What happened last week was the most alarming thing I've seen in the money markets for some time.
If those treasuries, let's call them $3 trillion, are not funded tonight, the whole system collapses, literally.
I'm a big fan of consolidation in Bitcoin.
Well, it's just compressing in volatility, and that's a sign of it maturing.
and the more compressed the volatility is the less likelihood of an 80% decline.
As more money is created into the system and flowing around the world,
Bitcoin becomes a really valuable collateral as time continues to pass.
Nick Bhartia, we're back, back on the show.
Things are getting pretty wonky out there at the moment.
You did a video last week on the repo market, and you were kind of saying this could be signaling a bit of a crisis in the market.
So do you want to explain what's going on?
Because this is the world that I don't follow super closely.
Sure.
I would love to get into what happened last week.
But let me, before that, Danny, just tell you and your audience that I'm a rates analyst, and I used to trade rates.
I used to trade repo. One of the things that I like to do is look for problems, but be really
hesitant to call anything a crisis or to put up these big alarm bells on a recession is coming
or a crash is coming or a crisis is coming. So when I do actually get cautious, it's not that
common. And I also still want to say that I'm not calling for a crisis. So before we get into it,
this, what happened last week, was the most alarming thing I've seen in the money markets
for some time. So I decided to make a video that was dedicated to it. Now what happened,
we can start directly with this chart that I sent you. This slide compares the two rates that I think
are the most relevant to my video last week.
You can see the spike that happened.
Today, we are at 0.01 on this spread,
so basically a spread of nil.
This is recorded on Tuesday, October 21st.
Now, on Thursday of last week,
this spread blew out to 14 basis points.
And when I say blow out, again,
it's material and warranted a video.
This spread represents the difference
between the repo rate and the risk-free rate.
So in this situation, the risk-free rate is the green line,
which is interest on reserve balances.
This is the rate that, say, J.P. Morgan has their reserves.
This is their deposit account at the Fed.
Fed reserves, the line item on the Fed's side of the balance sheet is $3 trillion right now.
So on that $3 trillion, the Fed is paying all these banks 4.15% annualized interest rate.
The orange line is the SOFR rate, which is a market-derived rate, a repo rate.
You can think of it as the average repo rate that money market funds are making by funding dealer balance sheets and other banks with treasury collateral.
So the spread represents the pickup, the yield pickup that a bank can get by letting go of reserves and funding a repo transaction.
Basically, being the investor in the repo market.
So lending the money and receiving the rate.
So when the spread is going up, it means that banks that hold reserves, even though they
can get a 14 basis point pickup in the repo market, they're still not lending the reserves.
Hence, there is reserve scarcity.
And that's, I'll pause there because that's the main takeaway from last week.
And you can see that, yes, in Friday, I mean, sorry, in the Monday and Tuesday time series, the spread came back down.
Okay, so I kind of want to go back a little bit here.
So you're saying that we're at, or we were at a point here where banks were unwilling to lend out their reserves.
But can we talk about why they do that anyway?
Like in normal market dynamics, why are banks lending out their reserves for this overnight rate?
It's a good question.
It's all about yields, Danny.
So in the end, the 4.15% IORB is meant to be a floor.
So why don't you pull up the slide two here in this pack?
This is the corridor.
So the Fed controls these flat lines.
the zigzaggy lines are repo rates that are market transaction rates but the flat lines are
the fed's policy rate so you can see here it's the purple line the 4.15 the interest on reserve
balances that's a rate that the fed has as a floor meaning that hey banks
I will pay you 4.15%. So don't go lending your money to anybody at lower than 4.15.
Don't go lending to somebody, a bank at 4.05. I'm paying you 4.15 and I'm the Fed.
So in that way, it's a floor. So I guess there's a few things I want to know in there. So one,
when we talk about like the Fed raising or cutting rates, which of these are we talking
about the fed funds rate no that's the key the fed funds rate and which is the green line and the
repo rates are what they're trying to control what they actually lower are the reverse repo rate which
now the facility isn't being used that's a floor they lower iorb which is also a floor
They lower the discount rate, which is a ceiling.
They lower the rate on the standing repo facility,
which isn't pictured in this chart,
but it's another ceiling.
And so they're raising ceilings and floors
because remember, I explained the floor, right?
The interest on reserve balances.
What about the ceiling?
Hey, I will, that's the red line.
I will let you borrow from me at 4.25
if you post good collateral to the discount window.
So don't you dare go borrow from somebody at 4.35.
I'm the Fed.
I will lend to you at 4.25.
So that's the ceiling.
So they move the ceiling and the floor down.
And then what they're doing is they're guiding the Fed funds rate
and the repo rate lower.
Now, I want to point out one thing quickly, Danny,
before we get to the next question.
which is that you see how the green line at the current moment is creeping up and it's not flat.
Yeah.
But in the previous interest rate zones, it was flat.
Yep.
So that's exactly the point here.
And the 4.11% Fed funds rate, it is a rate that is based off of transactions.
It's not the Fed's policy ceiling or floor.
And so the Fed funds rate is calculated by what is the rate at which banks are lending to each other.
You ask an important question, which is, is it the Fed funds rate that they're moving?
No, they're moving the interest on reserve balances and the discount rate.
The standing repo rate and the reverse repo rate.
Those are the rates that they move and they guide rates down. So the observation about Fed funds
ticking up right now means that, hey, there is some dynamic in the market now where there's a
little bit of reserve scarcity and this rate, it is going up in the transactions, banks lending
reserves to each other. You know, Fed cares about largely is going to be these repo rates and to
make sure that those are also inside the corridor. They don't want them above the corridor. It means
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Okay, so on this chart, there's a few times when it has spiked above the corridor and one that
really stands out would be September last year where it had a huge spike above it.
What's happening there? What's driving that above the ceiling?
That's the answer to the question also what happened last week. In repo, it's almost always
the same answer, which is the calendar. So the calendar means that on month end, quarter end,
and on year end, and on tax days, big movement in reserve balances, big movement in payments,
tax days meaning large checks are written, large bank transfers are sent from the banking system
through the Federal Reserve into the TGA,
which is the Treasury General account.
And then window dressing around month end,
which is that banks have to borrow funds
to make sure that all of their Treasury positions
are funded in the market.
This is what causes the repo rate to go above the corridor.
It's basically, it's going to be either a calendar event
or a tax day event, which is also a calendar event?
That is, it's almost always the answer, Danny.
So if, you know, in my episode last week,
I said, hey, repo desks are saying
that this might be a mid-month roll calendar issue
triggered by October 15th.
I, even though rates came back down, right?
We saw the spread is now down to one basis point
from 14 basis points.
Even though it came back down,
I am not fully buying this mid-month roll explanation for the current spike.
I think that there is some reserve scarcity that is developing in the repo market.
Powell has actually admitted this, so I'm not necessarily speculating there.
but the answer to your question is always going to be month end quarter end tax day
so one of the reasons that i was really interested when i saw this video
um is when the repo market gets dysfunctional it's sometimes um it's almost like foreseeing
something that's about to come in the market and i remember back in 2019 the very end of 2019
we did a show on the previous what bitcoin did with caitlin long and travis cling and they were
basically saying something's just blown up and this can't be sustained and then i mean i'm not
conspiracy theorist enough to say covid then happened because of that but it like almost
called the black swan of covid and it said that something wasn't sustainable in the market and is
that why you pay such close attention to this for reasons like that yes the the sensitivity of the
Fed to problems in the funding market, which are treasury problems, right? The Fed always responds
when there's a problem in the treasury market. So the repo market is the treasury market.
That's, people need to understand that, that the repo market exists because you have this huge,
basically multi-trillion dollar tranche of treasuries at all times that is not in the final
investors' hands. It's this interim pool of treasuries that haven't gone to their
ultimate investor yet. And if that number is several trillion dollars, which it is today,
Danny, I mean, the SOFR volumes are $3 trillion. It means there's at least $3 trillion of them
that need to be funded every night, three on 38. And I would suggest that it's closer to $5
$7 trillion of treasuries that are always kind of at any point looking for some funding.
There are only $7 trillion in money market funds. So it's not like there's an unlimited pool
of capital to fund these interim treasuries. That's why the repo market is so important,
is that if those treasuries, let's call them $3 trillion, are not funded tonight,
the whole system collapses, literally.
So the Fed can't afford anything like that to happen.
And yes, you do have to go back to September 2019
because it's an important moment in money market history
and the standing repo facility exists today.
The Fed realized that they didn't have a ceiling.
They didn't have an effective ceiling.
Now they have the standing repo facility.
So what we've been waiting for the whole time since 2019 is the point at which we get to test the standing repo facility. And that's one of the things that alarmed me last week is that, wait a second, why are participants starting to use the standing repo facility?
and I checked this morning, there was another $3 billion in usage. These are not massive numbers,
but somebody is struggling at the margin. The Fed funds market, if you go to the Fed funds,
the New York Fed website, and you look at the Fed funds webpage, what you actually see is all the
transactions on a curve. They show you where most of them get done, and then they show you the 75th
percentile and the 99th percentile. And you can see that 99th percentile means the edge of the
system is paying 4.18, not 4.11, which you see on your screen there in green. It's 4.18.
The standing repo facility, somebody said, I need 3 billion today. These are not crisis numbers,
But they are like, it's time to pay attention more than ever to the repo market, because this is the moment we've been waiting for to test SRF, Standing Repo Facility.
We're getting the test. It's a baby test, but it's non-zero.
Okay, so I want to just go back a little bit because I want to understand this better.
Because the repo market and the reverse repo market has been explained to me so many times, but I still struggle with it.
So just help me understand, if all these banks are sat on a ton of reserves, which is their collateral, what drives them to use the repo facility overnight?
Why don't they just sit on that collateral?
Is it just to try and chase the tiny little bit of yield they can get on it because it such a large amount it sort of meaningful Okay you going to have to ask it one more time because I going to answer one thing that you set up for me there
which is that reserves are not there.
You can think of them as collateral,
but it's the wrong way to think of them.
Collateral is fungible
in that you can post it elsewhere,
like outside the system, for example,
or to some other party.
Reserves are not, they can't move them.
You can convert them into assets like treasuries and things like that.
But reserves are not collateral for the banks.
They are a tool for interbank settlement in the onshore system.
So they need reserves to do business, like regular business, to settle checks and wires,
including the purchase of treasuries so sending money to the tga you have to have reserves to do
it because it's a swap for the fed they they they debit the reserves and they credit the tga when
you buy treasury so now i'll please ask you to ask your question again but it's an important
uh differentiator there okay so i think possibly you've answered that question in that in that they
can't just sit on them because they actually have to use them for the operations of the bank but
is that the reason that they have to go to these repo facilities because they might be
either short on on treasury oh sorry either short on reserves or they have excess reserves and can
just make a little bit of money overnight on them no the the treasuries that they need that they rely
on the repo market for are separate are separate from reserves so okay think of two types of
financial institutions. You have a dealer and you have a bank. J.P. Morgan is the bank. They have a
trillion of reserves sitting at the Fed. J.P. Morgan Chase has their dealer also. And the dealer has,
let's say, $100 billion in treasuries on its balance sheet. So the dealer needs $100 billion
in cash from the repo market to see the next day. As Perry Merling says, repo is how you live to
fight another day. Well, they have $100 billion in assets. They need $100 billion in cash to fund
that overnight. So every night they're in the repo market trying to get that $100 billion so that they
can have the inventory of $100 billion in treasuries so they can traffic, buy and sell, and make money.
That's the dealer.
JPMorgan, the bank, has a trillion in reserves,
and it has tens of millions of clients around the country.
Those clients are sending wires to each other.
They're sending wires to customers of Citibank.
So JPMorgan, the bank, needs reserves
so that when, let's say,
NVIDIA banks at JPMorgan
and Sam Altman banks at Citi,
and it's time for NVIDIA to pay OpenAI for something
and they send a hundred million
or let's say they send a billion dollars to OpenAI,
JP Morgan has to send a billion in reserves to Citi.
So they need that money for their operation.
So the bank needing reserves for its operations
is a completely separate dynamic
than a dealer that has treasuries
and needs cash tonight.
Who's the provider of the cash, Danny?
It's the money market funds.
My seat where I used to be,
where I have, you know,
I'm a fiduciary for corporations and governments
and I have, you know,
billions of dollars in short-term cash
and I have to decide what to do with it.
JP Morgan, the dealer, says,
hey, I'll pay you 4.16% overnight.
secured by treasury collateral. Can I borrow from you? And then the money market fund lends to the
dealer. So they are a little bit separate issues that we're talking about. Does that help?
Yeah, that does help. So then I want to go back to that first chart you brought up because the
spike that you were talking about last week, I think I understand now that's the dealer going to
the repo market and JP Morgan or whoever not being willing to part with their reserves until the price
was higher exactly okay exactly and and so that's signaling that they they feel what a lack of
confidence in the market that they can actually part with those reserves it's and that's the key
it's why they're not parting with it that's the key so my theory here is that
the percentage, the reserves as a percentage of GDP
is falling to a more dangerous level.
Because reserves are used for banking activity,
as we're explaining, wires from JP Morgan to Citi and back,
the larger the economy grows,
the more reserves you need inside the system to allow people to send wires to each other.
Big banking deals, bond deals, even treasury auctions are important to throw into that.
So the larger the treasury auctions and the larger the economy, the larger the deficit,
you just need more reserves so that Jamie can say, I'll lend you my reserves.
or I'll pull out reserves and put them in the repo market tonight.
So my big theory here is that we're at a point,
yes, the Fed's balance sheet is declining
and reserves have started to trickle down
now that reverse repo is gone.
As reserves decline, there's a mathematical minimum
to a healthy amount of reserves
to let the money market function.
And that's where I think we are.
So the answer to your question,
why wouldn't they do it,
is basically they realize we're at the point
that they need to just hold on to it,
even if they're being offered 14 basis points pickup.
It's not worth it to them
because they're risk managers first.
They're arbitrageous second, but they have to make sure their bank wakes up the next day.
And holding on to your reserves is sometimes better for your health as a bank than picking up that extra 14 basis points for one night.
And remember, it's 14 basis points divided by 365.
I mean, it's pennies, right?
But the banks do it.
They that's how they squeeze every penny out of, you know, in arbitrage. But at a certain point, they don't do it because health and safety, risk management and.
And and PTSD also 2019 PTSD. And honestly, the banking system is still, you know, in a 16 year hangover from the financial crisis.
So there's a lot of PTSD in the system.
I don't know why.
This is obviously really in the kind of financial plumbings of how banking works.
But this element of macro is the bit that I find the hardest to understand.
And I don't know why.
It doesn't seem very intuitive to me.
But obviously, you spent years and years and years working in this and living in this.
So is this the most important thing to watch right now?
And do you think it's actually showing signs that QT might be over and QE is about to start?
So QE is going to be relative because they might call it something else.
The point is that I do believe that reserves do need to be introduced back into the system.
So the mechanism will be QE-like.
I do believe that QT does have to end because of the mechanics of this that we're talking about.
Is it the most important thing to watch in the system?
You know, that's a lot of the answer to that is actually, do you think that the Fed is the most important actor right now in the global macro economy?
and I would argue no
because I don't think that the response
is going to be more liquidity creating
than what I do expect is going to be happening
in the private sector.
So there's some worrying stuff in the money market
that's going to put the Fed back in play.
It's going to make them have to end QT.
It's going to make them have to increase their balance sheet.
I've said for a while that I believe it'll be,
they'll call it something like nominal GDP targeting
for the balance sheet.
Like the balance sheet will now follow GDP targeting.
Something like that.
Where they don't have to call it QE.
They can call it something else.
We'll know what it is.
It's balance sheet expansion.
But QE are these,
they used to call it LSAP,
large scale asset purchases.
The LSAP days,
I don't see that happening right now. We could get LSAP in the future. You get this huge
balance sheet expansion, but that's not really what I see. I actually see balance sheet expansion
in the private sector. I'll point people to the JP Morgan announcement of $1.5 trillion
in funding that they are planning for 27 key American industries
to rebuild America's competitiveness on a technology defense mining front.
That's where I believe liquidity will be created.
So is it the most important thing, Danny,
that we should all be watching on the macro side?
It's not, actually. The CapEx boom that has already started and we're witnessing is the more important macro story.
I believe the standing repo facility plus Jerome Powell are capable of negating a repo crisis, avoiding large-scale asset purchases, and introducing liquidity in a more gentle way through the Fed that would make it not the most important thing.
Okay, I've got like five questions in that, but I'm going to try and keep us on track here before we get onto the private sector stuff. If they do a kind of GDP denominated expansion of the balance sheet, is that sustainable? Can they do that for a long time?
Or like just with the way the system is designed, does it need those huge expansions every now and again?
Yeah, it's a good question.
I think it comes down to how much the U.S. government needs to rely on the Fed.
So at the moment, or let's say during 2020, 2021, the government was entirely reliant on the Fed to finance the CARES Act and emergency response.
Entirely reliant.
There was no private sector capacity to absorb that type of fiscal deficit.
No capacity.
So the Fed and the government teamed up.
there's actually a way to categorize what the government did
as pinning the Fed into the QE.
Like, you know, we're going to spend $9 trillion
and you guys, you can't do anything about it.
You're just going to have to do trillions of QE.
And they did.
So the balance sheet expansion that they did back then was warranted by fiscal activity.
So your question is, can they just do baby increases?
Well, if the government is able to reduce its fiscal deficit from where it was at seven to now it's under six,
if they're able to get it to under five, et cetera, keep going,
then perhaps yes if there's no financial crisis that the treasury department goes and bails out
banks like what happened in 2008 and 2009 that required lsap because you take on the the debt
of the banks basically you inject liquidity means what the government borrows issues treasuries and
then sends the money into the banking system and recapitalizes the banks. Well, who's going to fund
the treasuries that they had to issue? They had to borrow the money from somewhere. You get LSAP.
So the LSAP, the large-scale asset purchases are triggered by the government spending the money
if we really look at the history of it.
Now, the LSAP that happened in 2010,
2012, which is that QE2, QE3,
and the LSAP that happened in late 2021,
which was not emergency, right?
COVID was already,
the emergency itself was already a year and a half
in the rear view, and they kept going.
Those are the ones where you say those were unnecessary or you didn't need to do that.
So you will need QT eventually because you went too far.
So I hope that answers your question.
I don't think it needs to come with the large scale unless the government does something.
and I'm quite bullish on the United States private sector
over the next coming years,
which might reduce the marginal
or might reduce the deficit as a percentage of GDP at the margin.
We're at 5.9% today.
I believe that that could creep down
and put any risk of the Fed having to come in
and do these large-scale QEs, maybe punt it down.
And I could be completely wrong,
or I could be right and just not see that a crisis
is maybe three or six months around the corner,
and then the government comes and has to bail out
a sector that we might not even think of right now
and then have to borrow, and the Fed has to do QE to join in.
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I love Larry Lippard. He's on the show fairly regularly. His book is brilliant. And he always
talks about this idea of like the big print coming. And he doesn't put a time frame on it. He's not
saying that it's going to happen tomorrow, but he's saying just the way the system is set up,
it has to happen at some point. Do you think he is missing something there?
it's not that he's missing something it's just that i don't agree with the with the it the the
fed print has to happen i think that the whole system is in a state of flux and it's responding
to unsustainable paths that it might have that it made might have been on so i believe much more in the self as opposed to the big print to just inflate everything away Again it probably comes back to my bullishness on the U
productivity and private sector in that I just don't see the big print being inevitable in the
same way he does. Now, Larry is a brilliant historian in the way that he set up the history
of the United States financial system and the different periods in which sound money was the
basis of the system and the days in which the fractional system was more controlled or better
controlled or more, perhaps the free banking system was a more free market system, but prone
to crisis too. So, you know, one can like another's history and context, but completely disagree
with, you know, the result. And Larry and I have had great conversations. We even were on stage
together in Vegas and discussed some of it. But I read his book before we did the panel
because I always like to learn about American financial history. There were some great nuggets
that I picked up there. I think that as a trader, a former trader of U.S. treasuries,
I can see how strong the asset class is. So this idea that the asset class itself is on weak footing
is something that I wholly disagree with.
And again, it's not that today
it's just a great asset class.
The government has to get its act together
for it to be a great asset class
for another 20 years, right?
So maybe that's the disagreement
is that my outlook is more bullish than his
on the US government's ability
to have a sustainable deficit,
a sustainable debt, grow the private sector, have the right taxes and regulations to have a
sustainable debt to GDP ratio that allows the government and the private sector to both prosper.
So that would be my thought on the big print. Yeah, I can understand that viewpoint. And I've
spoken to joe carlos area on this and it sounds like you probably agree with joe on a lot of
these takes because he's also like a big believer in the productivity um and the thing that i always
struggle with there is i can believe that the u.s becomes far more productive i think automation
robotics like ai all this stuff is going to have a massive boon but what i don't know is what that
does to jobs like i don't know if if ai like the number of jobs that ai will replace but i think
it's going to be really high.
And if the U.S. has like positive GDP growth
while joblessness is going up,
what happens then?
It's a good question.
There is a dynamic at play already, Danny,
in which the S&P 500 is going up,
but job openings are going down.
So we're already living in
this era. It's in front of us. So if we're already living through an era in which job openings are
going down, and anecdotally, too, we hear about it being tough to get a job for entry-level people,
for example, but the stock market is going up and GDP is doing fine. What is the sensitivity of US
GDP to the middle, you know, the middle of jobs, the middle income area of jobs or the
lower income area of jobs, it might be zero.
What is the sensitivity, right?
That's always what we're thinking about.
Yes, the labor market might be an issue.
Yes, AI might replace a lot of American jobs.
But how much does aggregate consumption go down if that's the case? And aggregate consumption is 70% of US GDP, so it's the main driver. So if people are losing their jobs due to AI, but aggregate consumption goes up 3%, then there's no more sensitivity to, I shouldn't say no more, but there's no sensitivity to this particular dynamic.
Now, what if it continues and starts to wipe out enough jobs so that it hits aggregate consumption and then hits GDP and tax revenue and all that kind of stuff?
I mean, that's not my base case at all.
Now, I'm looking at how is AI going to replace jobs and hit the economy and the labor force, and how does that feed back into consumption in the U.S. GDP?
Okay, but what is GDP?
If you go back to econ textbooks, GDP equals consumption plus government spending plus savings
and then the export factor, the net exports.
So throw out net exports for a second.
So you have the consumer and the government.
let's say the government doesn't spend more money because we don't really want it to if we're in this
bullish american thesis where we want sustainable debt to gdp we don't want the government spending
more and more money or increasing as a percentage of gdp we don't want that um now it now in the
econ 101 your whole income is either consumed or spent there's nothing else to do with it
mathematically. You only have two choices. You either spend it or you save it. Now you zoom into
savings. Econ 101 suggests that savings equals investment. S equals I. It means that if you save
a dollar, by default, you are investing it. Now you can invest it in a T-bill or you can build a
factory. My bet is that all of the consumption that is not spent, basically all the money that
is not spent in a previous regime, let's say the last 20 years, it's saved and hoarded and sent
Treasury yields lower, but not anymore.
We're on the upswing of yields.
And I'm not a big believer in this big bond bear market,
but the era of zero rates is over.
You have healthy rates now.
And that healthy interest rate in the market
is not enough to say to people, hide out in T-bills.
We're going to go build a factory.
And that's where a lot of my bullishness comes from,
is that it's the factory building.
I did a video just today.
Jensen Huang, he's talking about, the CEO of NVIDIA,
he's talking about the United States building thousands of factories
and using millions of skilled workers to do it.
It's a very bullish vision.
Where's the capital going to come from?
Where's the labor, the skill, all of that?
That's TBD, right?
I don't have blinders on and, you know, just think we can build a thousand factories tomorrow.
But they already built the fastest chip in the world, from my understanding, in the United States this year already.
And he's on TV talking about it and attributing almost everything to President Donald Trump and his efforts and the tariffs specifically.
That's wild.
it's actually way more accelerated of a timeline than I expected.
That you can go from a new president to tariff policy
to the fastest chip ever made already in the United States done, manufactured.
You asked me what's the most important.
That's the most important story.
It's these next thousand factories
and the build-out of tens of trillions in AI infrastructure,
which includes energy grid, electrification, and all of that.
And by the way, is it going to be all government financed?
No.
Part of my bullishness is that J.P. Morgan releases $1.5 trillion
dedicated to these 27 key industries.
And it includes 6G mesh networks, drones, robotics,
mining for all the material space exploration.
So this is a wealth and credit creation and money.
It's very fleeting.
That's why people love Bitcoin and they love gold.
It's more tangible.
They can feel the numbers.
They can feel the metal.
Real estate also, very popular.
But J.P. Morgan and its cohorts, Danny, could create $30 trillion in loans over the next decade, profit off of every one of them, and the United States could end up with thousands of new factories and industries that are world-leading.
and it could lead to the importing of skilled labor
where education is sourced
and skills are sourced from around the world
and you have two decades of American prosperity
in just the building out of it
and not even the benefits
that could come from the build-out.
So this is me being very patriotic,
bullish about the future of the country
of course, but the point here is that it's not the government itself that needs to spend the money.
JP Morgan can create it out of thin air. Citi can create it out of thin air. They've been doing it
for hundreds of years. And with a new regime, which if anybody is paying attention, you can
see we're in a new global order, whether it's a global trade order, a political order, the
death of globalism, the revitalization of nationalism, the return of the sovereign,
the end of the UN, whatever you want to call it. This era could unleash bank credit creation
in a way that we've never witnessed. That's the biggest story to me. It's a Bitcoin story too.
if people know where to find it.
So with JP Morgan,
you're saying they want to create $1.5 trillion.
How can they even do that?
Like, I understand like loaning money into existence
and like credit creation,
but like how do they do that
while in a sustainable way for their balance sheet?
They make loans that they know
that the customers can pay back.
So that's all it comes down to.
If they lend money for a 10-year project, the participant, the borrower, has to go out, build a factory, and sell goods, products, and services, and then pay back the loan.
So how can they do it?
Well, there's two answers to your question.
Number one, the changes in regulation are key in this.
And there's two components.
The first regulation change they need is the elimination of this penalty for holding treasury capital.
Basically, they should be able to hold treasuries without any capital charge on their balance sheet.
That's one thing.
The other thing are just the actual lending standards.
that are being, I mean, they're overly restrictive
and it's one of the things that Treasury Besant wants to unwind
are some of these overly restrictive regulations on lending.
So if you get some good banking deregulation,
you get the treasuries off of the penalty,
it's called the SLR, the supplemental leverage ratio.
If you eliminate that penalty on holding treasuries, you automatically unlock lending.
There are numbers that Goldman and Merrill did studies on this where if you eliminate
that charge, you automatically allow within the current banking regulations a couple trillion
in lending.
I think it was somewhere in the $2 to $4 trillion that gets unlocked.
I mean, overnight from one regulatory change.
So those are the regulatory changes.
so that's one place the capital can come from but another place the capital can come from
is out of these instruments that these entities hold that are for safety okay enough with the
safety it's time to invest remember s equals i so it's either s or it's i so it's turn the s into i
go invest the capital. There is equity all around the world. And that's existing capital. It's not
fresh credit creation. But if you get that capital out of a hoarder's mentality and you put it into
bank equity, you can go leverage it again. So if these banks can boost their equity positions,
it's the basis for more and more. Lending is fractional. So the answer to your question,
actually, it's you unleash the fractional reserve. How do you do that? You have to have
regulations go your way. And if you can get some new capital in there, you can really do it. But
it's a behavioral thing. I think it's a behavioral thing first that they just have to get into that
mentality that, okay, we're going to go out and make these loans. And they're hitting the tape with
you know, 1.5 trillion. And they say, oh, yeah, you know, 10 billion in equity, too, which is good.
You know, they're actually going to take stakes, but it's the lending that is material.
And if all this capital does get unlocked and we have trillions of dollars from the private sector
created for these businesses, what impact does that have on inflation when it's coming from the
private sector rather than from the government? The same, the same. And because it's a raise,
It's an increase in aggregate demand, right?
Because when consumption and investment go up, or let's say investment goes up and consumption goes down, but investment is going up, that is a purchase of materials, labor, and it sends money.
Credit creation that comes from the private sector sends money into the economy.
So, you know, you asked the right follow-up, which is what's the take on inflation?
The take on inflation is that it'll be sustained.
It will be sustained.
I'm not a big believer in this 5% to 10% inflation on the broad level, but on a more zoomed level, there will be sectors that will experience this type of inflation.
throughout this entire capex boom if that's what we are to see and the bond market right now says
that that number is you know in the two and two to two and a half percent range
you know that might be a little low but i'm not i'm not into the um
i don't believe that double digit inflation is going to be the result of the cap the capex boom
especially with the productivity gains and maybe driving down the labor cost as well.
The government, by the way, will need more of a social safety net if AI really does just
shatter the labor force and replace so many jobs.
That's where you need UBI or something similar.
Yeah, transfer payments and all of that kind of stuff.
It should be near people's base case for the next couple decades.
Um, if, if we're in these new regimes expecting something like that, but it, again, it would
have to be sustainable for my, uh, you know, stability of the treasury market thesis to
play out.
See, I could be being naive here, but I can't see a world where if AI does what I think
it's going to do and what a lot of people think it's going to do.
Um, I can't see a world where we don't have QE and that's going to be a serious increase
in the balance sheet going forward as well.
You know, again, QE has to be triggered by some sort of crisis. So if the crisis is 1% increase in unemployment every three to six months, is there a bailout package that needs to be sent to every citizen in the United States?
And if that's the case, then yes, I would agree with you that it's going to come along with some balance sheet expansion. But I don't think it can be triggered without some big spending package or some big financial crisis.
It seems like the future we're going into is just more and more wealth inequality as well.
There no doubt about that especially with what we talking about with the stock market going up and job openings going down And even the premise that a poor labor market doesn affect aggregate consumption that screams wealth inequality it a it a little bit of a scary future but if we
if we like to summarize your point you think sort of qt is probably coming to an end maybe ending
um qe in some form might be coming back even if it's sort of gdp uh denominated there's going to
be a massive private credit boom um what does all this mean for bitcoin yes bitcoin now i believe
is the way that we've been thinking about it is is a liquidity asset so as liquidity comes into
the system, Bitcoin is the recipient of some of that. When liquidity tightens up, we see Bitcoin's
price suffer. So if Bitcoin is receiving a passive flow from all credit expansion dynamics,
and it is a superior asset to other assets in terms of the relative catch-up,
then Bitcoin should perform very well.
Especially as more money is created into the system
and flowing around the world,
Bitcoin becomes a really valuable collateral
as time continues to pass.
So the thesis on Bitcoin is very bullish.
If we think about what are the big risks
for Bitcoin going forward,
I would say credit contraction
is probably the biggest risk.
But we live in this world where credit creation
is responded to by bailouts which are backed by QE.
And that world is...
We're going to have to see some dramatic event
to have to change our thesis.
Right?
It doesn't feel like it's the right thesis to say, well, there will be, you know, I'm sure that there will be credit losses somewhere.
And then the government is going to let all the banks fail.
And a big contraction of the credit system that the government, you know, it won't be there and the Fed won't be there either.
To backstop it.
Big destruction in credit.
big destruction in stock prices, Bitcoin, dollar soars, and that's the risk.
There's another risk which is separate than that, which is that inflation gets out of hand
and interest rates have to go way up or the market drives them up because the market is saying,
hey, inflation's at 6%, 7%.
I'm pulling my money out and putting it in fixed income,
pulling it out of risk,
and liquidity is affected through a big bear market in treasuries
because of inflation getting out of hand.
I would say that that's a risk to Bitcoin.
Bitcoin is not, I don't believe, ready to act as an inflation hedge
in that example.
In a big bear market in treasuries, Bitcoin isn't going to do great.
You can look at 2022 for a good example of that.
And I still believe that dynamic is there.
So in the absence of a big wave of inflation or a big contraction in credit that isn't responded to by policy bailouts,
I think Bitcoin does very well in this middle ground of big capex, passive flows from...
spending incomes. And even if it is only a certain portion of the economy that is earning in an AI
world, that some of that money ends up in Bitcoin as well. Why don't you think Bitcoin's ready to
behave as an inflation edge? Because I think we both probably agree that that kind of is what it
is and what it will be in the future. But why do you think it's not ready now? What is it that
makes sort of gold able to do that but not bitcoin yet i don't even think gold is the inflation hedge
so it when it comes down to looking at the the statistics the correlations the drivers
gold has had an incredible year with inflation being totally stable around 2.93 2.8 i mean
trending down, trending flat, no real tariff scare. Gold is just ripping.
So gold is not ripping as an inflation hedge this year. It's ripping. We can talk about that,
but it's ripping for other geopolitical reasons. It's not ripping because people are dumping
treasuries. Treasuries are trading very well this year. So I don't think gold is functioning
as an inflation hedge. This year's price action tells me that gold is performing well in the
absence of inflation, especially with the economy being in that kind of so-so area,
rates trending down. Remember, rates trending down means lower inflation expectations going forward.
So why isn't Bitcoin ready to trade as an inflation hedge? Because the market
shows us that when volatility spikes on a pop in interest rates
off of an inflation scare, the Bitcoin doesn't do well. It goes down.
So the market's just still treating it like a risk asset?
It just is. It's treating it like a liquidity asset.
We should talk about gold because I saw in that recent video, you were kind of alarmed at gold's
performance and you weren't really sure why it was happening. Checkmate, who good friend of mine,
I know you know well as well. He talks about gold as it's kind of showing us the path and Bitcoin
sort of follows. Why are you nervous about what gold is doing? So let me specify the word nervous,
I guess, in this context. First of all, I traded gold back in the day as a hobbyist,
not a professional, traded rates professionally and money markets professionally. So when I give
my opinion on these markets, it comes from a former professional practitioner. So I'm not a gold
trader in any sort of professional practitioner sort of way. I'm also not a gold researcher either.
Now, I am very passionate about geopolitics. I was a former gold bug before finding Bitcoin,
a big proponent of sound money before finding Bitcoin and after understanding QE.
So that's the context for gold.
So why am I nervous about it?
I'm nervous because when the gold price, or let's just say the gold price going up the
way that it has this year makes me feel like there's some very large geopolitical move being
played.
Is it a United States move?
Is it a Chinese move?
Is there some fear trade associated with a big blow-up in Europe?
Like European QE, ECBQE?
These are maybe three of the options.
I don't know.
And I, you know, reading theories, reading some street research on it, nothing is super convincing to me.
my hunch has this like the fact that Trump and Besant are absolutely silent on this matter
to me means that it might be something that's U.S. caused and that benefits the U.S.
because if somebody was doing this,
let's say this was China buying and delivering
and driving the gold price up,
which there's a lot of evidence
that gold is getting delivered to the US this year,
like US gold delivery.
So there's a lot of evidence
that this might be American driven,
but let's say it was China driving the gold price up.
And let's say that the price of gold going up
was hurting in some way the U.S., U.S. banks, or the U.S. government in some way, or the Fed,
or some position. You would see Trump do his thing and hit the tape and talk a bunch of smack and
blame somebody or something, but we don't see that. And so why am I nervous? I'm nervous when
I don't know what's happening. So, and I only have, you know, a limited amount of time,
you know, to do research. And it also means that some of the more theoretical, you know,
I believe this is happening, Besson is doing this, or this is some squeeze, you know, I'll shout out,
you know, some of the street research that I've been reading, that's been excellent.
some of it out of Merrill and, you know, mostly out of Bank of America. Merrill Lynch wrote some
good stuff on this. Nothing has me convinced because I'm too, you know, conspiratorial
minded in thinking about this, that who's getting squeezed and who's getting hurt
and who's benefiting from this, that nothing I've read really fits the bill. And the stuff that
is more conspiratorial that I maybe want to believe, I can't prove.
And so all of the not knowing makes me nervous. And also this hunch that maybe Europe is blowing
up and the ECB is setting up for some massive QE, or there's somebody in Europe that's being
squeezed like out of London, maybe the bullion banks or something like that. That has me nervous
because that can come with a big financial crisis, panic, perhaps a sharp fall in risk prices that
scares a lot of people, forces liquidations. And the people that are over leveraged,
God bless them, but it's the people that actually are not leveraged but still get
shaken out of their position that I worry for them because that's happened to people, you know,
that they get shaken out and then they don't realize that everything is going to get bailed
out. So they miss, you know, the, the pop back. And, uh, you know, we don't know if we're still
in a bailout culture or not. We'll never know until you get to the crisis. Uh, but I, I hope
that answers your question as to why I feel nervous about the gold price. My money's on,
we still are in a bailout culture. But I mean, I think it's interesting because earlier this year,
tons and tons of gold were leaving London, coming to America. I don't really know why that was.
I think people called it like an arbitrage trade. I don't know if I really buy that.
China are the biggest producer of gold. I'm sure they've been stacking a ton of gold over the last
year, probably multiple years. So is your worry here that like the US and China might be in almost
like a silent war to stack as much gold as possible? You don't know who's going to come
out on top at the end of that you know that that's less scary because that's just an accumulation
um so that would be less scary to me and we do know that china's stacking gold we have we have
you know the shanghai uh gold contract volumes are up also so we know that china's been stacking
gold for many years and that's not a surprise the united states is not admitting to any sort
of gold stacking it as a large gold position, but it would be the private sector banks or whoever
that's importing that gold and taking delivery, not necessarily the US government unless they're
doing it covertly or under the table in some way like that. So I don't think that a US-China fight
over gold would scare me. When a market goes up this quickly and there's not a lot of explanation,
It's like, wow, you know, there really is something going on behind the scenes.
And as a macro analyst, it's all fascinating to me.
And you're limited by time.
And you're also limited by what you want to be well-versed in.
I want to be a great rates analyst and a great Bitcoin analyst.
But I don't feel that I can be also a great gold analyst.
So it leaves it out of, you know, my immediate research purview.
And then when something happens in it, I'm caught off guard by the speed at which gold has gone up.
And, you know, not knowing is probably bothering me.
Yeah, I get that.
It's funny because like in previous cycles where Bitcoin has been doing well, you see a ton of retail people turn up and we've not really had that this cycle.
I've not noticed it that much.
I think potentially it's starting like I've seen a lot of new listeners on the podcast, but nothing like previous cycles.
But then at the same time, I'm sure you've seen the picture of queues outside gold dealerships.
And it seems like the retail FOMO is in gold this time, which is a really interesting dynamic.
With everything that's happened over the last couple of weeks in Bitcoin,
last time we spoke, you said you were sort of 60-40 on the cycles being broken.
Has anything changed now we're seeing the sort of sharp drop in Bitcoin and it's looking a little more uneasy?
Yeah, I would say it creeps up every day, that 60-40 number. I don't necessarily feel like I want to put a number that's higher than 60 today on the show.
But yeah, I believe with every day that goes by that we're not really beholden to this cycle. I haven't seen any of the FOMO trade in Bitcoin this time around, like you just mentioned.
And the cycle that we saw in 2017 and 2021,
both had just completely different behavioral patterns.
And now we're almost through with October here,
and the Bitcoin price just isn't going anywhere.
It's still consolidating.
I think that's super healthy.
I'm a big fan of consolidation.
in Bitcoin because it means that Bitcoin is not in any, well, it's just compressing in volatility.
And that's a sign of it maturing. And the more compressed the volatility is the less
likelihood of an 80% decline. So when I see volatility start to peak up, to pop up like it
has in the last couple of weeks, you start to wonder, oh, are we in for one of those big moves?
but um no i still believe uh consistent with our last interview all right nick this has been
awesome i mean the repo stuff i don't know why it just doesn't fit in my head very well but um
this was super useful i think i learned a lot um it's gonna be an interesting time coming up we've
got a an interesting sort of 12 months ahead of us we'll see what happens absolutely and you know
the gold weekly candle this week is one of those candles that, you know, the chart analyst in me
says, oh, now, you know, the gold run is over. It's going to consolidate maybe for another six
to 12 months and all that. But I thought that a couple times over this current bull market in gold
where I saw a candle and just, you know, a reversal and I said, oh, that's it. And then
it keeps going. So, you know, that's one of the things that's the most fascinating thing.
And on the repo side, it just takes so much repetition. And I remember just being on the
desk and it just takes, you know, months and months and months of reading about it every
single day to really understand what's going on. So I appreciate you letting me teach you and others.
No, I appreciate it, Nick. Thank you. And tell everyone where to check out your videos and the
newsletter, all the stuff that you do. Yeah, everything you guys can find at the
bitcoinlayer.com. So we have a show channel. If you like to watch, listen, we have a great
research newsletter and the links to my books as well. Everything is at the bitcoinlayer.com.
How's the sales on the Bitcoin age gone? Oh, it's gone great. I really feel
blessed to have so many great readers. And the fun thing about Bitcoin age is that
people are genuinely learning things that they didn't expect to learn.
So Bitcoiners that said, oh, I learned this particular thing.
And that always makes me excited.
I got to teach both of my books together as one product this summer,
which was excellent.
And I'm going to get to do that again next year.
Love it.
I've actually, I've not got it on the bookshelf yet, Nick,
but I'm going to buy it as soon as we get off this call and put it on there.
I was waiting for my signed copy, but I'll have to just get to Danny.
Well, I'll send you one. Absolutely.
All right, Nick. Thanks so much for this. It's been great.
Thanks, man. Appreciate it.