Original Title: Black or White?

Original Author: Arthur Hayes

Original Translation: zhouzhou, BlockBeats

The following is the original content (slightly reorganized for better readability):

Former Chinese leader Deng Xiaoping, when asked about his pragmatic economic policies that seemed contradictory to Chairman Mao's "pure" socialist or Marxist ideals, once famously said: "It doesn't matter if it's a black cat or a white cat, as long as it catches mice, it's a good cat." This means that no matter what means are used, as long as the intended effect is achieved. Beijing has put forward the idea of building an economic model of "Socialism with Chinese Characteristics." What exactly this means is not entirely clear, but it can be understood as "socialism" as defined by Beijing.

China has a system of "Socialism with Chinese Characteristics," which may sound like defining your own truth, because when Beijing is in power, truth is determined by you. If you have heard Kamala Harris speak without a teleprompter, you will know that similar sophistry exists in the land of freedom, pickup trucks, and Doritos. Drawing on this concept of "plasticity" in economic "ism," I also want to offer my interpretation of the "American Peace" economic system. I call it "American Capitalism with Chinese Characteristics," especially the latest economic policy pursued by the "Orange Man" President Donald Trump — the newly elected President of the United States.

Like Deng, the elites who rule the American Empire do not care if the economic system is capitalism, socialism, or fascism; they only care if the policies implemented help maintain power. The United States ceased to be purely capitalist as early as the beginning of the 19th century.

Capitalism means that the rich will lose money if they make wrong decisions, but this principle of capitalism was broken when the Federal Reserve was established in 1913. As privatized gains and socialized losses intensified, resulting in a huge class divide between the inland poor and the coastal elites, President Franklin Roosevelt had to take some corrective measures and provide some welfare to the poor through the New Deal. However, the expanded government subsidies were never accepted by those so-called wealthy capitalists.

Later, the pendulum swung from extreme socialism (with a highest marginal tax rate of 94% in 1944, applicable to incomes over $200,000) back to unconstrained corporate socialism beginning in the Reagan era of the 1980s. Then, neoliberal economic policies accompanied by massive money printing by the central bank to fund the financial services sector, in the hope that wealth would trickle down from the top to the ordinary people, persisted until the outbreak of the COVID-19 pandemic in 2020.

President Trump, following the example of FDR, directly distributed a large amount of money to the entire population, the largest amount since the New Deal. The U.S. dollars printed between 2020 and 2021 accounted for 40% of the total existing U.S. dollars. Trump kicked off a "stimulus check frenzy," and President Biden continued this highly popular policy during his presidency. Looking at the government's balance sheet, the fiscal changes between 2008 and 2020 and between 2020 and 2022 were surprising.

From 2009 to the second quarter of 2020, it was the heyday of "trickle-down economics," with funding coming from the central bank's money-printing operation, euphemistically called "quantitative easing" (QE). It can be seen that the pace of economic growth was lower than the accumulated pace of national debt.

In other words, the wealthy invested the government's massive subsidy into assets, and these types of transactions did not generate actual economic activity. Therefore, tens of trillions of debt-funded funds were allocated to the wealthy holding financial assets, a process that led to an increase in the debt-to-nominal GDP ratio.

From the second quarter of 2020 to the first quarter of 2023, Presidents Trump and Biden broke the previous trend. The debt issued by the Treasury was purchased by the Fed through money printing, but this time it was not only distributed to the wealthy but checks were directly mailed to everyone, with low-income earners receiving real cash in their bank accounts. Of course, Jamie Dimon, the CEO of JPMorgan Chase, still took a cut from the government's transfer fees... He's like the "Li Ka-shing" of the United States, unable to escape paying this "elderly gentleman."

Poor people are usually poor because they spend all their money on goods and services, and that's exactly what they did during this period. This consumption behavior significantly increased the velocity of money circulation, exceeding 1. This means that for every additional $1 in debt, over $1 of economic activity could be generated. As a result, magically, the debt-to-nominal GDP ratio of the United States decreased.

As the growth in the supply of goods and services did not keep pace with the purchasing power of the people relying on government debt, inflation became more intense. Wealthy individuals holding government bonds were dissatisfied with these populist policies, as they experienced the worst overall return since 1812.

The rich sent out a "white knight"—Fed Chair Powell—to respond. He began raising interest rates in early 2022 to curb inflation, while the general public hoped to receive another round of stimulus checks, but such a policy has become taboo. U.S. Treasury Secretary Yellen tried to counter the Fed's tightening impact by shifting debt issuances from long-term (bills) to short-term (T-bills) to siphon funds from the Fed's reverse repo tool. As a result, since September 2002, about $2.5 trillion of financial stimulus has mainly flowed to the wealthy holding financial assets, resulting in a significant rise in asset markets.

However, just like the situation in the late 2008, these rich people's government subsidies did not bring about substantial economic activity, and the U.S. debt-to-nominal GDP ratio began to rise again. Has Trump's cabinet learned from the recent "American Peace" economic history? I believe so.

Most people believe Scott Basset will become Trump's new U.S. Treasury Secretary to replace Yellen, and he has detailed in multiple speeches and columns how to "fix" America's plan, namely to execute Trump's "America First" plan. The plan is similar to China's development plan (started in the 1980s with Deng Xiaoping and still ongoing), aiming to revitalize key industries (such as shipbuilding, semiconductor factories, car manufacturing, etc.) by providing tax breaks and subsidies to drive rapid nominal GDP growth.

Qualified companies will receive cheap bank financing, and banks will eagerly lend to these companies because the U.S. government guarantees their profitability. As businesses expand in the U.S., they must hire American workers. Rising wages for ordinary Americans mean more consumer spending.

If Trump restricts immigration from "dirty, disorderly, and poor" countries, this will further stimulate economic activity, and the government will benefit from business profits and wage income taxes. The government maintains a large deficit to fund these projects, and the Treasury provides funds for the government by selling bonds to banks. With the Fed or lawmakers pausing the supplementary leverage ratio, banks can now ramp up leverage again. Ordinary workers, companies producing "compliant" products and services, and a U.S. government seeing a decrease in the debt-to-nominal GDP ratio are winners in this "enhanced version of pro-poor quantitative easing."

It all looks good, who would oppose such a "magical" era of American prosperity?

The losers are those holding long-term bonds or savings deposits, as the yield on these instruments will be intentionally kept low, below the nominal growth rate of the U.S. economy. If wage levels fail to keep up with higher inflation levels, low-income individuals will also be harmed. You may notice that joining a union has become fashionable again, with "4 years 40%" becoming the new slogan, meaning a 40% wage increase for workers in the next 4 years, equivalent to a 10% raise annually.

If you consider yourself a rich person, don't worry. Here's an investment tip (not financial advice): Every time a bill is passed and funds are allocated to a specific industry, carefully research and then invest in stocks in those areas. Instead of keeping funds in fiat bonds or bank deposits, consider buying gold (a traditional tool against financial oppression) or bitcoin (a new generation financial oppression hedging tool).

My investment portfolio is arranged in the following order: Bitcoin, other cryptocurrencies and related company stocks, followed by gold held in a vault, and finally stocks. I keep some cash in a money market fund to pay my Amex bill.

The following content will delve into how Quantitative Easing for the Rich and the Poor impacts economic growth and monetary supply. I will then predict how the Supplementary Leverage Ratio (SLR) exemption for banks might once again create the possibility of infinite "QE for the Poor." In the final section, I will introduce a new index to track U.S. bank credit supply and showcase Bitcoin's performance relative to other assets when considering bank credit supply.

Monetary Supply

I must express profound respect for Zoltan Pozar's "Ex Uno Plures" series of papers, as his research will play a significant role in the forthcoming articles.

Next, I will present a series of assumed accounting ledgers. On the left side of the T-account is assets, and on the right side are liabilities. Blue entries indicate asset increases, while red entries indicate asset decreases.

The first set of examples focuses on the Federal Reserve's impact on monetary supply and economic growth through Quantitative Easing (QE). Of course, these examples, including the following ones, may be somewhat exaggerated to make them more engaging and intriguing.

QE for the Rich

Let's assume you are Powell, during the March 2023 U.S. Regional Bank Crisis. To unwind, Powell goes to a tennis club at 370 Park Avenue in New York City to play squash with his billionaire finance friend. Powell's friend, let's call him Kevin for now, is a traditional financial titan who is quite upset. He says to Powell, "Jay, I had to sell my beach house. All my money is parked at Signature Bank, and apparently, I don't qualify for FDIC insurance because my deposits exceed the limit. You have to do something. You know Bunny can't stand the city in the summer. She's insufferable."

Jay replies, "Don't worry, I've got you covered. I will implement a $2 trillion Quantitative Easing (QE). This news will be announced Sunday night. You know the Fed always has your back. Without your contributions, who knows what the U.S. would be like. Just imagine if the financial crisis put Biden in a bind, giving Trump a chance to come back to power. That would be terrible. I still remember in the early '80s, Trump stole my girlfriend at Dorsia. That darn guy."

The Fed launches a bank term funding facility, different from direct QE, to address the bank crisis. But allow me some artistic license in this example. Now, let's see what happens to the monetary supply after the Fed implements a $2 trillion QE. All figures will be in billions of dollars.

1. The Federal Reserve purchased $2000 of Treasury bonds from BlackRock and paid with reserves. JPMorgan Chase, acting as a bank, played an intermediary role in this exchange, receiving $2000 in reserves and crediting BlackRock with a $2000 deposit. The Fed's quantitative easing (QE) allowed banks to create deposits, ultimately becoming money.

2. BlackRock lost the Treasury bonds, and Larry Fink (BlackRock's CEO) naturally wanted to reinvest this money in other interest-bearing assets. He recently became interested in tech companies and decided to invest $2000 in a new social media app called Anaconda. Anaconda has captured the hearts of a large number of male users aged 18-45, leading to a straight decline in their productivity. The company used debt issuance to buy back stocks, not only boosting earnings per share but also increasing the stock price, attracting passive index investors like BlackRock to continue buying its shares. As a result, the wealthy sold their stocks and received $2000 in deposits.

3. Anaconda's wealthy shareholders currently do not need to use this money, so they purchased art as "art patrons" at the Miami Art Fair. The buyer and seller belong to the same economic class, and the funds circulate between accounts without generating any real economic activity. The Fed injected $2 trillion in QE into the economy, ultimately only increasing the bank deposits of the wealthy without creating any actual growth or jobs. This QE for the wealthy from 2008 to 2020 has driven up the ratio of debt to nominal GDP.

Let's look at Trump's decisions during the pandemic. Going back to March 2020, with the COVID outbreak, advisors suggested he "flatten the curve," lockdown the economy, and only allow "essential workers" to continue working.

Trump: "What? Am I supposed to shut down the economy because some quack doctors are taking this flu seriously?"

Advisor: "Yes, Mr. President. I remind you, COVID-19 mainly affects elderly people like yourself. Moreover, if infected individuals require hospitalization, the medical costs will be high. You need to lock down non-essential workers."

Trump: "This will lead to an economic collapse. Just give everyone money to keep them quiet. Have the Fed buy the Treasury's issued debt to fund these subsidies."

QE for the Poor

Next, let's look at how QE for the poor operates through the same accounting framework.

1. The Fed conducted QE by purchasing a $2000 Treasury bond from BlackRock and paying with reserves, but this time the Treasury Department also got involved. To fund Trump's stimulus checks, the government needed to borrow by issuing Treasury bonds, which BlackRock purchased instead of corporate bonds.

2. JPMorgan helped BlackRock convert bank deposits into Fed reserves to buy Treasury bonds. The Treasury Department received a deposit into its General Account at the Fed, akin to a checking account.

3. The Treasury Department mailed stimulus checks to the public, causing the TGA balance to decrease while Fed reserves increased, becoming bank deposits for the common folks at JPMorgan.

4. The public used the stimulus money to buy new Ford F-150 trucks, ignoring electric vehicles because, well, this is 'Murica, leading to a frenzy of oil consumption. The common folks' bank accounts decreased while Ford's bank accounts increased.

5. Ford, in selling these trucks, did two things: first, they paid employee wages, moving deposits from Ford's account to the bank accounts of its workers. Second, Ford borrowed from banks to increase production, creating deposits for Ford as the borrower and increasing the money supply.

6. Eventually, the common folks wanted to go on vacation, applying for personal loans from banks. In a strong economy with well-paying jobs, banks were happy to provide loans. These loans to the common folks, like Ford's borrowing, created additional deposits.

The final deposit or money balance is $3000, $1000 higher than the initial $2000 injected by the Fed through QE.

From this example, it can be seen that QE targeted towards the public can stimulate economic growth, with the Treasury Department's stimulus encouraging truck purchases. The demand for goods allowed Ford to pay wages and apply for loans to increase production. Well-paid employees meeting bank credit standards further drove consumption. $1 of debt generated over $1 of economic activity, a favorable outcome for the government.

I would like to further discuss how banks are able to provide unlimited financing to the Treasury Department.

Let's pick up from step 3 above.

4. The Treasury Department is preparing to distribute another round of stimulus. To raise funds, the Treasury Department auctions Treasury bonds, with primary dealers like JPMorgan using Fed reserves to purchase these bonds. Selling the bonds increases the Treasury Department's balance in the Fed's TGA.

5. Similar to the previous examples, the Treasury Department will mail out subsidy checks, which then become deposits for the common people at JPMorgan.

When the Treasury Department issues Treasury bonds purchased by the banking system, this converts the Federal Reserve's reserve balances (which have no substantial use in the economy) into bank deposits for the common people, which can be used to purchase goods and thus generate economic activity.

Government Encouragement of Business Production

Let's look at another T-account scenario. What happens when the government encourages business to produce specific goods and services through promises of tax breaks and subsidies?

In this example, in a movie scene depicting "American Hegemony," ammunition is running low, so the government legislates a subsidy for ammunition production. Smith & Wesson applies for and receives a military contract for ammunition supply but cannot meet the order demand. They then apply for a $1000 loan from JPMorgan to build a factory for expansion. The loan officer at JPMorgan, after reviewing the government contract, confidently approves the loan, creating $1000 of funds out of thin air.

Smith & Wesson's newly built factory pays wages to employees, and these wages ultimately end up in JPMorgan. Here, the funds created by the bank become deposits in the hands of common people with a higher propensity to consume, thereby stimulating economic activity.

Next, the Treasury Department funds the subsidy by issuing $1000 of new debt. JPMorgan comes to bid, but lacking reserve balances, they apply for a loan at the Federal Reserve's discount window. Using Smith & Wesson's corporate debt as collateral, JPMorgan receives reserve balances to purchase Treasury bonds from the Treasury Department. The Treasury Department then pays the subsidy to Smith & Wesson, which becomes a deposit in JPMorgan's account.

This process illustrates how, through industrial policy, the U.S. government guides the banking system to inject funds into the market while using loan-generated assets as collateral to finance the purchase of Treasury bonds from the Federal Reserve.

Constraints

It appears that the Federal Reserve, Treasury Department, and banks are operating a "monetary magic machine" that can achieve the following effects:

1. Provide asset growth opportunities for the wealthy, although with limited impact on actual economic activity.

2. Inject funds into the hands of the common people through bank accounts, thereby stimulating the consumption of goods and services.

3. Ensure profitability in specific industries, enabling businesses to expand operations using bank loans, thereby driving economic activity.

But can money creation truly be unlimited? The answer is no. Each debt asset of a bank needs expensive equity as capital support. In other words, different asset types have corresponding risk-weighted asset charges, even risk-free government bonds and central bank reserve deposits require payment of equity capital costs. Therefore, at a certain point, banks find it challenging to further bid for US Treasury bonds or issue corporate loans.

The setting of equity capital is because when a borrower goes bankrupt (whether a government or a company), someone needs to bear the loss, and the bank's shareholders are supposed to bear this risk. If a bank cannot afford these losses, it will go bankrupt. Bank failures not only affect depositors but, more crucially, disrupt the entire credit expansion system, which is a key pillar of maintaining the current fiat currency system.

When a bank's capital is depleted, the central bank becomes the last resort and must create new money to take over the bank's loss-making assets.

Back to reality.

Assuming the government wishes to create unlimited bank credit, they must modify the rules so that government bonds and certain "approved" corporate bonds (such as investment-grade bonds, or bonds issued by certain industries such as semiconductor companies) are exempt from the supplementary leverage ratio (SLR) limit.

If government bonds, central bank reserves, or approved corporate bonds are exempt from the SLR limit, banks can purchase an unlimited amount of such debt without incurring expensive equity capital costs. The Federal Reserve has the power to grant this exemption. From April 2020 to March 2021, the Federal Reserve did indeed do this.

At that time, the US credit market was almost stagnant, and the Federal Reserve needed banks to lend to the US government again to support Treasury bond issuance because the government was about to distribute trillions of dollars in stimulus funds without enough tax revenue to pay for them. This exemption was very effective, leading to banks heavily buying government bonds. However, the side effect was that as Powell raised rates from 0% to 5%, the prices of these bonds plummeted, ultimately triggering a regional bank crisis in March 2023. There is no such thing as a free lunch.

In addition, the reserve levels of banks also limited their willingness to participate in Treasury bond auctions. When banks feel that their reserves at the Federal Reserve have reached the Lowest Comfortable Liquidity of Reserves (LCLoR), they will stop participating in auctions. The specific value of this LCLoR can only be determined afterwards.

This is a chart from the Treasury Borrowing Advisory Committee (TBAC) in a "Financial Market Resilience" report released on October 29, 2024. The chart shows that the amount of Treasury bonds held by the banking system is approaching the Lowest Comfortable Liquidity of Reserves (LCLoR) ratio to total issuance. This is a problem because the Federal Reserve is undergoing quantitative tightening (QT), and some surplus countries' central banks either are selling off Treasury bonds or are no longer reinvesting net export earnings in US Treasury bonds (de-dollarization). In this situation, the marginal buyers of the Treasury bond market are gradually shifting to some more speculatively driven bond hedge funds, whose buying behavior is unstable.

This is another chart from the same report. As can be seen, hedge funds are filling the gap left by banks in buying government bonds. However, hedge funds are not “real money” buyers; they are engaged in arbitrage trading: buying cash government bonds at a low price while simultaneously shorting government bond futures contracts.

The cash leg of the trades is financed through the repurchase market. Repurchase (repo) is the exchange of an asset (such as a Treasury security) for cash for a certain period, and the overnight financing cost in the repo market using government bonds as collateral depends on the available balance sheet capacity of commercial banks. As the balance sheet capacity decreases, the repo rate rises.

If the financing cost increases, hedge funds will only add to their purchases if the government bonds further depreciate relative to futures. This ultimately means the auction price of government bonds decreases, yields rise, which is not the outcome the Treasury Department wishes to see, as it aims to issue more debt at increasingly lower prices.

Due to regulatory constraints, banks cannot buy enough government bonds and cannot provide low-cost financing for hedge funds’ bond purchases. Therefore, the Fed must once again grant banks an SLR exemption, which not only improves liquidity in the government bond market but also allows for the unlimited QE to channel into the productive part of the US economy.

If you are not yet convinced that the Treasury Department and the Fed understand the necessity of loosening bank regulations, the TBAC clearly outlines the required actions on page 29 of this report:

Within the framework of “Trump Economics” that you described, we need to focus on the expected amount of bank credit growth. As seen in the previous example, we know that QE for the wealthy works by increasing bank reserves, while QE for the average person works by increasing bank deposits. Fortunately, the Fed releases weekly data on the entire banking system, including reserves and other deposits and liabilities.

I have created a custom Bloomberg index that combines reserves and other deposits and liabilities, labeled as the <BANKUS U Index>.

This is a custom index I created to track the quantity of US bank credit. I believe this is the most critical monetary supply indicator. As you can see, this index sometimes leads Bitcoin, for example, in 2020; and sometimes lags behind Bitcoin, for example, in 2024.

However, more importantly is how assets perform when bank credit supply tightens. Bitcoin (white), S&P 500 Index (gold), and gold (green) have all been adjusted by my bank credit index. These values have been indexed to 100 as a base, and from the chart, it can be seen that Bitcoin has performed outstandingly, surging over 400% since 2020. If you can only do one thing to hedge fiat depreciation, it's to choose Bitcoin. This mathematical conclusion is irrefutable.

The Path Forward

Trump and his monetary policy aides have been very clear in stating that they will pursue a policy of weakening the US dollar and providing the necessary funds to bring American industry back home. With the Republican party controlling the three branches of government over the next two years without effective opposition, they can push through Trump's economic agenda. It is worth noting that I believe the Democratic party will also join the money-printing army, as what politician can resist the temptation of doling out freebies to voters?

The Republicans will first incentivize producers of key goods and materials to bring production back home through legislation. These measures will be similar to the chip agency, infrastructure act, and green new deal passed by the Biden administration. As companies take advantage of government subsidies and loans, bank credit will surge. For those investors who think they can pick stocks, consider buying shares in publicly traded companies the government wants to support.

At some point, the Federal Reserve may relax requirements, at least exempting SLR (leverage ratio) for treasuries and central bank reserves. Once this happens, the path to unlimited quantitative easing (QE) will be unimpeded.

The combination of industrial policy in legislation and SLR exemption will lead to a surge in bank credit. I have already shown that the monetary velocity of this policy is higher than the traditional rich-fed QE. Therefore, we can expect Bitcoin and cryptocurrencies to perform very well, perhaps even better than from March 2020 to November 2021. The real question is, how much credit will be created?

The COVID stimulus injected about $4 trillion in credit, and this round will far surpass that. The growth rates of just defense and medical spending already exceed the pace of nominal GDP growth. Moreover, with the US ramping up defense spending to counter the multipolar geopolitical environment, these expenditures will continue to grow rapidly.

By 2030, the proportion of the US population over 65 will peak, meaning the growth of medical spending will accelerate from now until then. No politician dares cut defense and medical spending as they will be swiftly voted out. All this means the Treasury will be busy quarter after quarter injecting debt into the market just to keep things going. As I've shown before, combined fiscal borrowing with QE, its monetary velocity is over 1. This deficit spending will raise America's nominal growth potential.

When it comes to the goal of bringing American companies back to the homeland, the cost of achieving this will also reach the trillion-dollar level. Since 2001, when the U.S. allowed China to join the World Trade Organization, the U.S. voluntarily handed over its manufacturing base to China. In less than thirty years, China has become the world's factory, producing the highest quality goods at the lowest prices.

Even those companies hoping to diversify their supply chains to other so-called cheaper countries have found that due to the deep and efficient supplier integration on the eastern coast, even though the hourly wages in countries like Vietnam are much lower, these companies still need to import intermediate products from China to produce the final goods.

All of this indicates that readjusting the supply chain to the U.S. will be a massive task, and if it must be done for political reasons, it will be very costly. I am talking about the need to provide trillions of dollars in cheap bank financing to move production capacity from China to the U.S.

In order to bring the debt-to-GDP ratio down from 132% to 115%, the U.S. spent $4 trillion. Assuming the U.S. further reduces this ratio to 70%, the level it was at in September 2008. Using a linear extrapolation, it implies the need to create $10.5 trillion in credit to achieve this deleveraging process. This is why Bitcoin will surpass $1 million, as prices are determined by marginal prices.

As Bitcoin's circulating supply decreases, the most fiat currency in history will be chased not only by Americans, but also by the Chinese, Japanese, and Western Europeans all flocking to this safe-haven asset. I recommend you hold long-term and keep holding. If you are skeptical of my analysis of the impact of quantitative easing on the impoverished, just read the economic history of China over the past thirty years, and you will understand why I refer to the emerging "American hegemonic economic system" as "American capitalism with Chinese characteristics."

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