A few things to keep an eye out for (and, sorry if typos, but in a rush):
The gold reval play
As we set out this week, there’s a case to be made that the gold/silver rally is China’s Libor moment. That means it’s not a dollar debasement trade. It’s a yuan debasement trade. The absolute scenes from China in terms of the scramble for gold — and now silver, since the unit costs of even gold beans now far surpass average earnings — speak volumes on this front. And the bug is now spreading to BRI-influenced states.
The goldbugs and China bulls continue to spin this as some sort of 4D chess move by Beijing. But trust me. I was there in the 1980s in Poland. This is not a show of strength. What’s going on in the West in terms of fiscal dysfunction is a far cry from what is happening in China.
On the contrary, rumors are now circulating that the U.S. administration is hoping the China panic will induce gold prices of as much as $5,000 per troy ounce because that will levy a revaluation gain on America’s gold reserves of up to $1.3 trillion. If it really went for it — to book a solid gain of $1.5 trillion — the admin would be aiming for about $5,780.
Even JP Morgan’s Jamie Dimon is now saying gold can go as high as $10,000.
If that happens, and the U.S. revalues its gold reserves at that rate, it unlocks immediate fiscal headroom at China’s expense.
The CCP must know this. For years, they have very carefully controlled the import and export of gold and even capped purchases. All imported “standard gold” bars had to be registered on the Shanghai Gold Exchange first. If gold accumulation was really something the CCP desired en masse, they wouldn’t maintain such controls.
What’s more, Chinese banks have been altering the risk classifications on metals this week, with local Chinese media reporting that banks are actively discouraging gold investment and refusing to open new accounts for these products. This means that new investments in these products are either restricted or entirely halted. Again, this is a red flag if you believe China piling up on gold is a sign of its superiority or stability.
Again, trust me, we’ve been here before. And I personally have uniquely relevant experience in this domain.
The only difference between now and 1980s Poland is that communism wasn’t being toppled by soaring gold prices. At least not explicitly. It was being toppled by the depreciation of COMECON currencies against hard currencies like the dollar, sterling, and the Deutsche mark. Also, it was imports of physical bearer banknotes and wire transfers that were seen as a threat to the system more so than gold.
I know this because my father was one of a handful of “authorized agents” who had a precious license to import hard currency to Warsaw (money raised from diaspora) straight into the accounts of the National Bank of Poland.
At the peak of Poland’s economic stress, his money transfer business, J. Mehl/Tazab, which operated out of the Ealing Polish diaspora hub, was dealing with hundreds of remittances a day (while also running parcels of goods into the country). I know, because I was helping him stuff envelopes and organize invoice notes on Saturday after Polish school for extra pocket money, like some sort of child labor mule.
The business was highly profitable precisely because the communists were that desperate for hard currency, and paid extraordinary commissions. At the same time, they understood the consequences of explicit dollarization of their economies. But since the corrupt regime needed hard currency as much as anyone else to sustain their lifestyles and their control of the people, they made moves to enable their ability to have their cake and eat it. Their solution? To allow hard currency imports, but on highly controlled terms. All hard currency (usually routed through Allied Irish bank) had to go to the central bank, and, in turn, the NBP would issue its own dollar bonds to the people on the ground.
This is how bony towarowe, pegged 1:1 to the dollar — and which could only be spent in controlled import/export “dollar shops” — became a thing. They were the stablecoins of their day.
Not that the controlled distribution of dollars could prevent what was coming. The more dollars began to circulate, the more the free market did its thing. The regime knew its days were numbered, and by 1989, it opted to enter into Round Table talks to secure its future. The rest, as they say, is history.
History, of course, doesn’t repeat exactly, but it sure does rhyme. Based on my experiences in Poland, I am absolutely convinced that what was going on in Poland is now also going on in China, but below the radar, with stablecoins. We can’t see those queues because they’re virtual. But we can see the demand making itself visible by way of the rush for gold and, increasingly, silver, which the regime itself increasingly needs to support its trade and imports.
Crypto liquidity
As U.K. regulators prepare to authorize the first batch of retail-available crypto ETNs this coming Monday, the people behind the products have been assembling journalists to brief them on their many positive attributes to investors.
The spiel is pretty predictable. Bitcoin is no longer a vehicle for speculation but an essential mechanism to help investors guard against deepening investor unease about the limits of quantitative easing and the long-term stability of the fiat system. During recent shocks — from bank collapses to government shutdowns — Bitcoin’s 24/7 trading has functioned as the only continuously liquid market, providing investors with a refuge when conventional assets froze.
This liquidity role, they said, now underpins a structural shift: Bitcoin is no longer merely a “risk-on” asset but a hybrid instrument bridging digital and traditional finance, increasingly treated like a strategic reserve or insurance policy.
“Bitcoin is being used as a kind of liquidity of last resort,” said James Butterfill, head of research at CoinShares, the week before the U.K.
But here’s the thing. If that’s true, then it’s more of a liquidity of first resort mechanism. And if it’s true we’re about to come up against a major dollar squeeze, that means bitcoin’s big moment in the U.K. may coincide with one of its biggest dumps ever — just in time to send the fear of god into every single retail-facing or real money asset manager. Though see below for the real opportunity in crypto.
Pricing dollar liquidity properly again:
As long-time readers know, we believe much of the system’s fallibility in 2008 related to the fact that, walking into the crisis, intraday funding (aka daylight overdrafts) were being handed out to banks on an unsecured and increasingly limitless basis.
The mechanics of the real-time gross settlement system were predominantly responsible for this surge. The more globalized, 24/7, and instant transactions became, the more the system needed to counter the damaging effects of potential system-wide gridlock with temporary intraday liquidity. All provided at the Fed’s expense (and therefore the taxpayer’s). When those intraday imbalances became too much to bear, they spilled over into overnight markets and had to be mitigated with QE.
17 years later, we’re still carrying the excess liquidity we created to deal with those pressures, at taxpayers’ expense. But it’s also the case that we’re reaching the point where those buffers are becoming cost-prohibitive to maintain. As we come up against those constraints, pressure will rise to remove that slack, or even better, fund it differently.
Indeed, that is what the great fight right now between the Fed’s Lorie Logan and Michelle Bowman is all about. The former wants to maintain the system as it is, using the FOMC to steer rates via a markets-based funding system and standing borrowing facilities, such as the standing repo facility (SRF) to minimize the risk of repo spikes. The only difference is that she wants that market rate to better reflect securitized norms in funding markets these days. Hence, she is keen to shift the target away from Fed funds and over to the Treasury-repo reference rate (TGCR).
This is because targeting the SOFR rate, now used as an alternative to Libor in wholesale funding markets, includes bilateral repo transactions that are influenced by factors outside the Fed’s control, making it less directly tied to monetary policy operations. (In other words, the Fed might have to fight the market for influence.)
The latter, Bowman, wants to move back to a scarce reserves regime, which emulates much more the system of the Bank of England, where rates are set not by a market rate but by an administered deposit rate, aka the level of interest of reserves. This is set not by the 12-member FOMC but by the seven-member board of governors.
To guard against repo spikes, Bowman would enlist a special ops open markets desk that can actively trade around the “lowest comfortable level of reserves” to keep a lid on exploding repo rates.
“While creating a “release valve” to provide greater market liquidity has been a goal of the SRF, I remain concerned that one of its unintended consequences is to distort market signals by artificially affecting repo rate dynamics. It is not the Fed’s role to replace or arbitrage private-market activities,” she wrote in September.
She added: “holding less-than-ample reserves would return us to a place where we are actively managing our balance sheet, identifying instead of masking signals of market stress. In my view, actively managing our balance sheet would give a more timely indication of stress and market functioning issues, as allowing a modest amount of volatility in money markets can enhance our understanding of market clearing points.”
The key arguments are laid out here, by Logan and here, by Bowman.
If Bowman prevails, we believe the system will soon engineer methods, most likely via interaction with highly speculative liquidity pools such as those in crypto markets, to better manage the cost of funding at the intraday margin. This is especially the case if and when it is determined that the Fed’s overdraft facility can no longer be provided to the market at cost, and a hard constraint — in the form of no more USTs due to the debt ceiling being set in stone — becomes apparent.
It’s worth, at this point, revisiting a paper by William Bergman, an economist and financial markets policy analyst for the Federal Reserve Bank of Chicago from 1990 to 2004, that was published this July for the Institute for New Economic Thinking.
It details very clearly the interaction between daylight overdrafts and broader systemic issues related to Fedwire (the Fed’s RTGS system).
As Bergman notes:
Today, we have the Fed incurring massive losses driven by the Fed paying interest to banks for the privilege of reducing the risk they pose to the Fed, instead of charging banks to fully recover the cost of guaranteeing daylight-overdraft funded Fedwire payments.
Bergman’s broader point is that the Federal Reserve’s internal accounting structure currently obscures the important economic relationships between daylight overdrafts and excess reserves in the IOR regime brought in after the 2008 crisis.
He says — echoing our long-standing argument — that abundant reserves have effectively substituted for overdrafts: the more reserves banks held, the less they needed to borrow intraday from the Fed.
However, what Bergman adds is that this shift did not eliminate the economic cost of providing intraday credit; it merely changed its form and who bears it. In the pre-crisis environment, banks that ran daylight overdrafts were at least notionally charged a fee or were constrained by credit limits.
In the post-crisis environment, because the Fed flooded the system with reserves and began paying interest on them, banks could avoid overdrafts by holding more reserves— but those reserves themselves became a costly liability for the Fed. And were ultimately backstopped by the taxpayer.
Due to the new IOR regime, when interest rates rose, the interest the Fed paid on trillions of dollars of reserves ballooned, creating large operating losses.
Thus, what looks like a safer system with fewer overdrafts is, in Bergman’s view, one in which the Fed has taken on a large ongoing expense in order to suppress overdrafts. The cost of intraday credit has not disappeared — it has been transformed into the interest payments the Fed now owes on excess reserves.
Current accounting and pricing practices mask this reality.
The central bank, for example, excludes the cost of intraday credit and the interest paid on reserves from the calculation of its “priced services,” such as Fedwire. This omission means that the fees banks pay for using the Fed’s payment infrastructure do not fully reflect the true economic costs of providing those services.
The result is an implicit subsidy: banks benefit from either intraday credit or the holding of reserves without bearing the full cost. In his view, this creates a distortion in the payment system and shifts costs onto the public balance sheet, since the Fed’s losses ultimately reduce remittances to the U.S. Treasury.
In other words, we are all paying for the privilege of real-time settlements in our taxes. And this hidden subsidy must be removed from the system if it is to start functioning properly again.
Hence, if Bowman gets her way, that price might have to be provided by an actively priced overdraft daylight rate, with surge pricing characteristics for moments of stress. We maintain that this can be accomplished by using crypto’s best innovation, perpetual futures, to price liquidity on an intraday basis and turn the crypto markets into a true liquidity of first resort mechanism for the market.
Since we’ve been saying this for years now, we’d appreciate it if readers flagged our coverage if they see the point being discussed elsewhere.
