Ecoinometrics - GDP for your buck

July 07, 2021

In the US (but that’s true of any major central bank) the Federal Reserve has never pumped so much money into the system as last year. At the same time the Federal Government is sitting on an ever increasing pile of debt. 

That’s a lot of currency debasement and a lot of liabilities to take care of later down the road. 

But is it working at least?


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GDP for your buck

This post is the 2nd in a series started here.

I know that with Modern Monetary Theory gaining in popularity many people aren’t worried about currency debasement and exploding debt. It is like there is no problem.

But as with a lot of things, these aren’t problems until they become one. And if they become one the risk is pretty big: debt crisis, hyperinflation event, ask those who have experienced that outside of the US to know what it feels like…

For now the US and the EU think they are somehow protected from that. The world is changing though...

So if you are taking big long term systemic risks, you’d at least want them to payoff in the short term.  

Is it working then? 

I guess it depends on who you ask. 

For the average Joe, it seems to be working less and less. A random worker doesn’t care much about what's going on in the stock market. A solid real economy is what’s more likely to have a direct impact on his daily life. 

And the way the system is built, a solid economy means growth, GDP growth. 

Now the Federal Reserve is always pumping more money in the system to maintain that growth. But it seems that we have a problem. 

Until 2000 there was roughly a linear relationship between the growth of M2 and the growth of the GDP. The more money gets into the system, the more growth it generates in the real economy.

Since 2000 though it feels like we are hitting diminishing returns. In the US, you are getting less and less GDP for your buck. Check it out.

It is even more clear when you see how this effect compounds. That is measured by the velocity of money: simply the ratio of the GPD to M2 calculated every quarter.

Since the end of the dot-com bubble and even more since the 2008 financial crisis the velocity of money has been in free fall. 

That means less and less of the growth of the money supply finds its way into the real economy...

Indeed since 2008 the Federal Reserve has switched their strategy. A lot of the money they create comes from purchasing US Treasury bonds aka debt financing. 

See the growth of the US Treasury debt held by the Fed.

And the mechanism by which the Fed is financing the debt means that most of the money printed ends up trapped in the financial system instead of flowing towards the real economy.

Now, whether it is by design or simply a result of the Cantillon effect, this creates in asset price inflation. 

Just take a look at the SP500 plotted against the US$ M2. After 2008 you can see how M2 and the stock market started to grow hand in hand. After 2020 the phenomenon is getting even stronger...

Alright, so where is this heading?

Do you think this situation is sustainable? 

The way the system is setup can only lead to more growth of the financial assets at the expense of the real economy. This cannot last forever. 

But getting out of the current situation is tricky due to the very high level of debt in the system. 

So the trick for you is to be well positioned to benefit from most of the possible scenarios. And for that I think being invested into Bitcoin is a good bet:

  • In the current system money printing lifts hard assets. This is good for Bitcoin.

  • If central banks decide to inflate away their debt, once more Bitcoin as a store of value is well positioned to perform as a hedge.

  • If the system comes crashing down, you would certainly benefit from not being completely tied to the US$. Hence the advantage of being invested in a decentralized money network such as Bitcoin.

You probably don’t want to wait to consider those options. As the proverb says: dig the well before you are thirsty. 

We’ll continue digging into that topic next week. So don’t forget to subscribe to get the updates directly in your inbox.


CME Bitcoin Derivatives

Most of the time when I cover the CME Bitcoin derivatives everything I say can be summarized simply by “business as usual”.

But actually, we might be witnessing a shift of trends in the market. 

Hear me out.

For months the open interest on the futures has been steadily declining. That’s pretty clear when you zoom out.

That means two things:

  • The strategies that had been ramping up since February last year are getting unwound. More positions are closed outright than the ones that are rolled over.

  • There are no new strategies taking their place. Traders are either moving away from this market or just waiting to see what’s going to happen.

This is confirmed when you observe the trend in the Commitment of Traders report. 

Retail traders ramped up their long positions in 2020. That makes sense if in aggregate the retail crowd was playing a momentum strategy. But since the start of the year, long positions are getting rolled out. Soon we’ll be back at the base level of 2020.

Similar story with the smart money. The big demand for BTC derivatives since 2020 created a sizeable premium of the futures over the spot market. That allowed hedge funds to run a very profitable arbitrage strategy. 

They sold the more expensive futures while at the same time buying the cheaper spot BTC to pocket the difference. That’s a strategy called the basis trade and as you can see it allows you to make money regardless of where Bitcoin is going.

You can clearly see this strategy building up by following the rise of the amount of short positions starting in early 2020 on the graph below.

But this trade is getting rolled out too since the start of the year. Less demand for BTC derivatives probably means smaller premiums and thus a less profitable arbitrage. So less hedge funds are running this strategy now.

To be fair we are still far away from the base level of 2020 on that trade. But the trend is heading there.

So what does that tell us about the market?

I’m not sure. 

Maybe it is a sign of capitulation of the retail crowd. They’ve played the game, generated big profit (after falling -55% Bitcoin is still up +300% since the halving) and now they are moving on until the next sign momentum picks up again.

If we really are in a capitulation phase for the trading crowd then that’s not a bad thing. The price will probably settle around $30,000 for a while and we can wait for the next catalyst. For those playing the long term game this is nothing but another accumulation phase. Been there, done that...

No comments on the state of the options market this week. As usual there is very little activity and the positioning hasn’t changed.

See for yourself.


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Cheers,

Nick