(Any opinions expressed here are the personal opinions of the author and should not be relied upon for investment decisions or considered as recommendations or suggestions to engage in investment transactions.) Water, water, water everywhere. Soaked till the deck was wrinkled; Water, water, water everywhere. Not a drop of it can be swallowed. - Coleridge, The Rime of the Ancient Mariner I love specialty coffee, but the coffee I brewed myself was a disaster. I spent a lot of money on coffee beans, but the coffee I brewed was never as good as what I had at a café. To improve my brewing, I started paying more attention to details. I realized that one detail I had overlooked was water quality. Now, I realize the importance of water to coffee quality. Recently, an article in the 35th issue of Standard magazine gave me a wake-up call. I encountered similar situations during my time as a barista, when I learned that a cup of coffee is more than 98% water, and espresso is about 90% water. People tend to realize this late in their coffee journey, probably because it’s so much easier to buy a new machine to make better coffee. “Ah, you have a conical grinder! That’s why your pour-over is cloudy. Get a flat grinder!” But what if that 2% isn’t the problem? What if focusing on the solvent itself could solve our coffee woes? —Lance Hedrick, The Chemistry of Water Next, I digested the author's advice and ordered a home distiller. I know of a local coffee shop that sells mineral concentrates that, when added to water, will create the perfect base to bring out the intended flavors of the roast. By this winter, my morning cup of coffee will be delicious... I hope. I pray for the taste buds of those brave friends who will sample my black gold before climbing Mount Yotei. Good quality water is essential for brewing great coffee. Shifting your focus to investments, water or liquidity is important for building wealth. This is a recurring theme in my articles. But we often forget its importance and focus on the little things we think will impact our ability to make money. If you can recognize how, where, why and when fiat liquidity is generated, then it is difficult to lose money on your investments. Unless you are Su Zhu or Kyle Davies. If financial assets are denominated in US dollars and have nothing to do with US Treasuries, then the amount of global currency and US dollar debt is the most critical variable. We must look to the US Treasury, not the Fed, to determine the increase or decrease in US hegemony over fiat liquidity. We need to review the concept of "fiscal dominance" to understand why US Treasury Secretary Janet Yellen made Fed Chairman Powell her test towel man. Please read my article "Kite or Skateboard" for more in-depth discussion. In a period of fiscal dominance, the need to fund the government takes precedence over the central bank's concerns about inflation. This means that bank credit and nominal GDP growth must be maintained at high levels, even if this leads to persistently above-target inflation. Time and compounding determine when power shifts from the central bank to the Treasury. When the debt-to-GDP ratio exceeds 100%, the debt is mathematically growing faster than the economy. At this tipping point, the institution that controls the supply of debt becomes the boss. This is because the Treasury decides when debt is issued, how much is issued, and when it matures. Furthermore, since the government is now addicted to debt-fueled growth just to maintain the status quo, it will eventually instruct the central bank to use its printing press to cash the Treasury's checks. Central bank independence be damned! The outbreak of the coronavirus and the U.S. government’s response to keep people at home and pay them paycheck to paycheck has caused the debt-to-GDP ratio to rise sharply to over 100%. It’s only a matter of time before Yellen goes from “grandma” to “bad girl.” There is a simple way that Ms. Yellen can create more credit and stimulate asset markets before the U.S. falls into hyperinflation. There are two risk-free funds on the Fed's balance sheet that, if released into the market, will drive bank credit growth and push up asset prices. The first fund is the reverse repurchase program (RRP). I have discussed this fund in detail, where money market funds (MMFs) park cash at the Fed overnight and earn interest. The second fund is bank reserves, which the Fed pays interest on and works in a similar way. When money appears on the Fed's balance sheet, it can no longer be pledged to financial markets to generate broad money or credit growth. The Fed's quantitative easing program creates financial asset price inflation, rather than a surge in bank credit, by paying interest on reserves and repurchase agreements to banks and money market funds, respectively. If quantitative easing is not sterilized in this way, bank credit will flow into the real economy, increasing output and goods/services inflation. Given the current level of total debt in the United States, strong nominal GDP growth and goods/services/wage inflation are exactly what the government needs to raise taxes and deleverage. So, Ms. Yellen (Bad Gurl Yellen) started to take action to correct the situation. "Bad girl" Yellen doesn't care about inflation. Her goal is to create nominal economic growth, thereby increasing tax revenues and reducing the ratio of U.S. debt to GDP. Given that no party or its supporters have committed to spending cuts, deficits will continue for the foreseeable future. Moreover, because the federal deficit is so large, the largest in peacetime, she must use all available means to finance the government. Specifically, this means that she must take as much money as possible from the Fed's balance sheet and inject it into the real economy. Yellen needs to give banks and money market funds something they want. They want a cash-like interest-bearing instrument with no credit risk and very low interest rate risk to replace the interest-bearing cash they hold at the Fed. Treasury bills (T-bills) with maturities of less than one year and yields slightly above the interest on reserve balances (IORB) or the repurchase rate (RRP) are the perfect substitute. T-bills are an asset that can be widely used in the market and can generate credit and asset price growth. Does Yellen have the wherewithal to issue $3.6 trillion worth of T-bills? (Footnote: 1) You bet she does. The federal government runs a $2 trillion deficit each year that must be financed through debt securities issued by the Treasury Department. Yet Yellen or whoever replaces her in January 2025 does not have to issue T-bills to finance the government. She can sell longer-term Treasury securities, which are less liquid and carry more interest rate risk. These securities are not cash equivalents. Moreover, due to the shape of the yield curve, longer-term bonds yield less than T-bills. The profit motive of banks and money market funds prevents them from converting the money they hold at the Fed into anything other than T-bills. Why should we, as cryptocurrency traders, care about the flow of money between the Fed’s balance sheet and the broader financial system? Enjoy this beautiful chart. As RRP (white) fell from its highs, Bitcoin (gold) rebounded from its lows. As you can see, the two are very closely related. When money leaves the Fed's balance sheet, liquidity increases, causing the price of finite financial assets such as Bitcoin to surge. Why is this happening? Let’s ask the Treasury Borrowing Advisory Committee (TBAC). In its latest report, TBAC clearly points out the relationship between the increase in T-bill issuance and the amount of funds held by MMFs in RRPs. The high ON RRP balance may indicate unmet demand for T-bills. During 2023-24, ON RRP funds are depleted as money funds are converted to T-bills at an almost one-to-one ratio. This conversion helps to smoothly absorb the record issuance of T-bills.
— Slide 17, TBAC July 31, 2024
Money market funds will move cash into Treasury bills as long as the yield on Treasury bills is slightly above the repo rate - currently, the yield on the one-month Treasury bill is about 0.05% above the repo rate. The next question is whether Yellen can convince the remaining $300-400 billion to be transferred from RRP to T-bills. If you doubt Yellen, you are going to be sanctioned! Ask those poor people from the "shithole countries" what happens when you can't get dollars to buy necessities such as food, energy and medicine. In its recent Quarterly Refund Announcement (QRA) for the third quarter of 2024, the Treasury said it would issue $271 billion in T-bills between now and the end of the year. That's good, but there's money left over in the RRP. What else can it do? Let me quickly talk about the Treasury repo program. Through this program, the Treasury repurchases illiquid non-T-bill securities. The Treasury can fund the purchases by drawing on its general account (TGA) or issuing T-bills. If the Treasury increases the supply of T-bills and decreases the supply of other types of debt, there is a net increase in liquidity. Funds will leave the RRP, which is good for dollar liquidity, and as the supply of other types of Treasury securities decreases, these holders will move across the risk curve to replace these financial assets. The recently announced buyback program shows that a total of $30 billion worth of non-marketable securities will be repurchased between now and November 2024. This is equivalent to issuing another $30 billion in Treasury bills, bringing RRP outflows to $301 billion. This is a real liquidity injection. But how bad is Yellen, the "bad girl"? How much does she want the minority presidential candidate Momala Harris to win? I say "minority" because Harris changes her ethnicity depending on the audience. She has this unique ability. I support her! The Treasury could reduce the TGA from about $750 billion to zero, injecting a massive amount of liquidity. They can do this because the debt ceiling goes into effect on January 1, 2025, and by law the Treasury can spend the TGA to avoid or prevent a government shutdown. Bad girl Yellen will pump in at least $301 billion and up to $1.05 trillion between now and the end of the year. Wow! That will create a glorious bull market for all types of risk assets including cryptocurrencies before the election. If Harris still can't beat the orange man, then I think she needs to become a white male. I believe she has this superpower. Over the past 18 months, the Fed has injected an astonishing $2.5 trillion into financial markets by tapering its bond-buying program. But there is more dormant liquidity waiting to be released. From 2025 onwards, can Yellen's successor create the conditions to move money out of the bank reserves held by the Fed and into the broader economy? In the era of fiscal dominance, everything is possible. But how? As long as regulators treat capital adequacy ratios the same and the latter yields a higher rate, for-profit banks will trade one yielding cash-like instrument for another. Currently, Treasury bills yield less than the reserve balances held by the Fed, so banks will not bid for them. But what happens next year, when the RRP approaches zero and the Treasury continues to flood the market with T-bills? Ample supply and the inability of MMFs to buy T-bills with money from the RRP mean that prices must fall and yields rise. Once T-bill yields are a few basis points above the rate paid on excess reserves, banks will use their reserves to absorb T-bills. Yellen's successor (I bet it will be Jamie Dimon) will not be able to resist seeking political benefits for the ruling party by continuing to flood the market with short-term Treasury bills. There is still $3.3 trillion of bank reserve liquidity waiting to be injected into the financial market. Let's all shout: Bills, baby, bills! I believe TBAC is quietly hinting at this possibility. Here is another paragraph from the same report, with my comments in bold: Looking ahead, a number of factors may warrant further examination when considering future T-bill issuance: “TBAC wants the Treasury to think about the future and what T-bill issuance should be. Throughout the speech, they advocated that T-bill issuance should remain around 20% of total net debt. I think they tried to explain the factors that led to that increase and why banks would be the main buyers of these T-bills.” -- The evolution and ongoing assessment of the regulatory environment for banks (including liquidity and capital reforms, etc.), and the impact of banks and dealers effectively participating in the primary Treasury market to intermediate and warehouse (expected) future U.S. Treasury maturities and supply “Banks don’t want to hold more long-term notes or bonds that regulators require to be more strictly collateralized. They are privately saying, we’re not going to buy any more long-term bonds because it hurts their profitability and it’s too risky. If the primary dealer strike continues, the Treasury is in trouble because who else has the balance sheet to absorb the huge debt auctions?” -- Evolution of market structure and its impact on Treasury market resilience measures, including: > The SEC's central clearing rule, which requires a significant increase in margin payments to be made to collateral clearing institutions
“If the Treasury market were traded on an exchange, it would require dealers to post billions of dollars worth of collateral. They can’t afford that, and the result is less participation.”
> Predictability of future (expected) Treasury auction sizes and cash management and benchmark T-bill issuance
“If the deficit continues to be as large as it is now, the amount of debt issued is likely to increase significantly. Therefore, the T-bill as a ‘shock absorber’ will only become more and more important. This means that it will be necessary to issue more T-bills.”
> Future money fund reform and potential structural demand for T-bill
“If MMFs return to the market after RRPs are fully exhausted, T-bill issuance will exceed 20%.”
— Slide 26, TBAC July 31, 2024
The banks have effectively gone on strike by buying long term Treasuries. Poor Yellen and Powell nearly caused the banks to collapse by flooding them with Treasuries and then raising rates in 2022-2023…Silvergate, Silicon Valley Bank and Signature Bank are gone. The remaining banks will not sit idly by and will find out what happens if you buy overpriced Treasuries in large quantities again. Case in point: US commercial banks have bought only 15% of non-T-bill Treasury securities since October 2023. (Footnote: 2) This is not a good thing for Yellen, because she needs the banks to step up when the Fed and foreigners exit the stage. I think that as long as banks buy T-bills, they will be happy to perform their duties, because T-bills have a similar risk profile to bank reserves, but with a higher yield. The fall in the USD/JPY exchange rate from 160 to 142 has sent shockwaves through global financial markets. Last week, many were reminded to sell their assets. This is like a textbook correlation. USD/JPY will reach 100, but the next move will be driven by capital repatriation from Japanese companies’ overseas assets, not just hedge funds playing the yen carry trade. (Footnote: 3) They will sell US Treasuries and US stocks (mainly large tech stocks such as NVIDIA, Microsoft, Google, etc.). The Bank of Japan tried to raise interest rates, but global markets reacted strongly. They were forced to announce the cancellation of their rate hike plans. From a fiat liquidity perspective, the worst-case scenario is that the yen moves sideways, with no new net positions funded in cheap yen. With the threat of yen carry trades unwinding having passed, the market manipulation of the "bad girl" Yellen is once again in the spotlight. Without water, you die. Without fluidity, you collapse. Why has the cryptocurrency risk market been moving sideways and falling since April this year? Most tax revenues are concentrated in April, so the Ministry of Finance needs to borrow less. This can be seen from the amount of short-term Treasury bills issued from April to June. Liquidity is removed from the system as the net amount of Treasury bills outstanding decreases. Even if overall government borrowing increases, the net decrease in cash-like instruments provided by the Treasury results in less liquidity in the market. As a result, cash remains trapped on the Fed's balance sheet, in repurchase agreements, and is unable to drive financial asset prices higher. The chart of Bitcoin (gold) versus RRP (white) clearly shows that from January to April, when T-bills were net issued, RRP fell and Bitcoin rose. From April to July, when T-bills were net withdrawn from the market, RRP rose and Bitcoin traded sideways with several sharp declines. I stopped on July 1 because I wanted to show the interaction before USDJPY rose from 162 to 142, which led to a broad sell-off in risk assets. So, based on what Yellen said, we know that $301 billion in net Treasury bills will be issued between now and the end of the year. If this relationship holds true, Bitcoin will quickly reverse the sell-off caused by the stronger yen. The next stop for Bitcoin is $100,000. Altcoin are an upgraded version of Bitcoin. But in this cycle, there is structural buying for Bitcoin and Ethereum, which is manifested by net inflows into U.S. listed exchange-traded funds (ETFs). Although Bitcoin and Ethereum have corrected since April, they have avoided the brutal decline of the Altcoin market. The Altcoin market will only return after Bitcoin and Ethereum break through $70,000 and $4,000 respectively. Solana will also break through $250, but considering the relative market capitalization, Solana's rise will have a far less impact on the overall wealth effect of the cryptocurrency market than Bitcoin and Ethereum. At the end of the year, the rebound of Bitcoin and Ethereum driven by US dollar liquidity will lay a solid foundation for the return of sexy Altcoin. Liquidity conditions will improve with the issuance of short-term US Treasury bills and the implementation of the repurchase program. If Harris is wavering and needs a strong rise in the stock market to boost sentiment, Yellen will use the TGA. In any case, I expect cryptocurrencies to break out of the sideways and downward trajectory starting in September. Therefore, I will use the weakness at the end of the northern hemisphere summer to increase cryptocurrency exposure. The US election will be held in early November. Yellen will hit peak manipulation in October. There is no better time to get liquidity this year. Therefore, I will sell on strength. Instead of liquidating my entire crypto portfolio, I will profit from the more speculative momentum trades and park the capital in staked Ethena USD (sUSDe). The crypto market is moving higher, increasing the odds of a Trump win. The odds of a Trump win peaked after the assassination attempt and Slow Joe's disastrous debate performance. Kamala Harris is a first-rate political puppet, but she is not an octogenarian. She only needs to do this to beat Trump. The election is like a coin toss, I would rather watch the chaos from the sidelines and return to the market after the US debt ceiling is raised. I expect this to happen in January or February. Once the dust settles on the US debt ceiling, liquidity will flow from the Treasury and the Fed, and the market will get back on track. At that time, the bull run will truly begin. $1 million Bitcoin is still my base case. PS: Once "bad girl" Yellen and "towel boy" Powell join forces, China will surely release the long-awaited "bazooka"-style fiscal stimulus. The US-China cryptocurrency bull market in 2025 will be brilliant. 1: This is the total amount of bank reserves held by the Fed and the RRP. 2: According to the H.8 Fed report, from the week ending September 27, 2023 to July 17, 2024, commercial banks purchased $187.1 billion worth of Treasury bills. I assume that during the same period, MMFs purchased 100% of all T-bills issued. During the same period, the Treasury issued $1,778 billion worth of debt securities other than T-bills. Banks accounted for 15% of that. 3: Japanese companies include Japanese insurance companies, pension funds, businesses, households and Japanese banks. 
