FED MADNESS: The Revenge of the Repos (Episode One)

Source: Board of Governors of the Federal Reserve System (US), Nonfinancial corporate business; debt securities and loans; liability, Level [BCNSDODNS]; U.S. Bureau of Economic Analysis, Gross Domestic Product [GDP], retrieved from FRED, Federal Reserve Bank of St. Louis; October 31, 2019. Shaded areas indicate U.S. recessions.

Last month in mid-September, United States investment banks had liquidity needs that haven’t been so exaggerated to such an extent since the 2008 financial crisis. Using history as our guide to help shape our view of the future, it wouldn’t be prudent to overlook the significance of the securities repurchase, or “repo”, market developments over the past month without first giving consideration to their significance in the most recent financial panic. Prior to the massive Credit Crunch that caused the crisis in 2008, Bear Stearns went around Wall Street asking for such large sums of cash in the overnight lending markets from other banks (bank-to-bank) that the others simply did not have on them to lend out. Since Bear was turned away by the other banks, it made a notorious walk of shame that was frowned upon by investment banks to the “discount window” from the Federal Reserve for the overnight loans (central bank-to-bank) to cover their business operations plus expenses. One of the major downsides of doing this besides other banks being notified of this activity was that the lending rate comes at an interest rate typically about one percentage point above the Federal Funds Target rate.

Note: Figures show average daily discount window borrowing for the weeks ending on the dates shown. Average weekly borrowing exceeded $120 billion following the terrorist attack on September 11, 2001, during the financial crisis, and again recently this October. Shaded areas indicate U.S. recessions.

The news spread quickly that one of the largest and most systemically important financial institutions was having trouble with cash on hand for day-to-day operations, it led to poor credibility on Wall Street as it kept going back to the well in the overnight market to keep the lights on and gravy flowing so to speak. It quickly prompted all of the major investment banks then to head to the discount window to make sure they too had enough money for their business needs. In that scenario, it became so apparent that the valuations on the balance sheets of the investment banks were so mismanaged that the government had to get involved to bail them out. Similar to then, last month the banks scurried to the Federal Reserve discount window to ensure they had enough money. It became so dramatic that it drove the overnight interest rate over 10% from about 2% before taking a number of days last month to settle back down to normal levels.

Seeing the need to step in and help steer things this September, the Federal Reserve central bank has come to the rescue investment banks again. Quickly injecting $278B into the securities repurchase (or “repo”) market over a four day period in mid-September according to Bloomberg. Just as that news had time to break and surface to investors as well as Wall Street, the New York Federal Reserve Bank injected another $49.7B into the overnight repo markets. This surreptitiously came ahead of the announcement that there was going to be another 25 basis point cut in the Federal Funds rate from 2.00%-2.25% down to 1.75%-2.00% as part of a “not QE, mid-cycle adjustment” as to match the European Central Bank (ECB) and other central banks around the world. Officials from the Fed voted on lowering excess reserve requirements as well as opened up the possibility of another cut this year too.

Source: Board of Governors of the Federal Reserve System (US) for the Effective Federal Funds Rate https://fred.stlouisfed.org/series/FEDFUNDS and Yahoo Finance for the S&P 500 (^GSPC) Data; Shaded areas indicate U.S. recessions.

To illustrate the madness of this charade, investment banks quickly got $328B total in what is practically freshly printed cash while being required to hold less physically on hand and they are still asking for more. JP Morgan Chase, alone as the world’s largest investment bank, borrowed $52B in cash and new capital from the Federal Reserve (OR 22% of its own market capitalization). According to CoinMarketCap, the entire crypto asset market capitalization (over 3000 crypto assets) isn’t even $250B. The repo market operations resumed after years of being dormant this September and escalated this month as well as will continue rolling on through the end of the year into 2020. The late, great rapper, Notorious B.I.G., recorded a Billboard 100 top song entitled “Mo Money Mo Problems” that was released in the late 1990’s, which seems quite relevant to our financial system’s predicament today. It’s 2019 and the Fed wants to party like it’s 1999!

This recent financial alchemy looks very similar to the 1990’s when Alan Greenspan as Fed Chairman used the infamous “mid-cycle adjustment” to cut interest rates for added stimulus and liquidity with enough dry powder to sustain an epic bull market that raged into the late 2000’s. Now it appears that the Federal Reserve is following the same strategy and its governors are opposed to anymore rate hikes, so their plan is to act as necessary to facilitate their dual mandate while keeping asset prices inflated by practically giving away new cash to their member banks. Economically speaking, these institutions won’t be stimulating the economy as much as spending the money because they will mostly be investing it at prices that are already elevated and highly levered. Properly functioning markets do not have financial institutions conducting themselves with this type of behavior and mentality that they are now “Definitely Too Big to Fail” with the lenders of last resort injecting more and more temporary liquidity into the largest financial institutions of the United States and around the world. When you or I print money it’s considered counterfeiting, but when the Federal Reserve does it then it is deemed as “monetary policy” instead.

We are in one of the most glorious bull markets in the history of United States capital markets and everyone has their attention fixated on the bond and stock markets since much of their performance is deeply tied into their college savings plans, retirement portfolios, pension plans, and even ordinary income in some cases of our population. Despite global growth worries and China trade war tensions, the overall market has done quite well. Yet, investors have been so busy obsessing over the traditional market developments that for the most part they missed out Bitcoin and other investment grade crypto assets (the best performing investments over the past decade). While many are still just starting to learn about these developments and the financial engineering going on, students at top universities are being offered more and more classes about them in their academic curriculums or just in the workforce and being tasked with researching their benefits within established enterprises in the legacy finance and technology spaces. Those two industries, in particular, are threatened most by these peer-to-peer innovations within bitcoin and crypto donning more democratized market structures that reduce and/or eliminate excessive fees as well as provides a layer of privacy over users’ personal information. There are only a handful of the largest investment banks and technology firms who more or less oligopolized their respective businesses and markets while stifling the new competition along the way.

Knowing they would be leaving money on the table if they didn’t start to adopt (or at least announce) their exploration of blockchain technology, many firms not wanting to miss out anymore on the action have added to the hype around new initiatives focused on “blockchain, not bitcoin.” A slew of new ads and promos over the past year have come out slinging buzzwords like “enterprise blockchain” or “stablecoin” to masquerade centralized products and services labeled as decentralized. They are using fancy words to disguise the theatrical tales they are telling to appear to be on the cutting edge and seeming honest or noble, while still trying to sell you on their business and brand that they own and control. In reality, it is just another way for them to intermediate peoples’ lives and transactions while collecting data and fees. The bulge bracket banks of New York and internet giants in Silicon Valley do not want to loosen their grip on their hold over their respective industries and are directly going against the core principles of bitcoin and crypto assets by siloing this “proprietary” technology (as opposed to open source) within their four walls or in an industry consortium instead of truly distributing it among the public at large. The truth is they cannot compete with bitcoin and crypto assets because there is not another infrastructure or technology like them. Blockchain technology without bitcoin or crypto assets essentially is the equivalent of bringing a fish out of water, and if allowed to continue will be their ultimate demise where everyone loses out.

These so-called enterprise innovations in blockchain would be more exciting if they weren’t just hyped-up, overrated databases controlled by a centralized group of select “partners and validators.” Though we have seen highly funded projects and initiatives with fashionable members being dubbed as “fintech,” the right questions are being asked by highly-educated people involved and lawmakers using history as their guide to discern how secure and trustworthy these established Surveillance Capitalism companies truly are in this era of the Internet, especially given their history. Facebook’s founder and chief executive officer, Mark Zuckerburg, was grilled this month about his company’s plans and involvement with the Libra project. The project received a significant amount of scrutiny following its announcement this Summer from technologists, and even President Trump tweeted about it as well as bitcoin and crypto, specifically. The reason for doing so on his part was probably because they are a direct threat to the US government and the existing power structures that seek to continue to control the minting of the world’s reserve currency, the United States Dollar.

Aside from the fact that barely anyone has much trust left in Facebook, Congress wanted to speak directly about them possibly using their enormous 2.7 billion user-base to onboard them into the digital asset space as well as test out their own digital reserve asset and its digital wallet. If they let the project proceed, it would challenge the reigning fiat reserve currencies of the world as well as the central banks and governments that hold and oversee them. Every company wants to create a product that is “the next bitcoin” with comparable investment returns but the hard fact is that the next bitcoin, will be bitcoin because no company or organization today can do what it or Satoshi Nakamoto has successfully done. Congress cannot force he, she, or they to appear and answer to them since there is no leader to summon. Put plainly, it would be insane if anybody tried to kill it because Bitcoin could be the best shot at decentralizing as well as democratizing the web aside from it being the inspiration for this new Internet of Money movement that is not subjected by big banks, tech giants, or nation states.

With the emergence of the World Wide Web, the addressable market for companies went from being their local market (millions, maybe) to global (well into the billions). Although there was a catch, financial services got left out and locked out by currency and jurisdictional regulations. The promise of bitcoin and crypto assets, not just their blockchains acting as a public (not private) “Source of Truth,” is that they unleash new Internet protocols that open local markets into global markets for financial services. Since they are rooted around privacy and trust, the lack thereof for financial institutions and/or financial transactions over the Internet in these times of censorship and data privacy gives bitcoin and crypto users an option they otherwise might not have or need in extreme scenarios. As Andreas Antonopoulos said insightfully, “Bitcoin is not something you build companies on top of; Bitcoin is something you build economies on top of.” Bitcoin and crypto assets hold the potential to create a paradigm shift away centrally planned money as well as our warped version of Capitalism with its mix of socialism requiring almost half of successful peoples’ income to be taken and redistributed by the state and cronyism that provides political privilege granted to those in power (or adjacent to it).

The current scenario is exceptionally bullish for bitcoin and crypto assets taking into account the skirmishes between President Trump and the Federal Reserve and their negative effect on the traditional markets. He indicated that bitcoin and crypto assets weren’t a rival to the supremacy of the US Dollar that is backed by the full faith and credit of the Fed and our government, but he then quickly turned around to bash the Federal Reserve comparing it to an authoritarian regime running amok and claiming it is mismanaging the financial system. He has been pounding the table calling for massive interest rate cuts for months, which has historically been an emergency measure in the Federal Reserve’s financial toolbox to help an economy that is on the verge of stagnating or collapsing while at the same time cheerleading the stock market’s broad gains over the term his presidency. Following the testimony on Capitol Hill from Zuckerberg, China quickly embraced bitcoin and blockchain technology this month (giving the crypto market a much needed boost) after hearing the Facebook CEO state, “If America doesn’t innovate, our financial leadership is not guaranteed.” He warned that China, in particular, was moving quick to launch ideas similar to the Libra project in the coming months and possibly will launch the world’s first ever central bank-backed crypto asset. If you read my post “We choose to go to the Moon”, I took the opinion in March earlier this year saying that central banks, institutions, and investors alike who are exploring the space will realize sooner or later that all blockchains lead to Bitcoin and when they do it’s going to spark a buying bonanza that sends prices, “to the Moon!” Moreover, we are now in a 21st-century competition to see who achieves bitcoin and crypto asset adoption as well as dominance and hegemony on a multinational scale that will parallel the Space Race of last century.

Not only are the macro trends extremely bullish, but the fundamental and technical shifts like the mining block reward halving next May are too. Bitcoin does not require any central bank or government to manage it because it is distributed software set to on a fixed supply schedule that limits its issuance over time on a transparent timeline that is hard-coded into its algorithm. As such, the historical price action has followed a predictable stock-to-flow model (see @100trillionUSD’s above) that predicts these halving events to be extraordinarily positive in the past. In 2012, the original mining block reward fell from 50 bitcoins to 25 bitcoins after the discovery of 210,000 mined blocks or roughly every four years. The price of a bitcoin during the first and second halving’s were about $12 and $627, respectively. What will the third block reward halving have in store for us, and how much will it cost this time?

Compared to the stock-to-flow model for gold (see above for PlanB’s previous model charted by @digitalikNet), it not only presents that as hard assets they both are poised to be bullish but for bitcoin especially given its many advantages over physical gold. Taking the mantle as “digital gold,” bitcoin is superior to its physical counterpart for being counterfeit-resistant as well as censorship-resistant, decentralized, easily traced on the blockchain, highly secure, and more scarce as a deflationary asset as opposed to gold (like fiat money) being sneakily inflationary. The market for gold is mostly made up of central banks and investors who view it as “safe haven” asset that similarly with bitcoin is uncorrelated in relation to the rest of the traditional assets in their investment portfolios. The halving events, in particular for bitcoin, illustrates a scarcity-driven growth model that has historically shown an increase in scarcity directly induces an increase in price over the asset’s lifetime. Though past performance in not a guarantee of future results, a small bitcoin allocation from anywhere as low as 1% and as high as to 10% can greatly enhance the total return for investors’ traditional porfolio allocation mixes while only minimally impacting the cumulative volatility.

Source: Board of Governors of the Federal Reserve System (US), Currency in Circulation [CURRCIR], retrieved from FRED, Federal Reserve Bank of St. Louis; October 31, 2019. Shaded areas indicate U.S. recessions.

The financial sorcery at the moment suggests the market is on the verge of a practical correction or extending its powerful bull run that could only be explained by the famous economist John Maynard Keynes quote, “The market can remain irrational longer than you can remain solvent.” By cutting interest rates and pumping liquidity directly to further stimulate the private sector, the markets are looking to be in a precarious position as well as uncharted waters economically, socially, and politically. This is brewing a perfect storm for bitcoin and crypto assets that present more accessibility, equanimity, and transparency inherent to their market structures while being impervious to being debased by superfluous money printing as part of irresponsible monetary or fiscal policies enacted by any government or politicians (who probably do not even know any better). In the year ahead, I expect that we will see a continued full court press by the Federal Reserve to keep pumping in liquidity for “systemic stability” while cutting interest rates until they are at or below 0% to keep the bull market going or else they risk hesitating as they have before to not cut rates fast enough in order to do so. On top of these pressures, things look optimistic for the stock market in the near term at least with major brokerage houses also recently cutting the commission fees associated with retail stock trading to be free as part of a plan to keep trading volumes high. Remember there is no such thing as a “free lunch,” especially when you bear in mind that they gather clients’ trade orders in real-time and sell them to third parties who pay for access to them so the Flash Boys can front-run them and trade with or against the broker’s clients with their high-frequency-trading (HFT) algorithms. All of these aspects are bullish for bitcoin and crypto assets as well as will continue to push their demand over the coming years.

Source: BitcoinClock.com – Each halving event cuts the inflation rate of bitcoin (orange line) after 210,000 blocks mined, while the overall supply of bitcoin (blue line) approaches the total number of coins issued at 21 million.

As I have been confident about the future of bitcoin and the investment grade crypto asset market broadly since the bottom last December, the bull market has taken a needed breather from its run earlier this year after gaining the spotlight. President Trump, the Treasury Secretary, and the Congressional hearings this Summer added their input on the topics as well as helped by acknowledging their existence publicly while serving as a free promotion for them at the same time. While there may have been some overestimates on my end regarding the year end price target possibly reaching new all-time-highs for bitcoin, it doing so is still not out of the question although the probability is far less likely. Unless it makes some parabolic advances against some near term resistance points, bitcoin will likely still continue to chop sideways. Using a Fibonacci retracement tool on the chart below, the major resistance point at the bottom of the recent washout is the 61.8% point at about $7250 and since has seen prices rocket through the 50% (~$8500) and 38.2% (~$9800) resistance points and looks to be settling back down between the two levels. In the coming months, should there be a mean reversion towards the bull side that would need to break through the 23.6% (~$11,350) level as well as extend itself past the top resistance around $14,000 before seeing it return to or pass record highs. In the meantime, the bitcoin’s near term may continue to be choppy and probably retest the local lows around the 61.8% ($7250) resistance point prior to staging any sort of bullish reversal. There are no guarantees on the timelines or prices targets, but the factors like the hard-capped supply versus the ever-printed dollar remains to be in the favor of bitcoin as well as the investment grade crypto asset market when considering the big picture and their potential over the next year and coming decade.

To the Moon!

Happy Halloween!


Today also marks the 11th birthday of the bitcoin whitepaper


The Decentralized Web Is Coming
by ReasonTV

DISCLAIMER: Information contained herein is provided without considering your personal circumstances, therefore should not be construed as financial advice, investment recommendation or an offer of, or solicitation for, any strategy or transactions in bitcoin or any crypto asset.