Interview with Arthur Hayes With the burst of sovereign debt bubble, where will BTC go?

Exclusive Interview with Arthur Hayes Exploring the Impact of the Sovereign Debt Bubble on BTC's Future

Gold is mainly owned by the top 1% of society, who benefit from it while the cost is borne by the entire society.

Compiled by TechFlow

In today’s program, Arthur Hayes, the Chief Information Officer of Maelstrom Fund, discusses the bursting of the sovereign debt bubble as bonds continue to experience one of the largest sell-offs in US history, the terrifying steepening of the bear market, and its impact on bank balance sheets and market liquidity.

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Host: Michael, Blockworks Macro

Speaker: Arthur Hayes, CIO of Maelstrom Fund

The impact of rising global debt

Nature of debt: Arthur compares debt to time travel, borrowing from the future to fund current activities based on the expectation that the output of these activities will outweigh the cost of debt. This theoretically allows for current economic growth driven by potential future growth.

Arthur points out that debt structures are usually based on the assumption of future population growth, which creates wealth and income to repay these debts. If population growth declines, this fundamental assumption is challenged. In cases of slowing or negative population growth, there are fewer participants in economic activities, but the burden of debt remains, leaving fewer people to bear more repayment responsibility, which is particularly pronounced in developed countries.

Arthur criticizes the practice of attempting to eliminate business cycles since World War II. He believes this approach tries to smooth the natural ups and downs of the economy through debt financing to avoid economic recessions and promote stable growth, resulting in an unsustainable situation. The global debt-to-GDP ratio is around 360%, making managing these debts and their interest a major challenge.

Arthur emphasizes that when debt reaches such high levels, a significant amount of resources must be allocated solely for interest payments, reducing funds available for other productive investments. This high debt burden limits the fiscal space of governments, as they must allocate a significant portion of their budgets to debt repayment instead of investing in education, infrastructure, or other growth-promoting measures.

The steepening of the bear market, are US bonds no longer appealing?

Definition: Steepening of the bear market refers to the situation where long-term interest rates rise relative to short-term interest rates, which is seen as a negative signal in the bond market.

Arthur compared the performance of long-term US Treasury bonds ETF (TLT) and bitcoin. Since Russia invaded Ukraine on February 24, 2022, bitcoin has risen by about 50%, while TLT has fallen by about 17%. From October 7, 2022, to now, bitcoin has risen by about 24-25%, while Treasury bonds have fallen by 3%.

Arthur pointed out that the traditional investment strategy is to invest in US assets in times of market instability. However, now investors are starting to seek globally accessible assets like bitcoin because it is not directly controlled by any government like traditional assets. It is virtual and cannot be seen or touched like physical assets. Investors are losing interest in US Treasury bonds because they are concerned that the US government, due to its involvement in global military actions, will not be able to sustain its economic commitments to retirees.

Arthur mocked those investors who continue to buy Treasury bonds, despite the fact that the performance of the US 30-year Treasury bonds has fallen by 50% in the past three years. He predicts that when these investors realize that bonds can no longer reduce the overall volatility of their portfolios, they will have to look for other investment channels.

Arthur believes that as investors gradually recognize the changing market dynamics, they will seek assets with fixed supplies, such as bitcoin and gold. This shift will drive up the prices of these assets because the global bond market is huge. If investors start to question the ability of bonds to reduce portfolio volatility and whether governments can sustain the purchasing power of the bond market in terms of energy, the demand for bitcoin, tech stocks, and other assets may increase significantly.

Dilemma for policymakers

Arthur mentioned that the MOVE Index, which is often used to measure market instability, reflects increased market anxiety when the index rises. To alleviate market turmoil and prevent further turbulence, the Federal Reserve or the US Treasury Department may intervene in the market and take measures to stabilize the situation.

He pointed out that although the rise in long-term interest rates is usually seen as beneficial for banks, in reality, banks were induced to heavily purchase US Treasury bonds between 2020 and 2022. Now, as the value of these bonds has fallen, banks are actually unable to cover their debts, unable to engage in lending activities, and unable to make money.

In a conversation with a volatility fund manager, Arthur mentioned that Bank of America disclosed a significant amount of unrealized held-to-maturity losses in its quarterly report. These losses, although not reflected in the income statement, have actually impacted the bank’s capital adequacy.

Arthur emphasized that there are issues within the US banking system, and market signals indicate that if the bank stock index falls below the level it was in March, more banks may face the same problems. As the interest rate curve accelerates, we may see more pressure.

Arthur posed a hypothesis: what if there comes a time when market participants or investors choose a bank and discover that it holds a large amount of devalued commercial real estate and unrealized losses? In such a case, it could force the bank to sell these assets to balance its books. If the bank cannot resolve the situation on its own, it would require intervention from the FDIC and the US taxpayers’ funds to help overcome its financial difficulties.

Editor’s Note: FDIC, the Federal Deposit Insurance Corporation, is a government agency that protects depositors from the impact of bank failures.

Arthur presented a crucial decision point: will there be a comprehensive safety net mechanism that not only protects bank depositors’ savings, ensuring that they do not lose their deposits due to banking problems but also extends support to various types of debts?

Arthur pointed out that the primary owners of financial assets are the top 1% of society who benefit from them, while the costs are borne by the whole society. This has led to class division, social injustice, and inflation issues, which may manifest in different ways in different places.

Arthur mentioned that governments and central banks may continue to print money and intervene in the market, especially when financial institutions face difficulties. He noted that while money can be printed, energy cannot, which could lead to energy price hikes and become a lasting factor in inflation.

Arthur believes that inflation statistics are manipulated by governments worldwide, and everyone’s consumption basket is different, so everyone’s inflation rate is different. The method of using nominal GDP growth rate minus government bond yield is needed to determine the real interest rate, which reflects the actual level of economic activity.

Arthur pointed out that the successful implementation of financial repression strategies in the 1940s and 1950s in the US was possible because the US was the only major producer in the world at that time. However, in the current globalized economic environment, this strategy may no longer be applicable.

Debt, global competition, and asset market performance

Arthur noted that in 2023, every country is producing goods, with workers needing jobs, and these workers hope that the government fulfills its promise of providing employment. Arthur mentioned that the current global trade imbalance, particularly with the US as a net debtor and Germany, China, and Japan as net creditors, is an unsustainable extreme relationship.

Arthur pointed out that the US government’s monetary policies such as the chip act and the inflation reduction act are aimed at encouraging domestic production in the US by printing money, which poses a direct threat to China, the European Union, and Japan. He quoted a saying: “Trade Wars Are The Mirror Image Of Currency Wars”, and trade wars could lead to currency wars, ultimately leading to real conflicts.

Arthur emphasized that the US government’s military interventions and actions in Afghanistan, Iraq, and Syria over the past twenty years have cost trillions of dollars, which have impacted the current economic situation in the US.

Arthur pointed out that central banks around the world need to issue debt, but the question is who will buy these debts, and ultimately the burden may be borne by ordinary global citizens. He predicted possible scenarios in the current market: rising yields on long-term bonds, increasing prices of gold and Bitcoin, and a downward trend in the stock market.

Arthur believes that ETFs may increase the price of Bitcoin as a fiat currency, but they may also centralize ownership of Bitcoin, which goes against its decentralized spirit. Arthur emphasized that cryptocurrency provides a way to escape the unsustainable traditional financial system. With more fiat currencies flowing into the market, while the supply of Bitcoin and other major cryptocurrencies remains unchanged or becomes deflationary, this scarcity will cause the value of cryptocurrencies to rise relative to fiat currencies.

Arthur believes that the value of money lies not in its quantity but in how much energy it can purchase. He emphasized that whether it is any currency, including Bitcoin, what matters is how much energy it can purchase. Energy is a resource that cannot be printed, and if we continue to print everything else except for energy, the price of energy will continue to rise and become a persistent sticky component of inflation.

The script of BTC in the current economic environment

Arthur mentioned that in 2021, Bitcoin’s performance is similar to that of technology stocks, and they both have similar reactions to market volatility and macroeconomic factors.

However, in recent months, Bitcoin’s behavior has diverged, and unlike the performance of technology stocks, Bitcoin has started to behave more like gold. This shift means that Bitcoin is starting to be seen as a more stable store of value rather than being tied to high-risk technology stocks as before.

Arthur sees the price of Bitcoin as a combination of fiat currency liquidity and technology. When the focus is on Bitcoin as a decentralized peer-to-peer currency technology, combined with the liquidity of fiat currencies, it can lead to a huge bull market.

Arthur further pointed out that when the liquidity of global fiat currencies increases (for example, through central bank quantitative easing policies), this additional liquidity often seeks investment channels, and Bitcoin, with its limited supply and decentralization, becomes an attractive investment target.

Arthur mentioned that when the market’s focus is on the technical advantages of Bitcoin and accompanied by an increase in the liquidity of fiat currency, this combination can trigger a huge bull market.

Arthur also mentioned that large institutional investors such as BlackRock may have an impact on the Bitcoin market. If these institutions control a significant amount of Bitcoin and mining operations, it could have a significant impact on the future of Bitcoin. He presented a scenario where institutions like BlackRock absorb a large amount of circulating Bitcoin through ETFs, which could result in Bitcoin becoming less liquid as these Bitcoins would be locked in ETFs rather than being freely traded.

Arthur is concerned that if these institutions become major shareholders in Bitcoin mining operations, they may not support upgrades to the Bitcoin network, which may include enhancing privacy or encryption to ensure Bitcoin remains a strong cryptographic asset.

He believes the involvement of institutional investors is a double-edged sword. On one hand, they can bring a significant amount of funds and credibility to the Bitcoin market, but on the other hand, they may have a negative impact on Bitcoin’s decentralization and free liquidity. Arthur points out that if these institutions control a majority of Bitcoin’s supply, the essence of Bitcoin as a decentralized and freely tradable asset may be threatened.

Regarding market cycles, Arthur believes the usual sequence is starting with Bitcoin, then moving to major alternative cryptocurrencies like Ethereum, and finally to higher risk assets. He notes that each cycle brings new “things” to attract market attention, and although Maelstrom Fund has participated in these cycles, getting consumers to accept new things and change their long-held habits is very challenging.

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