will do well, fueled by a spendthrift government. As a result, the median voter will be quite happy with a rising stock market, a strong economy, and low inflation.

Short-term Treasury bonds

Yellen is not omnipotent. If she shoves trillions of dollars worth of debt into the market, bond prices will fall and yields will rise. This will destroy any benefit the financial system has gained from the Fed's pause in rate hikes. Yellen needs to find a pool of money that is more than happy to buy a whole bunch of debt without demanding a higher yield.

MMFs currently hold about $1 trillion in the Fed's RRP. This means that the yield on MMFs is close to the lower limit of the federal funds rate of 5.25%. The yield on 3-month and 6-month Treasury bills is about 5.6%. MMFs keep their funds at the Fed because the credit risk is lower and they can get funds overnight. MMFs do not sacrifice much yield to reduce risk. But if Yellen can provide more Treasury bonds at a slightly higher rate, money market funds will move funds from the low-yield fixed deposit rate (RRP) to the high-yield Treasury bonds.

In the latest quarterly funding report, Yellen promised to increase note issuance. One could argue that the sell-off in long-term Treasuries would have been worse without the $2 trillion RRP. Remember, Yellen restarted borrowing in early June after US politicians "shockingly" agreed to raise the US debt ceiling, allowing them to spend more money. At the time, the RRP was $2.1 trillion. Yellen has since sold a record amount of notes, and the RRP balance has halved since then.

Yellen issued $824 billion in notes and RRP decreased by $1 trillion. Success!

Please refer to my article on USD liquidity "Teach Me Daddy" to fully understand why USD liquidity rises when RRP balances fall. It is important to note that if Yellen increases the Treasury General Account (TGA), it will offset the positive liquidity deficit from the decline in RRP balances. TGA is currently around $820 billion, above the $750 billion target. Therefore, I do not expect TGA to rise from here - instead, I think it will probably remain the same or fall.

As the RRP is exhausted, $1 trillion of liquidity will be released into global financial markets. It may take six months to fully exhaust the facility. This estimate is based on the speed at which the RRP falls from $2 trillion to $1 trillion, and a forecast of the pace of bond issuance.

Before I go on to discuss how this money will find its way into cryptocurrencies, let me briefly touch on how other central banks might respond.

Weak dollar

When more dollars flow through the system, the price of the dollar should fall relative to other currencies. This is good news for Japan, China, and Europe. These countries all face fiscal problems. They come in different forms, but ultimately they need to print money to prop up parts of the financial system and government bond markets. However, not all central banks are created equal. Because the People's Bank of China, the Bank of Japan, and the European Central Bank do not issue the global reserve currency, there is a limit to how much they can print before their currencies fall relative to the dollar. All of these central banks have been hoping and praying that the Fed will ease monetary policy so that they can also ease monetary policy.

These central banks can also ease monetary policy, as the Fed’s policy will have the biggest impact, as the amounts involved are truly mind-boggling. This means that any money printing actions by the People’s Bank of China, the Bank of Japan, and the European Central Bank will have less impact, relatively speaking, than the Fed. When converted into currencies, the renminbi (China), yen (Japan), and euro (Europe) will strengthen relative to the dollar. They can print money, rescue their banking systems, and prop up their government bond markets. Finally, dollar-denominated energy imports become cheaper. This is in stark contrast to recent times, where money printing caused their currencies to depreciate against the dollar, which in turn increased the cost of dollar-denominated energy imports.

As a result, a massive injection of U.S. dollar liquidity will be accompanied by a corresponding injection of RMB, yen, and euro. Between now and the first half of 2024, the total amount of legal credit available globally will accelerate.

Stupid and smart deals

Given all the fiat liquidity in global markets, what should people buy to beat currency devaluation?

First, the dumbest thing one can do is to buy long-term bonds with a buy and hold mentality. This positive liquidity condition will continue as long as RRP > 0. When RRP = 0, all the problems with long-term bonds will reappear. The last thing you want is to be unable to profit from any form of illiquid long-term debt when liquidity conditions change.

Therefore, the dumbest take on this trade is to buy long-term bonds, especially government bonds, and be mentally prepared to hold on. Today you will experience a market-to-market gain, but at some point the market will start to price in further declines in RRP balances and long-term bond yields will slowly rise, which means falling prices. If you are not a skilled trader, you will smash your golden eggs with your diamond hands.

A moderately smart trade is to go long short-term debt with leverage. Stan Druckenmiller, the god of macro trading, recently told the world in a Robinhood interview with another god, Paul Tudor Jones, that he bought super long 2-year Treasuries. Great trade, bro! Not everyone is interested in the best expression of this trade (hint: it's crypto). So if all you can trade are manipulated TradFi assets like government bonds and stocks, this is a good option.

A slightly better trade than the moderately smart trade (but still not the smartest trade) is to go long large-cap tech companies, especially those that have anything to do with artificial intelligence (AI). Everyone knows that AI is the future. That means anything AI-related will boom because everyone is buying it. Tech stocks are long-term assets that will benefit from cash becoming trash again.

As I mentioned above, the smartest trade is to be long cryptocurrencies. Nothing outperforms the growth of central bank balance sheets more than cryptocurrencies.

Here is a chart of Bitcoin (white), the Nasdaq 100 (red), the S&P 500 (green), and Gold (yellow) divided by the Fed’s balance sheet indexed at 100 starting in March 2020. As you can see, Bitcoin has beaten all other assets (+258%) as the Fed’s balance sheet has expanded.

The first stop is always Bitcoin. Bitcoin is money and only money.

The next stop is Ether. Ether is the commodity that powers the Ethereum network, the best internet computer.

Bitcoin and Ethereum are the reserve assets of cryptocurrencies. Everything else is shitcoin.

Then we get into other layer 1 blockchains that claim to be improvements over Ethereum. Solana is one example. These have all been beaten badly during the bear market. As such, they will rally from extremely low prices and offer huge returns to brave investors. However, they are still all over-hyped and will not be able to surpass Ethereum in terms of active developers, dApp activity, or total value locked.

Finally, various dApps and their respective tokens will be launched. This is the most interesting because this is where you get your 10,000x return. Of course, you are also more likely to be strong, but there is no reward without risk.

I like shitcoin, so don't call me Maxi!

The way forward

I am watching the [RRP - TGA] network closely to determine if USD is flooding into the market. This will determine if I will accelerate the pace of my Treasury sales and Bitcoin purchases as my confidence grows with the expectation of increased USD liquidity. But I will remain nimble and flexible. The best-laid plans of mice and men tend to fail.

The Fed has injected a net $300 billion since Yellen gave the green light to borrow again in June 2023. This is a combination of a reduction in the RRP and an increase in the TGA.

The final uncertainty is the price of oil and the war between Hamas and Israel. If Iran is drawn into the war, then we should consider that there will be some disruption to the supply of oil to the over-leveraged Western countries. This will make it politically difficult for the Fed to pursue a hands-off monetary policy. They may have to raise interest rates to combat higher oil prices. But on the other hand, one could argue that there will be a recession due to the war and higher energy prices, which will give the Fed a license to cut interest rates. In either case, uncertainty will rise and the initial reaction may be a sell-off in Bitcoin. As we have seen, Bitcoin has proven to outperform bonds in times of war. Even if there is an initial period of weakness, I would buy the dip.

Since the start of the Ukraine/Russia war, the Long Term U.S. Treasury Bond ETF (TLT) has fallen 12%, while Bitcoin has risen 52%.

Since the Hamas/Israel war began, TLT is up 3%, while Bitcoin is up 26%.

If lowering the RRP is Yellen’s goal, it will only last so long. All the Treasury market concerns that caused Treasury yields to spike in 2010 and 2030 in a bearish way and put pressure on the financial system will return. Yellen hasn’t convinced her baby daddy to stop drinking, so after the calm, Bitcoin will return to being a live scorecard for the health of the wartime fiat financial system.

Of course, if those in charge of Pax Americana were committed to peace and global harmony, I'm not even going to finish that thought. These mofos have been waging war since 1776 and show no signs of stopping.