Mikko, the founder of Zhibao, believes that the future macro environment may change in a direction that is not conducive to the cryptocurrency market.
Original title: “Mikko: On the Impact of U.S. Dollar Liquidity on Digital Currency”
Written by: Zhu Chen Mikko, Founder of Zhibao
The topic I am sharing today is about dollar liquidity and digital currency. When opening the whole topic, I need to clarify some things with you, and this process may break your basic understanding of currency creation.
The essence of money creation
First of all, where do people think the money that the bank lends to you comes from? Most people think that the bank acts as a financial intermediary, absorbing everyone’s savings and then lending it to another person. In fact, banks have no right to do this. When a bank makes a loan, it creates a currency: it creates a currency (deposit) for you, instead of taking another person to deposit it for you. So how did the bank create this deposit? Here we will introduce double-entry bookkeeping and T-list to disassemble the process of money creation.
Double-entry bookkeeping is a method of bookkeeping in accounting, and T-symbol (balance sheet) is the structure of double-entry bookkeeping. In the balance sheet, assets are the investment of all your monetary resources, for example, you bought a real estate or bought a bitcoin. And debt refers to your debts, such as credit card or Huabei debts. Equity is your real money, a monetary resource that does not involve any liabilities. For example, if your parents give 100 yuan, that is your rights. Then the left side of this T chart is assets, and the right side is liabilities plus equity.
Take the example of a bank loaning you. The bank lent you 100 yuan, and you need to repay it to the bank. Suppose, after you apply for a bank loan from ICBC, after ICBC approves, you can withdraw the line of credit given to you by the bank in your ICBC account at any time. At this time, you have an extra deposit in the bank. When the bank lends, it actually creates a currency and a deposit for you.
Then bank assets + 100 yuan in loans, liabilities + 100 yuan in deposits
Your debt + 100 yuan loan, because you need to repay in the future, an additional 100 yuan bank deposit on the asset side.
The most classic example of money creation is that loans create deposits, not deposits create loans .
The flood of water has led to a boom in the digital currency market
Last year was a special year. Affected by the epidemic, the Fed used monetary policy stimulus (commonly known as “sweeping water”) to revive the US economy. Last year’s “big water release” also spawned a bull market in the currency circle. In the last round of financial crisis, most of the money created by the Federal Reserve flowed into the hands of some banks and non-bank institutions (including hedge funds, asset management companies, etc.).
The current stimulus is of a different nature. While the Federal Reserve is issuing additional currency, the U.S. Treasury Department has absorbed the additional currency through the issuance of bonds, and then distributed it to the people. It is difficult for banks and hedge funds to buy coins because it does not comply with regulatory requirements, and ordinary people can buy coins. Last year, both the U.S. stock market and the digital currency market showed a very interesting feature: the market was not entirely dominated by institutional investors, but by retail retail investors. Here, I will use a T-chart to explain how the U.S. dollar flows into the hands of the people after the Federal Reserve issued additional U.S. dollars.
Here you need to list the Fed, the bank, the U.S. Treasury and your T-list. First of all, before the Fed implemented the quantitative easing policy, the bank’s asset side had a large number of national debt as its asset allocation, and investors also had US debt.
The Federal Reserve buys the Treasury bonds of banks and individuals and pays them for deposits. Since individuals cannot open an account with the Fed, the Fed buys Treasury bonds from individuals or non-bank institutions to pay the agent banks that sell Treasury bonds, such as JP Morgan Chase. After receiving the reserve deposit from the Federal Reserve, JPMorgan Chase records a deposit in the investor’s account.
Therefore, the Fed’s asset side + Treasury bonds, liability side + deposits (reserves)
At the same time, the assets of banks and individuals have sold treasury bonds,
The asset side of the bank-national debt + deposits (reserves);
Personal asset side-treasury bonds + deposits
Then, the U.S. Treasury Department issued new Treasury bonds. According to U.S. law, U.S. primary dealers must subscribe for U.S. Treasury bonds in the primary market. The U.S. Treasury Department issues as many U.S. bonds, the primary dealers have to take on as many U.S. bonds. Therefore, the bank’s reserves (printed money) have become U.S. bonds again. It can hold U.S. bonds on its own or sell to customers. So when the bank was in the process of increasing U.S. debt, his deposits and reserves were spent. The money went to the deposit account of the Ministry of Finance. At this time, the accounts of the Ministry of Finance have been settled.
U.S. Treasury Department debt + Treasury bonds (it is U.S. bonds purchased by banks and investors);
U.S. Treasury Department Assets + Treasury Department Deposit
Bank assets-reserves + U.S. bonds
Then, the U.S. Treasury Department will implement a money-spending policy and provide subsidies to individuals to stimulate economic recovery.
U.S. Department of Treasury Assets-Deposits
Personal assets + deposits
Regarding the Federal Reserve QE, you will find that the US financial system is a cycle of money creation. Its funds are idling in the financial system and have nothing to do with the real economy. When you receive the deposit subsidy from the Ministry of Finance, you have two options: the first is to hold this deposit foolishly to enjoy a deposit interest close to 0% in the United States, and the second option is to configure it to a higher value. Among risky assets (such as digital assets and some technology stocks in China’s concept stocks and US stocks). In fact, the Fed issued a total of nearly 4 trillion U.S. dollars of currency last year. If you count the deposits created by the banking system’s loans, the entire liquidity creation last year should be the highest in history. When investors face the entire risky asset market last year, they don’t need to use their brains, because all assets are rising.
The impact of U.S. dollar liquidity on digital currencies
Then I will talk about the recent liquidity of the US dollar. From this hard money data, we can see how much money has increased. The blue line in this graph is the U.S. dollar bills in circulation. From 2008 to 2020, this blue line has been rising. According to data from the Federal Reserve, its annual growth rate is 90 billion U.S. dollars.
We can see that the bank deposit reserve increased to 400 million U.S. dollars a year last year, which is a very staggering figure. Because the Fed’s reserve level was only about 2 trillion in 13 or 14 years. The current level of 4 trillion is equivalent to doubling the deposits of all financial institutions. If asset prices do not double, is it reasonable? This is only the currency on the Fed’s table, and we have not yet calculated the situation of commercial banks.
The green line is the deposit of the Ministry of Finance. I have already explained its logic before. First, the Fed prints money, and then the printed money flows back into the hands of the U.S. Treasury Department; the U.S. Treasury Department spends the money (to individuals), and the individual deposits in the bank will turn into deposits. Therefore, the red and green lines sometimes run in the same direction, and sometimes they run in the opposite direction. Running in the same direction means that too much money is printed, and running in the opposite direction means that the speed of printing money has slowed down, and the money is structurally transferred between personal and bank accounts.
From these two figures, we can see that the size of US commercial banks’ deposits is rising, while the size of loans has not risen much, only 400 billion. This shows that money creation is currently directly led by the Federal Reserve, rather than commercial banks creating deposits through loans. Why is the loan growth rate of commercial banks not enough? Because the U.S. economy is relatively sluggish during the epidemic, credit demand has also been relatively sluggish. In the case of insufficient consumption power, insufficient loans, and money creation not intending to help the real economy, money can only enter the stock, futures, and digital currency markets.
The above picture shows that not only the Federal Reserve is printing money (to issue additional currency), but also central banks all over the world are printing money. We can see that the ECB (European Central Bank) and BOJ (Bank of Japan) have strong money printing capabilities. Among them, ECB is going crazy this year. The size of BOJ’s balance sheet is similar to that of the European Central Bank and the Federal Reserve, but the size of the Japanese economy cannot be compared with them. Therefore, BOJ’s banknote printing scale is also exaggerated.
The only thing that is more Buddhist is our People’s Bank of China (PBOC). The country’s monetary policy is relatively tight compared to developed economies. The main reason is that we have controlled the epidemic better, and there is no need to support recovery through a lot of stimulus. From a certain point of view, additional currency issuance is beneficial to GDP: when there is more money in the market, people will naturally consume and spend, and various business activities will be carried out.
Digital currency is classified as an alternative asset
JPMorgan Chase’s report on tether
Do you have such a perception? In fact, mainstream investment banks have now included Bitcoin and digital assets as a very important alternative asset category. Recently, JPMorgan Chase’s US fixed income team wrote a research report on Tether. Tether recently announced its asset composition. More than half of its asset composition is commercial paper (commercial paper). Here I want to talk about why the proportion of commercial paper is so large?
The premise for Tether to issue USDT is that it has sufficient reserve assets. Before, Tether had US dollar deposits in major banks, such as JPMorgan Chase. In order to solve the compliance problem, Big Bank rejected Tether’s deposit. So Tether deposited the U.S. dollar deposit in another small bank. As a result, these small banks (because they do not have the ability to settle at the central bank, usually open an account with JPMorgan Chase) deposited their money in JPMorgan Chase. Because the financial system is nested, Tether’s deposits still fall on the big bank’s balance sheet.
Commercial paper is actually a short-term personal IOU. Two types of institutions now issue such invoices in the US market. One is large companies with traditional businesses (such as Coca-Cola) and technology companies (such as Apple). So, Tether took his dollar deposit to buy the IOUs of Apple and Coca-Cola.
So is there any risk to Tether’s liquidity reserve? It is risky. Of course, you can say that the IOU risk of Coca-Cola and Apple is very low, and their bond issuance interest rate may be lower than that of some sovereign countries. But the commercial paper of these companies is also risky. Because these companies do not have the ability to print money, they have to rely on real money to repay them. So why does Tether have liquidity risk, and everyone is still willing to accept it? Because users who speculate coins don’t really care about the amount of Tether’s asset reserves, users who speculate coins never care about risks.
So after the announcement of Tether’s asset reserves, why has it received a lot of attention from investment banks? Because it is a CP holder, its size is already one of the best in the United States. This shows that the scale of digital currency is no longer small, and this is a liquidity matrix that is very worthy of attention. And this system is getting bigger and bigger, which does not include other stable coins.
Two days ago, Federal Reserve Board Director Brainard said that the US CBDC (the digital currency of the US central bank) must be launched as soon as possible and to dominate the global digital currency. why? Because he discovered that what the government did not do had already been done for him. If the Fed does not issue a digital currency, then his future market share will be Tether. Here is a lesson from the past. Why is the People’s Bank of China anxious to launch CBDC, because 80 to 90% of its payment market share comes from WeChat and Alipay. And these large technology giants can directly open reserve accounts with the central bank. When the user deposits the money in Alipay, and Alipay deposits 100% of the money in the People’s Bank of China, then the user’s deposit is almost risk-free. In other words, Alipay can be regarded as the world’s largest stable digital currency. One is that it is digital, and the other is that Alipay and WeChat Pay together account for 80% to 90% of the entire payment ratio. The purpose of China’s launch of CBDC is to re-dominate the payment business through the CBDC system.
The current monetary environment is not conducive to digital currencies
The subsequent macro environment will not be conducive to the digital currency market. Here is an excerpt from the Fed’s meeting minutes: Many participants emphasized that the committee must communicate to the market in advance about Taper before the economic situation has been assessed as “substantial progress.” Taper refers to reducing asset purchases, which means that the Fed will print less and less money in the future. Because too much money was printed last year, it may take 5-10 years to digest the additional currency. Second, the Fed may begin to release a signal at the June meeting-tightening US dollar liquidity.
The US Congressional Budget Office recently issued a report called options for reducing the deficit. This shows that the United States wants to reduce its fiscal deficit in the next 10 years. And the deficit of the US Treasury Department is too serious. Because the U.S. Treasury Department wants to distribute money to the people, and the money is issued by the Federal Reserve to help increase currency to support the issuance of bonds, the Treasury Department has absorbed a large amount of liquidity to fill the deficit expenditure. Recently, U.S. Treasury Secretary Yellen has done a lot of things, hoping to reduce the fiscal deficit. She hopes to change the global tax system, including raising personal taxes, increasing inheritance taxes, and increasing capital profits taxes. Because she wants to change the revenue and expenditure structure of the Ministry of Finance, so that income exceeds expenditure. In the future, you may need to pay the tax on currency speculation to the account of the Ministry of Finance.
Starting from the second half of this year, the United States has a big theme that is slowly tightening its currency in the next 10 years. In the past 10 years, the U.S. dollar has hardly tightened. Although there has been an interest rate hike cycle from 15 to 18 years, the scale of its balance sheet is still very large. The US government has not substantially tightened its currency liquidity. When the Clinton administration suddenly began to tighten fiscal policy in 1998 and 1999, the bull market in U.S. stocks for more than ten or two decades made people form an inertial thinking; but when monetary policy began to tighten, people realized that the government is not only Implement loose policies. At present, the debt/GDP ratio of the United States is already very high. The US debt can only be rolled over through taxes or newly issued currency. And the Fed has issued a lot of additional currencies. The additional issuance of currencies will inflate asset prices and bring bubble risks.
Although the macro environment is not very favorable, there are still straws, and digital assets are an important part of asset allocation. One of the core research reports of Goldman Sachs is called Top of Mind, which is a research report made by Goldman Sachs using the entire research network and connections of its think tanks. In the research report, Goldman Sachs believes that crypto will become an important asset class. The report also shows that if you allocate a certain percentage of Bitcoin in the 60/40 equity bond portfolio, it will increase your total income. Because the correlation between Bitcoin and actual assets is not so strong. Bitcoin and the U.S. dollar have an obvious negative correlation. Therefore, the only enemy of digital assets is the U.S. dollar, but the U.S. dollar is what makes it again. Therefore, the trend of the US dollar index is very weak. In a weak trend, digital assets and risk assets have such a rise. If one day the US dollar index starts to pick up, you must pay attention to risks.
Finally, the so-called digital currency cannot be called a digital currency. First of all, all currencies in the current financial system are digitized. For example, your deposits are digitized, and Alipay is also digitized. So the word number does not add extra content to the meaning of currency. Second, digital currency such as Bitcoin is not currency, it is an alternative asset. No one will use Bitcoin as a currency in the mainstream currency environment. This is a point that everyone must admit. USDT has a certain degree of currency, but it cannot be called a currency. So when you are buying digital assets, do not have the illusion that it will replace the U.S. dollar in the future.
