Johnson argues that a strong US dollar (the straw) sucks up liquidity from global markets (the milkshake) into dollar-denominated debt and assets.

51�Թ� Editor-in-Chief Atul Singh has explained the Dollar Milkshake Theory simply. According to this theory, the dollar owes its strength not to markets, superiority of technology or confidence in future growth, but to expansionary monetary policy distortions. As Singh says: 

A constant supply of artificially cheap credit and market interventions has created a global economic order in which capital is allocated not based on productivity, innovation, or comparative advantage, but instead on the relative ease of financial arbitrage. No currency or commodity allows for this arbitrage better than the dollar. Moreover, policymakers believe that the US dollar is the only truly safe currency in the world and that increased geopolitical turbulence is likely to lead to a greater demand for dollars.

According to the Dollar Milkshake Theory, the US dollar acts like a bully in the global economy. Those who buy into this theory base their argument on the following:

1. The US dollar is still the world’s reserve currency.
2. Most global trade happens in dollars.
3. Most foreign debt is denominated in dollars.
4. The entire global financial system runs on dollars.

The inevitable question arises: Why?

Convenience

Imagine you own a market. You sell oranges, bananas and black olives. You have buyers from different countries, and they would like to pay in their local currencies, and you price the goods in many different currencies. Bananas in dollars, in euros, and in yen. When foreign exchange rates change overnight, you would have to change the price tags in the morning, or risk getting taken advantage of. Your oranges could be copper, your bananas gold and your black olives, crude oil. Now, imagine selling copper, gold and crude oil in different currencies. Suffice to say, your life is much easier if you price everything in the same currency!

Necessity

Imagine living in the Principality of Seborga, a small village in Italy that claims independence. It uses a local currency called the Seborga Luigino (SPL). There are only a few thousand SPL coins in circulation. Your local gas station is running dry and you order a fuel truck to replenish the tank. For the refinery that lies outside the Principality of Seborga, your local SPL coins are worthless, since they are not convertible into any goods outside of the principality. So, you need to pay with a currency that is globally accepted, which, in this case, is the euro. That’s what happens to importers in many countries that do not have a globally accepted currency and they are forced to use the dollar!

More Necessity

Imagine you are a vanilla grower on the island of Madagascar. Your production is growing. You need a larger storage and packaging facility. The local banking infrastructure is underdeveloped, so you apply for a loan from the World Bank. The World Bank believes you will be able to pay back the loan in five years. But the bank has no Malagasy ariary (MGA), which is the local currency. Also, the bank does not want to be paid back in MGA, since nobody knows how much it will be worth in five years’ time. The World Bank lends in dollars; it wants to be paid back in dollars, and you don’t have a choice but to use dollars!

Fear

Imagine you are responsible for investing the $1.3 trillion foreign currency reserves of the Bank of Japan, which are the result of years of trade surpluses achieved through the hard work of Japanese workers making some of the world’s most reliable cars. Suppose you could choose any currency of your liking, which one would you pick? 

Foreign exchange investing carries risk. If your investments lose money, you will lose your job. So, you want to avoid losing money and definitely avoid blame if you end up losing money. Here, the old saying applies: “Nobody ever got fired for buying IBM.” This means that if you are the head of the IT department, and you bought IBM computers, you will not get fired even if those computers don’t work, because (a) they are very unlikely not to work, and (b) nobody can fault you for buying the “gold standard” in computing!

As a non-American central banker, you prefer US dollars, since you are unlikely to lose your job for buying them.

Practicality

Imagine you are the central banker of an oil-exporting country on the Arabian Peninsula. Your oil revenue makes up between 35% to 40% of the gross domestic product (GDP). This means an awful lot of dollars are coming into the country since you are selling oil for dollars. Your local currency is either pegged to the dollar, as in the case of Saudi Arabia, United Arab Emirates, Iraq and Qatar, or to a basket of international currencies, as in the case of Kuwait. 

In theory, you could exchange your dollar proceeds from oil into local currency. But the amount of incoming dollars relative to the size of your local currency is so large that the peg would break, and your exchange rate would go through the roof. You are better off keeping the dollars, recycling them into US Treasury securities instead.

Despair

Ecuador adopted the US dollar in 2000 after a severe financial crisis destroyed the value of its currency, the sucre. Was it a success? Initially, yes. The move killed hyperinflation and stabilized the economy. However, Ecuador now had a currency it did not control, and the same holds true for interest rates. When oil prices — Ecuador’s main source of revenue — dropped, the government was unable to devalue its currency. 

A central bank acts as the ‘lender of last resort’. In a credit crisis, it can help to reliquify lending markets by purchasing assets (loans) and taking doubtful loans off commercial banks’ balance sheets. This prevents bank runs and enables credit creation to continue. However, Ecuador’s central bank cannot “print” dollars and create credit in a crisis. Unsurprisingly, Ecuador has defaulted on its external dollar liabilities twice already. Following these defaults in 2008 and 2020, Ecuador “survives” only thanks to dollar loans from the International Monetary Fund (IMF).

We now know why the world uses the dollar. Now, another question arises: Why does the dollar strengthen in a crisis?

1. The size effect

The US equity market has a market capitalization of nearly $70 trillion and commands a 48% share of the global equity market. Foreign investors own a relatively small share of the US domestic market. Because of the sheer size of the US equity market, foreigners have a relatively small impact on stock prices. 

In contrast, the German equity market has a market capitalization of $3 trillion, comprising only 2% world market share. Notably, American investors own around a third of German stocks and, consequently, have a major impact on stock prices.

In a crisis, investors cut risk by withdrawing from foreign “adventures,” recoiling from less familiar markets. US investors repatriating money from German equity markets have a far greater impact on stock prices than German investors selling shares of American companies. This phenomenon intensifies crashes for the German stock market, while the US market is largely insulated from capital outflows and, more often than not, rebounds quickly.

2. The lending effect

A lot of dollar lending outside of the US is done in so-called eurodollars. To keep things simple, those dollars are created outside the US banking system. They are literally lent into existence by non-US institutions. The eurodollar is a currency without a central bank, even though its value is pegged to the US dollar. The Federal Reserve, rightly, does not feel “responsible” for those eurodollars. They are created outside the Fed’s jurisdiction. Also, they lie outside US regulations and were created without its blessing. Those eurodollars have no lender of last resort.

A credit crisis often begins with an innocent event: some borrower cannot service its debt. The bank licks its wounds, writes down the loan and takes a loss. It instructs the credit committee to be “more careful” going forward. After this event, the bank may decide to lend less aggressively or not to extend credit lines to certain borrowers. These borrowers then go on to knock on other doors, often without success.

The lack of a lender of last resort creates a potential instability for the eurodollar market. It is best compared to a game of musical chairs. As long as the music plays, the kids happily dance around and enjoy the party. When the music stops, a mad scramble for available chairs ensues and often ends up causing panic. Even the absence of a single chair throws the entire party into disarray.

In a crisis, forced repayments of Eurodollars often cause dollar shortages. This occurs because the loan proceeds have been invested in longer-dated assets that cannot immediately be liquidated. Access to on-shore dollar creation is only possible through a US financial institution willing to extend additional dollar loans, which will come at a price. In case of a severe shortage, the Federal Reserve might offer so-called dollar swap lines to foreign central banks, which, in turn, can use those to lend dollars to financial institutions in their jurisdictions. The Federal Reserve takes neither currency nor counterparty risk — those remain with foreign central banks. Under the current US administration, the withholding of swap lines could be used as a weapon, even against countries formerly believed to be allies.

3. The flight to a safe haven

A similar phenomenon occurs on the investment side. When times are good, investors venture out on the risk ladder, often attracted by higher yields abroad. Currently, Brazilian government bonds yield above 13%, compared to just above 4% for the US. To invest in Brazilian bonds, you first have to purchase Brazilian reals using US dollars. This demand for reals appreciates the value of the Brazilian currency. 

When a crisis hits, investors panic and retreat to the safest assets possible. Despite rising US debt and excessive money printing, US Treasuries remain the ultimate safe haven for investors worldwide. No other alternatives exist at scale. Investors sell Brazilian reals and buy US dollars. Hence, the dollar appreciates.

Everyone needs dollars to pay their debts, fund their trades and buy safe assets. In a crisis, though, dollars are flowing back to America. The most basic economic law of supply and demand tells us what happens next — the dollar appreciates as demand spikes while supply outside the US shrinks.

What does the Dollar Milkshake Theory predict

In a crisis, a stronger dollar makes everything worse for the rest of the world. Foreign companies with dollar debt suddenly owe more in their local currency. This creates more stress, more defaults and a greater flight of capital back to the US.

The US literally “drinks the milkshake” of global liquidity. This phenomenon happened both in 2008 and 2020: Despite financial crises and extremely loose monetary policy, the dollar strengthened as global capital fled to the only market big enough to absorb it. America’s financial dominance means even a crisis originating in the US strengthens America’s position.

Valéry Giscard d’Estaing, the late French finance minister and president, captured this phenomenon with the term privilège exorbitant — better known as ”exorbitant privilege” in English — for the dollar. Simply put, this means that the issuer of the international reserve currency can issue debt at cheaper rates than other countries and run perpetual trade deficits with impunity. 

Having a trade deficit means more stuff is coming into the country than leaving. It also means more money leaving the country than coming in. Every other country experiencing large, persistent trade deficits would inevitably see its currency depreciate. Recipients of the currency of a country running a trade deficit would want to exchange it for local money. An increased supply of this currency would exert downward pressure on its exchange rate value. Once this currency has a lower exchange rate value, exports would become cheaper and imports more expensive. This would encourage exports and discourage imports until, ideally, the trade balance would reach equilibrium.

This does not happen in the case of the dollar because of its status as the international reserve currency. Everyone wants the dollar, allowing the US to run persistent trade deficits. But such a status comes with strings attached.

Exorbitant privilege comes with a dangerous curse

As the international reserve currency, the dollar is hoarded globally. This stops the dollar from depreciating and pumps up its value artificially. Over the last few decades, this persistent overvaluation caused a hollowing out of the US manufacturing base. The number of employees in the manufacturing sector declined from in 1980 to a mere today.

A strong dollar not only discourages exports but also encourages imports. It serves as a transfer of wealth from foreign workers to US consumers. The latter can afford a higher standard of living by spending less on imported goods thanks to the strong dollar. In contrast, foreign workers need to produce additional goods for export to satisfy their trade surplus. In exchange for goods consumed by Americans, exporting economies receive foreign-denominated IOUs — dollars. In aggregate, exporter nations will never be able to collect on these IOUs because this would require the US to run a trade surplus.

Being the issuer of the world’s reserve currency is indeed an exorbitant privilege in the short term. In the long term, though, this privilege turns into a dangerous curse, hollowing out the industrial base and causing overindebtedness. This is not a desirable position for the economy of the world’s reserve currency because industrial decline and overindebtedness inevitably lead to a financial crisis. 

This phenomenon has occurred in recent history. Before the US, the UK enjoyed exorbitant privilege from 1815 to 1945. In 1815, when the Duke of Wellington beat Napoleon Bonaparte in the Battle of Waterloo, British national debt for more than half of the world’s traded securities. In February 1943, the pound sterling 74.9% of central bank foreign exchange reserves. The story of British industrial decline is all too familiar to be repeated here.

Before the British pound, the French livre briefly had currency reserve status. The Dutch guilder replaced the Spanish real, which substituted the Portuguese real. The Venetian ducat took the crown from the Florentine florin. Note that most reserve currencies lasted around 100 years.

In the case of the dollar, it seems inevitable that the milkshake becomes so big that it breaks the straw. America’s monetary superpower has become so asymmetrically dominant that it destroys the host country, and with it the current monetary system. A dollar has no intrinsic value. It is neither backed by gold nor land. Ultimately, the dollar is a fiat currency. People around the world accept it out of convenience, practicality, necessity and other reasons enumerated above.

Most importantly, people accept the dollar because of trust in the US government. If that trust erodes significantly, people will stop using the dollar as a store of value, even if they continue to use it as a means of exchange.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Dollar Milkshake Theory Is Still Useful appeared first on 51�Թ�.

The escalation: “gross incompetence” and indictment threats

The conflict reached a boiling point when reports surfaced that the Trump-aligned Justice Department was preparing to seek an indictment against Powell. The alleged charges do not stem from monetary policy errors, but rather accusations of perjury and “gross incompetence” related to the renovation costs of the Federal Reserve’s Eccles Building in Washington, DC

This legal maneuver follows months of escalating rhetoric. Since taking office in January 2025, President Trump has reportedly disparaged Powell in private and public forums, calling him a “moron,” a “jerk” and a “stupid person” on at least a dozen occasions. The animosity was on full display during a bizarre incident in , when Trump insisted on visiting the construction site of the Fed’s headquarters. During the tour, witnesses described the President jostling with Powell over cost overruns, using the backdrop of the construction zone to berate the Chairman in front of the press corps.

The Chairman of the Federal Reserve, of course, has very little involvement with the construction project.

Despite having Powell for the position during his first term, Trump has called for his resignation multiple times in the last year, frustrated by the Fed’s refusal to slash interest rates to zero. The threatened lawsuit — ostensibly about building management — is widely viewed by legal experts as a spurious pretext to remove a barrier to the President’s economic agenda.

Powell’s “video response” and the European shield

In a move that surprised Washington, Powell broke with the Fed’s century-old tradition of stoic silence. On Sunday, January 11, the Fed released a featuring a steely Powell looking directly into the camera. Without naming the President, Powell reaffirmed his commitment to the “rule of law” and the Fed’s mandate, declaring that he would not be intimidated by political pressure. The video, stripped of the usual central bank jargon, was a clear signal: Powell was not resigning.

The international community has rushed to Powell’s defense. On January 13, a coalition of 10 major central banks — including the European Central Bank (ECB) and the Bank of England — released a expressing “full solidarity” with Powell. The letter, a diplomatic bombshell, underscored that “the independence of central banks is a cornerstone of price, financial, and economic stability.”

However, the expression of support was not well received at home. Stephen Miran, a Trump-appointed Fed Governor who has become a vocal internal critic of the Powell consensus, dismissed the letter immediately. Miran the foreign intervention “not appropriate,” arguing that global bankers have no business opining on US domestic legal matters. 

The media reaction

Prominent voices in the financial world have begun to sound the alarm. Michael Bloomberg, the former mayor of New York City, published a stinging opinion titled “Let Powell and the Fed Do Their Jobs,” arguing that the politicization of the dollar would have catastrophic long-term consequences for US borrowing costs.

Market veterans like Mohamed El-Erian and Rob Arnott have also weighed in, though often with a focus on the broader implications of “fiscal dominance.” While El-Erian has frequently warned that the Fed is losing control of the narrative, recent discussions in the bond market suggest a growing fear that the Fed’s independence is being eroded not just by tweets, but by structural changes. 

Senator Cramer, a member of the Senate Banking Committee, that it “would be an elegant solution for the Fed chair to step down in exchange for dodging a political indictment”. Which carries the same vibes as offering to purchase someone’s corner store for a dollar “to avoid losing it to flames one day”.

“Well I’d love that, I mean, we all talked about getting him [Powell] out of there [Federal Reserve] Larry Kudlow on FOX News.

The attempt to fellow board member Lisa Cook — a case currently winding its way through the Supreme Court — further illustrates the administration’s “cleanup” strategy to install loyalists at the Board of Governors.

The Data: A “supercharged” economy complicates the narrative

The irony of the President’s demand for rate cuts is that the US economy, by many metrics, is running too hot, not too cold.

According to the Atlanta Fed’s “” model, the estimate for real GDP growth in quarter four (Q4) 2025 stands at a staggering 5.4% as of January 21, 2026. This “supercharged” growth rate defies the narrative of a recessionary economy in need of monetary stimulus.

Furthermore, inflation remains sticky. Core personal consumption expenditures (PCE) inflation — the Fed’s preferred gauge — is currently tracking around 2.7% to 2.8% year-over-year, above the 2% target. With unemployment at a relatively healthy 4.4% (as of December 2025), the data suggests the Fed should be cautious, not aggressive, in cutting rates.

The Taylor Rule calculation

To understand just how divergent the President’s demands are from standard economic theory, we can use the , a standard formula used by the Atlanta Fed and economists worldwide to estimate the “appropriate” federal funds rate.

In simple terms, the Taylor Rule is a formula for finding the “perfect” interest rate. If prices rise too fast (high inflation), the Fed needs to cool things down by raising interest rates. If people are losing jobs and businesses are closing (recession), the Fed needs to warm things up by lowering interest rates.

The rule starts with a “Neutral Rate.” This is the interest rate where the economy is cruising comfortably — neither speeding up nor slowing down. The neutral rate is assumed to be 2%. 

The Taylor Rule then looks at two gauges and tells the Fed to adjust the rate up or down: inflation and growth. 

For every percentage point inflation exceeds the target (currently 2%), the neutral rate is increased by the difference, multiplied by 1.5. With inflation at 2.7%, we should add 1.05 (0.7 x 1.5) to the neutral rate.

Next, the Taylor Rule considers GDP growth and the job market to determine if there is an “output gap” (when economic output is below potential), in which case points are deducted from the neutral rate.

However, with the latest estimate for Q4 2025 real GDP growth (5.4%), the US economy seems to be running “hot” and above potential. This would require a surcharge on the neutral rate. 

Given strong economic growth (around 8% nominal), the Taylor Rule prescribes a rate significantly higher — potentially over 5% — to prevent overheating. By this metric, Powell is already being incredibly dovish.

Governor Miran, however, argues that the neutral rate has fallen due to specific fiscal and migration factors. He has stated that the Fed Funds rate should be slashed immediately by 100–150 basis points (1–1.5 percentage points). Miran’s interpretation provides the academic cover for Trump’s political demands, suggesting that the “true” rule points to much cheaper money.

In December 2025, Miran claimed that official inflation was overstated, implying that monetary policy should be more accommodative (i.e., lower interest rates). He asset management fees contributing 30 basis points (0.3 percentage points) to core inflation. Have you ever heard your Uber driver complain about rising asset management fees?

Did you know that US health insurance premiums are apparently falling? That’s what recent government data . This occurs because the Bureau of Labor Statistics (BLS) uses an “indirect method” to calculate the health insurance component of the Consumer Price Index; it deducts benefits (payouts) from insurers’ retained earnings (profits). If your insurance raised your premium by 5%, but increased payouts by 10% (due to a bad flu season, for example), the insurance company’s profits shrink, which BLS will report as a price drop (even as you pay higher insurance premiums). Have you ever heard a person say, “My insurance reduced my premium?”

Implications: the dollar in the crosshairs

The assault on Powell and the attempts to purge members like Cook signal a shift toward a “pliant” Federal Reserve. If the central bank loses its credibility to fight inflation, the premium investors demand to hold US Treasury bonds could soar.

A long time ago, we used gold coins as a means of exchange. Those were replaced by receipts for gold coins, for safety and convenience. Then, the gold coins were removed, but we continued to exchange receipts, despite the fact that they had no tangible backing. Later, we moved to an electronic representation of those receipts. Today, stablecoins offer another layer of abstraction. 

Central banks’ formidable task is to prevent a loss in a trust-based system. Undermining central bank independence is the best way to destroy this fragile construct we call “money”. Once trust is destroyed, it is very hard to earn back, usually only by offering additional assurances, like a gold backing. 

The markets are reading the signs, bidding up the prices of gold, silver and many other commodities. There are no “lines at the gold shop” yet, but we are on the best route towards a disruptive outcome of irresponsible monetary and fiscal policies.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Trump vs. Powell: The War for the Federal Reserve Escalates appeared first on 51�Թ�.

The European Union has moved beyond merely freezing these funds. In a landmark and legally perilous shift, the bloc has begun to actively the profits generated by this capital to fund Ukraine’s defense and reconstruction. This strategy, however, has exposed deep fissures within the EU and placed a singular, private Belgian company, , in the geopolitical crosshairs.

The vault: Euroclear and the mechanics of immobilization

To understand the scale of the situation, one must understand the custodian holding the keys. Euroclear is not a bank in the traditional consumer sense; it is a Central Securities Depository (CSD), a critical piece of the “plumbing” that underpins the global financial system. Headquartered in Brussels, Belgium, and employing approximately 6,000 people, Euroclear settles securities transactions for stock exchanges and major financial institutions, ensuring that when a bond or share is traded, the ownership transfers and the cash is delivered.

A consortium of major international financial players owns Euroclear. Its shareholder registry includes Caisse de Dépôts (a French public-sector financial institution), GIC (the sovereign-wealth fund of Singapore), Euronext (the pan-European stock exchange) and Sicovam, the French central securities custodian (now integrated into the group structure but historically a key stakeholder).

The sheer volume of assets flowing through Euroclear is difficult to visualize. At the end of the third quarter (Q3) of 2025, Euroclear held a staggering in custodial assets. Much of this sum is held on behalf of clients — pension funds, central banks and commercial banks — and does not sit on Euroclear’s own balance sheet.

However, income generated by Russian-owned securities does end up on Euroclear’s books. As of the latest financial disclosures, Euroclear Bank’s own balance sheet stood at €229 billion. Of this amount, a massive €194 billion — nearly 85% — is classified as “related to sanctioned Russian assets.” These are primarily maturing bonds and coupon payments belonging to the Central Bank of Russia that sanctions have blocked. Unable to be transferred back to Moscow, this cash piles up in Belgium, requiring reinvestment.

The “windfall”: turning cash into weapons

In the first half (H1) of 2025 alone, these immobilized Russian assets generated in interest income. Under normal circumstances, this profit would belong to the client (Russia). However, the EU that these “windfall profits” are not sovereign assets but rather a byproduct of the sanctions regime itself.

Following legislation in May 2024, the EU formalized a mechanism to seize these profits. Of the €2.7 billion earned in H1 2025, was declared a “windfall contribution.” After Belgian corporate taxes and management fees were deducted, a net total of €1.6 billion was paid out to the EU Commission.

The money is transferred to the Ukraine Facility and the European Peace Facility (EPF), where it is used to directly reimburse EU member states for weapons shipments to Kyiv and to fund the purchase of new ammunition and air defense systems. In effect, the EU has successfully engineered a system where Russia’s own sovereign wealth is partially financing the war effort against it.

The Belgian resistance: fear of the “Euroclear run”

While the EU Commission in Brussels pushes for aggressive use of these funds, the Belgian government, located just a few miles away, has urged extreme caution. Belgium finds itself in the uncomfortable position of being the sole guardian of the vast majority of Russia’s frozen wealth.

Belgium’s resistance is not rooted in sympathy for Moscow, but in fear for the stability of its financial sector and the Euro itself. The Belgian government, along with Euroclear’s management, strongly opposes the full confiscation of the principal assets (the €194 billion itself), as opposed to just the interest profits.

The primary concern is legal precedent and “capital flight.” If the EU were to seize the principal assets, it would cross a Rubicon in international law, effectively declaring that sovereign property is no longer immune. Belgium fears this would send a shockwave through the Global South. Large international asset owners — such as Saudi Arabia, China, Brazil or Indonesia — might look at the precedent and decide that the Eurozone is no longer a safe haven for their reserves.

If these nations were to move their securities custody from Euroclear (EU) to competitors in Dubai, Hong Kong or a potential future BRICS-created depository, it could trigger a “run” on Euroclear. Given that Euroclear holds €42.5 trillion in assets, even a partial exodus would be catastrophic for European capital markets.

Furthermore, Belgium fears it would be left holding the bag for the inevitable legal retaliation. Russia has already filed dozens of in Russian courts against Euroclear, seizing the entity’s meager assets within Russia. Belgium worries that if the principal is confiscated, it will face decades of litigation and potential liability for billions of euros, potentially bankrupting the custodian without an explicit backstop from the rest of the EU.

The legal hammer: triggering Article 122

Recognizing that unanimity on Russia policy is becoming impossible due to resistance from member states like Hungary and Slovakia, the EU Commission has resorted to a powerful and controversial legal tool: of the Treaty on the Functioning of the European Union (TFEU).

Traditionally designed for economic emergencies (such as the energy crisis or natural disasters), Article 122 allows the Council to adopt measures by a qualified majority, bypassing the need for unanimous consent.

This month, the EU Article 122 to fundamentally alter the sanctions regime. Previously, sanctions on Russian assets had to be renewed every six months by a unanimous vote. This gave leaders like Viktor Orbán of Hungary a biannual opportunity to hold the bloc hostage, threatening to veto the renewal unless concessions were made elsewhere.

By invoking Article 122, the EU has moved to freeze the assets indefinitely until Russia ends the war and compensates Ukraine. This move serves two purposes:

1. Political Insulation: It removes the assets from the six-month veto cycle, locking them down regardless of shifting political winds in Budapest or Bratislava.
2. Collateralization: It provides the legal certainty needed to use the assets as collateral for larger loans. If the assets are guaranteed to remain frozen for years, G7 nations can issue “Reparations Loans” to Ukraine, to be repaid by the future income streams (or the eventual confiscation) of the Russian funds.

The implication of using Article 122 is profound. It signals a shift in the EU toward a more federalized, majority-rule foreign policy, much to the chagrin of smaller, neutrality-inclined states.

The geopolitical fallout: BRICS+ and the Euro

The aggressive utilization of these assets has not gone unnoticed in Beijing, Riyadh or Brasília. For the BRICS+ nations, the “weaponization of finance” confirms their long-held suspicions about the Western-led order.

The immediate impact has been a “quiet diversification.” While a wholesale dumping of the Euro has not occurred — simply because there are few liquid alternatives to the Dollar and Euro — trust in the EU as a neutral arbiter of capital has eroded. Central banks in the Global South are increasingly gold reserves and exploring non-Euro settlement mechanisms for trade.

The danger for the Euro is slow but existential. If the perception solidifies that Euro-denominated assets are subject to political seizure, the Euro’s status as an alternative reserve currency could diminish over the next decade. This would raise borrowing costs for all European governments, as demand for European debt softens. Belgium’s resistance is essentially a warning: Do not sacrifice our long-term financial credibility for a short-term cash injection for Ukraine.

Alternative legal avenues

Critics of the EU’s approach argue that there were other, perhaps more legitimate, paths to making Russia pay.

1. International Reparations Mechanism: The standard path would be a ruling by the International Court of Justice (ICJ) mandating reparations. However, Russia does not recognize the court’s jurisdiction in this matter, and enforcement would still require the seizure of assets, bringing the EU back to the same legal hurdle.
2. The Countermeasures Doctrine: Legal scholars have that under international law, states can take “countermeasures” against an aggressor to induce compliance. This theory posits that seizing assets is a lawful countermeasure to Russia’s illegal invasion. The US has largely backed this interpretation, but European legal scholars (and the Belgian government) remain skeptical, viewing it as a slippery slope that blurs the line between executive action and judicial process.

The Trump factor: pressure from across the Atlantic

Hovering over this entire debate is the shadow of the White House. With Donald Trump in office in late 2025, the dynamic has shifted dramatically. The Trump administration has made it clear that American taxpayers should no longer foot the primary bill for a war in Europe’s backyard.

Pressure from Washington has been intense. The US has pushed the EU to stop “dithering” with interest payments and seize the full €194 billion principal to fund the war effort, thereby allowing the US to reduce its own financial aid. Trump’s “Peace through Strength” rhetoric implies that if Europe wants Ukraine to survive, Europe must pay for it, using Russian President Vladimir Putin’s money.

This pressure partially explains the EU’s rush to trigger Article 122 and lock in the loan mechanisms this month. European leaders fear that if they do not present a self-sustaining funding model for Ukraine soon, the Trump administration might cut aid entirely or force a peace deal on terms unfavorable to Kyiv. The mobilization of Euroclear’s assets is, in many ways, Europe’s attempt to “Trump-proof” the defense of Ukraine.

The €194 billion question

The situation at Euroclear represents a defining moment for the intersection of law, finance and war. The EU has managed to uncork a stream of billions to aid Ukraine, paying for weapons with the aggressor’s own accrued interest. Yet, in doing so, it has ventured into uncharted legal territory, risking the reputation of its financial system and bypassing its own democratic unanimity rules.

For now, the €1.6 billion transferred to Ukraine is a lifeline. But as the war drags on and reconstruction costs mount into the hundreds of billions, the temptation to seize the full €194 billion sitting in Brussels will only grow. Belgium stands as the final gatekeeper, holding the line against a move that could redefine the concept of sovereign property forever. Whether that line holds against the combined pressure of a desperate Kyiv, a federalizing Brussels and an isolationist Washington remains the €194 billion question.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post The Battle Over Euroclear and Russia’s Frozen Billions appeared first on 51�Թ�.

The skirmish: tariffs for cash (and control)

In early 2025, the US broad tariffs on Korean exports. During negotiations, the US offered to lower those tariffs if Korea pledged to invest a considerable amount of money in the US. The number that stuck was $350 billion from Seoul (as part of a larger US–Asia push), which the White House at times framed as “upfront” money.

However, Seoul pushed back, offering incremental, commercially justified projects, not a lump-sum transfer, and only with financial safeguards like a standing dollar swap line to prevent a balance-of-payments shock. Talks stalled; the won slid to ₩1,400 per dollar; and South Korean President Lee Jae-myung that agreeing on Washington’s terms could recreate a 1997-style crisis.

While some central banks enjoy standing (permanent) swap lines with the Federal Reserve, the Bank of Korea had only temporary, limited access on ($30 billion in October 2008, $60 billion in March 2020).

A swap line is an agreement between two central banks to exchange currencies now and swap them back later at a fixed rate. This enables the foreign central bank to lend dollars to its commercial banks during times of market stress without anyone taking currency risks. 

Since a lot of lending and trade finance is conducted in US dollars, a financial crisis can lead to a dollar shortage, funding problems for corporations, and speculative attacks against the currency. This, in turn, could make raising interest rates necessary, potentially aggravating economic conditions.

Having a standing swap line of a decent size sends a message to speculators that any attempts to attack the currency would be futile.

The Georgia shock: 475 arrests at the EV hub

Then came the raid. On September 2–4, federal agents detained roughly 475 workers — mostly Korean nationals, many employed by subcontractors — at Hyundai Motor Group Metaplant America (HMGMA) and the adjacent LG Energy Solution (LGES) battery joint venture (JV) near Savannah, Georgia, the largest single-site immigration action in the United States Department of Homeland Security (DHS) history. Hyundai now expects the battery plant’s startup to by at least two to three months.

President Lee praised US President Donald Trump’s handling of the incident in public — a bid to keep lines open — but the broader climate could chill Korean capital in the US. 

Georgia is the anchor of Korea’s US electric vehicle (EV) production plans. Hyundai’s has a combined investment volume in the low double-digit billions — the auto plant and the battery joint-venture each costing around $7.5 billion. A construction-phase labor shock pushes back Inflation Reduction Act (IRA)-sensitive timelines and adds perceived “rule-of-law risk” to foreign capex.

A Big Ask

The US is offering lower tariffs (Korea seeks parity with Japan/EU around 15%) in exchange for a Korean-funded US investment vehicle of nearly  $350 billion, with rapid disbursement and strong US say over where the money goes. That’s with pressure to re-shore or “friend-shore” sensitive supply chains and to align with US tech controls. The US is demanding that Korea hand over an amount equal to 20% of its .

Seoul, however, is suggesting stretching the funding over years, replacing most of it through loans and guarantees, and getting a standing Fed swap line or an equivalent backstop (so the dollar reserves at the Bank of Korea aren’t depleted).  Korea’s foreign exchange (FX) reserves were at the end of August. Demanding that Korea hand over 84% of its dollar reserves seems neither reasonable nor practical.

Korean reactions

Lee has tried to run a two-track strategy: talk tough at home, pragmatic abroad. He the currency risk (“without a swap, crisis risk rises”), criticized US control over any investment pool and simultaneously kept praise handy for Trump on the Georgia enforcement episode. 

Politically, his has been whipsawed: it rebounded to 59–62% after his late-August US–Japan swing, then dipped toward 55% after the tariff standoff and FX jitters returned, narrowing his room for concessions.

The skirmish is unpopular. conducted in August showed most Koreans are opposed to tariffs and skeptical of the compromise; Pew also recorded a decline in Korean favorability toward the US this summer.

Impact on Korean battery manufacturing in the US

In the short term, the Georgia raid delays commissioning and creates supply-chain friction (visa checks, contractor audits, insurance repricing). Hyundai expects a delay of two to three months in the case that tariff relief doesn’t arrive. Korean autos and parts could face a price handicap into 2026, eroding the logic of US final assembly. Certain production steps face deadlines in order to qualify for IRA credits (US federal tax credits created by the 2022 Inflation Reduction Act to subsidize clean energy, EVs and domestic manufacturing).

For now, batteries could be sourced from other producers as a temporary patch. The broader effect is a chilling realization — “we invested billions, then got hit with raids and tariffs”.

Lithium Power Play

While the US Geological Survey (USGS) does not disclose domestic lithium production, it is that the US currently has a global market share of less than 2%, stemming from a single mine. As electric vehicles replace ICE cars, access to inexpensive lithium becomes critical.

The “” project in Nevada is expected to ramp up production in 2028, giving competitors in battery production a multi-year head start. The US Department of Energy intends to its $2.26 loan into a 5% equity stake in the company developing the lithium deposit (Lithium Americas). With General Motors being the main customer for lithium produced in Nevada, disrupting competitors, like Korean Hyundai, might have played a role in the ICE raids.

One nation’s trade surplus is another nation’s deficit

In , the US exported $66 billion to and imported $132 billion from Korea, for a $66 billion US goods deficit, fueled by $50 billion in imports of autos and parts. The US enjoyed a $12 billion surplus in services, which partially mitigated the deficit in goods.

US trade deficits can be traced back to an overvaluation of the US dollar. By insisting on remaining the world’s reserve currency, surplus nations, like Korea, are forced to accumulate dollars as a safety cushion, to provide coverage for imports, and for lack of alternative uses. The natural adjustment in exchange rates, therefore, is not allowed to happen. 

A weak currency would not be suitable for reserves; central banks would shun wasting assets, since losses would raise questions and potentially endanger their independence.

A foreign-sector surplus, from a US perspective, dictates that one or more domestic sectors must run a deficit, causing perennial US government fiscal deficits. Lacking domestic savings, the US is dependent on external financing, leading to increased indebtedness towards foreign investors. Billions of interest are due to friends and foes alike.

Russian dollar reserves were “neutralized” via sanctions. Now, the US has laid its eyes on other countries’ dollar stashes.

The Miran Plan spelled it out

Few should have been surprised by economic bullying from the US. All the steps, from tariffs to forced investments, have been laid out plainly by Stephen Miran, now Trump’s Chief Economic Advisor, in his 2024 “A User’s Guide to Restructuring the Global Trading System”. He writes: “There is another potential use of the leverage provided by tariffs … the removal of tariffs in exchange for significant industrial investment in the United States by our trading partners.”

So far, Trump has followed the Miran Plan diligently. The next step would shock foreign holders of Treasury securities: a withholding tax on interest. Instead of paying coupons to, say, the People’s Bank of China at 4%, the US Treasury would simply snip off 10 or 20%. 

This would likely upset US trade partners even more, potentially leading to an accelerated dumping of US securities, with negative implications for the US dollar, too. It is not hard to see the adventure ending with an own goal.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Chaebol Versus Capitol: Shaking Down Seoul for Dollars appeared first on 51�Թ�.

Fitch finally pulled the trigger, France’s credit rating from “AA-” to “A+”. But in markets, everyone’s been watching this chase scene for years — and most traders already knew France carried a truckload of unsustainable deficits. Other rating agencies – Standard & Poor’s, �ѴǴǻ��’s and Morningstar DBRS – are likely to follow suit , as they have France’s rating currently “under review”.

France’s rating has gradually since 2011, when it still held the coveted “AAA” rating. “A+” is not a disaster, but for a core Eurozone government, it is worrying. This is especially troubling, as French debt is not trading like that of an “A”-rated country, but rather in with “BBB”-rated issuers like Italy and Greece.

In debt markets, traders often refer to the “spread,” meaning the difference in yield between a “pristine” borrower, in this case Germany, and others.

OATs, BONOs and BTPs

The French ten-year government bond, known as “OAT” (Obligation Assimilable du Trésor), traditionally at a small spread over German “Bunds” (Bundesanleihen), between 0.25 and 0.5 percentage points.

In the past, Spanish (“BONO”) and Italian (“BTP”) government bonds had to pay significantly higher premia than French ones (one to three percentage points). Not anymore. Since the beginning of 2025, French government bonds traded “wider” than Spanish bonds and have almost caught up to Italian bonds. Paris has to offer higher yields than Athens.

In its credit review, Fitch France’s debt-to-GDP ratio to rise further from its current 113% to 121% by 2027. After repeatedly missing targets, the current fiscal deficit at almost 6% of GDP.

France and Germany used to be nearly identical in terms of their debt-to-GDP ratios; they followed each other from the early 1990s to the Great Financial Crisis of 2008/9. Since then, however, they have gone their separate ways. While Germany managed to reduce its debt levels, France kept piling on.

A government’s rating usually serves as a rating lid on national banks. In a severe financial crisis, banks would depend on the government’s ability to afford to bail them out. Therefore, domestic banks cannot carry a higher rating than the entity that is supposed to offer financial support.

Some institutions are prevented from dealing with single-A-rated banks due to counterparty risk considerations. BNP Paribas, the largest French bank, carries of more than €2.7 trillion, more than 90% of France’s GDP.

However, not all is lost; the cost of insuring against a default of France, so-called credit default swaps, remains subdued at 0.35% — more expensive than (0.07%), but in line with the United States (0.35%).

Who is to blame?

France’s economic performance under President Emmanuel Macron has been less than stellar; his “report card” deteriorating conditions in most areas. The country has gone through several governments; former Prime Minister (PM) Bayrou recently a vote of confidence after proposing a large budget squeeze. Now, new PM Sébastien Lecornu must build consensus in a fractured assembly.

The French government has been to retirees. Pensioners now have higher incomes than working-level adults, a record among comparable countries. Retirement income has grown far more quickly than wages.

During his first term, Macron the corporate tax rate from 33.3% to 25%, lowered mandatory tax contributions paid by French companies and abolished the country’s wealth tax. France also struggles to reduce its overall social spending, which for 32% of GDP, compared to an EU average of 26%.

Meanwhile, a few French families were able to accumulate significant , led by Bernard Arnaud, Chairman and CEO of luxury goods company LVMH, with an estimated net worth of $200 billion.

What if French bond spreads blow out?

Failure to address the budget deficit would lead to further rating downgrades. Speculators and hedge funds are already betting on increasing spreads between French and German government bond yields. Rising yields would make French debt more expensive to finance, leading to a vicious circle.

Some commentators a French government default may not signify the end of the Euro. Yes, Greece on private-sector debt during its restructuring in 2012. However, the Greek debt crisis brought the Eurozone to the edge of . Contagion was rampant, with Irish and Portuguese government bond yields reaching double digits. Governments had to issue blanket deposit guarantees to prevent bank runs.

The Greek default caused havoc for Cypriot banks, which held large amounts of Greek government bonds, forcing Cyprus to ask for a bailout itself. To prevent a bank run, capital controls were introduced, limiting daily bank withdrawals. Depositors with balances above €100,000 lost part of their savings.

A default of the French government would very likely cause a run on French banks. Customers would try to withdraw as many Euros as possible, with the aim of depositing them with German banks.

ECB has tools to intervene…

The European Central Bank (ECB) would certainly step in to prevent such an outcome. However, its hands are tied. Due to elevated fiscal deficits, France is already in a so-called “Excessive Debt Procedure” (EDP) by the European Commission.

The EDP is the enforcement tool of the Stability and Growth , triggered when a country’s budget deficit exceeds 3% of its GDP or its debt surpasses 60% of its GDP. The European Commission reviews the breach, the Council sets deadlines and corrective measures, and the country must adjust fiscal policy accordingly. Eurozone members that fail to comply can face fines of up to 0.5% of GDP or suspension of EU funds.

… but may have to be creative

The ECB may buy a eurozone member’s government bonds, but only under strict conditions. In normal times, it uses monetary policy tools like the Asset Purchase Programme (APP). In a crisis, it can step in with instruments such as the Outright Monetary Transactions (OMT) program, which allows unlimited bond purchases but only for countries under an EU/European Stability Mechanism (ESM) adjustment program, and the newer Transmission Protection Instrument (TPI), designed to counter “unwarranted” spikes in borrowing costs that threaten monetary policy transmission.

The ECB is unlikely to let France fail, since this would very well signify the end of the Euro. The will to keep the Euro, a political project, alive should not be underestimated. Then-ECB President, Mario Draghi, famously to do “whatever it takes to preserve the Euro”.

If push came to shove, the ECB would likely find an acronym for a new program to buy French government bonds. However, the ECB must also be careful not to appear rushing to help at the slightest sign of distress — moral hazard might prevent French politicians from finding the will for fiscal reform.

Markets love to find out the amount of pain politicians are willing to bear before acting. Bailouts are, of course, highly unpopular in the former hard-currency countries like Germany (and not allowed). One way to help France could be for Germany (or the EU) to assume some of France’s costs for nuclear defense. “France will open its nuclear umbrella, and Germany will open its wallet”, suggests Jürgen Michels, chief economist at BayernLB in Munich.

Following this route would ensure that the “French connection” would not have to end in a divorce, the economic cost of which would be prohibitively large. France must find a path towards improving its fiscal situation, while at the same time preventing social unrest and keeping right-wing forces out of the parliament — not an enviable endeavor.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post The French Connection: Fitch Downgrades France’s Credit Rating appeared first on 51�Թ�.

US job creation disappoints

The BLS reported lower-than-expected job creation in July, with substantial downward revisions to May and June. Days later, Trump McEntarfer, accusing her of rigging the data. Was the agency’s data flawed? Or was Trump simply shooting the messenger?

According to the July 2025 payroll , the economy added a mere 73,000 jobs, below expectations of 115,000. Meanwhile, revisions slashed May’s gain from 125,000 to 19,000, and June’s from 147,000 to 14,000 — a cumulative downgrade of 258,000 jobs.  

The BLS compiles jobs data by surveying roughly 120,000 business establishments each month, gathering payroll, hours worked and wages. Initial estimates (the so-called “advance” and “preliminary” numbers) come from incomplete data and projection models. These are later revised as more responses trickle in. 

Once a year, BLS conducts a benchmark revision, replacing survey estimates with unemployment insurance (UI) administrative records, which capture actual payroll tax-reporting by firms — far more complete and accurate. Differences between survey-based estimates and UI data lead to systematic adjustments in the fourth quarter release each year, recalibrating the entire prior year. 

Unfortunately, the survey response rate has fallen — only 58% responded in July, down from a historical 72%. Additionally, BLS is facing budget cuts and reduced staffing, as by the Financial Times.

Statistical significance

In a technical note, BLS out that employment changes between a decline of 86,000 and an increase of 186,000 are not statistically significant if the actual gain was 50,000, as numbers within the range were still part of a 90% confidence interval. The 73,000 increase in July was therefore statistically not significant, as zero job growth would have been part of the actual count.

Think of it this way: if you managed a movie theater with 163 attendees, would you fret over a difference of one or two-tenths of a person? This is what the employment revision corresponds to in an economy with 163 million employees.

to the BLS, only one out of 16 sectors (private education and health services) saw a statistically significant employment change different from zero for the one and three-month intervals.

Revisions to employment numbers happen regularly, and recent revisions do not suggest any foul play. President Trump made repeated claims that the employment numbers were “rigged” to make him look bad, but experts these assertions. The former head of BLS, Bill Beach, Trump’s claims.

Damaging trust in statistics

Unfortunately, Trump’s firing of McEntarfer, an economist, will have negative consequences. Can financial markets still trust future employment releases? Will future BLS leaders resist the urge to please the President by twisting numbers or adjusting survey design in favorable ways? 

US government statistics may be reaching a point where they cannot be trusted — ironically, the same issue the US once criticized in Chinese statistics.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Shooting the Messenger: How Trump Blamed the Bureau of Labor Statistics for Weak Job Creation appeared first on 51�Թ�.

Golf isn’t the only thing Trump is known to cheat at. Monday’s newspaper headlines suggest the EU got the short end of the stick in the newly announced trade deal with the US. Absent from most commentary is the fact that the importing country pays tariffs, and therefore a tax on its citizens. Let’s dive in.

Terms of the deal

The US will a flat 15% tariff on most EU exports, including automobiles, machinery and pharmaceuticals. That’s down from a threatened 30–50% but still a sharp shift from prior near-zero rates. Critical items — such as aircraft components, semiconductors and essential medicines — fall under “zero-for-zero” terms with no mutual tariffs. Existing 50% US tariffs on steel and aluminum remain in place for now, with a vague promise of moving to quotas later. 

European commitments

The EU to buy $750 billion in US energy — primarily Liquified Natural Gas (LNG), oil and nuclear — by the end of 2028. That translates to roughly $250 billion annually through 2027, far above current levels. EU firms pledged $600 billion of new investment into the US economy, aimed at manufacturing, energy infrastructure and defense. Though not precisely quantified, the EU committed to significantly increasing purchases of US-made defense systems and aerospace technologies.

Who pays tariffs?

Tariffs are levied and paid by the importing country. In the case of the EU-US deal, custom dues will have to be paid by US importers (not EU exporters). Tariffs are already causing havoc for US businesses, as in recent surveys of purchasing managers.

According to monthly statements from the US Treasury, monthly revenue from customs duties from $8 billion to $26 billion in recent months. Annualized, the amount could reach $300 billion or more. 

For products with low value-added that are easily replaceable, the EU exporter will likely face the choice between lowering the price or foregoing US sales. High value-added products not available from US manufacturers, however, could see customs duties passed on to US customers. 

The top three EU-made imports to the US nuclear reactors, machinery and cars. Nuclear reactors are, naturally, a lumpy business, but unlikely to be easily replaceable. 

Bertram Kawlath, President of German Verband Deutscher Maschinen- und Anlagenbau (VDMA) — Mechanical Engineering Industry Association, representing over 3,000 mostly German and European engineering companies — the deal as a “regrettable development”. He also how “every US production company depends on imports of European machinery equipment — and this will remain the case going forward”.

An earlier story by the Wall Street Journal how US producers of canned foods, like Campbell, Hormel and Del Monte, are getting squeezed by rising steel tariffs. A recent analysis by the same publication that the price of a can of Campbell’s “New England Clam Chowder” increased by 30% since the beginning of the year.

Data published by the US Bureau of Statistics that furniture prices rose at a three-month-annualized rate of 9% in June, the likely result of tariff pass-on, as the US imports roughly one third of furniture sold.

German car industry in uproar

“The US tariff rate of 15%, including for automotive products, will cost German automotive companies billions annually,” to Verband der Automobilindustrie (VDA) — German Automotive Industry Association — President Hildegard Müller. German automakers were already struggling with the transformation to electric vehicles and increased competition from China. 

German car manufacturers are unlikely to lower prices in the US as they are already around home market levels. A 12% in the value of the dollar since the beginning of the year did not help either, reducing revenue and profit per car in Euros. 

Audi recently its 2025 sales and profit guidance, citing the impact of US tariffs and restructuring costs. General Motors a $1.1 billion hit to profitability from tariffs in the second quarter of 2025.

Not all is lost

A car-buying expert I spoke to explained that car makers are “eating” tariff costs for now.  However, cost increases will be worked into the prices of new 2026 models coming out in late summer.

US car imports from the EU are by German cars, led by premium brands like BMW, Mercedes, Audi and Porsche.  Industry sources that foreign car makers had already lowered price incentives (discounts) in May to combat tariff costs. Lower incentives equal higher sales prices for the customer.

The average sales price for a new BMW ($74,400) is 50% above the average US car price, indicating the customer base is less price-sensitive than the average buyer. Price increases are therefore likely to be easier for high-priced German brands than for US manufacturers. 

$750 billion energy shopping spree

According to the White House’s “,” “the EU will purchase $750 billion in US energy”, consisting of oil, gas and nuclear fuel. The $750 billion is said to be spread over three years, or $250 billion per year. Currently, the EU imports around of fossil fuels from the US. Thus, tripling or quadrupling imports from the US is required to reach said target.

The EU already around 50% of its LNG from the US, and 17% from Russia. Even completely replacing Russia’s share would increase US deliveries by only around one third. LNG has important capacity constraints. The exporting country needs liquefaction terminals, specialized LNG ships and regasification terminals in the importing country. 

Those terminals are huge, ugly and can cost $1-2 billion to build. How much coastline is there left in Europe where you could build such massive installations? Floating Storage Regasification Units (FSRUs) are a less expensive option, yet environmental concerns as well as lack of space might prevent deployment.

Assuming LNG imports from the US increased to $75 billion, crude oil imports would have to make up the gap, increasing fourfold to $175 billion. With oil trading at $66 a barrel, 2 billion additional barrels per year, or 5.6 million barrels per day (bpd), would be required. Where is that going to come from? 

US crude production is by approximately 1 million bpd per year, with most of the increase stemming from “tight oil” (shale/fracking). Shale oil well production peaks after 8-12 months. Wells are 80-90% depleted after 2 years. Unless new holes are constantly drilled, production falls off quickly, as in the recent decline in the number of rigs. Shale production needs oil prices of at least $60-$70 to be profitable. At current prices, fewer new holes are being drilled, resulting in a decline in production. The $250 billion a year energy exports to the EU are therefore nothing but a pipe dream.

European efforts to wean off fossil fuels

Expectations of a European energy shopping spree ignore the ongoing efforts by European countries to wean themselves off fossil fuels. Following the Russian invasion of Ukraine, which led to an energy price shock, consumers are willing to switch to alternative energy supplies. 

In the first half of 2025, German installations of gas-fired heating systems by 41%, with oil-based heating systems declining by 80%. Meanwhile, sales of heat pumps surged by 55%. The Building Energy Act (), often referred to as the “heating law,” was introduced in 2024 to ramp up the replacement of fossil heating with low-carbon technologies, including heat pumps.

$600 billion investment bonanza

The $600 billion in “new investments” in the US should be taken with a grain of salt, too. The US is hoping to sell “significant amounts of military equipment” to the EU.

However, JD Vance’s at the Munich Security Conference shocked European attendees, bringing the conference host to tears. It was understood as the end of NATO. A rapprochement between Trump and Putin could see the US possibly taking Russia’s side in the Ukraine conflict, which would pit the US against Ukraine-supporting Western Europe.

Any military equipment of US origin became worthless overnight, since the US could remotely disable it, refuse to deliver spare parts or ammunition or scramble communication systems. The EU must now redevelop many weapon systems from scratch, making them “US-proof”. Hence, the €1 trillion spending plan in Germany (requiring an amendment to its constitution).

Off the record, European politicians and military leaders agree that NATO is dead. However, it would be unwise to say so publicly, as things could change in four years. The best strategy seems to be to pretend “everything is fine” while at the same time working on a “divorce”. It is highly questionable that under these circumstances, billions will be spent on potentially worthless US military equipment.

Big words, little substance and self-harm

In short, the announced “deal” is unlikely to live up to the fanfare with which it was announced. The targets seem unrealistic. In the end, the US consumer will likely have to bear the brunt of the cost, if only with a time lag. Tariffs are a cost borne by everyone, with the proceeds being used to finance tax cuts for the wealthy.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Neither Art nor Deal: Trump’s Risky US-EU Trade Agreement appeared first on 51�Թ�.

“H.R.” stands for “House of Representatives”, with “1” being the bill number. The number “1” is reserved for a top legislative priority of the majority party in the House. Each new Congress gets a new H.R.1 — so “H.R.1” is not a permanent bill title; it changes every session.

The branding was classic Trump: grandiose, vague and built for cable news. But unlike many of his other rhetorical flourishes, this one came with substance — roughly 800 pages of it. In sheer scope, cost and political ambition, the bill is arguably the defining legislative achievement of Trump’s second term. It is also a window into the soul of contemporary : populist rhetoric married to plutocratic policy, an iron fist for immigration and a velvet glove for capital gains.

Play it again, Sam

The “Big Beautiful Bill” is a rhetorical phrase frequently used by Donald Trump to describe his administration’s planned legislation, particularly regarding immigration and border security. Trump often spoke about a “” during his 2016 campaign, referring to a physical barrier on the US–Mexico border. The phrase “Big Beautiful Bill” originated from the same rhetorical style, typically employed in speeches or interviews to promote pending legislation, portray the bill as comprehensive, effective and patriotic and position Democrats as obstructionists for not supporting it. “Big Beautiful Bill “is a branding device to sell policy to the public in simplified, catchy terms.

So, what’s in the Big Beautiful Bill? 

While the bill touches everything from taxes to border security to Medicaid, its central thesis is clear: reward work (as narrowly defined by Republicans), punish dependency (as broadly defined by Republicans) and cement Trumpism as a long-term governing framework.

Tax cuts dressed as working-class relief

At the heart of the BBB is a permanent extension of the 2017 Trump . But to rebrand those widely criticized, high-end giveaways as pro-worker, the bill adds a populist gloss. Tips and overtime pay are now tax-exempt for anyone earning under $150,000. Trump it a “tax cut for waitresses and truckers,” though the real dollars still flow to the top. The was modestly increased to $2,200 per child and indexed to inflation. Auto loan interest is now deductible, a peculiar throwback to the 1980s. Perhaps the most on-brand feature is a $1,000 deposit in “Trump Accounts” for every baby born between 2025 and 2028, a gimmick aimed at boosting both birthrates and brand loyalty.

Critics these giveaways do little to help the poor and disproportionately benefit those already earning enough to pay income taxes. The Congressional Budget Office (CBO) the tax portions of the bill will, over the next 10 years, reduce federal government spending by $1.25 trillion while reducing revenues by $3.67 trillion, adding a whopping $2.4 trillion to the deficit.

Russell Vought, Director of the Office of Management and Budget (OMB), labeled the CBO’s score of the “One Big Beautiful Bill” as “”, arguing it wrongly assumed Congress wouldn’t extend 2017 tax cuts. This argumentation adds insult to injury, as sunset clauses in the 2017 tax cuts were introduced to limit the amount of damage to federal finances. It is indisputable that tax cuts increase deficits — anyone insisting the opposite is gaslighting.

Carve Up the Safety Net

To offset some of that cost — on paper, at least — the bill makes deep cuts to Medicaid and SNAP (food stamps). Medicaid faces $1.2 trillion in reductions over a decade, accompanied by new work requirements and enrollment caps that could result in Americans being removed from the rolls. SNAP gets a $186 billion haircut, with stricter work mandates and a requirement for states to cover a portion of benefits.

These provisions were sold as “promoting dignity and work,” but for many families, they translate to lost coverage and empty pantries. The bill doubles down on the idea that if you’re poor, it’s probably your fault, and if you’re rich, it’s probably because you worked harder.

Border security on steroids

sets aside between $150 and $170 billion for immigration enforcement, wall construction and surveillance technology. Immigration and Customs Enforcement (ICE) gets a massive funding boost. A new $100 annual fee is slapped on asylum seekers. The number of border patrol agents is expected to increase by over 25%, and construction will resume on segments of the border wall that had previously been halted.

This is the materialization of Trump’s long-running campaign promise. But beyond the headline-grabbing wall, the bill institutionalizes a more militarized, punitive approach to immigration — an approach designed not just to stop unlawful border crossings but to make asylum itself a more burdensome, bureaucratic ordeal.

Defense budget: Bigger and more beautiful

Not to be outdone, the Pentagon gets another $150 billion infusion. Some of this goes to traditional hardware: destroyers, drones and missile defense systems. However, a surprising portion is earmarked for and undersea surveillance areas where China and Russia have intensified their activity.

This segment of the bill garnered relatively little attention but represents a quiet militarization of climate-impacted geographies. Trump may not believe in global warming, but he’s betting on a hotter Arctic.

Never mind Trump, only a few months ago, Financial Times he would “check the military” for waste, with the aim of uncovering “billions, hundreds of billions of dollars of fraud and abuse” in the ~$800 billion-plus Pentagon budget. At a press briefing in February, Trump to cut military spending “in half”.

Killing clean energy with bureaucracy

In perhaps the most ideologically revealing section, the BBB guts clean energy tax credits. Solar, wind and electric vehicle incentives are phased out. The argument? These subsidies distort markets and burden taxpayers. However, energy economists that the rollback could stall or reverse progress toward decarbonization and put tens of thousands of jobs at risk.

In , where renewables have quietly boomed, the backlash has already begun. Energy CEOs who once supported Trump now warn the bill could cost the state billions and undercut energy independence. Meanwhile, coal and natural gas receive new tax preferences — a sop to legacy producers.

While China presses ahead with investments in clean energy technology, the US remains ideologically trapped in its love for fossil fuels.

The deficit grows, but that’s not the point

Despite cuts to Medicaid and food aid, the BBB is a fiscal time bomb. Trump shrugged this off as “a good investment in America,” the same way he might describe a failed casino.

Republican leadership is . Fiscal conservatives hate the cost. Populists love the optics. Democrats, for their part, have found an attack line: this is a “ in reverse” bill, taking from the poor to give to the rich.

But here’s the real twist: Trump doesn’t care. The BBB was never about fiscal responsibility. It was about visibility. It consolidates Trump-era themes into a single, on-brand document: anti-immigration, anti-welfare, pro-business and performatively pro-worker. It’s not so much a policy as a political identity made into law.

Public opinion: Lukewarm at best

Polls show the public is skeptical. A CNN survey conducted days after passage 61% of Americans opposed the bill, with only 29% in favor. Among independents, support was under 20%. Even some Trump voters expressed concern over the cuts to Medicaid and SNAP. However, in a fragmented media landscape, disapproval doesn’t always translate into a political cost.

The White House that Americans “will come around” once they see bigger paychecks and feel the patriotic pull of new border infrastructure. Whether that happens before the 2026 midterms remains to be seen.

The takeaway: Trumpism, codified

The One Big Beautiful Bill is not just a law — it’s a worldview. It assumes the poor need discipline, the rich need incentives and the nation needs walls more than social workers. It is trickle-down populism wrapped in a red, white and blue bow. And though its long-term economic impacts are murky, its political message is crystal clear.

Trump has often been accused of lacking policy depth. The BBB proves he doesn’t need it. All he needs is a slogan, a spectacle and a signed piece of legislation large enough to read as destiny. And in that sense, the One Big Beautiful Bill may be the most Trumpian thing ever written into law.

[ edited this piece]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post The One Big Beautiful Bill: Trumpism in Legislative Form appeared first on 51�Թ�.

But the problem isn’t that the US dollar plays this role. The problem is that it is both the global reserve currency — the currency most widely used in global trade and held by foreign central banks — and the national currency of the United States. That creates dangerous repercussions for both the US and foreign nations’ accumulation of US dollars.

The dollar trap

US President Donald Trump and his followers aren’t wrong in saying the US pays a price for issuing the global reserve currency. For foreign countries to obtain US dollars, which they need for international trade and to repay dollar-denominated debts, they must run current account surpluses (exporting more than they import). That requires the United States to run perpetual current account deficits (importing more than it exports).

Of course, being the issuers of the world’s reserve currency allows the US to import anything it desires and simply pay with financial claims (US dollars), without the fear of devaluing the dollar, at least in the short term.

This benefits US consumers, who enjoy cheaper imported goods. But it comes at a cost to exporting countries, where workers produce authentic goods in exchange for financial claims that may never be redeemed for US goods. The result is a global wealth transfer from foreign laborers to American consumers. Meanwhile, foreign countries accumulate dollars and acquire US assets — including bonds, stocks, companies and land. 

A key measure of this trend is the Net International Investment Position , which tracks the difference between a country’s external financial assets (what Americans own abroad) and its external financial liabilities (what foreigners own in the US). The ����’s NIIP has significantly from less than negative $1.7 trillion in 2008 to more than negative $24 trillion at the end of March 2025. In the fourth quarter of 2024, NIIP declined by more than $2 trillion, partly due to the strong dollar that increased the value of US assets held by foreigners. Annualized, the figure would be equal to more than a quarter of GDP, a staggering amount.

As foreign holdings of US debt grow, so do interest and dividend payments flowing out of the US economy — a steady drain of income to overseas investors.

Sectoral view of economics

One way to understand global economics is through the view, a way of understanding financial flows using accounting identities. It breaks the world down into three sectors: private (households and businesses), government (taxation and public spending) and foreign (trade balance with foreign countries). 

Every dollar spent or saved by one sector must be matched by an opposite balance in one or both of the others: (Private Sector Balance) + (Government Sector Balance) + (Foreign Sector Balance) = 0

For example, when Americans import a car, dollars leave the country and show up as a surplus in the foreign sector and a deficit in the private sector. When someone pays taxes, their savings decrease, while the government’s revenues increase.

In recent years, the US government’s deficit (shown in purple in this ) mirrors the private sector’s surplus (orange). Meanwhile, the foreign sector’s surplus (green) comes at the expense of US households and firms. Even though corporate are at record levels — around 12% of GDP — many households are struggling to save. Publicly traded corporations pay about $2 trillion annually in dividends to shareholders, but that money is concentrated among the wealthiest Americans — and increasingly, foreign investors.

A brief history of US external balances

The US began running persistent current account deficits in the early 1980s, during the administration of President Ronald Reagan. The deficits widened in the late 1990s and early 2000s, reaching over 5% of GDP during the . Although the 2008 financial crisis temporarily reduced the deficit, it did not disappear. 

As of , the deficit remains large, driven by a chronic imbalance in goods trade (heavy imports of consumer products and industrial inputs). The shortfall is partially offset by a surplus in services trade, exports like software from Apple, licensing of American movie rights and global usage of US-based financial services.

These imbalances are not merely economic accidents; they are structural features of a global financial system built around the dollar. 

The limits of dollar demand

Foreigners are accumulating US assets — not out of charity, but necessity. They need dollars to settle international trade, service dollar-denominated debts and build FX reserves. But this accumulation has limits.

First, foreigners cannot redeem their dollar claims for US goods and services, in total, unless the US runs a trade surplus, which it doesn’t. Second, it means non-US labor is producing real goods in exchange for paper claims that they may never redeem in kind.

While the US can theoretically print as many dollars as needed, this doesn’t mean the rest of the world will always want to hold them. You can force-feed financial claims to producers or authentic goods only for so long. The dollar system rests on confidence. At some point, this confidence could break. 

The dollar’s status as the world’s reserve currency also depends on its stability. So far, no central banker has been fired for holding too many dollars. However, nobody wants to hold a wasting asset. 

The hoarding of US dollars by foreign central banks prevents the exchange rate from adjusting to a price where trade imbalances would decline. Insofar as the dollar is a victim of its own success, to be a reserve asset, it cannot be weak. Its continued strength, at least until the beginning of 2025, hollowed out the US industrial base, exporting jobs and inflation to other nations.

The Eurodollar mirage

An alternative access route to US dollars — and it’s an imperfect one — is the . This is a global financial system of offshore US dollars created by non-US banks. Despite the name, Eurodollars are not related to the euro. They are dollar deposits held in foreign banks, often in London or the Caribbean.

You can think of the Eurodollar market as a casino. Players use chips as currency. They settle bets with chips that represent and may look like dollars, but aren’t backed by the Federal Reserve Bank. The monetary system within the casino works fine until either someone with large winnings wants to cash out or a player is unable to repay their debt.

Offshore dollar markets function until they don’t. Eurodollars are not automatically convertible into onshore dollars without a corresponding credit line from a US institution. When liquidity dries up, those credit lines become hard or impossible to obtain. The Federal Reserve may step in — as it did with in 2008 and 2020 — but it is under no obligation to save the system. Swap lines are dollar loans to foreign central banks, which, in turn, lend these dollars to borrowers in distress (at their own risk). 

The current administration will likely make a point of excluding “non-friendly” countries from access to those swap lines. 

Ecuador, which abandoned its own currency and in the year 2000, found out the hard way. The government defaulted on dollar-denominated debt twice (in 2008 and 2020) because it lacked the ability to issue its own currency during a crisis.

The case for a neutral reserve currency

The obvious solution is a supra-national reserve asset. Ironically, such a thing has already existed for decades: the (SDR), created by the International Monetary Fund (IMF) in 1969. It is not a currency used by consumers but rather an accounting unit used between governments. It only exists in digital form, based on a basket of currencies (dominated by the US dollar and the Euro). 

Initially, the SDR was linked to gold, as one unit was set to represent slightly less than one gram (0.888671) of gold. After Former US President Richard Nixon “temporarily” the dollar’s convertibility into gold in 1971, the gold link was removed in 1973.

An SDR-based monetary system would still face challenges. In our (where trust rather than commodities backs currency), money can only be created by issuing an equal amount of debt. This would require a global lender of last resort to intervene in case national central banks ran out of debt-bearing capacity to create additional SDR liabilities. It would be a highly centralized system with few potentially unelected officials deciding over the allocation of credit. 

The world would know only one interest rate. There would be no national sovereignty over monetary policy.

Commodity currencies? Be careful what you wish for

What about backing a global reserve currency with commodities? Gold? Oil? Bitcoin?

A commodity-backed system brings discipline — but also rigidity. They restrict how much money governments can create, since the supply is tied to commodity prices. When prices fall, the money supply shrinks. The money supply becomes pro-cyclical, causing deflation and recessions. And it favors commodity-rich nations like Russia and Saudi Arabia, while hurting import-dependent economies like Japan.

Bitcoin appears to be unsuitable as a medium of exchange, as its limited issuance may lead to hoarding. Expected price appreciation would mean that other goods expressed in Bitcoin would fall in value; they would deflate. Prolonged periods of deflation can harm the banking system, leading to depression and widespread unemployment.

The dangers of small currency fragility

What if there won’t be a new global reserve currency? What if the international monetary system disintegrates into countries trying to use their domestic currencies to settle international trade? Imagine the friction of having to price your product in 20+ different currencies and adjusting prices almost daily. Hedging costs would explode, and inefficiencies soar.

Furthermore, the currencies of smaller nations often serve as playthings for speculators. Their currencies are vulnerable to speculative attacks (when investors suddenly pull out money). Hot money inflows — short-term capital chasing high interest rates — can vanish in a crisis. Exchange rates collapse. Imported inflation spikes. Living standards fall. 

Take Turkey — not exactly a minion of a nation (16^th largest by GDP). In 2016, the Turkish lira at 2.5 per dollar. Today: over 40. Nominal wages soared from 2,210 lira (~$1,000) in 2014 to 26,600 (~$665) in 2024. The average Turk is poorer in US dollar terms. 

A collapsing currency can make energy imports unaffordable. Resulting power cuts may lead to social unrest.

America’s missed opportunity

The US never seriously pursued transitioning to a neutral reserve system, a massive policy failure. The ability to run deficits without immediate punishment (i.e., currency depreciation) proved too tempting.

The endgame is in sight. The US is now addicted to deficits, with neither party being able to rein in spending. Rather than engineering a soft landing, the current administration seems eager to speed toward the cliff by alienating international creditors. No one sinks a leaking ship faster by grabbing an axe. But here we are. 

[ edited this piece]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post The Problem with the Dollar: When One Nation’s Currency Becomes the World’s appeared first on 51�Թ�.

After the election, the flags didn’t come down right away. They lingered like holiday lights in March — faded, wind-flapped, defiant. But by spring, they were gone. All of them. As if packed away with the plastic Santas and patriotic bunting.

US President Donald Trump’s approval rating has to 45% — a record low for any postwar president in their first quarter — except, of course, for his own first term.

Yet online, you wouldn’t know it. Social media still hums with MAGA fervor, the comments sections undeterred if not emboldened. In the virtual town square, the Trump train still runs express.

A recent cable TV survey Fox News commanding a 59% share of the prime-time news audience among 25-to-54-year-olds. CNN trailed far behind at 17%. It sounds dominant until you check the headcount. Fox’s prime-time audience? 345,000 people. That’s 0.1% of the US population. Not exactly a mass movement — more like a crowded dinner party with production values.

Meanwhile, the real action is online. According to , 86% of American adults now get their news from digital devices. YouTube personalities have built media empires: Ben Shapiro has 7 million subscribers. The Young Turks boast 6 million. Sean Hannity’s radio show reaches 14 million listeners. These aren’t just platforms; they are ecosystems.

And they are sealed tight. These media spheres don’t trade in news — they manufacture narratives. There’s no distinction between reporting and opinion, between what happened and what it means. It’s all one frothy ideological milkshake, shaken, not stirred.

In a recent segment, the hosts of New York Public Radio themselves to 12 straight hours of right-wing content. They emerged dazed, like researchers back from Chernobyl.

The divide isn’t just political. It’s metaphysical. Two realities hermetically sealed, running on parallel tracks. The possibility of a shared national conversation? Gone. Replaced by algorithm-fed outrage and tribal reinforcement.

Each side is convinced that the other is either brainwashed or bloodthirsty. The imagery is apocalyptic: one half sees a savior marching toward greatness; the other sees a wrecking ball headed for the foundation of the republic. There’s no middle ground when the other side is the end of the world.

In rural Pennsylvania or New York, the economic decay is physical. Boarded storefronts. Empty factories. Roads that haven’t seen fresh asphalt since the Cold War. The American dream, hollowed out. Meanwhile, the coastal elites cash in stock options, slurp oysters and speculate in ultra-luxury real estate.

The result? A system that works for the few and fails the many. GDP growth headlines mean little in places where the post office is the last functioning institution. And just like rural America watches Wall Street but never touches its wealth, countries abroad watch the dollar dominate even as they quietly prepare alternatives.

And then there’s the fatigue. Keeping up with American politics feels like binge-watching a bad reality show that never ends — just new seasons with a similar cast. Somewhere between doomscrolling and disengagement, I found myself in a souvenir shop in a sleepy town. Amid the mugs and faith-based merch was a small bar of soap that read, “I can — and I will.” A profound reminder we are not helpless if we concentrate on our inner strength.

The world feels like it’s closing in. But we’ve lived through worse. A global pandemic shut down the planet. Supply chains snapped. Economies buckled. Somehow, we endured.

We’ll get through this too.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Bubblelicious — How Our Media Spheres Trap Us In Separate Realities appeared first on 51�Թ�.

The formula isn’t economic; it’s narrative arithmetic

Let’s start with basic math. The Trump administration’s 2025 tariff plan, as The Atlantic‘s Derek Thompson it, takes the US back to “the highest tariff duty as a share of the economy since the 1800s” — a pre-industrial throwback justified with 21st-century populism. 

The White House was using an AI model—built not by the Council of Economic Advisers, but by a private consulting firm—to generate the tariff schedules now making headlines. According to internal memos leaked to The Atlantic, the model ingested bilateral trade flows, elasticity estimates and a hodgepodge of political sentiment data scraped from social media to calculate “optimal pain points” for foreign exporters. In effect, tariffs were set not by economists but by a machine trained to maximize leverage in trade negotiations—prioritizing geopolitical pressure over economic efficiency. One senior official reportedly described it as “war-gaming the global economy with ChatGPT on steroids.”

Unsurprisingly, transparency was absent. No peer review, no published methodology; just a black box churning out tariff rates designed to look tough on paper while playing chicken with global supply chains.

The AI-driven tariff formula ended up slapping duties on tiny island nations with no significant exports to the US — places like Vanuatu and the Seychelles. The algorithm, designed to target trade imbalances, flagged them as “net beneficiaries” despite their having virtually no economic relevance. Among the territories hit with tariffs were the Heard Islands, a place inhabited only by .

Instead of basing “reciprocal” tariffs on the rate charged by trading partners, the Trump formula is based on trade balances or parity – which has little to do with actual trade imbalances.

Ben Hunt, in his blistering Epsilon Theory , nails the narrative shift. He describes how the US is shifting from a coordination game — Pax Americana — to a competition game: America First.

The coordination game produced global prosperity: The US offered access to its consumer base and military protection and in return dominated the world system. But that required trust. Once the US defects and imposes tariffs unilaterally, it forces others into their own corners.

Suddenly, we’re all in a prisoner’s dilemma. In this thought experiment developed by game theorists Merrill Flood and Melvin Dresher, prisoners are presented with the opportunity to rat out their co-conspirators in exchange for going free — but if no one confesses, then none can be convicted. Mutual silence gives the best collective outcome, but individual incentives push each prisoner to defect.

International trade is similar. It works only as long as everyone agrees not to break faith with the others. The Trump administration has now decided to take the second option. And the result? Everyone defects. Everyone loses.

Passing the buck

Amid the carnage in global capital markets, both Chief Economic Advisor Stephen Miran and Treasury Secretary Scott Bessent tried to themselves from the tariff plans. Bessent he “wasn’t involved in the calculation of the numbers,” while Miran “the President chose to go with a formula … suggested by someone else.”

Those denials reveal the unsettling news that Trump neither consulted nor valued the input of the treasury secretary nor the chief economist.

In a at the Hudson Institute, Miran tried to rebrand the disastrous tariff adventure.  The “costs” of US reserve currency status posed an unfair tax on American workers. “Persistent currency distortions” caused by dollar demand, he argues, fuel trade deficits and hollow out US manufacturing. 

The idea that manufacturing decline stems from trade deficits collapses when compared to Germany. As the Peterson Institute’s Adam Posen , North Rhine-Westphalia — �ұ�������Բ�’s industrial heartland — lost manufacturing jobs at nearly the same rate as Ohio, despite Germany running massive trade surpluses. The percentage of employees in German manufacturing was since the 1970s.

The on why tariffs are necessary is constantly shifting. Early arguments ranged from “reshoring manufacturing” to “protecting domestic industry.” Later, potentially abolishing income taxes was introduced as a sweetener. More recently, “border protection” from drugs and/or illegal immigration was added. Finally, higher tariffs were supposed to “pressure other countries to lower tariffs,” and “getting countries to pay their fair share” for defense.

Yields on US Treasury bonds briefly fell as markets priced in a higher risk of recession triggered by the tariffs. For a moment, the administration floated a new rationale: that tariffs could help lower interest payments on government debt. But when bond yields , that narrative quietly vanished.

FOX News viewers were to receive the cherry on top of all narratives — tariffs “could reverse the crisis in masculinity.”

What would a real solution look like?

Widely respected investor and Berkshire Hathaway CEO Warren Buffett issued a in ���������Dz�’s in 2003: persistent trade deficits, he wrote, were effectively a long-term sell-off of American assets to foreigners. His island parable of “Squanderville” living off debt issued to “Thriftville” was an early blueprint of today’s concern.

But unlike Miran, Buffett didn’t push for tariffs. He proposed “import certificates” — a market-based balancing mechanism that would cap imports to the dollar value of exports, creating natural incentives without starting a trade war.

Buffett’s critique was not of global trade, but of imbalance. The solution was system reform, not narrative-fueled retaliation.

Little did Warren know that the net international investment position, which measures the gap between what the US owns abroad and what it owes to foreign investors, would get ten times worse. That figure now stands at $−26 trillion, close to −100% of GDP.

Curiously, policymakers won’t even mention the most “free market” approach; if the US dollar is overvalued, let it devalue! The Federal Reserve doesn’t even need the cooperation of other central banks (like in 1985 ) — it can create and sell dollars in unlimited quantities.

This, of course, would damage the status of the US dollar as the world’s reserve currency — after all, what non-US central bank or investor would like to hold a decaying currency? But the US cannot have the cake and eat it.

As this revelation dawns, the US is acting like an irate chess player realizing he has maneuvered himself into a corner: flipping the board, throwing pieces, storming out of the room and leaving the other players stunned amidst the self-inflicted damage.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post After the Market Meltdown, the Trump Administration Is Rebranding Tariffs appeared first on 51�Թ�.

With no outright majority, coalition negotiations are underway. Merz is in talks with the SPD, aiming to form a government by Easter. Yet, AfD’s strong performance has unsettled mainstream parties, reflecting a growing populist sentiment within Germany.

A CDU/CSU–Green coalition would fail to reach a simple majority, and AfD and Die Linke are incompatible with CDU/CSU’s values. Thus, allying with the SPD as the only viable option. Ironically, this would allow the SPD to remain in government despite a resounding defeat.

The SPD, trying to repair its image, may push for considerable concessions from CDU/CSU, complicating negotiations.

Constitutional challenges

Merz has a controversial workaround to �ұ�������Բ�’s constitutional debt brake (Schuldenbremse) by using off-budget special funds (���DzԻ����������ö�����). Although a vocal defender of fiscal discipline, he suggests temporarily suspending the Schuldenbremse to finance key investments, particularly in defense and infrastructure, without violating its formal rules.

This approach mirrors the Scholz government’s strategy to fund a €100 billion military upgrade after Russia’s invasion of Ukraine. By shifting borrowing outside the core budget, Merz aims to balance economic pragmatism with conservative fiscal principles. Critics argue it weakens the Schuldenbremse’s credibility and entrenches off-budget debt mechanisms.

�ұ�������Բ�’s constitution (Grundgesetz) limits government borrowing and ensures long-term fiscal discipline. Enshrined in Articles 109 and 115, the Schuldenbremse restricts the federal government’s structural deficit to 0.35% of GDP per year, while the states (��ä�Ի���) are prohibited from running structural deficits. Exceptions exist for emergencies, such as economic crises or natural disasters, but any deviation requires a repayment plan.

Introduced in 2009 in response to the financial crisis, the Schuldenbremse reflects �ұ�������Բ�’s deep-rooted aversion to excessive debt. While praised for maintaining fiscal stability, critics argue it limits public investment and economic flexibility, especially during downturns.

The Greens and the FDP have been “ of [Merz’s] proposals” without their party representatives present at the announcement. The current government fell apart over much smaller fiscal issues — one can only imagine how FDP, being fiscally conservative, must feel regarding these proposals.

Changing �ұ�������Բ�’s constitution is deliberately difficult in order to ensure stability and protect democratic principles. Constitutional amendments require a two-thirds majority in both the Bundestag and Bundesrat, making broad political consensus essential. This rigidity prevents legal manipulations that once enabled authoritarianism. Even widely supported reforms often stall due to political fragmentation or federal-state disagreements, reinforcing the constitution’s role as a safeguard against abrupt shifts in governance.

A race against time

In the new Bundestag, Merz will not have the majority needed to make changes. AfD will nearly double its seats in parliament, from 83 to 152, only 12 seats behind CDU’s 164. Along with the Die Linke’s 64 seats, two non-centrist parties will control over a third of the Bundestag, enabling them to block decisions requiring a two-thirds majority.

In a stunning move, Merz proposed amending the constitution before the new parliamentary session begins at the end of March. He aims to increase borrowing, particularly for defense spending. The proposal requires a two-thirds majority in both the Bundestag and Bundesrat. Fiscal conservatives fear it could weaken �ұ�������Բ�’s strict debt rules.

Some constitutional law experts the current Bundestag lacks the legitimacy to change the constitution since it no longer reflects the people’s will. Others . Legal challenges are likely, with AfD and Die Linke action.

Even if Merz’s proposal passes in the Bundestag, securing a two-thirds majority in the Bundesrat will be difficult. The Bundesrat represents �ұ�������Բ�’s 16 ��ä�Ի���. Its 69 members are by state governments, not elected. States must cast all their votes as a block — either all in favor, all against or abstaining. If a state cannot agree, its votes count as abstentions, making a two-thirds majority harder to reach.

Missing votes from six states, including those where Die Linke and BSW hold influence, would leave the remaining states with just one vote above the threshold. If any of the five states with Green-led governments abstain, the proposal fails.

The Bundestag will proposed reforms on March 13, with a vote scheduled for March 18. If the Bundesrat rejects the bill, a mediation committee (Vermittlungsausschuss) will be convened to negotiate a compromise.

The Vermittlungsausschuss has 32 members, 16 from each chamber. AfD, FDP, and Die Linke hold 10 seats combined. Members are not bound by directives or party mandates, leaving room for surprises. Lengthy negotiations or delays could make compromise impossible before time runs out.

Reactions at home and abroad

�ұ�������Բ�’s Bundesbank has allowing a maximum fiscal deficit of 1.4% of GDP, provided the debt-to-GDP ratio stays below 60%. The proposal has little chance of adoption, as �ұ�������Բ�’s debt-to-GDP ratio currently sits at 62%.

Meanwhile, the EU is adjusting its fiscal rules, particularly the Maastricht deficit criteria, to accommodate increased defense spending. These rules cap government deficits at 3% of GDP and public debt at 60% of GDP.

The EU may expand what qualifies as defense investment, including military equipment, arms manufacturing, and dual-use infrastructure. Germany has for an indefinite exemption for defense spending from EU fiscal rules, a significant shift from its traditional fiscal conservatism.

The markets have had their own reaction to the developments. Expectations of increased European defense spending have driven up defense industry stocks. Companies like , and have seen share prices soar, some doubling within weeks, as governments boost military budgets in response to geopolitical tensions.

The proposed fiscal expansion will lead to increased government borrowing, higher bond issuance, and rising yields. German 30-year government bond yields saw their biggest daily since the fall of the Berlin Wall.

Despite this, the European Central Bank interest rates by 0.25 percentage points on March 6, disregarding inflationary risks from large government spending programs. Higher long-term rates in Europe increase the euro’s attractiveness, its exchange rate.

�ұ�������Բ�’s shift away from fiscal rigidity marks a Zeitenwende — a historic turning point. Long committed to balanced budgets and the Schuldenbremse, Germany now faces pressures from geopolitical instability, economic stagnation, and aging infrastructure. Fiscal conservatives are reconsidering their stance.

This transformation mirrors �ұ�������Բ�’s abrupt reversal in defense policy after Russia’s invasion of Ukraine. As pacifism gave way to military investment, fiscal discipline now faces challenges from economic and security realities.

European governments are likely to welcome �ұ�������Բ�’s shift toward looser fiscal policies, as it could ease financial constraints across the eurozone. For years, �ұ�������Բ�’s strict austerity stance clashed with the preferences of France, Italy, and Spain, which favored more flexible spending to stimulate growth.

What will happen next?

A more expansionary German budget could boost domestic demand, benefiting European exporters and reducing economic imbalances within the European Union. Increased German investment in defense and infrastructure would also align with broader European priorities, particularly as the continent seeks greater strategic autonomy. A less rigid German fiscal approach could pave the way for EU-wide initiatives, such as joint borrowing for defense or industrial subsidies, marking a shift from Berlin’s historical opposition to collective debt mechanisms.

Increased fiscal spending on defense and infrastructure may create jobs and stimulate economic activity, but it will not directly address the social and economic grievances fueling right-wing populism in Germany. Rising living costs, immigration concerns, and a growing disconnect between political elites and ordinary citizens have driven support for AfD. The party has capitalized on public frustration by positioning itself as the voice of the disillusioned.

Without targeted policies to address wage stagnation, housing shortages, and social cohesion, simply lifting fiscal restraints may not curb the populist surge. If higher spending triggers inflationary pressures or tax hikes, it could even deepen resentment, reinforcing the populist narrative of an out-of-touch establishment.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Winners and Losers – Deciphering �ұ�������Բ�’s Election Results appeared first on 51�Թ�.

This ideology inspired him to create in 2011, a darknet marketplace enabling anonymous transactions, made feasible by Bitcoin. Ulbricht saw the platform as a free-market experiment, allowing participants to buy and sell without government interference. However, the site quickly became synonymous with illegal activities, primarily drug trafficking, drawing law enforcement attention.

A harsh sentence

In October 2013, authorities arrested Ulbricht at a San Francisco public library, charging him with operating Silk Road under the pseudonym “Dread Pirate Roberts.” He faced multiple charges, including:

• Engaging in a continuing criminal enterprise (the “kingpin statute”).
• Conspiracy to traffic narcotics.
• Conspiracy to commit money laundering and computer hacking.

Prosecutors presented evidence from his seized laptop, including logs, communications and Bitcoin transactions, linking him directly to Silk Road’s operations. His defense claimed he had relinquished control of the site and was scapegoated, but the jury remained unconvinced.

In 2015, Ulbricht was convicted on all charges and to double life imprisonment without parole — an exceptionally severe punishment for a non-violent, first-time offender. The court justified the harsh sentence based on:

• Scale of operations: Silk Road facilitated billions in illegal transactions, primarily for drugs.
• Symbolic deterrence: Prosecutors sought to discourage others from creating similar platforms.
• Uncharged allegations: Though not formally charged, murder-for-hire accusations based on chat logs influenced sentencing.

Legal experts argued the sentence was excessive, particularly compared to similar crimes. For instance, Sam Bankman-Fried, convicted of stealing billions of customer funds and perjury, received a 25-year sentence.

Ulbricht’s libertarian ideals resonated with those valuing personal freedom, privacy, and minimal government intervention. Many viewed him as a martyr rather than a criminal mastermind. The rallied libertarian support, emphasizing his non-violent nature, the disproportionate sentence, and alleged government overreach during the trial.

Ron Paul, former US congressman and prominent libertarian, publicly supported Ulbricht. In a letter to then-President Donald Trump, Paul argued that:

• Ulbricht’s life sentence was a miscarriage of justice.
• Allegations of misconduct by investigators — two federal agents were later convicted of stealing Bitcoin from Silk Road — cast doubt on the trial’s fairness.
• Mercy should be extended to non-violent offenders.

Paul’s plea reflected broader libertarian concerns about government overreach and the justice system targeting those challenging traditional power structures.

Trump pardons Ulbricht

On January 21, 2025, Trump granted Ulbricht a full and unconditional pardon. The decision was reportedly influenced by libertarian lobbying. In May 2024, Trump had clemency at the Libertarian National Convention, stating, “If you vote for me, on Day One, I will commute the sentence of Ross Ulbricht.”

Ulbricht’s release from the United States Penitentiary in Tucson, Arizona, ended over 11 years of incarceration. showed him, now 40, carrying a potted plant as he left prison.

A central question in Ulbricht’s case is why he could not claim immunity under Section 230 of the . Enacted in 1996, the law shields online platforms from liability for user-generated content and has been instrumental in the rise of tech giants like Facebook, Twitter, and YouTube.

However, Section 230 did not apply to Ulbricht because:

• Active participation: Section 230 protects neutral intermediaries. Ulbricht actively managed Silk Road, implemented policies facilitating drug sales, and profited from transactions.
• Criminal charges: Section 230 shields platforms from civil claims, not federal criminal liability. Ulbricht was convicted of crimes outside the law’s protection.
• Platform design: Silk Road was built to enable illegal transactions, unlike platforms like Facebook or eBay, which prohibit and moderate such activity.

A 2023 Radiolab , “26 Words That Changed the Internet – The Internet Dilemma,” examines Section 230 in more detail.

Opinions on this case remain divided. Some believe Ulbricht’s sentence was excessively harsh, intended to set an example. Others see law enforcement’s perspective — deterring future attempts at creating copycat exchanges. Notably, the US government developed onion routing, the anonymous connection technique indispensable to the Dark Web, in the 1990s. Silk Road was just one site among many, and its shutdown did not eliminate sophisticated illegal transactions.

Libertarians champion minimal government intervention, but concerned parents want authorities to prevent easy drug access. The pardon raises further questions. Will it embolden others to test legal boundaries? Could it demoralize law enforcement? At the same time, what message does it send about technological innovation? The 1990s encryption crackdown drove breakthroughs overseas, weakening US leadership in privacy and commerce.

Ulbricht was fortunate his case became a political tool for capturing votes. To libertarians, he remains a hero. To those who arranged his release, he was a means to an end.

His story serves as a cautionary tale at the intersection of technology, crime, and ideology — especially as AI and quantum computing present new inflection points.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Donald Trump Pardons Libertarian Idealist and Silk Road Founder Ross Ulbricht appeared first on 51�Թ�.

To understand just how strained relations have become, consider a recent Toronto Raptors game where Canadian spectators during the playing of the American national anthem. This behavior is highly unusual for Canadians, who are often stereotyped as overly polite. The boos reflected widespread frustration and resentment over how the US government is treating its northern neighbor. This sentiment underscores how deeply these tariffs and related policies affect economies and international relationships.

The mechanics of tariffs

A tariff is essentially a tax on imported goods. When the US government imposes a tariff, it makes foreign products more expensive for American importers. These importers often pass the increased costs onto consumers in the form of higher prices. For instance, a 25% tariff on Mexican and Canadian goods means that products like fruits, vegetables, and automobiles from these countries could see significant price hikes on US shelves.

Beyond the immediate effect on grocery bills, these tariffs could have a ripple effect throughout the economy. Higher costs for raw materials and components can lead to increased production costs for US manufacturers, which may then be passed on to consumers. Industries such as automotive and electronics, which rely heavily on parts from Mexico and Canada, could see production costs rise, leading to higher prices for consumers. Additionally, retaliatory tariffs from Mexico and Canada on US goods could American exporters, potentially leading to job losses in affected industries. 

The case of crude oil

One often overlooked consequence of tariffs on Canada and Mexico is their impact on crude oil imports. Canada is the supplier of crude oil to the US, followed by Mexico. Together, they far exceed crude oil imported from all OPEC countries combined. Imposing tariffs on this critical energy supply could significantly raise fuel costs for American consumers, affecting everything from transportation expenses to heating bills. This added cost would ripple through the economy, increasing the price of goods and services that rely on fuel for production and distribution.

Crude oil reaches US refineries through several transportation : pipelines, tankers, barges, and trucks. According to the US Energy Information Administration (EIA), pipelines are the dominant mode of transportation, especially for Canadian crude, due to an extensive cross-border pipeline . Most Canadian oil pipelines deliver crude directly to US refineries in the Midwest, highlighting Canadian crude’s critical role in sustaining these operations. Pipelines like the Enbridge Mainline and Keystone system transport medium-heavy sour crude, which is essential for producing diesel and other heavy products. Disrupting this flow with tariffs could severely impact refinery output in this region, leading to broader supply chain issues. 

Mexican crude, on the other hand, is primarily shipped via tankers to US Gulf Coast refineries. Tariffs on Canadian and Mexican crude could disrupt these efficient, cost-effective supply chains, forcing reliance on pricier alternatives and driving up fuel costs domestically. ()

Crude oil isn’t one-size-fits-all. It varies in sulfur content and density, as sweet or sour and light or heavy. Sweet crude has low sulfur and is easier to refine into products like gasoline, while sour crude has higher sulfur content, requiring more complex processing. Light crude flows easily and is best for fuels like gasoline and naphtha, whereas heavy crude is thicker and better suited for products like diesel and heating oil.

The US shale industry produces around 9 million barrels per day (Mb/d) of light sweet crude, which is ideal for gasoline, lighter fluid, and natural gas liquids (NGL). However, US refiners only use a portion of this output, leading to exports of approximately 4 Mb/d. Expanding shale production will only yield more light sweet crude, which cannot replace the medium-heavy sour crude imported from Canada. The US imports about 6–7 Mb/d of mostly medium-heavy sour crude, driven by the demand for diesel and heavier products. Of this, approximately 4 Mb/d comes from Canada. These imports are irreplaceable in the short term, as US production cannot meet the specific quality and volume requirements.

Only Saudi Arabia, Kuwait, and Iraq could potentially replace some of the Canadian crude, but the US has aimed for decades to reduce dependence on Middle Eastern oil.

The broader fallout of tariffs

The situation might even be more difficult for Canada, as the US accounts for a staggering 77% of all exports. Among hydrocarbons, America’s share is close to 90%. If Canada wanted to redirect crude oil towards other markets, new pipelines and export infrastructure must be built first. Canada might hence be forced to lower its prices to compensate for tariffs. This might cushion the blow for US consumers but devastate Canadian profit margins.

While one of the motivations for these tariffs is to address issues like drug trafficking, it’s worth noting that Canada has already pledged to act on fentanyl in 2024. The Canadian government plans to strengthen border security and enhance its immigration system to curb the illegal flow of substances. This initiative questions the necessity of punitive economic measures like tariffs when cooperative solutions are already in progress. The declaration of an ‘emergency’ was used to circumvent following normal procedure for the introduction of tariffs, which would have taken some time.

The cumulative effect of these tariffs could be substantial for American households. Estimates suggest that the typical US household could face additional costs exceeding $1,200 annually due to increased prices stemming from the tariffs. () This added financial burden could strain budgets further for families already grappling with inflation and stagnant real wages.

Concerns from the business community further underscore the risks of these tariffs. According to the January ISM Report on Business, correspondents expressed concern over rising prices and potential supply chain disruptions. Tariffs on key trade partners like Canada and Mexico could exacerbate input costs and slow supplier deliveries, hindering sustained growth and stability. ()

A German pharmaceutical CEO complained to me that the threat of tariffs absorbed management attention, as contingency plans had to be devised. 

My contact at a family-owned American importer of household goods from China admitted to having purchased one year’s worth of supplies in anticipation of tariffs. Sudden increases in orders lead to overtime work and strained capacities at supplies, only to see a sharp fall-off in orders once tariffs are enacted. 

Large swings in orders and capacity use lead to decreased margins and possibly to forced labor reductions. Companies are unlikely to hire additional staff during times of high uncertainty. The threat of tariffs might, therefore, cool the labor market.

America’s northern and southern neighbors won’t forget how they were treated. Burned once, companies might look for alternative markets to reduce dependence on the US market. Once regarded as a strong proponent of free trade, the US might not be considered a reliable trading partner going forward. Speaking loudly and carrying a big stick might end up being a shot in one’s own foot.

[ and edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Trump’s Canada and Mexico Tariffs Are a Magnificent Own Goal appeared first on 51�Թ�.

My mother had snagged a room at the Waldorf Astoria Hotel for $99 a night. What a steal! Who cared about the wallpaper peeling off, who cared about the unconventional bathroom door. It was the Waldorf!

The United States was just emerging from crushing back-to-back recessions (1980 and 1981–1982). The Waldorf apparently experienced low occupancy and used the opportunity to renovate its somewhat dated rooms. Ongoing renovations were a minor inconvenience, and the opulent lobby more than compensated for them. Hotel staff were busy constantly polishing brass handrails, vacuuming carpets and wiping handprints off the revolving door’s glass. A floral arrangement worth thousands of dollars towered over the main walkway.

While the room rate ($99 a night) was attractive in terms of dollars, it certainly wasn’t in terms of deutsche marks. At the time of my stay at the Waldorf, in the summer of 1984, one dollar purchased almost 3 marks. By February 1985, one dollar equaled 3.48 marks, 263 Japanese yen, 0.96 pounds sterling or 2.94 Swiss francs.

Reaganomics contributed to dollar strength

Persistent dollar strength was a consequence of Reaganomics, a portmanteau for economic policies enacted by US President Ronald Reagan (1981–1989). Reaganomics a reduction in government spending, lower corporate and individual income tax rates, fewer regulations, and lower inflation by controlling the growth in the money supply. 

Increasing revenues by lowering tax rates was justified by the idea of the , popularized by US economist Arthur Laffer in the 1970s. Laffer realized that governments cannot increase revenues indefinitely by increasing tax rates. He reasoned that a government that set its tax rate at 0% would collect no revenue, and that a government that set its tax rate at 100% would also collect no revenue (since it would allow no economic activity to occur). So, in between these two extremes, there must be one point at which maximum revenue is collected. Increasing tax rates beyond that maximum would lead to lower revenue. 

Proponents of Reaganomics thus inferred that, in theory, lowering tax rates could lead to higher revenues. But they missed the mark by a wide margin. Empirical in Europe suggest that maximum revenues were achieved at marginal income tax rates of 60% to 74%. The Reagan administration on the other hand, set marginal income tax rates at around 28%.

The US current account balance, which had hovered around for thirty years, deteriorated quickly. After reaching a deficit of $135 billion by the end of 1985, it continued to fall until 1987 ($57 billion). It took four more years until the current account balance broke even briefly (1991).

Inflation was . The end of the gold standard (the of 1971), large fiscal deficits to fund the war in Vietnam (1955–1975) and the oil price of 1979 led to a rapid decline in the purchasing power of the US dollar. Inflation reached 14.6% in 1980.

Paul Volker, chairman of the Federal Reserve (1979–1987), had to raise interest rates as as 19% to get inflation under control. These high rates attracted foreign capital, leading to an appreciation of the US dollar.

The strength of the US dollar featured in the December 1984 Federal Open Market Committee (FOMC) . Earlier dollar sales by the Bundesbank, the German central bank, were unsuccessful in stemming the rise of the dollar. According to the FOMC minutes, “Bundesbank intervened on September 21, [causing] the dollar to fall nearly 4 percent in a couple of hours. During the latest intermeeting period, the Bundesbank has sold dollars on a number of occasions, a total of $1.2 billion, but with much less market effect than in September and October. Also, total Bundesbank sales of dollars were more than compensated by purchases of dollars by other central banks.”

Frustrated Bundesbank tried to stem the tide 

Interestingly, the 1985 Bundesbank annual featured a segment titled “Countermeasures by central banks initially not without problems of coordination,” which was a nice way of saying, “They left us out to dry.” Noting “large and rapidly growing US deficits on trade and current accounts” it warned of “always latent protectionist tendencies in the United States.” For non-US countries, a “strengthening of the US dollar” caused “considerable increases in their import prices,” thus endangering progress made in the fight against inflation.

To this day, memories of the devastating period of (1921–1923) during the Weimar Republic influence German monetary policy, with price stability as the top priority. Since crude oil trades in US dollars, any increase in the price of the US dollar immediately translates into higher energy costs for European countries, with the risk of fanning inflation. Therefore, the rising dollar posed a problem for the Bundesbank in 1985.

The strong dollar meant a weak yen and deutsch mark, translating into cheaper Japanese electronics and German cars in dollar markets, leading to more sales and jobs. Conversely, a higher dollar meant declining sales for US exporters, declining jobs and increasing calls for protectionism.

US Treasury Secretary James Baker “the United States was facing a real [unintelligible] fire of protectionism. There was a lot of protectionist sentiment in Congress; legislation was being discussed if not introduced. It was our view that something had to be done about that.

German Finance Minister Gerhard Stoltenberg that “the United States could be negatively affected by an expanding trade deficit which created tensions also for the other countries. So, we wanted a surplus in trade, but not as big as we had when the dollar was more than three deutsch marks.” 

In mid-January 1985, a meeting of finance ministers and central bankers from the G5 (US, UK, Germany, France, Japan) warned they were determined to stop the rise of the dollar with “coordinated foreign exchange operations.”

A “small amount of currency to depreciate the dollar was agreed upon and subsequently took place … US intervention was small in [February and March], but the German authorities intervened heavily to sell dollars.”

Disagreement among central bankers

The Bundesbank increased its dollar sales from $0.5 billion in December 1984 to $1.3 billion in January 1985. However, these interventions failed to have a lasting effect. The bank blamed “doubts in respect to the scope of the agreements on intervention policy” — an obvious signal that the Federal Reserve was participating only with token amounts at best.

“Operations on the foreign exchange market can be expected to be successful only if the monetary authorities are willing to cooperate closely as regards the size of the amounts involved and the length of the periods over which intervention operations are conducted,” and “only if the US monetary authorities provide vigorous support.”

The Bundesbank was getting frustrated with the lack of support from the Federal Reserve. The Federal Reserve, on the other hand, was opposed to meddling with the price-finding mechanism of free markets.

The US Treasury had closed its foreign exchange desk prior to the arrival of James Baker as Treasury Secretary in February 1985. “This meant that the Treasury was not a participant in foreign exchange markets,” to him.

Between February 27 and March 1, 1985, the Bundesbank and “most of the central banks with which it cooperates” (hinting the Federal Reserve did not participate) “sold a total of $4.6 billion in spot and forward markets, with more than half ($2.7 billion) being accounted for by the Bundesbank.”

In the first quarter of 1985, G5 central banks sold $10.2 billion worth of dollars, with $3.9 billion coming from the Bundesbank. However, these interventions failed to break the dollar’s rise. To make matters worse, volatility in exchange rates increased significantly. The number of days with moves exceeding 1% rose from less than 30 in 1976 to 90 in 1985. Traders were kept on the edge as new rounds of interventions could hit without warning. Increased volatility led to higher cost of currency hedging for companies.

The Plaza Accord

In the first quarter of 1985, Europe, especially Germany, suffered one of its coldest winters on record. As �ұ�������Բ�’s construction activity came to a standstill in the freezing temperatures, slow economic growth was expected to spill into the second quarter, leading the deutsch mark to fall again versus the dollar. 

Continued strong growth in the US exacerbated growing imbalances. However, there was little appetite for intervention in currency markets among US policymakers. Traditional US manufacturing industries were being hit hard by the strong dollar, threatening to turn the American Midwest into a “rust belt.” In the US Congress, work had begun on a bill regarding comprehensive protectionist trade measures to shield US industry and save US jobs.

To avoid protectionist moves, US Treasury Secretary Baker devised a plan to break the dollar’s strength. Deputies from the G5 met repeatedly throughout the July, August and September of 1985 to work out the details. To ensure markets did not anticipate the move, the plan had to be kept secret; details were shared only with a very small number of officials.

On Sunday, September 22, 1985, the finance ministers and central bankers met at the New York Plaza hotel. The meeting coincided with the annual UN General Assembly, just prior to the annual meetings of the International Monetary Fund and the World Bank in Washington, DC. The meeting’s 18-point included a to-do list of items for each government. There were few references regarding exchange rates. The only hint at interventions came from a sentence stating that “recent shifts in fundamental economic conditions among their countries together with policy commitments for the future, have not been reflected fully in exchange markets.”

The following Monday was a holiday in Japan, leaving market participants unable to react to the news. After an immediate decline of 4%, the dollar around 40% over the following 17 months.

Unintended consequences

Currency trades happen in pairs. When one currency is bought, another one must be sold. The Bundesbank selling dollars meant it was buying deutsch marks, leading to upward price pressure of the mark vis-à-vis other European currencies. This threatened to upset trading bands agreed upon in the European in 1979. The Bundesbank had to “provide various partner central banks within the EMS [European Monetary System] with US dollars for intervention purposes in exchange for Deutschmarks after their currencies had come under pressure.”

The US had aimed to rebuild its economy through Reaganomics, but fiscal stimulus resulted in trade deficits that became structurally entrenched, along with a growing trend towards protectionism. As the competitiveness of US companies declined, criticism was directed at Germany and Japan, both of which had current account surpluses and much stronger manufacturing companies. Reagan’s tax cuts failed to tackle any core issues. Imbalances turned out to be more persistent and unlikely to be solved by simply adjusting exchange rates against the yen and the mark. Japanese and German companies were able to quickly adapt to living with strong currencies, partially due to the lower price-sensitivity of high-value-added products.

The Louvre Accord and the 1987 crash

By early 1987, the US dollar had fallen more than intended. One dollar bought only yen in early 1987, compared to 260 in 1985. While helping US export companies, the weak dollar spurred fears of inflation as the price of many imported goods rose.

On February 22, 1987, the finance ministers and central bankers of the G5, now plus Canada and Italy to make G7, met at the Louvre Museum in Paris. Italy refused to sign the Louvre Agreement, it “had been left out of the decision-making.” The US administration and the Federal Reserve Board indicated that they would not tolerate a further decline in the dollar and that they might join Japan in market interventions.

Inflation concerns in the US caused a rise in long-term interest rates, leading to “,” October 19, 1987, the single biggest daily percentage drop in US stock market history (22.6%).

Finally, by 1991, Europe’s surplus with the US had all but been eliminated and Japan’s large surplus had been cut by approximately two-thirds.

The Japanese bubble and crash

After World War II, Japan became the world’s second-largest economy, trailing only the US. It produced innovative, high-quality products at attractive prices. Sony, Nikon, Toyota, Canon, Mitsubishi and Honda became synonymous with excellence.

To slow down the rise of the yen, the Bank of Japan cut interest from 5% in 1985 to an unprecedented low of 2.5% in 1987, unleashing a wave of speculation in stocks and real estate. The Nikkei 225 stock market more than tripled from 12,500 points at the beginning of 1985 to 39,000 in December 1989 (coincidentally where it is, approximately, today). The term Zaitech was coined, describing the use of financial engineering to generate profits through speculation and non-operating financial activities. At one point, a square mile in Tokyo’s government district was worth than the entire state of California. 

A strong yen combined with lower interest rates spurred spending among Japanese consumers. Japanese companies bought foreign properties, like Rockefeller Center in New York and as golf courses across the US.

To combat rising inflation, the Bank of Japan interest rates from 2.5% in May 1989 to 6% in September 1990, causing a stock market crash. Over the following 13 years, the lost almost 80% of its value. It took 33 years to recover to levels seen in 1989.

Extended periods of deflation caused losses in the banking sector, leading to limited credit availability. Japan suffered from a prolonged period of economic stagnation. Even today, Japan’s is lower than in 1993.

Japan’s economy experienced no fewer than six recessions since the bubble burst. Each time, the Japanese government tried to simulate the economy with additional fiscal spending, leading to ever-increasing government debt. Today, Japan has the highest debt-to-GDP ratio of all industrialized nations, standing at .

The current situation 

The US current account deficit is much larger than in 1985, both in terms ($1.2 trillion) and to GDP (estimated around 4% in 2024). trade balance (around $90 billion surplus per month) is largely the opposite of the ($80 billion deficit per month). 

Among US trading , China has the largest annual trading surplus ($300–$420 billion), followed by Mexico ($100–$150 billion), Vietnam ($60–$125 billion), Germany ($70–$85 billion) and Canada ($33–$93 billion). For China, the US represents the trade partner with the largest trade surplus.

The size of the trade imbalance makes China an obvious target for US protectionist policies. As Japan had quickly grown to become the second-largest economy by 1985, threatening the US position as number one, so has China in recent years.

While the Plaza Accord was dubbed “the deal that broke the Japanese economy,” any future deal will likely target China.

However, China is not Europe and is not aligned with or obligated to the US in any way other than WTO rules. China also must take into account its exchange rates with other Asian currencies. Most likely, it would allow the yuan to rise only if other Asian currencies rose, too.

China might not be particularly interested in saving the current international monetary system based on the US dollar, as this unilaterally benefits the US as the issuer of the international reserve currency. It is therefore questionable if the People’s Bank of China would even be willing to participate in any interventions in foreign exchange markets.

Furthermore, private capital flows might be too large to be impressed by central bank interventions. to the Bank for International Settlements (BIS), daily trading in foreign exchange increased from $200 billion in 1985 to almost $7.5 trillion in 2022. The amounts necessary to credibly influence exchange rates today would be orders of magnitude larger than in 1985.

Central banks trying to fight a currency that is too strong face a much easier task than those trying to save a struggling currency. The former can simply issue more of its currency, while the latter will eventually run out of foreign currency reserves with which to purchase its own currency.

The Federal Reserve is, theoretically, not limited in how many dollars it can issue and subsequently sell in foreign exchange markets. However, this runs the risk of increasing the amount of money in circulation where it would fan inflation, potentially destabilizing the bond market.

The Swiss National Bank, for example, quickly grew its balance sheet to more than 100% of GDP trying to stem the strength of the Swiss franc versus the euro (2011–2015), an attempt that eventually failed.

Finally, the Chinese currency has a dual exchange rate; a domestic one (CNY), which is a tightly controlled managed float within certain bands, and an international one (CNH), with minimal capital controls and determined by market forces (as well as arbitrage with CNY). 

Since 1985, the world has changed a lot. The Waldorf Astoria was purchased by the Chinese Anbang Insurance Group in 2014. The Plaza Hotel has been owned since 2018 by Qatari firm Katara Hospitality. 

China is aware of what the Plaza Accord did to Japan and will be loath to agree to similar terms. The US, short of outright purchasing billions of yuan, cannot unilaterally force China to revalue its currency. A rerun of the Plaza Accord therefore seems unlikely. 

What are the options?

It remains to be seen if the US will follow through on its threats of substantially increased import tariffs, which, in the end, are borne by US consumers. Another round of price increases is probably the last thing Americans would like to see from the incoming president. Tariffs might hurt US consumers. What other options does the US have?

What about trying to renegotiate existing trade agreements? The US, under President Bill Clinton, awarded China the status of “Normal Permanent Trade Relations” (NPTR) in the year 2000, becoming effective with ��󾱲Բ�’s inclusion into the WTO in 2001. Before joining WTO, the US had to annually renew ��󾱲Բ�’s “Normal Trade Relations” status through the legislative process, which created uncertainty for importers and exporters. For the US, the inclusion of China in WTO was motivated by opening the Chinese markets for US export products as much as forcing China to abide by international trade rules. This provided the US with a mechanism to address trade disputes through WTO’s settlement system rather than unilateral action. This seemed important for US companies worried about copyright infringement and intellectual property rights, from garments (Nike) to software (Microsoft) and movies (Disney).

Reserve currency — a blessing in disguise

In the end, there is no escape from the blessings or the curse of being the issuer of the world’s reserve currency. Blessings, since the issuer can never run out of money to purchase products from other countries (as those products are priced, and paid, in the reserve currency). A curse, since, due to the , the issuer of the reserve currency has to run perennial trade deficits in order to supply the rest of the world with said currency.

Perennial external deficits require domestic sector deficits, as shown empirically by Polish economist . The sum of domestic sector balances must equal the external sector balance. Since US corporations enjoy historically high profits and households save moderate amounts, the government sector must bear the brunt of the negative balance.

Perennial deficits, of course, lead to increased indebtedness towards foreign investors. This can continue only as long as foreigners are willing to accept US dollars in exchange for sending their products abroad.

The only exception is the so-called Eurodollars, dollar deposits created by non-US entities outside of the US — a (digital-only) currency without its own central bank, and hence outside of the control of the Federal Reserve. The BIS that offshore US credit amounts to $15 trillion on-balance sheet and $41 trillion off-balance sheet, for a combined $56 trillion — more than three times the amount of all bank at US banks. 

Curiously, nothing stops entities outside the US from issuing dollars, including China. In November, China $2 billion in dollar-denominated debt via Saudi Arabia, paying little to no premium with respect to yields offered by the US Treasury. For China, this debt is in a currency it cannot print. Usually, there is a certain premium that a foreign-currency issuer must pay compared to issuing debt in its own currency. The fact that China didn’t pay this speaks volumes regarding its perceived creditworthiness. 

The US should pay attention to these developments or risk having its status as the world’s safest government bonds being undermined by a non-US country. The significance of losing said status might be higher than any tit-for-tat trading wars. The US risks not seeing the forest for the trees.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post In Trade Rivalry With the US, China Will Not Become Another Japan appeared first on 51�Թ�.

The budget battle that broke the camel’s back

Scholz is scrambling to save face amid approval ratings that have plunged to an unprecedented low of 14%. The SPD’s own approval ratings are similarly abysmal.

Polls of voting intentions show the party now tied with the far-right Alternative for Germany (AfD) at around 16% — a dramatic drop from the SDP’s 26% support in the last election. The FDP faces even bleaker prospects, polling around 3–4%, just below the 5% threshold needed to enter parliament.

While tensions within the coalition were no secret, the breaking point came when a proposal by Lindner leaked. The 18-page “Turnaround Germany – A Concept for Growth and Generational Justice” suggested cutting financial aid to low-income families and refugees, which panicked the SPD and Greens.

The election of Donald Trump as the next US president has raised fears the US will soon cut its support for Ukraine, forcing Germany to pick up the tab or risk the defeat of Ukrainian forces. Lindner claims he was pressured to agree to another suspension of the debt brake. He refused, afraid of embarrassment by the constitutional court. Scholz floated the possibility of new elections, which Lindner leaked to Bild while parties were still deliberating. This was the final straw for Scholz, who asked for Lindner’s dismissal. 

The economic headwinds Germany has been facing only add to the drama. Budgets crafted on the assumption of GDP growth that never materialized have left government departments strapped. Austerity measures have strained even the nation’s soft power as cultural icons like the Goethe Institute have been forced to close German schools abroad.

Related Reading

Is the German Economy Now Destined to Decline?

The crux of the budgetary deadlock is �ұ�������Բ�’s “debt brake,” a constitutional limit capping new debt for structural deficits at 0.35% of GDP. While this debt brake was suspended temporarily during the pandemic and the Ukraine invasion, it has since snapped back into force, severely restricting the government’s freedom of action.

Who stands to gain?

With elections likely in early spring, �ұ�������Բ�’s political map could shift drastically. The center-right Christian Democrats (CDU/CSU), currently polling at 33%, are poised to regain power, though their numbers fall short of a parliamentary majority. A coalition with the Greens remains unlikely due to ideological divides, and the SPD’s recent failure makes it a dubious ally. That leaves the CDU/CSU with only a handful of feasible partners — including an intriguing, if controversial, one in the newly-formed Bündnis Sahra Wagenknecht (BSW).

BSW, led by former leftist Sahra Wagenknecht, has captivated voters disillusioned with mainstream parties but unwilling to embrace the far-right AfD. Known for her anti-immigration stance and advocacy for a negotiated settlement with Russia, Wagenknecht is a questionable candidate to offer the CDU/CSU a politically stable alliance. 

It should be noted that AfD came out as the party with the most votes during recent state elections in Thuringia (34.3%, slightly ahead of CDU 33.5%). It missed to reach that goal in Saxony, but only by a hair (34.0% compared to 34.4% for CDU).

Voter discontent in Germany, especially in the former East German states, has led to a surge in support for right-wing AfD. Due to �ұ�������Բ�’s history, politicians are very aware of the danger of fascism, but they seem rather helpless in addressing the root causes (increased unemployment in rural areas, social anxiety, xenophobia, feelings of being second-class citizens).

Financial and global implications

The collapse of the German government sends shivers through markets already sensitive to geopolitical risk. Shares of �ұ�������Բ�’s iconic automakers — BMW, Mercedes-Benz, Porsche and Volkswagen — have fallen sharply, anticipating the return of Trump-era import tariffs on European goods. With �ұ�������Բ�’s political attention diverted inward, “budget sinners” like Italy, France and Spain may find relief, as former members of the hard-currency block, such as Germany, have historically pressured them to meet strict fiscal criteria under the Maastricht Treaty.

So far, little or no spread widening between German and other Euro-area government debt has been observed in reaction to the earthquake in Berlin. While the German 10-year government bond yield stands at 2.4%, France and Spain pay a clear premium at 3.2%, followed by Greece at 3.3% and Italy at 3.7%. Still, Italy (135% debt-to-GDP ratio) and Greece (162%) pay lower interest rates than the UK (98%) and the US (123%). Those yields only make sense if the political will to keep the Euro area together would galvanize politicians into further bailouts of countries should the need arise.

If no stable coalition emerges, Germany faces the prospect of another election, potentially plunging Europe’s largest economy into a period of prolonged instability. A caretaker government may limp along in the interim, but effective governance and ambitious legislative agendas will be on hold.

Internationally, the political crisis could have wide-reaching effects. As Germany becomes preoccupied with its own domestic woes, European allies such as Italy and France may gain breathing room in their own budgetary struggles, potentially facing less scrutiny from Berlin on debt under the Maastricht Treaty. However, any withdrawal from a Trump-led US could leave Europe drifting in the high seas without clear leadership, missing out on a potentially generational opportunity to determine the geopolitical direction of a future Europe unshackled from US dominance.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post The Collapse of �ұ�������Բ�’s Government: An Earthquake With Global Aftershocks appeared first on 51�Թ�.

The VIX index, a measure of volatility, , its third-highest reading in history. Only in 2008, after the demise of Lehman Brothers, and in 2020, during the onslaught of COVID-19, did the index top that number.

A reading of 65 on the VIX is very high. To justify such a high volatility, stock prices would have to move by at least 4% (in either direction) on at least 13 trading days over the following 20 trading days. This would indicate a major economic calamity of global importance, which, to our best knowledge, has not occurred.

What happened?

On Wednesday, July 31, the Bank of Japan interest rates to 0.25%, sparking a rally in the yen that caught hedge funds off guard.

The same day, the US central bank at a possible interest rate cut in September. Two days later followed a worse-than-expected US job market . The unemployment rate reached a 3-year high.

As predicted by futures markets, the probability of a 0.5%-point cut in interest rates by September briefly reached 100%, with some contracts even implying a reduction by 0.75 percentage points. Jeremey Siegel, who lectures on finance at the Wharton School at the University of Pennsylvania, for an immediate 0.75%-point via cut emergency meeting followed by another 0.75%-point cut in September.

Within a few days, the Japanese currency reversed its weakness and compared to the US dollar, causing large losses to the so-called yen carry trade.

A carry trade involves borrowing funds in a low-yielding currency, like the yen, and investing the proceeds in a higher-yielding currency, like the US dollar. Since the summer of 2023, a large difference in interest rates between the US (5.3%) and Japan (-0.1%) attracted plenty of money.

The exact size of the yen carry trade is unknown. Cross-border yen loans as of March. Speculative positioning in yen futures at the CME futures exchange in Chicago contracts at the beginning of July. With each contract being worth ¥12.5 million, a total of ¥2.25 trillion ($15 billion) was thus at stake.

The prospect of rising Japanese interest rates combined with falling US interest rates meant the yen carry trade became less attractive. Higher volatility in the yen/dollar exchange rate led quantitative and trend-following investors to reduce their positions.

Why did the Bank of Japan raise rates?

Around of the Japanese population is aged 65 and older, making Japan the country with the highest share of elderly people globally.

Elderly people are retired and live off their savings or fixed pension payments. Their income usually does not adjust to inflation. Elderly people are hurt by inflation.

Japan had built up a network of 54 nuclear reactors. The Fukushima incident in 2011 led to the shutdown of all 54 reactors, of which only 10 are back in operation today. This has left a wide gap in energy production, leading Japan to import large amounts of fossil fuels, which make up roughly a of Japanese imports.

Fossil fuels are quoted in US dollars. A decline of the Japanese yen thus makes imports more expensive, leading to higher inflation. The further the yen/dollar exchange rate declined, the lower the approval rating of the current government fell.

Throughout May, the Japanese Ministry of Finance in foreign exchange markets with more than $62 billion, which did not help to stop the yen’s slide. Hence the surprise interest rate hike in late July.

After having achieved its goal of stabilizing the yen, the Bank of Japan quickly reverted to damage control by stating it would not raise rates during times of market instability.

What does this mean for investors?

Stock markets quickly recovered from Monday’s shock — the Nikkei Index 10% and the S&P 500 around 1%. Volatility receded; while current reading (about ) is still elevated, it is a far cry from Monday’s panic-driven levels.

Monday’s sell-off can be explained by technical factors. But what about fundamentals? The market value of all US equities amounted to as of December 2023, or nearly twice the US . In the past, this has been considered an “expensive” ratio.

Market breadth, or the number of shares participating in a trend, has narrowed down to a few mega-cap stocks. The weight of the ten largest US companies makes up around of the S&P 500, a proportion that has been growing for at least 50 years. The weight of the largest stock compared to the stock in the 75 percentile even levels seen in 1929.

Microsoft trades at operating cash flow while NVIDIA is valued at . Few market observers dispute that US stock valuations are exceptionally high, and therefore vulnerable to setbacks.

But what about the economy?

Market turmoil, if sustained, can feed into the “real” economy. Initial public offerings might get postponed due to a lack of risk appetite. Financial costs for corporations might increase as the risk premium over (presumably risk-free) US Treasury bond yields widens. Leveraged takeovers might fail due to lack of financing.

A recent survey of purchasing managers in the manufacturing sector (ISM) showed many companies reporting a noticeable slowdown in business. On the other hand, the (much more important) service sector painted a more benign picture.

Undoubtedly, employment growth is slowing down, while the rate of unemployment has begun to increase slightly. Consumer confidence is between mediocre and abhorrent. Adjusted for inflation, retail sales in 15 out of the past 20 months. While personal disposable incomes are still by a low single-digit percentage, little is left after accounting for inflation.

Even the current large fiscal deficit of of GDP fails to stimulate the economy; the government sector deficit instead translates into a surplus for the foreign sector (a mirror image of the US trade deficit).

Investors hoping that falling interest rates benefit stocks might be disappointed. Financial markets have anticipated those cuts for years, as evidenced by the negative slope in the .

Now would be a good time to go through portfolios and ask questions. “Would I buy this entire company at this price?” (the question of valuation) and “Would I be comfortable holding this company if the stock market closed for 10 years?” (question of quality).

Yes, in the long run, stocks go up, thanks to the inflationary bias of our fiat system. In the short- and medium-term, the stock market doesn’t owe you anything.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Japanese Rate Hikes Cause Colossal Losses in World Markets appeared first on 51�Թ�.

Mutual funds in the US a century ago. This financial instrument in 1924 was popular with our parents’ generation. Their advantages include diversification, professional management, affordability, daily liquidity, variety of choices by region, sector, company size or investment style and automatic reinvestment of dividends and capital gains.

However, most mutual funds come with considerable up-front sales charges as well as annual fees, eating into returns over longer periods. Making matters worse, up to 96% of all active US equity funds underperformed their benchmark over a 15-year period, as described in this earlier article. They underperform the market.

The emergence of ETFs

A relatively new type of fund has been cannibalizing mutual funds in recent years. Known as exchange-traded funds (), the first such fund was launched in Canada in 1990. In 1993, the first ETF was launched in the US. ETFs took time to catch on before growing rapidly in popularity. They seek to an index, which is typically weighted as per market capitalization, in order to capture the risk and return of a given market. ETFs comprised only 1% of total fund trading in 2000. The crash of the dotcom bubble in 2001 boosted the popularity of ETFs, and a graph on the popular site Investopedia reveals that they have really taken off since 2010. 

Since most mutual funds underperform the market and ETFs are largely so-called passive investment vehicles that replicate the market, why would someone pay higher fees for an inferior performance?

Before we carry on, it is important to understand what active and passive investment means. “Active” describes the process of actively selecting a few stocks, hoping their performance would beat a broad index, like the S&P 500. “Passive”, on the contrary, involves simply replicating the performance of said index. Once funds are invested according to the weights prescribed by the index, the manager can fold his hands and remain passive. 

Why do ETFs perform better and what are the risks?

Why are an increasing number of investors switching to so-called passive investment vehicles? Since there is no need to do any security research, passive ETFs can do without hiring expensive analysts. This allows them to charge much smaller fees and outperform the mutual funds.

The State Street Global Advisors SPDR S&P 500 ETF Trust (symbol “SPY”), with more than $500 billion in assets, charges annual of less than a tenth of one per cent, ie <0.1%. By contrast, Capital Group’s “,” the largest active US equity mutual fund, carries an expense ratio of 0.63% — more than 6 times as much as “SPY.” In addition, investors in the active fund need to digest a front-load of up to 5.75%.

Unsurprisingly, passive ETF have been cannibalizing active mutual funds over the past years. Conversely, since 2017, US equity mutual funds had only one month of net inflows, and 87 months of outflows.

According to fund analytics firm , active US equity funds saw outflows of $290 billion over the past 12 months, while their passive counterparts enjoyed inflows of $320 billion. Passively managed equity vehicles now make up more than 60% of the total funds invested in markets.

As the share of passively managed investment grows, so does their ownership of individual stocks. In some companies, passive investors are already in the majority. Take Central Garden and Pet (symbol “CENT”), for example, where 60% of shares are owned by passive vehicles. Those funds are not interested in the fundamentals of the company such as sales, earnings or dividends. The company might announce terrible results, and passive investors would not sell a single share. It could, theoretically, be approaching bankruptcy, and, as long as the company remains in the index the fund tracks, the fund would not sell. 

Passive investment vehicles are insensitive to price. They are always fully invested. If fresh money comes in, the funds buy no matter what. Regular contributions to retirement accounts (“401k”) lead to a continuous stream of money driving index members share prices regardless of fundamentals.

As more investors become price insensitive, you expect to see more “crazy” price movements, leaving rational investors scratching their head. A rally induced by the recent index inclusion of Super Micro Computer (symbol SMCI) serves as an example. The company’s stock price rose from $284 at the end of 2023 to $1,229 on March 8, 2024, shortly before its inclusion into the S&P 500 Index on March 18. It has since lost around 37% of its value.

Erratic price movements could lead to the impression fundamentals did not matter anymore. Inexperienced investors might be tempted to bet on so-called “momentum” stocks, or worse, options, with quickly eroding time value.

Of course, indiscriminate inflows could reverse. An aging population of investors might want to cash out of stocks, realizing their capital gains. Persistent outflows would lead to selling, with the sellers, again, being insensitive to price. 

So, are ETFs a cure, or rather a curse in disguise?

Low-fee, passive index ETF are the most efficient investment vehicle available to individual investors. For each individual the decision to move into passive ETF is, undoubtedly, rational. However, individual rational behavior doesn’t guarantee a rational outcome in aggregate. For investors as a group, the outcome might be detrimental.

[51�Թ�’s interns, working as a team, edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Are ETFs Now Cannibalizing Mutual Funds, and Is That Good? appeared first on 51�Թ�.

On March 13, the US House of Representatives passed the “Protecting Americans from Foreign Adversary Controlled Applications ,” which would ban TikTok completely unless it separates from ByteDance. The Senate passed the bill April 23, and US President Joe Biden signed it into law next day. The act gives ByteDance 270 days to act before the ban goes into effect.

This article reveals possible commercial considerations behind the attempt to ban TikTok.

Since its launch, TikTok has become one of the world’s  social media platforms. Its proprietary recommendation algorithms are better than those of alternative apps at connecting content creators with new audiences. Many of TikTok’s users are young, making it more attractive for advertisers than social media with aging userbases, like Facebook.

TikTok cuts into Alphabet and Meta’s bottom line

TikTok’s advertising revenue has seen explosive growth. In the final quarter of 2023, advertising spending on the platform reached , a growth of 43% compared to the first quarter. 

In 2024, TikTok’s ad revenue is expected to triple to Its video ad revenue could exceed the combined revenue for Meta (formerly Facebook) and YouTube combined by the year . TikTok’s unique approach to integrating advertisements seamlessly into the user experience contrasts sharply with the more intrusive advertising models of traditional social media platforms.

While Alphabet (which owns Google and Youtube) and Meta have long held a duopoly in online advertising, their market share has recently begun to decline. In 2022, for the first time since 2014, their combined market share dipped below 50%, and it was to have fallen further to 44.9% by the end of 2023​. This decline is partly due to the innovative strategies of new entrants like TikTok and partly due to external pressures such as privacy changes led by Apple, which have particularly Meta’s ad targeting capabilities.

Meta’s business model depends on ad revenue. In the past year, ad revenue made up 97.5% of sales. In the past, Meta was able to rely on its monthly active users as a moat against competition — roughly one third of the world’s population. Because online businesses are uninhibited by material or geographical boundaries, they can be scaled up indefinitely. Facebook’s meteoric growth in the mid-2008s, crushing its competitor MySpace, proved how this leads to a “winner-takes-all” system, where the dominant site can eliminate any competition. 

However, the moat is not invincible; users might get tired of curating a constant stream of pictures of their pets, kids and food plates.

TikTok captures younger audiences

A significant factor in TikTok’s success is its popularity among millennials and Generation Z. Advertisers highly value these younger users, because they are more likely to spend on consumer goods like clothes, electronics and games and are less likely to have established brand loyalties. Further, they have the most influence over current trends.

Younger users are impatient with ads and likely to scroll away when they realize they are being sold to. However, TikTok employs content-driven advertising that is often indistinguishable from regular user content. This disrupts the user experience to a far lesser degree, offering a level of engagement that traditional platforms are struggling to match.

The advertising industry is seeing a broader shift in spending away from traditional giants towards platforms that offer more engaging and innovative ad experiences. TikTok, with its compelling blend of entertainment and commerce, has a preferred platform for many brands looking to tap into a younger demographic​. Furthermore, changes in user privacy preferences and the increasing ineffectiveness of conventional ad strategies on platforms like Meta and Instagram have accelerated this shift​.

Threat to US social media landscape

TikTok’s rise in the advertising market is indicative of broader changes in consumer behavior and the digital landscape. As users gravitate towards platforms that offer more authentic and integrated advertising experiences, traditional advertising giants are being forced to rethink their strategies to remain relevant. The future of digital advertising is likely to be dominated by platforms that not only understand the importance of user experience but also continuously innovate to keep pace with changing consumer preferences.

Yet, as users abandon older sites in favor of a disruptive upstart like TikTok, tech giants need to buy more time. It is easy to understand why they would want to eliminate a troublesome adversary.

TikTok’s strategic approach to advertising, combined with its deep understanding of its user base, poses a significant threat to the established order. The ban on TikTok should therefore be seen through the lens of squishing competition rather than concern for its users.

Cui bono?

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post The TikTok Ban: Unpacking the Battle for Advertising Dollars appeared first on 51�Թ�.

Sometimes, we create mind models that, in hindsight, turn out to be completely wrong, even though they made a lot of sense at the time. The geocentric world model, for example. People looked at the sun, saw it rising in the east and setting in the west, and concluded that it must be revolving around the Earth. Later, it dawned upon humanity we got it all wrong. A new narrative emerged — the heliocentric world model. Turns out we are not the center of the universe.

Even though it is a physical thing, you cannot see the center of the solar system in the way that you can see a dog or a bowl of oranges. That is why we must model it, and why a model may sometimes go wrong. We need to marshall the evidence to make sure that our model squares with the best information we have available.

Like the center of the solar system, money and Bitcoin are physical phenomena. They describe the way that physical banks or physical computer systems actually work. Yet, they are not visible, and hence they are hard to understand without a model. I propose a mind model involving the Dutch painter Vincent van Gogh that might help.

Mind model of money

Money, being among the most important things for many, is also one of the least understood. How can mere pieces of paper, backed by nothing, be of such value? You could, for example, purchase a Boeing 747 with pieces of paper.

Things get weirder when you consider that paper money accounts for only a small fraction of the overall amount of money outstanding, estimated to be less than 1%. Most of our money exists in digital form. Bank deposits are the digital liabilities of private banks; they exceed the amount of currency (bills and coins) by a factor of 6. It would therefore be impossible to pay out all deposits in cash.

However, the model of money that we have often consists of handing over our hard-earned cash to a bank where it “works” for us, “earning” interest. Nothing could be further from the truth. Any cash held in the bank’s vault is just dead paper, doing exactly nothing. 

Most of what we think of as “our money” entered the bank in digital form as a wire transfer. And most wire transfers between private banking institutions are settled by moving reserves between various accounts within the same bank, the Federal Reserve System. Before the transaction, the Fed owed money to bank “A”; now, it owes money to bank “B.” Money never left the Federal Reserve; the only thing that changed was an update within its balance sheet, or ledger.

This ledger is not much different from the of Yap Island — large, heavy limestones that served as a marker of who owned what amount of an agreed value. These stones did not move, but everyone remembered who they belonged to at a given time.

Our brain will meet new mind models with initial resistance, especially if they threaten long-held beliefs. “I was wrong all that time” is a hard thing to admit.

Bitcoin as a mind model of money

If is already difficult to understand, Bitcoin might be even harder. Or perhaps not! There is only a of Bitcoin ever to be mined. No such limit exists in fiat money, which can seemingly be created out of thin air. 

The narrative concludes that Bitcoin must be valuable since it is scarce. It must be a great store of value, and hence it must be a better form of money. Central banks cannot print Bitcoin! The government cannot devalue Bitcoin! Good money drives out bad money, and we will — eventually — transition to Bitcoin. Get educated, get on the train, or have fun staying poor!

Narratives rely on beliefs, and it should come as no surprise that followers of a certain narrative will often congregate in groups or churches. The brain finds comfort in having its narratives confirmed. We like to be surrounded by like-minded individuals. These days, passionate and often strident groups supporting Bitcoin and other cryptocurrencies have seemingly cropped up everywhere online, from to and the infamous . They preach a gospel in which a few hundred dollars today will turn into millions, as long as you have faith and hold on to your coins.

A Bitcoin fan, or promoter (it’s hard to tell the difference) recently :��

“If you want to be a millionaire – you can get one million Satoshis [100 million Satoshis equal 1 Bitcoin] for less than $700 at the moment. Most people will never own one whole Bitcoin in their life. Not just because it’s becoming increasingly more expensive to accumulate one. But also because there simply aren’t enough bitcoin for everyone on the planet, since only 21 million bitcoin will ever exist. There are more than enough Satoshis for everyone, though.”

Here is where Van Gogh comes in. His epic painting Starry Night is estimated to be worth about . Imagine the artwork was represented by 100 million tokens, offering fractional ownership. One Van Gogh token, let’s call it a VanGoghi, would be worth around 1 dollar. Now, everybody can afford a fraction of Starry Night.

(The example of VanGoghi is purely hypothetical, of course. But fractional ownership of art is a . And, of course, there are of improper sales tactics. But that is not our main concern.)

Imagine someone floated the idea that VanGoghis were a new, better form of money. Supply is limited, and value should increase over time. VanGoghis would trade on electronic exchanges, and the Securities Exchange Commission might even approve some exchange traded funds investing in VanGoghis. 

Would you go to a supermarket and purchase an apple for one VanGoghi? If the price was as volatile as Bitcoin, a VanGoghi could be worth as much as one dollar today, but five dollars a couple of months later. Or it might lose 87% of its value within a few hours, as seen in Bitcoin. The supermarket had to frequently adjust prices. The friction of buying and selling anything would increase tremendously.

Despite being (potentially) a good store of value, using VanGoghis as a means of exchange would be a terrible idea. The same applies to its use as a unit of account — imagine a corporation trying to do its accounting in VanGoghis.

Here’s why fiat money is good money

Fiat money is not a great store of value. Over long periods of time, it is terrible. Since the inception of the Federal Reserve System in 1913, the US dollar has around 97% of its purchasing power. Many other currencies have fared even worse. 

But is this really a problem? Who uses cash as a long-term store of value? There are many options (bonds, stocks, real estate, gold to name a few) that compensate or protect from loss of purchasing power.

Fiat money has its flaws, but it has arguably allowed the creation of unprecedented wealth by enabling frictionless commerce. Yes, there is income and wealth inequality. But is that a function of our monetary system or could it be remedied with appropriate tax policy? Fewer than of Bitcoin addresses control more than 90% of Bitcoin — not exactly screaming “democratization of money.”

A medium can either be a great store of value or a great means of exchange, but not both. That’s why we use fiat money for everyday business, but other options for long-term wealth preservation. A combination of the best of both worlds.

The narrative of Bitcoin, or VanGoghis, initially sounds appealing. Much less so once you lift the veil.

A common narrative of fiat money consists of the view that central banks create inflation by printing too much money. In reality, however, the private sector is responsible for approximately 95% of money creation. 

In fact, money and debt are inevitably linked to each other; you cannot create money without simultaneously creating the same amount of debt. Admittedly, there is a lot of debt, meaning there is a lot of money, too. The narrative “there is too much debt” also implies “there is too much money.” Few people complain about “too much money.”

This is not to say elevated debt levels are not without problems. Money and debt are often in the hands of separate entities or people, resulting in income and wealth inequality, as well as insurmountable debt burdens for some. However, rather than laying blame at the doorstep of our monetary system, income and wealth distribution could be ameliorated by appropriate tax policies.

Fiat money is an accounting mechanism to record who owes whom. Bitcoin is nothing more than a protocol, solving the problem of users spending the same money in absence of a trusted central counterparty. However, fiat money is government-sanctioned (legal tender), while cryptocurrency is not. 

Don’t expect governments to give up control over the definition of money without a fight. The narrative of Bitcoin being out of the reach of law enforcement is questionable. Recently, two executives from Binance, the world’s largest cryptocurrency exchange, were in Nigeria. The Nigerian government is demanding Binance reveal the top 100 users of Bitcoin in the country, including transaction history. Nigeria accuses Binance of undermining government efforts to stabilize its currency, the naira.

Bitcoin “mixers” like Tornado cash, used to obfuscate the origin of coins, have been banned by the US Treasury. At best, you could be holding “tainted” Bitcoin. Your wallet might then trigger compliance alerts at exchanges once you try to “off-ramp” your coins back into fiat. At worst, your account will be blocked, and your coins frozen.

It is true that, so far, nobody has managed to hack the Bitcoin blockchain. Exchanges, however, have been hacked repeatedly, or even run by malicious actors who suddenly “rug pull” their users.

The dream of “hard” money, miraculously solving all problems of society, is appealing. However, it is just a narrative that you should think about twice before adopting it.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post How Van Gogh Can Unravel Bitcoin’s Simple Narrative appeared first on 51�Թ�.

Let’s take a look at the CBDC critic’s arguments.

“The government wants to control what I spend.”

This claim seems to stem from the potential programmability of CBDC. There are some very limited use cases where this could be possible. In some of these, frankly, it would even be desirable.

Take, for example, the US food stamps program, or SNAP (Supplemental Nutrition Assistance Program). In 2023, about Americans received financial aid for the purchase of select food items at a cost of $120 billon. To avoid the stigma associated with actual “stamps,” the program often comes in the form of a pre-loaded debit card, or Electronic Benefits Transfer (ETB). Alcohol and tobacco products cannot be purchased with ETC. Imagine the public outcry if US taxpayers were to finance alcohol and tobacco addictions!

Today, governments already control spending; I was unable to buy a t-shirt from the Wikileaks store with my US credit card. In 2022, a Canadian judge to donations for striking truckers. Yet, no CBDC was necessary to enable government control.

One could ask why the government would wait for CBDC to control our spending when it is perfectly able to do so already now.

“The government can make my money go away with a click.”

It might not be a bad thing to be able to create money with an expiration date.

US during COVID were meant to cushion a drop in economic activity. However, rather than spending the additional income, many recipients chose to increase their savings instead. The personal savings ratio jumped from 7 to — the highest level since at least 1960. Consumers reduced their credit card balances by .

A reduction in debt does not help boost consumption. It would therefore make sense to require any stimulus checks to be spent within a certain time frame to increase the efficacy of such programs. A programmable CBDC would help achieve this aim. Those “free” CBDC dollars would come with an expiration, just like many gift cards, airline miles or even public transportation tickets. To suggest that this is driven by nefarious intentions is missing the point.

Additionally, stimulus payments could be limited to those with a high propensity to spend — lower-income households. The reduced stimulus payments for those with incomes above a certain threshold. A CBDC could make administration of such limitations less cumbersome.

One area of real concern, however, is the potential for negative interest rates. To combat the threat of deflation, the European Central Bank (ECB) lowered its deposit rate into from 2014 until 2022. Some commercial banks began charging large deposits negative interest. However, this applied only to bank deposits. Negative interest rates cannot be applied to physical cash. With CBDC, central banks could impose negative interest on currency, too. (From the viewpoint of a central bank, the ability to pass on negative interest rates is an advantage.) It should be pointed out, however, that prolonged deflation is a rare occurrence. This is especially true for fiat monetary systems, which have an inflationary bias by design.

“CBDC is not real money.”

According to the , “US coins and currency (including Federal reserve notes … ) are legal tender for all debts, public charges, taxes, and dues.”

Critics claim that CBDC cannot be legal tender since it is not mentioned in US code. According to this logic, even bank deposits are not “real money,” and wiring monthly payments would not repudiate your obligation towards the mortgage company (unless the company agrees to accept such payments). But why would anyone insist on payment in legal tender only? What would be the purpose? How cumbersome would it be to deliver coins and banknotes, in person or via courier, and then to prove that delivery has successfully occurred?

The relevant section of the US Code was established in 1965. Lawmakers could not have anticipated improvements in payment systems in the following 50 years.

Besides, even if the current statute did exclude CBDC, it would take a simple act of Congress to change it.

As of early 2024, however, there are several noteworthy efforts in the Congress and state legislatures aimed at limiting or preventing the introduction of CBDC. These efforts primarily focus on restricting the Federal Reserve’s ability to develop or issue one.

Republican Senator Ted Cruz, member of the Senate Committee on Commerce, Science, and Transportation, one such bill. This legislation seeks to prohibit the Federal Reserve from developing a direct-to-consumer CBDC, which could, allegedly, be used as a financial surveillance tool by the federal government.

Similarly, Senator Mike Lee, also a Republican, reintroduced aimed at preventing the Federal Reserve from reshaping the US financial sector with the implementation of a CBDC.

In Texas, a Senate Concurrent expressed opposition to CBDC. In Florida, Governor Ron DeSantis signed a prohibiting the use of CBDC in the state, claiming, amusingly, that CBDC would “.”

Similar legislative efforts are underway in states like Louisiana, Alabama and North Dakota. These bills largely focus on concerns about privacy and government surveillance, as well as the potential for increased control over financial transactions and individual freedoms. The topic of CBDC has become increasingly partisan, with most of the opposition coming from Republican lawmakers. However, no bills other than Florida’s have advanced as significantly in the legislative process.

Advantages of CBDC

CBDC has various advantages over the use of cash, as , a former senior financial expert for the International Monetary Fund (IMF), describes. Cash needs to be printed at significant cost due to security requirements. It also requires regular distribution to bank branches and ATMs. Consumers must obtain cash, often paying a withdrawal fee. Cash must be carried in sufficient quantity for payment at points of sale. Businesses need to be equipped with registers, constantly having to restock change while depositing larger bills into vaults. Commercial banks need to sort out damaged banknotes and send them back to the central bank for destruction. At all those stages, physical money needs to be counted.

In many countries, banking customers face significant monthly service fees. Meanwhile, CBDC could be held in a digital wallet, provided by an app for mobile phones, and provided free-of-charge.

CBDC is more than just more efficient. As time goes on, it will become indispensable.

What if you were told that you would never be able to withdraw the money in your bank account? In aggregate, this is true. US deposits at all commercial banks amount to around . There are around in currency in circulation, of which an estimated 70% is , leaving less than $700 billion for domestic purposes. The amount of deposits exceeds the amount of “cash” by a factor of 25.

Related Reading

Money Matters: Revealing Who Is Holding Billions of US Banknotes

Intuitively, we understand the bank does not have all our money in “cash” in its vault. We rely on the assumption not every customer would want to withdraw all the money at once. And that we could, up to certain daily limits, withdraw cash at our pleasure.

You, as a customer, have become an unsecured creditor of a private institution. In other words, from the bank’s perspective, customer deposits are liabilities. When you make a withdrawal, you exchange that unsecured claim against a private institution into a claim against the central bank. Private institutions can go bankrupt; the central bank cannot.

This option of a 1-for-1 exchange into public money is what keeps our entire private monetary system functioning. More than in global monetary claims outstanding are supported by less than in major central bank assets. Thus, 90% of money outstanding is of private origin, consisting in deposits credited by commercial banks to customers, rather than public money like cash or central bank deposits.

Since individual citizens cannot open accounts at the central bank, withdrawing cash is currently their only way to access public money. As the use of cash continues to decline, citizens lose that access. People in a cashless society would not be able to convert any private money into public money. Your bank deposits will remain in the private banking system forever. The “peg” with risk-free public money is gone.

This is an important reason why central banks need to issue digital versions of public money. Money should be a public good. CBDC is necessary to keep it that way.

[Alex Gloy is a member of .]

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post The Truth About Central Bank Digital Currency: It’s Indispensable appeared first on 51�Թ�.

How Treasury rates affect other rates

Since US public debt is widely regarded as a “risk-free” asset, it is taken as a baseline for pricing other, riskier debt investments.

Pricing of newly issued corporate bonds is usually expressed as a premium to US Treasuries. For example, if you are a BBB-rated US corporation, you currently would need to pay 6 percentage points more than the yield on 10-year US Treasury bonds, currently at 4%. Hence, the corporate bond would yield 5.6%). 

The same applies to non-US governments issuing debt. , the Philippines (rating: BBB+) sold new 5½-year debt. The bonds were priced to yield “T+144bps”, meaning “Treasury yield plus 144 basis points,” or 1.44 percentage points. Lower-rated State of Mongolia (B3, equivalent to B-) had to offer a spread of 4.25 percentage points over Treasuries for a total yield of 8.75%.

The yield premium over Treasuries is also known as the “spread.” you will find a table explaining the credit scale used by rating agencies.

The entire world’s debt is priced off Treasury securities. If the yield for Treasuries goes up by one percentage point, most borrowers of US dollars will see their yields increase by the same amount. With more than in global debt outstanding, a one percentage point increase in interest rates would cost borrowers $3 trillion (which is larger than the GDP of all but the nations).

Given their importance, we need to understand how Treasuries are created, traded and treated.

How the sausage is made

Treasury securities are born out of necessity—the need for the US government to raise funds. Since the government spends more than it raises in taxes, any shortfall must be filled by selling debt. For the 2022–23 fiscal year, the deficit amounted to nearly .

In addition to plugging the hole torn by deficits, the US government needs to refinance existing debt coming due — which is a lot. An astonishing of Treasury debt issued in 2023 is due within one year or less. This leads to constant refinancing needs. 4-week Treasury bills, for example, need to be refinanced twelve times per year.

Despite the annual fiscal deficit being “only” $1.7 trillion, the gross financing needs for November 2023 alone added up to .

To figure out how much debt to issue, the Congressional Budget Office drafts a “,” typically each January, and updates it in August. Treasury officials meet quarterly with the Treasury Borrowing Advisory , comprising senior from banks, broker-dealers, hedge funds and insurance companies. The committee then issues a to the Treasury Secretary with recommendations on debt issuance for the coming quarter, culminating in table with a recommended . The Treasury department subsequentlyissues a tentative . This way, market participants can anticipate future supply and plan accordingly.

Treasury securities come in three main categories, classified by time to maturity: Treasury Bills (one year or less, namely 4-, 8-, 13-, 17-, 26-, and 52-week), Treasury Notes (2-, 3-, 5-, and 10-year) and Treasury Bonds (20- and 30-year).

The bills do not have a coupon, or interest payment. Instead, are sold at a discount to their face value. For example, a 52-week bill would be issued at 95%, so that the ultimate yield would be 5.26%. All other Treasury securities carry a coupon.

All issues have a fixed rate, except for the 2-year note, which can be issued with either a fixed or variable rate.

In addition, 5-, 10-, and 30-year notes and bonds also come as Treasury Inflation Protected Securities (TIPS). Unlike other Treasury securities, where the principal is fixed, the principal of a TIPS receives an inflation adjustment over time. For example, the 5-year TIPS has a coupon of 2.375%. On top of that, the principal gets adjusted for inflation in regular intervals, compensating the owner for the loss of purchasing power. 

How Treasuries are sold

New Treasury securities are sold via auctions. Institutions submit bids, stating which minimum yield they are willing to accept. The Treasury then fills all bids, beginning with the lowest yields, until the entire auction amount is sold (i.e., it uses a Dutch auction). All successful bidders are then awarded the same final yield.

Indirect bidders do not have accounts with the Treasury and must submit their orders through primary dealers, who act as intermediaries.

Primary dealers are a of banks and financial institutions that are obligated to bid in Treasury auctions. If no other buyers show up, primary dealers will end up buying the entire auction. In theory, this could amount to $90 billion or more. However, in March 2020, the Federal Reserve introduced a lending , the so-called “Primary Dealer Credit Facility,” where Primary Dealers can obtain loans against collateral (consisting of the Treasury securities they just bought). The amount of borrowing is , thereby eliminating the possibility of a failed auction.

This is an important piece of information to understand: US Treasury auctions cannot fail. The Federal Reserve will lend unlimited funds to private sector institutions to absorb any unsold securities. However, the Federal Reserve does not cover any price risk; if interest rates were to rise rapidly, bond prices would decline, creating losses for financial institutions holding them. This effect was seen in March 2023, when Silicon Valley Bank was brought down by losses on Treasury securities and other bonds usually deemed “high quality liquid assets.”

The secondary market

Buying a Treasury security in an auction is also referred to as the primary market. Once a Treasury security has been issued, trading in the secondary market begins. 

Trading volume in the secondary market is impressive. According to the Securities Industry and Financial Markets Association, more than worth of Treasury securities were traded daily during November 2023. On busy days, trading volume is likely to exceed $1 trillion, equal to 3% of the total amount outstanding.

On top of that, futures contracts on those bonds are being traded. A futures contract is a trade where the price between buyer and seller is set, but the settlement is made at a specified date some time later. Most futures positions are unwound before settlement.

The average daily for the most popular contracts (10-year, 2-year and 5-year) exceeded 13 million in November of 2023. Multiplying the number of contracts traded by their face value of $100,000, the total value of those futures traded amounted to more than .

Maintaining this level of market liquidity is important because it makes sure that large buy or sell orders can be absorbed without much impact on price.

The repo market

If you are in a financial pinch and need to borrow money, you may go to a pawn shop. A simple promise to pack back the loan will not convince the store clerk. However, you can use a gold watch as collateral. The store clerk keeps your gold watch until you pay back your loan.

Treasury securities are considered the safest and most liquid investment. This makes Treasuries the perfect collateral for borrowing money.

After the 2008 global financial crisis, unsecured lending (without collateral) all but disappeared. Even banks do not trust each other anymore.

Borrowing money by using Treasury securities is called a repurchase agreement, or short “repo”. In a repo transaction, the borrower agrees to buy back the securities used as collateral at a later date. The repurchase price will be at a slight premium, compensating the lender for lost interest. The time frame for these transactions is usually very short, often overnight.

Here, too, the amounts involved are mind-boggling. In November, the average daily repo financing reached a stunning , comprising $4 trillion of Treasury securities.

As if this wasn’t enough, a reverse-repo market exists where the Federal Reserve lends out Treasury securities in exchange for cash, with a peak volume of . 

Who owns Treasuries?

“Somebody” needs to own (and keep buying) US federal debt. A look at the of Treasuries reveals that only two out of five groups are price-sensitive: foreign and domestic private institutions. The other three groups are the US government trust funds, the Federal Reserve and foreign official holders — central banks and sovereign wealth funds.

US government trust funds include like the Social Security and Medicare. These funds are “captive” buyers. They are obligated to invest in Treasuries, regardless of the price.

Central banks, including both the Federal Reserve and foreign central banks, are also insensitive to price. They acquire securities for reasons other than profit maximization. Their purchases are motivated by monetary policy (Federal Reserve) or exchange rate policy (foreign central banks).

Foreign entities hold worth of Treasury securities, of which foreign official accounts hold more than half. Among the largest holders by country are traditional export countries like Japan ($1 trillion) and China ($0.8 trillion). As most internationally traded commodities and goods are invoiced in US dollars, the exporter ends up with excess dollars. To prevent its exchange rate from appreciating, their central bank then needs to absorb those dollars.

This has important implications; as long as non-US nations produce more goods and services than they consume, they will have positive trade balances, and hence US dollar inflows (that often get absorbed by a central bank). As long as the US consumes more than it produces, a trade deficit implies more money leaving the US than coming in. In other words, the US is exporting Treasury securities. The export of debt is the mirror image of its balance of trade. Financial flows must match flows of goods and services.

According the Polish economist , a nation’s economy consists of four sectors: households and corporations (the private sector), the government and the foreign sector.

If the foreign sector has a surplus, domestic sectors must have a deficit. This could be either the government, or the private sector, or both. In the case of the US, the large and growing trade deficit therefore requires a large and growing fiscal deficit.

Only if Congress stepped in and put the brakes on government spending would the fiscal deficit shrink. This, in turn, would force a reduction in the trade deficit. Such a reduction is characteristic of a recession, as US consumers are forced to cut consumption, a lot of which consists of imported goods. 

Foreigners would then cut their purchases of US securities. But now, the need for foreign financing of US debt is reduced since the fiscal deficit was addressed. 

The numbers may seem scarily large, but the Treasury market is far from being at the edge of a cliff.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Trillion Dollar Dilemma: Is the US Treasury Market in Trouble? appeared first on 51�Թ�.

Before examining the reasons for this underperformance, it is important to look at the numbers. The average investor achieved annualized returns of 3.6% over 20 years. The Standard and Poor’s 500 (S&P 500 — an index comprising stocks of the 500 largest companies listed on US stock exchanges) achieved annualized returns of 9.5% over the same period. Even bonds, units of debt issued by governments and companies, gave returns of 4.3% over 20 years. 

Generally, investors put their money into both stocks and bonds. A 60/40-ratio of stocks and bonds would have returned 7.4% annually, while a 40/60-mix would have yielded 6.4%. Older investors are risk averse and often favor bonds over stocks because of guaranteed returns. In contrast, stocks can fall dramatically and, at times, lose all value.

With annualized returns of 3.6%, the average investor was able to double his or her money. The 60/40 stock-bond ratio should have led to 4.2 times increase in wealth while a 40/60 mix should have led to 3.4 multiple. Charles-Henry Monchau, the chief investment officer at Swiss Group Syz, 95% of individual investors underperform the market. After fees and commissions, that number might be closer to 100%. Note this means that, except for a tiny percentage, investors almost invariably underperform the market.

In dollar figures, individual investors have left a lot of money on the table. From the end of 2018 to the same time in 2021 the S&P 500 rose by 90%. At year-end 2018, individual investors held equities worth . The annualized return figures tell us that individual investors missed out on gains of $3.6 to $5.9 trillion. What is going on?

Underperformance leads to the rise of passive investing

It makes sense that individual investors underperform the market. They do not have the same information as professional and institutional investors. They suffer from information asymmetry. These investors also fear losses, chase market darlings (stocks often discussed at dinner parties and rarely questioned as a good investment), chase hyped-up companies, fail to time the market and make other mistakes that individuals often do when investing or trading alone.

Surprisingly, professional and institutional investors do not outperform the market either. A study by reveals that up to 96% of all active US equity funds underperformed their benchmarks over a 15-year period. Note that only 30-60% of these funds survived over this period. Most underperforming funds simply closed shop. Some merged with others. So, there is a survivorship bias — a type of selection bias that ignores the unsuccessful outcomes of a selection process — to this 96% figure. The real figure is even higher.

So, why are individual and professional investors struggling to beat the market? After all, an index is a mix of companies of varying quality — some are great, some mediocre and some outright bad.

There is a logical problem with the idea of investors beating the market. Very simply, the market is nothing but all the investors buying and selling to each other. For any trade in the market, one investor has to sell to another. For every investor outperforming the market, another has to underperform.

Over the years, passive investors have emerged. These are exchange-traded funds (ETFs) that contain hundreds — sometimes thousands — of stocks or bonds listed on the market. Their basket of stocks or bonds closely follow the performance of the index neither out- nor underperforming the market.

In recent years, passive investing is rising. As a result, the number of market participants who still can under- or outperform is shrinking. According to data, more than 54% of all assets in US equity mutual funds and ETFs are now managed passively.

Who outperforms the market and why?

As most individual and institutional investors are underperforming, who then is outperforming the market? 

Outperformers tend to be hedge funds, activist and quantitative investors, insurance companies, pension funds and conglomerates like Berkshire Hathaway. 

Hedge funds use strategies usually not available to individual investors or mutual funds, such as leverage, arbitrage, combination of long and short positions, derivatives, and algorithmic trading. Activist investors take concentrated positions in companies to force management or strategic changes, which is impossible for individual investors due to lack of size. Unlike hedge funds, mutual funds usually do not take a combative stance towards company boards.

Quantitative investors use mathematical models and computer algorithms to exploit patterns and trends in financial markets. Individual and most institutional investors do not have access to trading technology to enter and resell positions within fractions of a second. Insurance companies and pension funds can afford to ignore short-term market turmoil as their capital is usually of long-term nature. Conglomerates like Berkshire Hathaway get a detailed look into the accounts of a potential takeover target before an acquisition, receiving better information than what individual shareholders obtain via quarterly and annual reports.

Note that this long-term advantage of pension funds might be lost as many outsource management of their assets. According to a BNY Mellon , 50% of the largest public asset management companies exclusively use external managers. These managers tend to take short-term, not long-term decisions. Furthermore, these institutions often suffer from poor governance. This can have a detrimental impact on their performance.  Compared to their Canadian peers, “American public pension funds are stuffed with politicians, cronies and union hacks” and tend to more poorly.

A simpler reason for why it is so hard to beat, or even match, the performance of benchmark indices like the S&P 500 lies in a skewed distribution of returns. The performance of index member companies is not normally distributed (which would follow the bell curve) but has a . Simply put, only a few companies have astonishingly outsized returns. Not owning those few companies automatically leads to underperforming the index.

Between 1995 and 2022, (just 2% of 500 companies) accounted for at least one-fifth of the performance of the S&P 500. In some years, the top ten stocks provided more than 100% of index performance. This means if we exclude these ten stocks, the S&P 500 would have had a negative return. 

Over the first nine months of 2023, the “magnificent seven” — Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, and Tesla — , while the remaining 493 members of the S&P 500 have gained only 3%. Seven out of 500 are tiny odds. And it would not have been sufficient to simply own those stocks — one would have had to own them in the same ratio as the index. Those “magnificent seven” stocks currently command a 28% of the index. Those who want to match the S&P 500 would have to have the same weighted portfolio. This means, investors would have to heavily invest in technology stocks precisely when the sector commands historically high valuations. 

Only a few winners emerge from the large number of companies listed on the market. Out of 28,114 publicly-listed US companies, the top 25 (less than 0.1%) are responsible for nearly of all shareholder wealth created since 1926. These numbers underline the fact that the odds of picking those few massive outperforming stocks are very slim. Almost invariably, stock picking turns out to be a losing proposition.

Stock indices are simply less risky

Apple went public in December 1980 at a price of $22. Adjusted for stock splits, its initial public offering (IPO) price was per share. At today’s price of , Apple has since gained 179,390%, a 19% annualized return. Yet to get that return, an investor would have had to sit through multiple difficult periods. From 1991 to 1998, Apple’s stock price declined by 83%, from 2000 to 2003 by 82% and from 2007 to 2009 by 61%.

Any potential Apple investor would have had to shrug off negative news headlines, like one — “The Fall of Steve Jobs” — from Fortune Magazine in 1985. Shortly after this story, Jobs was fired from Apple. He returned 12 years later and led the company to great success. However, it would have taken a brave and stubborn investor to hold on to Apple stock and they would have had to refrain from taking any profits for a long period of time.

Asked which stock investors wished they had bought (in hindsight), most would likely name Apple or Tesla. However, a beverage company, emerging out of bankruptcy in 1988, steals the crown. Formerly known as Hansen Natural, Monster Beverage rose from a split-adjusted price of $0.0062 in 1995 to around $50 today, for a return of more than 800,000%. The annualized gain of 37% for Monster Beverage is almost twice Apple’s 19%.

There is no guarantee that companies can come back from steep declines in stock prices. In such cases, investors’ stubbornness can backfire. The share prices of former market leaders were nearly or completely wiped out. Former stock market darlings such as Nokia (-90%), Palm (-94%), Blackberry (-98%) and Nortel Networks (-100%) are part of a long list of companies that have sunk like lead in water.

In the case of an investment manager, he would have been fired for holding on to Apple or Nokia stock. Holding an ETF saves professional fund managers from the risk of losing their jobs.

Jack Bogle, the founder of investment management company Vanguard, famously “Don’t look for the needle in the haystack. Just buy the entire haystack.” The “needles” investors are looking for are the few companies whose shares go on to have an astronomically high performance. The “haystack” is the entire stock index. Vanguard introduced a low-cost index fund in 1976, leading to the success of the ETF. Not only does an index ETF guarantee to closely follow the market but it does so at very low cost. The Vanguard S&P 500 ETF charges 0.03 and even the State Street Global Advisors “SPY” ETF charges 0.09%, a much lower figure than active professional and institutional investors.

What if everyone goes passive?

From a rational perspective it does not make sense to spend millions of dollars on salaries of analysts and portfolio managers if the prospects of outperforming a simple (and cost-efficient) ETF are slim. So what would happen if most investors shifted to passive investing via index-linked vehicles? What if nobody did any research anymore into companies’ fundamentals, balance sheets and products? 

Index members could rely on steady buy orders from automatic investing by pension funds and insurance companies. However, this raises other issues. Would the stock price of a company reflect the fact that it was on the verge of bankruptcy or that it had just invented a cure for cancer? Would the price mechanism of the market still work?

In theory, there must be a maximum share of passively managed money beyond which active investing would become profitable again. But the fundamental conundrum of the market would still remain: for every investor that outperforms there must be another who underperforms the index.

For individual investors, going passive does by no means guarantee investment success. Passive investing simply means no underperformance relative to an index but does not guarantee absolute (positive) performance. It took the technology-heavy Nasdaq Composite to recuperate losses after the dot-com bubble burst in 2000. Between 1995 and its peak in March 2000, this index rose 800%, only to give back most of its gains by October 2002.

Today, S&P 500 heavyweights such as Apple and Microsoft are valued together at over $5 trillion. They are sporting historically high valuations with their valuations at and times their estimated earnings respectively. The index containing these stocks doesn’t care about the valuations of Apple and Microsoft. The S&P 500 does not care about the future performance of Apple and Microsoft. Passive investing can solve relative underperformance vis-à-vis the market but not guarantee high returns because, like the Nasdaq in 2000 or Wall Street in 1929, the market itself can lose value.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post How to Invest: Forget the Needle, Buy the Haystack appeared first on 51�Թ�.

We might wonder why glass is transparent, given that most other materials seem to stop light in its tracks without any effort. However, this perspective shifts dramatically when you envision an atom magnified to the size of a football stadium. In this atom, the nucleus, resembling a mere pea, resides at the stadium’s center while electrons whiz around the outer stands. The vast expanse in between is empty space. This revelation challenges our perception. Instead of pondering “Why is glass transparent,” we should inquire, “Why do most materials block light?”

A similar thing happens when we talk about money. Most of us think that we understand what money is, because we use it every day. A little bit of science will tell us that matter is really mostly empty space, and that money is really debt. Wow! But leave aside the abstract money that exists in banks’ computers. What about the cash in your wallet — at least we understand how that works, right?

Cash is not where you think it is

Recently, I stumbled upon a piece of information buried within the US Treasury Department’s quarterly “.” The total amount of US currency, encompassing both coins and notes, currently stands at a staggering $2.3 trillion. But what’s really astonishing is that this amounts to a “per capita” figure of $6,998. That’s $6,998 for every man, woman and child in the United States. That ought to mean that, on average, a typical five-person family possesses an astounding $35,000 in cold, hard cash. Not in a bank account, but in the form of tangible currency.

Of course, we must account for other entities holding cash. Around $100 billion is kept in . According to a by JPMorgan, small and medium-sized enterprises (SME) hold, on average, $12,000 in cash. With roughly , the amount of cash can be estimated at $400 billion. Finally, there are around 450,000 ATMs (automated teller machines) in the US, with each holding, on average, around $20,000 in cash, or $9 billion in total. In addition, small amounts of currency will be found in vending machines, parking meters, and organizations receiving cash donations.

Sure. But this still leaves around $1.8 trillion behind — $5,375 per capita. This is hard to believe, since have shown that 64% of Americans would have to deplete their savings to cover a $400 emergency expense. So where is all the money?

According to an article published by the Federal Reserve Bank of St. Louis, an estimated 45% of all Federal Reserve Notes (paper cash), worth $1.1 trillion, are held by non-US persons. A published by the Federal Reserve Bank of Chicago even suggests that more than 60% of all US bills and nearly 80% of $100 bills are held overseas. With $1.88 trillion in $100 bills outstanding, this would total up to $1.5 trillion.

The Federal Reserve makes money from foreign use of US currency

For the Federal Reserve, currency in circulation is a liability. You can conceive of a dollar bill as an interest-free debt note with no end date. Since it never has to be paid back, it is “free” debt. 

Commercial banks have money in accounts at the Federal Reserve, which means the Federal Reserve owes them money. When they withdraw that money as cash, the debt is now represented by paper notes. By offloading its liabilities as currency in this way, the Federal Reserve can then invest its freed-up resources elsewhere. Income earned on such investments is called seigniorage. If invested in short-term Treasury bills, those profits can be described as risk-free.

Where Do New Dollars Come From?

With $2.3 trillion in currency outstanding, assuming the proceeds are invested in 1-month Treasury bills currently yielding 5.5%, the central bank would generate risk-free profits of $126.5 billion per year. This amount is larger than the of all but China and the US itself.

Of those $126.5 billion, $88 billion would be earned thanks to dollar bills held by foreigners. That’s $88 billion the Federal Reserve is earning on safe interest. Foreign investors could have earned that money themselves if they had held Treasury bills instead of cash. So why would they forgo the money and allow the Federal Reserve to make the investments instead?

The answer is that US currency is quite useful.

In some countries, the US dollar is used alongside or even instead of the local currency for everyday transactions. This is usually the consequence of a substantial devaluation and loss of confidence in the local currency.

Ecuador adopted the US dollar as its official currency in the year 2000, following a severe financial crisis. Since then, the US dollar has been the sole legal tender in the country.

In September 2021, El Salvador became the first country in the world to officially adopt Bitcoin as legal tender alongside the US dollar. While Bitcoin is now a recognized currency, the US dollar remains the primary and most widely used currency for daily transactions.

Panama does not have its own national currency; instead, it uses the US dollar exclusively for all transactions.

Due to hyperinflation and the collapse of the Zimbabwean dollar, the US dollar, along with other foreign currencies, such as the South African rand and the euro, has been used for transactions.

In Argentina, lack of trust in local currency has led to strong demand for US dollars, resulting in a 100% premium for US dollar bills in black markets over the official exchange rate.

So, all of these countries make wide use of US currency as a means of exchange and as a store of value, and the Federal Reserve collects the profits.

Digital currency competes with stablecoins

However, this system only works as long as we are still using paper cash. As we shift towards a cashless society, those seigniorage profits will disappear!

This is one of the major reasons why all central banks are keen on introducing “central bank digital currency” (CBDC). Like cash, it would be money issued by a central bank (as opposed to bank deposits, which are money issued by a private institution). In a cashless society, CBDC would be the only way for citizens to get their hands on publicly issued money and for central banks to issue public money to citizens. The ability to continue to generate seigniorage profits depends on the successful introduction (and acceptance) of CBDC.

Here is where private issuers of stablecoins enter the scene. A stablecoin is a digital token that is designed to have a stable value, typically by being pegged to a reserve of assets or through algorithmic mechanisms, but which is neither issued by a central bank nor a commercial bank. Thus, stablecoins are direct competitors to CBDC.

What You Need to Know About Cryptocurrencies

Take Tether, for example. According to its , Tether has issued almost $83 billion worth of tokens. Assuming the operation is not fraudulent, Tether invests proceeds received in exchange for the issuance of tokens in interest-bearing securities like Treasury bills. $83 billion invested at a yield of 5.5% results in interest income of around $4.5 billion per annum. Since Tether does not pay any interest on tokens issued, this interest income, after subtracting some administrative expenses, is profit. The business of stablecoin issuance is extremely profitable! Seigniorage profits, but privatized.

Since the Federal Reserve remits most of its profits to the US Treasury, seigniorage profits by the US central bank indirectly benefit US taxpayers. Privately-owned stablecoin issuers are eating into the cake of public seigniorage. And there are limited options on how to prevent private issuers from taking a growing share of the cake.

But stablecoins are not as trustworthy or easy to use as cash. So why would anyone forgo risk-free interest income on US Treasury bonds and instead hold a non-yielding stablecoin like Tether?

Stablecoins provide a means for crypto-currency traders to quickly exit the cryptocurrency market without the need to transfer funds back to a traditional bank account. This liquidity is particularly useful for arbitrage opportunities and active trading. In traditional banking and brokerage, proceeds from a sale are not immediately available for another trade, as settlement of funds does not take place until a few business days later.

95% of Tether, to the extent that we can , is held outside the US. Tether is likely gaining popularity in countries with failing local currencies for the same reasons we cited above for the use of US paper money abroad.  For a person living in Argentina, unable to access dollars at the official exchange rate of 350 pesos to one dollar, and faced with a black market rate of pesos, the remote possibility of a stablecoin issuer becoming insolvent pales in comparison with the certainty of 113% inflation in local currency.

From a regulatory perspective, stablecoin issuers are accepting deposits while lacking a banking license. Therefore, they cannot call themselves banks, and the deposits they hold are not covered by any deposit insurance scheme. The lack of transparency and high risk of fraud set stablecoin issuers apart from highly regulated commercial banks.

But what if a stablecoin issuer did act like a legitimate bank? If it were a member of the Federal Reserve System and deposited its proceeds into an account with the Federal Reserve Bank, the existence of funds would be easily verifiable. Moreover, since the central bank cannot go bankrupt, there would be no default risk!

Custodia Bank of Wyoming, a US state with crypto-friendly legislation, has tried for years to do exactly that by becoming a member of the Federal Reserve System. The Federal Reserve, however, recently Custodia Bank’s application as the firm’s “novel business model and proposed focus on crypto-assets presented significant safety and soundness risks”.

Seigniorage profits are substantial, especially if most holders reside outside the country of the issuing institution. The prospect of virtually risk-free gains will continue to attract privately owned stablecoin issuers. Central banks will try to prevent those private issuers from eating into their share of profits. Perhaps users will only stop flocking to stablecoins after a good proportion of issuers run into financial troubles, fall victim to theft from insiders, get hacked or see their peg to the underlying currency fail. Central banks probably wouldn’t shed many tears if that happened.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Revealing Who Is Holding Billions of US Banknotes appeared first on 51�Թ�.

Despite its importance, very few could answer even the most basic questions about money: Where does it come from? How much money actually is there?

If I asked you how much money you own, you could likely determine the answer with a few clicks by checking your account balances. Store owners are aware of the dollars in their cash registers and in the bank. Any bank knows exactly how many dollars (or any other currency) are on its balance sheet. The government knows. The number of total dollars in circulation, then, should be a known quantity.

Here is an experiment you can do right now: google the question, “How many dollars exist in the world?” You will be puzzled by the result: a wide range of different figures. For example, will tell you there are $2.1 trillion in circulation, while the lists $20.8 trillion as the monetary base just of the US. The of the US mention $95 trillion in outstanding public and private debt—to which we can add more than $80 trillion in hidden debt identified by the , bringing the total figure for American debt to over $175 trillion. Surprisingly, the exact total number of dollars in existence remains unknown.

The lack of a definitive figure stems from varying definitions of what qualifies as money. Consider the unused portion of your credit card limit—does it fall under the category of money? Similarly, when two non-US banks engage in a cross-currency swap agreement involving US dollars, booked as potential liabilities off of the balance sheets, should that be considered money? These examples highlight the complexities and uncertainties surrounding the precise determination of the total amount of money in circulation.

What is money?

Money exists in diverse forms and exhibits varying characteristics. For instance, for a car dealer, the primary concern would not be the specific form of payment a customer uses to purchase a car. Whether the customer pays with a suitcase full of cash (money laundering concerns aside), obtains financing from a bank, or secures a loan or lease from the manufacturer’s in-house financing arm, the main objective, from the dealer’s point of view, would be completing the sale.

In the first scenario, the customer uses money created by the central bank, which is commonly referred to as public money.

In the second case, the customer relies on money created by the private banking sector, known as private money.

The third example involves the in-house financing arm bundling customer loans and selling them to investors in the form of collateralized car loan obligations. This practice exemplifies money creation by the shadow banking sector. (The term “shadow banking” refers to financial activities that fulfill similar functions to traditional banking but take place outside the scope of traditional banking institutions.)

These examples demonstrate the varied sources and mechanisms that create money, encompassing public money issued by central banks, private money generated by commercial banks, and even forms of money creation within the shadow banking sector.

In all three examples, debt plays a significant role as a method of payment. In our fiat monetary system, the creation of money is tied to the creation of an equivalent amount of debt. In other words, when new money is brought into existence, an accompanying debt is simultaneously created.

This means that one person’s savings represent another person’s debt. As a result, the total amount of money in circulation must match the overall amount of outstanding debt. This explains why, when searching for the number of dollars in existence online, it is common to encounter search results mentioning “debt.”

The functioning of our monetary system can indeed be unintuitive. It can be challenging to grasp the notion that money we hold in our bank accounts represents someone else’s debt and that when we transfer money, we are essentially passing on IOUs.

This lack of awareness or disbelief about the nature of money is not uncommon. Many people may view money as a tangible and independent entity without recognizing its interconnectedness with debt.

Where do the dollars come from?

I spoke about institutions that create money. “Isn’t it the government that creates money?” you might ask. The reality is not so simple.

A country’s central bank creates money in physical (notes, coins) and digital form (deposits credited to its clients, which are other banks). Both forms constitute a liability for the central bank. By examining its liabilities, the total amount of money created can be determined. In the case of the Federal Reserve, the US central bank, this amount currently stands at approximately .

Of the over $175 trillion of debt in the economy, the vast majority has not been created by the central bank but rather by the private sector. The US central bank accounts for less than 5% of total money outstanding. However, despite its small contribution, the central bank is often held responsible for the entire amount outstanding, despite this amount being 20 times greater than its own creation.

Central banks face criticism for their perceived role in “printing” vast sums of money seemingly out of thin air. However, as previously mentioned, their direct impact on the total amount of money in circulation is relatively small compared to the contributions of the private sector.

Instead of solely focusing on central banks, it can be valuable to recognize and appreciate the functioning of our monetary system. This system, despite not being backed by any physical commodity like gold, has been operational for several decades. The longevity and resilience highlight the system’s ability to facilitate economic transactions, support economic growth and maintain relative stability.

Why do we need private banks?

Money, as a medium of exchange, is a public good. However, private sector banks are permitted to create money, under strict regulations, through the issuance of loans. Why should the private sector be allowed to participate in money creation?

The reason lies in the nature of lending and the risk of individual loans. It is not feasible for average citizens to lend significant amounts of money directly to strangers for purchases like cars or homes. It would be impossible for individuals to assess creditworthiness and risk. Banks, with the help of equity buffers and deposit insurance, take care of that risk. This enables your neighbor to finance his house without you having to worry about his creditworthiness causing sleepless nights.

In theory, it is conceivable for central banks to undertake the lending function. However, central banks primarily have a public mandate to ensure monetary stability and implement monetary policy. Determining the creditworthiness of individual borrowers on a local level would require a vast network of branch offices, which could divert resources and focus away from the central bank’s core responsibilities.

Private banks not only perform risk transformation, by shifting credit risk from individual depositors onto the bank, but also maturity transformation. This means that while banks provide longer-term loans to borrowers, depositors have the flexibility to access their savings daily. This maturity transformation allows banks to match longer-term loans they make with shorter-term deposits, ensuring the smooth functioning of the financial system.

Economic growth requires the expansion of debt

Most big-ticket items, like cars as mentioned in the earlier example, are financed rather than paid for in cash. As a result, availability and accessibility of credit play a vital role in facilitating car sales and driving economic activity.

A credit contraction, in which credit institutions tighten lending standards, leads to fewer loans and therefore economic contraction.

As the expansion of debt often outpaces economic output, debt service levels may eventually become overwhelming. This situation can result in borrowers being unable to meet their debt obligations, forcing banks to write off loans and thus triggering a recession. In cases where loan losses exceed safety buffers, banks may face the risk of closure. Fortunately, depositors can rely on deposit insurance schemes within certain limits, which is crucial to instill trust in private institutions despite the possibility of insolvency.

In addition to deposit insurance, trust in private institutions is also bolstered by the possibility of converting bank deposits, representing a claim against a private institution, into cash, which carries no risk of bankruptcy. However, this feature can trigger bank runs once the trust in a particular bank has been shattered.

The role of cash

Public money, in the form of cash, serves as a critical mechanism to maintain the uniform value of dollars, regardless of their issuer. Prior to the establishment of the Federal Reserve Bank System, a dollar note issued by a bank in Connecticut, for example, would be cashed at a discount to its face value when presented in New York City. Only the introduction of a central bank ensured full fungibility of dollars regardless of their origin or issuing entity.

Bank deposits can be thought of as stablecoins, with deposit insurance and convertibility into cash functioning as the mechanism guaranteeing the 1-for-1 peg.

As we transition towards a cashless society, the role of public money (cash) as the anchor of our monetary system is undergoing a transformation. Currently, cash serves as the only means through which individuals can access public money, as only banks are permitted to hold accounts with the Federal Reserve.

This is where Central Bank Digital Currency (CBDC) comes in. With the eventual retirement of physical forms of money, CBDC will emerge as the sole means for central banks to directly engage with individuals.

CBDC can be thought of as tokenized cash, representing a digital form of central bank-issued currency. It retains the characteristics of cash in terms of being a liability of the central bank, ensuring its stability and reliability.

Keeping seigniorage alive

Central banks benefit from cash in circulation as cash represents interest-free debt, providing them with a significant source of income from investing proceeds in interest-bearing securities, resulting in profits known as seigniorage.

The US Federal Reserve, for example, has around of currency in circulation. If these funds were invested at a hypothetical interest rate of 5%, the annual return would amount to $115 billion, a sum greater than the of any country other than the US and China.

With the disappearance of physical cash, the traditional source of such profits would cease to exist. However, the introduction of Central Bank Digital Currency (CBDC) presents an opportunity to sustain and continue generating seigniorage profits. Furthermore, public money is vital to support increasing sums of private money outstanding. The introduction of CBDC should therefore be welcomed.

A debt-based monetary system is a feature, not a bug

The current monetary system frequently faces criticism for lacking tangible backing and enabling unlimited issuance. In contrast, assets like gold and Bitcoin are seen as different because they do not represent any counterparty’s obligation. However, while some proponents applaud this aspect, it can be viewed as a drawback rather than a desirable feature.

The absence of counterparty risk and limited issuance in assets like gold and Bitcoin can lead to a phenomenon known as hoarding. This hoarding behavior is reminiscent of medieval kings sitting on vast treasure chests filled with gold, rendering the gold inert and unavailable for circulation within the economy. Consequently, this results in a restricted monetary base in circulation, which hampers economic growth.

A fiat monetary system possesses the unique feature of allowing for the simultaneous creation of savings and debt, enabling economic growth even in the presence of accumulating savings. This characteristic is a significant advantage of such a system.

The potential drawback of a fiat monetary system lies in the temptation to create excessive debt or money, which can lead to devaluation. This factor renders fiat money less reliable as a store of value, while it represents an excellent medium of exchange.

The stability and functionality of a fiat monetary system relies on individuals’ willingness to hold their savings in fiat currency. While it is impossible for everyone to convert fiat into tangible assets, individuals still have the freedom to make such choices.

Despite its drawbacks, a fiat monetary system remains preferable to a system based solely on hard assets, which would create deflationary pressures and possible economic depression. The dynamic nature of a fiat system allows for central banks to make adjustments in money supply to accommodate economic needs.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Where Do New Dollars Come From? appeared first on 51�Թ�.

The debt ceiling in the United States originated from the need to control government spending and ensure fiscal responsibility. Initially, Congress had to authorize each new batch of debt issued, a cumbersome process that was modified with the passage of the Second Liberty Bond Act of 1917. This act established an aggregate amount, or , to govern the total debt to be issued. Since World War II, the debt ceiling has been adjusted over 100 times to accommodate the country’s evolving financial needs.

The concept of a debt ceiling, however, itself poses logical inconsistencies. All federal government spending is already authorized by Congress, making it contradictory to prevent the Treasury Department from raising the necessary debt to fund these authorized expenditures. In other words, Congress forbids spending which it has already mandated. Reaching the debt limit forces the government to choose between not fulfilling previously agreed obligations or defaulting on existing debt service. Either of these would be a violation of obligations established by law, and would therefore have severe implications for the US economy.

Implications of reaching the limit

Reaching the debt ceiling carries significant implications for the US economy. It can lead to a government shutdown, disrupt essential services, and even result in default on financial obligations, jeopardizing the nation’s creditworthiness. Credit rating agencies closely monitor debt ceiling debates. If they were to downgrade the federal government’s credit rating, this would increase borrowing costs and undermine investor confidence. Uncertainty surrounding the debt ceiling, even if it is not eventually reached, also introduces volatility into financial markets and can impact global economic stability.

An Outstanding Deep Dive Into the American Economy

Government default entails the non-payment of interest or principal on its obligations. This triggers a credit event that has far-reaching consequences. Individuals and institutions relying on government funds would not receive payments. Credit default (CDSs)—insurance contracts taken out against credit events—would be triggered, potentially causing financial difficulties for institutions which have written CDSs. Rating agencies would downgrade the US credit rating, impacting other borrowers, and Treasury securities would no longer serve as acceptable collateral for institutional borrowing, leading to a collapse of credit availability, choking the economy and leading to a severe contraction.

Rating agencies such as Fitch and Standard & Poor’s have expressed concerns about the United States’ , despite the recent agreement on the debt ceiling. A potential downgrade could have implications not only for the US but also for all other borrowers whose credit rating is usually influenced by the sovereign rating. With the US bond market dominating global markets, the loss of the anchor role of US Treasuries, which form a substantial part of institutional portfolios worldwide, could create disarray in international bond markets.

Partisan shenanigans and a borrowing spree

The debt ceiling has become a contentious political issue in recent decades, with both major parties sharing responsibility for substantial increases in outstanding debt. The threat of a debt default has often been used as a bargaining tool in political negotiations. However, neither party wants to bear the blame for driving the country into a crisis, resulting in a risky game of chicken in which each party attempts to see who will budge first and agree to concessions favorable to the other party’s spending policy. This raises questions about whether the debate really revolves around the debt itself. The recent deal, featuring a suspension of the debt limit, essentially provides the Treasury the freedom to borrow as much money as needed until January 2025—a carte blanche.

The government’s account at the Federal Reserve, the Treasury General Account (TGA), has almost been depleted. It will have to be replenished to 600 billion US dollars (it peaked at US dollars during the pandemic). Those funds will have to be raised by raising additional debt—on top of money needed to fund the current federal fiscal deficit of around 2 trillion dollars. As I mentioned in a previous article, it is not apparent who would buy that amount of Treasury securities. The Federal Reserve might be forced to reverse its plan to slowly shrink its balance sheet, having to absorb additional government debt.

Who Will Buy America’s Debt Now?

After borrowing 726 billion dollars during the second quarter of 2023, the Treasury Department expects to raise another in the following quarter. Total government debt is hence guaranteed to continue rising at a fast pace. Having briefly been arrested at 31.4 trillion dollars (the amount of the debt ceiling), federal debt is expected to exceed by 2033. The exponential growth of government debt is going to continue unabated.

The includes some mild cuts of non-military discretionary spending in 2024, and a limit of all discretionary spending in 2025. Military spending, however, will increase further, to 886 billion US dollars in 2024, and 895 billion in 2025, a 23% increase over the amount spent in 2022.

The bill’s drafters found other devices to cut costs. 20 billion dollars originally awarded to the IRS (Internal Revenue Service) to fight tax evasion will be clawed back. The bill imposes new requirements for adults to maintain access to food stamps. It also ends the freeze on student loan repayments. In short: money taken from the poor is being given to the military and to people crafting “innovative” tax returns.

Hidden under the surface-level negotiations was a fight over permit reform. Local governments had the ability to block interstate pipelines and electricity lines by dragging out the permitting process. Alternative energy companies need new transmission lines to transport energy produced by wind and solar farms towards population centers near the coasts. Fossil fuel companies need pipelines to move abundant natural gas from sparsely populated areas with shale reservoirs towards the big cities or harbors for export. In the end, the Mountain Valley Pipeline, bringing natural gas from the Marcellus shale fields in West Virginia to Virginia, made it into the bill, securing Senator Joe Manchin’s vote.

A proposal to end recurring debt ceiling drama

US lawmakers the insanity of recurring debt ceiling debates, especially since it is a question of funding spending that has already been authorized by Congress once.

One option contemplates a bureaucratic rather than a legislative solution. This would involve the Treasury Department disregarding the debt ceiling and continuing to issue debt. The perspective finds support in the 14th Amendment of the US Constitution, which states that “the validity of the public debt of the United States, authorized by law…shall not be questioned.” However, pursuing such a unilateral move could result in a legal dispute and potentially generate still more uncertainty.

Another suggestion entails the Treasury minting a platinum with a denomination of 1 trillion US dollars, as it is legally permitted to do. This coin would then be deposited with the Federal Reserve in exchange for a credit of 1 trillion dollars. However, Treasury Secretary Yellen has dismissed this idea, noting that the Federal Reserve is unlikely to agree to such a proposal.

It is worth noting that the US government has in fact experienced instances of default in the past. Esteemed Wall Street veteran Jim Grant that a default can occur through a unilateral change in payment terms, resulting in a diminished financial obligation, such as forced currency redenomination. Two events over the past century align with this definition. Firstly, the devaluation of the dollar relative to gold under US President Roosevelt in 1933, when the gold price was raised from $20.67 to $35 per ounce. Secondly, the “temporary” suspension, which has since become permanent, of the dollar’s convertibility into gold by US President Nixon in 1971.

In reality, persistent inflation can be viewed as another form of default, albeit spread out over many years. Over time, the US dollar has lost approximately of its purchasing power since the establishment of the Federal Reserve in 1913. While the dollar remains an effective medium of exchange, it has proven to be a poor long-term store of value due to the erosion of its purchasing power through inflation.

If spending is not controlled, the government will find one way or another of making ends meet, and all too often it is the consumer who foots the bill.

[ edited this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post What You Need to Know About the Debt Ceiling appeared first on 51�Թ�.

What is money?

Money is defined as a medium that fulfills at least three conditions:

1. Medium of exchange. Instead of bartering chicken against wheelbarrows, we can use the money for intermediation, which reduces friction and facilitates trade.
2. Store of value. Money should not be perishable. Ice cream would be a terrible store of value. Same for air since air is abundant. Gold is a good store of value.
3. Unit of account. A collector of classic cars might boast about the number of vehicles he owns, but it might not mean much to a farmer who measures his wealth in acres of land. However, most can relate to the value of things expressed in dollars.

Before the advent of paper money, people used gold coins as a medium of exchange. Unlike paper money, which is just ink on paper, a gold coin has tangible value and is easily understood. However, carrying around heavy coins was inconvenient and risky. The introduction of paper money was a game-changer as it provided a lightweight and convenient alternative to gold coins. In 1971, the was abandoned, and paper money became detached from its physical backing. Today, money is merely a social construct, and its value is based on our collective agreement. Despite being intangible, it is a powerful tool that enables trade and economic growth.

The rise of electronic banking has brought about the concept of digital money, which takes the abstraction of money to a whole new level. While we traditionally associate money with its physical representation as cash, the truth is that most of the money exists purely in digital form, represented by strings of zeros and ones stored on computer servers. In fact, only a tiny fraction of the money supply in the United States is in the form of physical cash, with estimates suggesting that only around 1-2% is available domestically. The sheer scale of digital money is staggering, with the in the US amounting to a staggering $93 trillion, compared to just $2.3 trillion in.

Pokémon Theory of Money

To illustrate how our monetary system works, let’s use an analogy with Pokémon cards. Pokémon trading cards were first introduced in 1996 in Japan and have since been sold more than times worldwide. Let’s assume all Pokémon cards are equally common and different designs equally distributed. While the production cost of each card is just a few cents, they are sold to the public for $1, much like how our paper currency is printed at a very low cost but has a much higher face value. These cards have almost zero material value, being made of cardboard and ink, just like our dollar bills. In this analogy, the company that produces the Pokémon cards represents the central bank, whose role is to serve the public by supplying currency. The central bank manages the production of cards so that the market isn’t flooded with them, which would cause the value of each card to plummet. Instead, they aim to produce enough cards for new players to accumulate, while maintaining the overall value of each card.

Pokémon exist in the digital world, too. Players can collect Pokémon through an electronic game by either finding them by chance or completing in-game tasks. Motivated by the game’s popularity, certain private companies have entered into a license agreement with the CPC (“Central Pokémon Company”) to produce digital Pokémon. These companies function like commercial banks, creating only digital representations of the Pokémon. However, players can still exchange their digital Pokémon for real cards if they wish. Private banks hold a certain stash of physical cards in their vaults for this purpose.

Some players wish to borrow digital Pokémon for business purposes. The creation of those Pokémon happens via double-entry in the bank’s books – as an asset and a liability. The bank records Pokémon on loan to the customer as an asset. Simultaneously, the bank records the same Pokémon as a liability since it was also credited to the customer’s online wallet. The customer can now either exchange his Pokémon into a real card or send it from his account to other players in digital form.

Private banks create additional digital Pokémon out of “thin air” with a keystroke on a computer. Most players do not understand this feature, wrongly believing the bank was dependent on other players depositing their Pokémon cards first.

As a result, digital Pokémon exist in two forms – as an asset and as a liability – each complementing the other like yin and yang.

No money without debt

This is exactly how our monetary system works. It is impossible to create money without creating the same amount of debt at the same time. This has various important implications:

1. Growing the amount of money available requires growth of debt.
2. For someone to save, someone else must go deeper into debt.
3. Your savings are only as good as the corresponding debt.

What does that mean for your money in the bank?

Your bank deposit – what we call “money” in the bank, represents a liability for the bank. In case the bank becomes insolvent, you are only entitled to what is left over after liquidation. Which in many cases would be little. Therefore, deposits are usually guaranteed by some form of insurance ($250,000 per account in the US).

Players know that they can individually exchange their digital Pokémon into real cards at any time. They are (mostly) aware that, in aggregate, not enough real cards exist in case every player tries to exchange at once.

The bank keeps a limited stash of real cards on hand based on estimates of average customer requests for exchange. In case of larger exchange requests, the bank orders a shipment of additional Pokémon cards from the CPC, which arrives in armored trucks. The bank pays for the shipment by having the amount deducted from its account with the CPC.

Social media accelerates bank runs

A bank run can occur when customers rush to exchange their digital Pokémon into real cards simultaneously. In such a situation, the bank might not have enough real cards to honor all requests, leading to potential losses for customers. Customers with deposits below the insurance limit need not worry as they are protected by some form of insurance, such as the FDIC in the US, which insures deposits up to $250,000 per account.

In the event of rumors regarding a troubled bank, customers with large deposits might withdraw funds immediately and transfer them to a supposedly safer financial institution or purchase government-issued securities. Failing to withdraw large deposits could result in financial losses due to lack of insurance coverage. There are almost no negative consequences to withdrawing immediately, while there could be a considerable downside in not doing so. This asymmetry is what often leads to a dangerous and self-fulfilling acceleration of bank runs.

In recent bank failures, such as with Silicon Valley Bank and First Republic Bank, large deposits have been covered even when they exceeded the insurance limit, despite no obligation to do so. While this is a benefit for customers, it weakens the insurance fund, and surviving banks might have to pay higher insurance fees, which they could pass on to their customers.

Deposit insurance guarantees the “peg”

The (DIF) of the Federal Deposit Insurance Corporation (FDIC) had at the end of 2022. amounted to $10 trillion compared to total deposits of $17 trillion. The DIF covers 1.3% of insured and 0.75% of total deposits.

Think of a bank deposit as a stablecoin, with the FDIC guaranteeing the “peg” (making sure the exchange ratio of 1:1 from bank deposits into central bank-issued cash holds). In a bank run, that “peg” gets challenged.

As more US regional banks are running into financial trouble, the cost of making depositors whole rises. A significant decline in assets of the DIF could cause savers to question the “peg” even for insured deposits, which would trigger a bank run on institutions previously deemed safe.

Act now to stop the spread of the banking crisis

To prevent the situation from getting out of control, policymakers must act, and soon. One solution would be to guarantee all deposits regardless of size. This should stop the deposit bleeding at regional banks. However, insurance fees would have to be increased.

A further spread of the banking crisis would make it necessary to cut interest rates, drastically. This could help reduce banks’ losses on fixed-income securities on the asset side and relieve funding stress on the liability side.

Capital markets are already betting on significant cuts in interest rates. The Fed Funds Rate, the US central bank’s main refinancing rate, currently has a target range of 5-5.25%. see this rate in a range of 4-4.25% by the end of the year, with further cuts to 2.75-3.00% by the end of next year.

Large rate cuts could undermine the ability of the Federal Reserve to combat inflation. The central bank might not be able to maintain the stability of both the financial system and the value of money. If forced to choose, it is likely that the survival of the system is more important than tolerating higher inflation.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post The Pokémon Theory of Money and How to Stop Bank Runs appeared first on 51�Թ�.

• $12 trillion is owned by US private investors such as mutual funds, pension funds, banks, and insurance companies.
• $6 trillion is held by the Federal Reserve, the US central bank.
• $7 trillion is owed to US agencies and trusts, such as the Social Security Trust Fund, the Military Retirement Fund and the Medicare Fund.
• $7 trillion has been purchased by foreign holders, with 50% owned by foreign official accounts, i.e. central banks, and 50% by foreign private investors.

Many investors have suffered substantial losses from holdings of long-term US government bonds. As interest rates rose, the prices of existing bonds with lower coupons had to drop in order to make them competitive with newer bonds issued with higher coupons.

The price of too many “high-quality” assets

After the Global Financial Crisis of 2007-08, regulators forced banks to increase their holdings of so-called high-quality liquid assets. These were debt instruments issued by the US government and government-sponsored entities (GSE). 

Banks duly raised their bond holdings from around $1 trillion in 2008-09 to almost in 2022. As interest rates rose, unrealized losses reached in the fourth quarter of 2022, eating into banks’ capital. This directly led to the undercapitalization and collapse of Silicon Valley Bank, the 16th largest bank in the US, in March 2023.

Given recent events, it is doubtful that banks or insurance companies will be willing to absorb large amounts of government debt.

The Federal Reserve is, by far, the largest holder of US government debt, with . As stated earlier, $6 trillion is US government debt. Another $2.4 trillion is debt issued by government sponsored entities (GSEs) like Fannie Mae, Freddie Mac, and Ginnie Mae. Legally, GSE debt isn’t government debt. In reality, the government backs GSEs and, therefore, this is US government debt too. In any case, as interest rates rose, prices of existing bonds declined, causing over $1 trillion inunrealized for the US central bank. Those losses exceed its ($35 billion) by more than 30 times.

Interestingly, the Federal Reserve treats its capital deficiencyas an . The US central bank usually generates large profits, most of which are transferred to the US Treasury. If the Federal Reserve incurs a loss, it would have no profits to remit to the Treasury. It would accumulate what is known as a “deferred asset.” The deferred asset must be reduced to zero before any further transfers to the Treasury can be made.

While the central bank cannot become insolvent, its credibility could still suffer. The Federal Reserve already owns a large share of outstanding government debt. Private investors could question if the prices of such bonds reflected free market forces or whether they were artificially propped up by intervention from one large, price-insensitive buyer.

The balance sheet of the Bank of Japan (BOJ), for example, nowexceeds of the GDP. It ownsmore than of all Japanese Government Bonds (JGB) outstanding. As a result, trading in JGBs has dried up. In October 2022, 10-year JGBs, supposedly among the most liquid bonds, didnot register a single for four consecutive days.

Theoretically, there is no limit to how many government bonds central banks can own. However, they must consider practical issues such as market domination, impact on credibility and liquidity of government bonds when making their purchases.

Apart from the Federal Reserve, another large holder of US government debt is the Social Security Trust Fund. It owns almost of US debt. Since 2021, payouts from the fund have exceeded its income. As per current estimates, the fund will be by the year 2034. This will transform the fund from a buyer to a seller of Treasury securities.

Foreign Central Banks Are Reluctant to Buy More US Treasuries

As of January 2023, foreign investors own of Treasury securities. This represents 23.6% of US government debt.

Among foreign holders, official accounts (central banks, sovereign wealth funds and supra-national organizations) and private investors (corporations, investment funds and individuals) held approximately $3.7 trillion each. 

It is important to note that foreign central banks have not added to their holdings of Treasury securities over the past ten years. In fact, they have now become net sellers. Since June 2021, they have reduced their holdings by $564 billion. This reduction has occurred largely because Japanese and Chinese central banks have sold over $200 billion of US Treasury securities.

Over 80% of the reduction in Japanese holdings occurred in the three-month period from August to October 2022. This coincided with a pronounced weakness in the exchange rate of the Japanese yen, which reached 150 yen per US dollar. If Japan had bought more US treasury securities, it would have released more yen in the market. This increase in the supply of yen would have caused a further fall in the value of the Japanese currency. Therefore, the Japanese Ministry of Finance had no option but to sell US Treasury holdings to raise dollars and then sell these dollars to buy yen. This operation supported the price of the Japanese yen and stopped it from falling further.

Despite growing US-China tensions, the Chinese central bank remains the second-largest foreign holder of US Treasury securities. Now, it has no reason to keep financing US fiscal deficits and, by implication, American military spending. Beijing and Washington are now increasingly hostile to each other and the prospects of a military confrontation have been rising in recent months.

In contrast, the holdings of other countries are not as large as their Asian counterparts. The UK owns $129 billion, Belgium $111 billion and Canada $86 billion. They continue to purchase US securities but cannot fill the gap left by Japan and China.

Over the past two decades, private foreign investors have increased their holdings from a mere $424 billion to $3.7 trillion. This increase occurred because these investors were looking for better returns. Government bonds in Europe and Japan were offering negative yields. Banks and insurance companies purchased US Treasury securities instead.

Norinchukin Bank, a Japanese cooperative for agriculture, fishing, and forestry, once accounted for23% of of all US and European collateralized loan obligations (CLO). As Europe and Japan begin to raise interest rates, investors like Norinchukin Bank no longer have to put all their money into US Treasury securities.

Along with relatively higher interest rates, the strength of the dollar attracted private foreign investors. A strong US dollar helped improve returns for foreign investors over the past 15 years. However, since September 2022, the Dollar Index has lost around 13% of its value. A weaker dollar is eating into returns for foreign investors. Therefore, they are more likely to sell US Treasury securities.

There is another development hurting the US dollar. According to recent announcements, foreign nations are moving away from using the US dollar as the settlement currency for international trade. This makes large holdings of dollars unnecessary, adding further downward pressure on the currency.

Another $19 Trillion in Additional Debt on the Horizon

While the current debt is already high, future debt will be even higher. The (CBO) projects US government spending to increase over the next ten years from $6 trillion to $10 trillion dollars. Of the $3.7 trillion increase during this period, only $533 billion is discretionary spending. The majority of increased spending will be mandatory such as Medicaid, Medicare, Social Security and interest payments on US debt. 

The annual fiscal deficit isforecasted to from $1.3 trillion to $2.7 trillion by 2033. This will increase American debt from $27 trillion to $46 trillion. Someone will have to absorb an additional $19 trillion in debt. The US government raises money by levying tax and issuing debt. The US Treasury Department sells securities through auctions by the so-called. These are large US and international financial institutions. The yield (i.e. return) and the price of the debt depends on investor demand. 

Despite the seemingly open market nature of these auctions, they are designed not to fail. Primary Dealers are required to submit bids in case of a lack of investor demand. Since 2008, Primary Dealers can borrow money from the Federal Reserve through the so-calledPrimary Dealer Credit Facility (). This means that the central bank can effectively finance government debt under the disguise of loans to Primary Dealers.

The most likely outcome of PDCF is an ever-increasing share of government debt held by the central bank. This raises another important question: Can the central bank simply write down its holdings of government bonds, so as to lower government debt? 

Technically, the Federal Reserve could do so. But this would worry other investors if the largest holder of the US debt writes down its value, or worse still, declares it to be zero. This action also would create a large hole in the balance sheet of the Federal Reserve. A big chunk of its assets would evaporate. 

The central bank’s liabilities represent public money—currency in circulation and bank reserves. After a write down, its corresponding assets would not cover those liabilities. This would undermine public confidence in money, leading to potentially destabilizing consequences, including an economic meltdown. With constantly ballooning debt, it is clear that the US is entering tricky waters in the 2020s.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Who Will Buy America’s Debt Now? appeared first on 51�Թ�.

Further,  the price of crude oil—around $80 per barrel, or 42 gallons (159 liters)—makes it one of the cheapest liquids ($1.90 per gallon, 50.3 cents per liter). A liter of San Pellegrino or Coca-Cola costs around $2, four times as much as crude oil. Olive oil costs around $13, vodka $4, a Canon printer black ink $270, Dom Perignon Brut $346, nail polish $777, and Chanel Perfume No.5 $1,173.

Do We Still Need Fossil Fuels?

Despite being relatively and absolutely cheap, significant increases in oil prices regularly wreck economic growth and lead to inflation, as seen in the aftermath of the Russian invasion of Ukraine.

A from 2016 visualizes the comparative size advantage of the global oil market to all other raw materials. Since then, the oil price has risen from $50 to $80 per barrel, and global annual consumption has increased from 94 to 102 million barrels a day. This has resulted in a demand for oil worth $8 billion per day, or roughly $3 trillion annually.

The US consumes roughly barrels per day (mbpd) and produces around. That leaves 90 mbpd of consumption for the rest of the world. Crude oil, like most commodities, is priced in US dollars. When a non-US country wants to import oil, it first needs to acquire dollars to pay for it. Depending on exchange rates, countries can find themselves paying more for the same amount of oil.  Currently, global oil consumption creates a demand for US dollars amounting to $7 billion a day, or $2.6 trillion per year. 

Oil exporting countries cannot simply sell the dollars they receive into local currency. Saudi Arabia, for example, had a current account surplus in the third quarter of 2022 of. Selling those dollars in exchange for Saudi Riyal would lead to a dramatic reduction in the amount of Riyal in circulation, thus pushing up its value. This would threaten to break the currency peg to the US dollar, which has beenfixed at 3.75 per dollar since 1986. Most local currencies of net exporting nations are simply too small to be able to absorb massive dollar inflows.

What to Do with all the Dollars

The dollar proceeds from oil exports continue to pile up. Non-US countries call them foreign exchange reserves, and they are usually seen as positive. However, for the US, this is worrying. Currently, the country is approaching a per year trade deficit. When more money is exiting the US than entering, and imports exceed exports, the trade deficit must expand. 

Until the US resolves its trade deficit, it will continue to export its debt. Its trade partners, in the aggregate, will be forced to purchase treasury securities rather than goods and services. “Foreign official institutions” (for example, central banks and sovereign wealth funds) have amassed nearly in US government debt. Private foreign entities accumulated another. The “net international investment position” (NIIP) of the US- measures the difference between a nation’s stock of foreign assets and a foreigner’s stock of that nation’s assets-  has declined to more than negative, from a mere $2 trillion in 2006.

A negative NIIP means more dividends and interest payments flowing to foreign nations. It is not a coincidence the Swiss National Bank is among the largest shareholders of some US corporations, as mentioned in this article.

Non-US countries are effectively financing the US’ fiscal and trade deficits by purchasing large amounts of debt issued by the Department of Treasury. A large fiscal deficit, in turn, allows the US to spend as much money on itsmilitary than the next ten countries combined. To put it bluntly, some countries pay for the bombs being dropped on the heads of their constituents.

The Problem with Current Account Deficits

Normally, a country with large current account deficits will soon find its currency under pressure. In a system of freely floating exchange rates, import prices would rise, volume would reduce, and exports would boost due to heightened competition. The trade deficit would therefore shrink.

The longer a country runs a current account deficit, the greater the likelihood of a debt crisis. Many non-US countries rely on dollar-denominated debt for funding. A decline in local currency makes those dollars more expensive to service, often making debt restructuring necessary.

In the case of the US, this does not happen, as it has virtually no debt in foreign currency, and can always “print” more of its own currency to repay foreign debt. Due to the status of the dollar as the world’s reserve currency and “involuntary” accumulation, the normal exchange rate mechanism does not work. The US can keep running current account (and fiscal) deficits with impunity.

According to the Kalecki Profit Equation, named after the Polish economist, the sum of all flows of the three sectors of an economy (government, private and foreign)must balance to . A government running a fiscal deficit will cause a surplus to pop up in either the private sector (households and corporations) or the foreign sector (as a surplus from the viewpoint of foreign countries), or a combination of both. 

Consequently, a foreign sector surplus (as in the case from the US viewpoint) must create a negative US government sector balance (a fiscal deficit). If the government tried to run a balanced budget, the negative sector balance would appear in the private sector, with households being forced to dissave or go deeper into debt, while corporations’ profits would disappear.

Repercussions of Dollar Overvaluation 

The more dollars non-US countries accumulate, the more it appreciates in value. This, in turn, means US consumers pay less for imported goods than they would otherwise, and foreign purchasers, in contrast, overpay. This also translates into a higher standard of living for US residents and a lower one abroad. 

A growing US fiscal deficit implies a growing trade deficit. Under President Reagan’s administration, it was common to hear economists refer to the , as both the fiscal and trade deficits grew considerably. Abroad, this means that workers are forced to produce goods for US consumers in exchange for fiat money. This comes at the detriment of US workers, as production moves to lower-cost countries, thanks in part to an overvalued dollar. Since the 1980s, employment in the US manufacturing sector has declined from almost20 million to 13 today. This, in turn, allowed China to become the world’s leading .

Oil Price as a Threat to Dollar Dominance

The flow and foreign accumulation of dollars depend mainly on two things: the price of oil and the willingness of oil exporters to invoice in dollars.

Lower oil prices equal fewer dollars, which means less recycling of those so-called petrodollars. Cheap oil, therefore, is against US interests and must be kept off the market. It is not a surprise the US has tossed some of the (potentially) largest oil producers, like Russia, Iran, Iraq, and Venezuela, with either war or heavy economic sanctions (Venezuela has the largest proven oil reserves in the world, amounting to almost300 billion ). 

Military adventures in the Middle East have been misunderstood as a fight for oil; in actuality, the purpose has been to suppress supply. A few select nations (e.g. Saudi Arabia) are “allowed” to enjoy full production, albeit in exchange for large orders for US weapons manufacturers and a promise to not sell oil in any other currency than dollars.

Proponents of selling oil in euros (such as Saddam Hussein, former President of Iraq) or against a gold-backed pan-African currency (Muammar Gaddafi, former leader of Libya) have been removed.

Threat from Energy Transition to Alternatives 

Given that the dollar’s status as an international reserve currency depends on oil, it should not come as a surprise that the US is vehemently opposed to any form of alternative energy.

President Reagan famously removed solar panels from the White House that had been installed by former President Jimmy Carter in 1979. The panels ended up in a museum in, the world’sleading producer of solar energy (75% world market share), cells (85%), and wafers (97%).

In 2017, legislators in the state of Wyoming, which generates 90% of its energy from coal, introduced a to prevent Wyoming utilities from selling electricity generated by wind or solar farms. In 2021, the same statetabled a that would ban the sale of electric vehicles by the year 2035. 

Texasbanned government from doing business with financial firms that won’t invest in fossil fuels and firearms. The state also banned several asset management like UBS, Credit Suisse, and Blackrock for violating ESG (Environmental, Social, and Governance) guidelines. The Retirement System of Texas, with $183 billion of assets under management, is among the top five public pension systems in the US. The US has spent enormous funds to become energy independent and a net exporter of energy. But though renewable energy is growing fast, it will take even longer for the country- once considered the leader in science and innovation- to cut its overreliance on fossil fuels. 

In today’s global commerce, fossil fuels offer less value and more unfavorable terms of trade, of the kinds often found in emerging economies. Former Saudi oil minister Sheik Yamanifamously , “the Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.” As the sun sets on the Oil Age, the days of the dollar as the anchor of the international monetary system seem numbered.

[Naveed Ahsan edited this article.]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Oil Now Makes Our Dollar-Based Global Economy Inflammable appeared first on 51�Թ�.

Let us examine the potential culprits one by one.

The Federal Reserve

In an with YouTube channel Blockworks Macro, Chris Whalen, an investment banker and author, puts the blame for SVB’s failure at the footsteps of the Federal Reserve, the US central bank. He argues that long periods of near-zero interest rates forced management to venture into longer-dated securities to find acceptable yields without compromising the quality of assets. The speed of subsequent increases in rates, the of the past six cycles, led to steep losses on longer-duration bonds. 

While this is certainly true, it is doubtful a central bank should take individual positioning into consideration when deciding on its monetary policy. Unfortunately, rising interest rates usually create casualties, especially after long periods of low rates. Should the fight against inflation, which affects every individual, trump the wish to protect certain institutions against financial harm?

Whalen predicted that the Federal Reserve would cut interest rates in an emergency meeting before financial markets open on Monday morning or face the risk of contagion. Whether that happens or not, it seems Whalen is not entirely right in blaming the Fed for SVB’s collapse.

The Management

Over the past ten years, grew almost tenfold from $38 billion in 2012 to $375 billion in 2022. Inflows in 2021 alone amounted to $137 billion. From a bank’s perspective, client money inflows represent an increase in liabilities. The bank has to do a corresponding transaction on the asset side of its balance sheet, preferably earning an interest rate higher than the one owed to its clients.

During the period of largest inflows, yields in securities considered risk-free, such as, ranged between 0.02% and 0.16%. Management could have chosen to relax standards for loan approvals in order to increase lending to customers. This would have been a recipe for increased credit losses in the future. Low interest rates forced management to venture into bonds with longer maturities in order to achieve acceptable yields on their assets.

Despite such pressures, management does not seem to be able to escape entirely scot-free. �ѴǴǻ��’s has severely downgraded SVB, citing “significant interest rate and asset liability management risks and weak governance.” In hindsight, purchasing hedges against a rise in interest rates would have been beneficial. However, those hedges would have eaten further into margins. Management could be forgiven for dismissing the necessity of hedging after experiencing a decade of interest rates below 2.5%. Yet it is worth investigating shortcomings in governance.

The Customers

Social media are rife with comments demanding “no taxpayer bailout for rich clients” or blaming customers for not being aware of the $250,000 limit of Federal Deposit Insurance Fund (FDIC) insurance per account. Many of SVB’s clients were start-ups in the technology and healthcare sectors. Their deposits at SVB often consisted of capital raised from venture capital firms—money intended to carry them through the first loss-making years. These funds are needed for payroll, rent and other current expenses. Losing them would most likely result in the start-up closing down and laying off all employees.

A bank customer should not be required to study the bank’s balance sheet or be familiar with implications of monetary policy decisions on duration risk. During the 2008-09 financial crisis, the FDIC managed to all depositors of almost 500 failed banks without using a single tax-payer dollar. The same is expected at SVB, especially given the losses incurred seem manageable in relation to its assets.

The Rating Agencies and the Regulators

A news article by titled “Silicon Valley Bank’s demise began with downgrade threat” describes how an imminent downgrade in credit ratings by �ѴǴǻ��’s derailed a plan by SVB to raise $1.75 billion in fresh capital. For legal reasons, investors need to be made aware of significant developments when purchasing newly issued securities. While the news of a looming downgrade certainly scared off any potential investors, it would be unfair to blame rating agencies for the demise of the bank.

Following the 2008-09 crisis, banking supervision has become stricter.Bankers regularly how stringent regulation hampers their operations. “Where Were The Regulators When SVB Crashed” the The Wall Street Journal. The article raises valid questions yet it is important to note that regulations require banks to hold a certain percentage of assets in so-called “High Quality Liquid Assets.” These can be quickly turned into cash if depositors want to withdraw funds, which is exactly what SVB did. Its losses did not stem from bad credits or investments in low quality assets, but from unrealized losses on high-quality bonds.

Regulations cannot foresee every business decision any bank might take. Banking is already one of the most regulated industries and more regulations do not seem to be the answer.

The Crypto Bros and the Short Sellers

Bitcoin advocates were quick to celebrate the demise of SVB as a sign thecurrent fiat money system was about to . Meanwhile, Circle Internet Financial, the issuer of stablecoin USDC, confirmed having out of $40 billion dollars of its reserves stuck at SVB. This revelation led to turmoil in the market of stablecoins, withUSDC breaking its . It is not without irony that crypto still depends on traditional banking—the system it seeks to liberate its followers from—only to get caught with funds in said system, leading to a bank run on its stablecoin.

Stablecoin reserves are hard to manage since withdrawal could be required in a short period of time. Many banks refuse deposits from stable coin operators for exactly this reason apart from legal considerations.

As usual, short sellers are blamed for driving down the stock price of a failed company. However, short sellers analyze companies in depth and are well informed. Rising short interest (number of shares sold short) is often an indication of trouble brewing. According to an online service, as of February 15, around outstanding were sold short. This is only a slightly elevated figure. If short sellers had any impact on SVB’s share price, it would have been relatively minor.

SVB was Unique

The business model of banking is to borrow short (at low rates) and to lend long (at higher rates). Otherwise, there is no way to accept deposits and make a profit. Net interest margins are slim. It would not make sense to run a bank without leverage. The business model has inherent risks, but those risks are not to be borne by depositors. The depositors themselves are a risk, should they decide to withdraw funds all at once. This is discouraged via the FDIC’s deposit insurance, which has worked very well in the past.

The combination of rapid deposit growth during a low-yield period, lack of lending opportunities, high share of non-insured deposits, and rapidly rising interest rates led to an unfortunate shortfall in risk-bearing capital. Calls on start-ups to their funds were individually rational, but they led, in aggregate, to a bank run and the irrational outcome of the bank being closed.

Containing contagion is important: the stock prices of other regional banks have suffered. Investors are now concerned about unrealized losses on long-duration bonds at other institutions too. In order to prevent increasing mistrust becoming a self-fulfilling prophecy, the Federal Reserve might be forced to stop the fire from spreading by lowering rates or lending against collateral. The fight against inflation might have to take a backseat.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Who Broke the Silicon Valley Bank and What Now appeared first on 51�Թ�.

A previous article by 51�Թ�, “Is The Gold Standard Alive or Dead,” came to the conclusion that a gold standard would be unworkable due to its .  Deflationary bias in terms of gold represents large disadvantages. For example, if a nation backs its currency with the stock of gold, it is faced with the following problem: the stock of gold is around 200,000 tonnes, while produces only about 3,500 tonnes per year. This means that the stock of gold increases by only 1.75% a year. That low growth rate directly dictates the rate at which the money supply in that economy can grow. This would simply not be enough to accommodate population growth and productivity, resulting in a decline in the overall prices of goods and services. So why are central banks, who are surely aware of these limitations to the gold standard, frantically accumulating gold?

A by the 2022 Gold Reserves studied 56 central banks, and provided very interesting insights. When asked which topics they considered relevant for “reserve management decisions”, respondents named “low / negative interest rates” as the number one item (chosen by 91% of respondents), followed by inflation (88%) and geopolitical instability (84%). The fact that “low / negative interest rates” was ranked so highly as an influencer of monetary policy is somewhat ironic, since interest rates are typically controlled by central banks themselves. 

Is the Gold Standard Now Alive or Dead?

The same could be said about inflation, although many experts attribute the 2022 inflationary surge to the unprecedented alloted in response to COVID-19, as well as the persisting supply chain that occurred when countries went into lockdown. When analyzing the survey results concerning factors relevant to the decision of whether or not to hold gold, two common answers by central banks raise eyebrows: (1) “anticipation of changes in the international monetary system” (which 20% of respondents deemed “somewhat relevant”), and (2) as “part of de-dollarization policy” (which 9% of respondents deemed “somewhat relevant”). While these statistics may seem negligible, their responses  are actually quite revolutionary. 

These insights most likely came from central banks in developing countries, and are an expression of concern regarding the stability of our current international monetary system, which is currently dominated by the US dollar. The severe economic placed on Russia in response to its invasion of Ukraine have rendered its dollar reserves useless, a fact which has not gone unnoticed by other countries. As a result, many developing countries are now questioning the continued use of US dollars as reserves.

When asked about the reasons for increasing their gold reserves, 39% stated that they did so “as a buffer against balance of payment crises”, while 34% (up from 13% in 2021) claimed their increases in gold serve as a “backstop for the domestic financial system”.

A crisis is a common occurrence in developing nations, when import costs, to be paid in dollars, exceed the value of export profits over an extended period of time, leading to an overall shortage of dollars.

But can gold really be used as a “backstop for the domestic financial system”?

Is the Reckless Swiss National Bank Endangering Its Independence?

Can gold really jumpstart the economy?

In case of a breakdown of the international monetary system, the primary concern of most governments will be to prevent the collapse of the domestic banking system, as it would lead to widespread economic depression and civil unrest. Commercial banks will be largely insolvent if this occurs, due to devastating credit losses. Central banks would have to extend fresh loans to reliquefy commercial banks, which they could potentially accomplish with gold reserves.

But is there enough gold to back all currency? The answer is surprisingly simple; yes, there is technically always enough gold – it just depends on the price. However, it also depends on what is defined as “money”.

For example, the current outstanding value of US currency (dollar bills and coins) is about. The US government also owns ounces of gold. At the current price of $1,875 per ounce, US gold reserves are worth approximately $490 billion. In order to back all outstanding currency with gold reserves, the price of gold would have to reach $8,800 per ounce, roughly five times higher than it is today.

If gold were to cover all money created by the Federal Reserve (which is equal to its currentliability of ) the price of gold  would have to be upwards of $32,000 per ounce (nearly eighteen times the current price of gold).

If you add to that sum the $17.7 trillion in , the correlating price of gold required would come close to $100,000 per ounce, a practically inconceivable amount compared to today. Furthermore, the widest measure of money in the US,total credit outstanding, has accrued a hefty $92 trillion, which would require a gold price of more than $350,000 per ounce to be fully insured. 

The Reality of Bank Deposits

A bank deposit is a digital token. You cannot take it home. Traditional bank deposits are not issued by a central bank – they are conducted by commercial banks. The moment you walk into a bank and deposit cash, you exchange a central bank’s liability against the liability of a commercial bank. Your counterparty has changed, unbeknown to most.

Bank deposits cannot, in aggregate, be converted into central bank-issued currency, since, as we saw above, the amount of bank deposits ($17.7 trillion) exceeds the amount of available currency ($2.3 trillion) by a factor of eight.

Bank deposits are supposed to match central bank-issued money one-to-one, but with certain limits. In the US, bank deposits are “insured” by the Federal Deposit Insurance Corporation (FDIC) forup to per account. According to theFDIC’s 2021 , the Deposit Insurance Fund (DIF) had assets of $124 billion, or 0.7% of all US bank deposits, a mere drop in the ocean of the $17.7 trillion that Americans have deposited into commercial banks – deposits they will eventually want back. Most people think of bank deposits as “money”, when in fact, they are nothing but (with a very questionable stabilization mechanism).

Central Banks and the Potential of Digital Currency

A functioning monetary system is crucial for any society, so central banks have contingency plans for all kinds of calamities. , the German central bank, hadhidden an entire set of alternate worth 15 billion deutsche mark (approximately $7.5 billion) in the basement of a house camouflaged as a residential villa in the suburbs of Frankfurt. Bank notes with a new design were ready to be exchanged overnight in case the existing ones had been rendered unusable. The list of potential threats included poisoning, nuclear contamination or attempts to derail the economy by mass introduction of counterfeit bank notes.

According to the , awebsite which monitors the status of Central Bank Digital Currency (CBDC) projects across the globe, all major central banks are either in the beginning stages of research or piloting for the introduction of a . The advantages of a retail CBDC for the average user are not immediately clear, but become more evident with further research. 

Most of what we call “money” is digital already. Instant settlement options are being offered by private sector companies (such as Venmo, Zelle, and Cash App), which offer currency for users to trade and distribute that is not backed by a central bank. The massive popularity of these apps have effectively cut time and costs of cross-border transactions across the globe. 

However, a retail CBDC would have one major advantage: being able to offer central bank-issued money directly to users. Currently, the only way for citizens to get access to central bank-issued money is by obtaining cash via a commercial bank. Having a CBDC would allow  central banks in crisis to credit users with new currency, enabling them to bypass commercial banks completely. 

However, for this method to be effective, users would need to establish digital wallets and be comfortable using them. The introduction of CBDC has the potential to resolve many monetary inconveniences. Central banks with gold reserves would be able to offer both partial or full gold-backing for their digital currency. However, countries lacking in gold would not be able to participate in a gold-backed monetary system, and may have to back their currencies with other items, such as government-owned land or the rights to raw materials to be mined in the future.

While unprecedented, combining a 5,000-year store of value (gold) with modern technology (digital currency) could turn out to be just the tool the world needs to reset its monetary system. Once confidence in the novel CBDC system has been established, gold backing could be gradually removed, and the cycle of credit-based monetary expansion could begin anew.

Gold is the anathema to a monetary system. Record gold purchases by central banks are a red flag regarding the stability of our current monetary system. When central banks embrace gold, it is an indicator that they are losing trust in the current system. 

This phenomenon was seen previously during the of 2008, when commercial banks refused to lend each other money on an unsecured basis. Central banks lacking in gold reserves have good reason to increase their holdings, as it could help them establish their own digital currencies and avoid future financial ruin. Historically, central banks tend to prepare for the worst. Will the combination of gold reserves and digital currency be enough to bail us out? We can only wait and see. [ edited this piece]

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post The Great Gold Rush: Central Banks in Frenzy appeared first on 51�Թ�.

Alan Greenspan, former chairman of the Federal Reserve Bank, in a 2016 stated “If we went back to the gold standard as it existed prior to 1913 it would be fun. Remember that the period 1873 to 1913 was one of the most progressive periods economically that we have had in the United States.”

Current chairman Jerome Powell, however,does not a return to the gold standard would be a good idea. Economist John Maynard Keynes famously referred to gold as a “,” which was no longer needed as a backing for currency.

Is the Reckless Swiss National Bank Endangering Its Independence?

READ MORE

What is a gold standard and why is gold valuable?

A is a monetary system where a country’s currency has its value linked to gold. This can be done directly, by setting a fixed price of gold to the dollar, or indirectly, by other currencies setting a fixed price in relation to the dollar, thereby linking indirectly to gold. One could imagine a full gold standard, where 100% of paper money issued must be backed by gold. Another option is a partial backing, covering only a fraction of money supply that is backed by gold. Under the Bretton Woods currency system, only non-US official holders of dollars (i.e. central banks) were able to exchange dollars into gold at the fixed price of $35 per ounce. Private ownership of gold in the US was under President Franklin Delano Roosevelt in 1933. President Ford gold ownership in 1974.

The amount of above-ground gold is limited ( around 200,000 tonnes). The amount of gold contained in ores has been declining as most rich deposits have been exploited. The average grade of gold mines has fallen to. Large amounts of energy are needed (to crush and transport rock, for example), limiting how much gold can be economically mined. Over the past decade, ranged from 2,800–3,600 tonnes, adding less than two percent annually to the stock of gold available.

Pros and cons of a gold standard

The idea behind a gold standard is to ensure a stable currency that is the bedrock of a well-functioning economy. A currency collapse impoverishes large sections of the population. This could lead to political extremism, and, ultimately, threaten democracy. Historians point out how hyperinflation in Germany led to the rise of Nazis.

There are several advantages to a gold standard, which are as follows:

1. Linking the growth of money supply to the growth of gold stocks would keep inflation in check, thereby ensuring monetary stability.
   
2. Government spending would be limited to the amount of tax receipts. Any deficit financing via debt issuance would require additional gold.
   
3. Central banks would be immune from political pressure as the amount of money in circulation is determined by gold.

However, there are considerable drawbacks, which are as follows:

1. Under a gold standard, growth of money in circulation would be severely restricted and could suffocate economic growth.
   
2. Fixed supply of money would be deflationary, and most likely lead to a period of depression with bankruptcies and high unemployment.
   
3. The expansion of money supply would depend on successful gold mining operations and continued investment in exploration of new deposits.
   
4. Gold standards in the past might only have worked because the stock of existing gold was much lower. So an increase in the stock of gold was possible. The of gold stock between 1900 and 1909 would be impossible to repeat today.
   
5. Policy makers would be unable to respond to economic shocks.
   
6. Not all countries have equal access to gold for lack of gold mines or existing reserves.
   
7. International trade deficits, if settled in gold, would, over time, lead to a depletion of gold reserves, leading to a balance of payments crisis coupled with the inability to pay for critical imports.
   
8. In the (unlikely) event that the amount of gold available would allow for additional debt to be issued, who would be entitled to do so? The government? Banks? Households? Who would decide on who has access to fresh debt?

The problem with a gold standard

In August 1971, US President Richard Nixon “temporarily” the convertibility of the US dollar into gold, effectively ending the gold standard. Since then, the total amount ofUS dollar debt has increased from $1.6 billion to $92 trillion — an annual expansion rate of 8%. During the same time, gross domestic product () has grown from $1.1 billion to $25.7 trillion, an annual increase of 5.8%. Debt, synonymous with “money,” is growing faster than GDP.

Most economic activity is dependent on the availability of credit. An increase of average rates in the US from 2.7% at the end of 2020 to over 7% in October 2022 has led to a decrease in from 6.5 million to 4.1 million, a 36% reduction. Potential homeowners without access to debt would have to accumulate the entire purchase price through savings for an “all-cash” deal, which would exclude most people from being able to afford a home in their lifetime.

Proponents often counter that a gold standard could be flexible, with adjustments of the amount of gold backing (downwards) or the price of gold (upwards, hence devaluing the currency) as necessary. But how would that be different from the current system? A flexible gold standard would let imbalances accumulate over time, require large adjustments, introduce speculation, financial friction, and potentially unintended consequences. The cure could turn out to be worse than the disease.

The current monetary system is unsustainable

The current fiat monetary system seems unsustainable in the long run, for mathematical reasons. 

First, it is impossible to create money without simultaneously creating an equal amount of debt. The current system is “damned” to increase debt continuously to enable the economy to grow. Given positive interest rates, debt with interest owed is an exponential function (interest on interest in subsequent periods), which is a problem in a world of finite resources.

Second, the marginal utility of debt has decreased as debt levels increased. Since 2007, US increased by $11 trillion, while the amount of grew by $40 trillion. In other words, an additional dollar of debt generates only 27 cents of additional GDP. Interest on debt is owed annually (and increases the debt pile), while GDP resets on January 1^st to zero. It gets harder and harder to generate additional GDP with additional debt.

Third, the amount of interest due on rising debt levels is reaching dangerous levels. According to the Institute of International Finance (IIF), theglobal ratio of stands at 343%. If we (generously) assume an interest rate of three percent, more than 10% of GDP is siphoned off the economy for interest payments – every year. This does not even include repayment of principal.

Is return to the gold standard inevitable?

Would a crisis or collapse in the current system open the way for a return to the gold standard? Central banks, while denying gold had any monetary function, still holdmore than of gold valued at more than $2 trillion at current market prices ($1,838 per ounce; 1 metric tonne = 32,150.75 troy ounces). Central banks reduced their gold holdings from 1968 to 2008. Interestingly, gold sales ceased after the “Great Financial Crisis” of 2008/9, and central banks began purchasing between 250 and 750 tonnes annually.

Over the past two decades, purchases have been led by countries mostly outside the Organisation for Economic Co-operation and Development (OECD ), led by Russia (1,875 tonnes), China (1,447 tonnes), India (428 tonnes), Turkey (373 tonnes) and Kazakhstan (324 tonnes).

In absolute terms, the largest holders of gold are the US (8,133 tonnes), Germany (3,355 tonnes), the International Monetary Fund (IMF), (2,814 tonnes), Italy (2,452 tonnes) and France (2,437 tonnes), mostly “old world” countries. Members of the euro-area, including the European Central Bank (ECB ), hold a combined 10,771 tonnes. But none of those countries are adding to their holdings, since doing so could signal to markets a dwindling confidence in their own currencies. Emerging market economies have, in absolute terms and relative to GDP, to catch up to developed ones.

The advantage of gold holdings is evident: in a currency crisis, a central bank could arbitrarily set a (dramatically increased) gold price, thereby realizing a large revaluation gain on existing gold holdings. Euro-area central banks could, for example, by raising the price of gold ten-fold, generate a book gain of roughly 6 trillion euros. In a recent interview, Klaas Knot, Governor of the Central Bank of the Netherlands, suggested as a tool to remedy any solvency crisis.

As a bonus, gold revaluation would lead to windfall profits at private owners, potentially providing consumers with a boost in otherwise dire economic circumstances. According to reports, German citizens privately than the Bundesbank, �ұ�������Բ�’s central bank.

For the US, the outcome is less clear. Data on private ownership of gold in the US is not available. The Federal Reserve, unbeknown to most, does not own any gold. The Gold Reserve Act of 1934 required it to all of its gold to the Treasury. In exchange, the Fed received a “non-redeemable gold certificate,” valued at the “statuary” gold price of $42.22 per ounce, a fraction of today’s market price ($1,838 per ounce). The Fed is “owed”, but only at the book value of, due to the gold price of $42.22.More than 75% of US gold is actually controlled by the military, as it is stored at West Point and Fort Knox.

The European Central Bank (ECB), on the other hand, values its gold at market prices (currently worth around, about $633 billion), listing it above all other assets. The ECB is free to sell or buy gold in the market.

The Federal Reserve cannot sell any gold since it does not own any. It might also have difficulties buying gold at market prices since this would, due to the above-mentioned mandatory gold price of $42.22, create an immediate loss on the position.

The Fed’s hands are tied regarding gold. As the issuer of the world’s reserve currency, demonetizing gold was necessary for the dollar to replace gold as prime reserve asset for central banks around the world.

This reveals a fundamental rift across the Atlantic Ocean: European central bankers are, albeit covertly, gold-friendly, the Federal Reserve is not. The former is ready to use gold as a tool to recapitalize its central bank (and subsequently commercial banks), while the latter is not.

In case of a break-down of the current monetary system, an international conference (akin to Bretton Woods) would unlikely be able to agree on a common position on the role of gold. This would signify the end of the dollar as the world’s reserve currency. In the ensuing turmoil, market participants would value currencies issued by central banks with sufficient gold holdings. Central banks will not revert to a gold standard, given before mentioned disadvantages, but use their revalued holdings to restore confidence in the continued use of paper currencies.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Is the Gold Standard Now Alive or Dead? appeared first on 51�Թ�.

How to lose 1/6th of GDP

The loss is almost entirely due to . Around half of the losses of $74 billion (CHF 70 billion) came from . As global bond prices fell, so did the value of these securities. Another $57 billion (CHF 54 billion) came from losses in , among them many US technology stocks. The loss wiped out almost three quarters of the bank’s equity. How did we get here?

In March 2009, the SNB began to purchase euros to stop the rise of the Swiss franc. The mission failed, as the euro continued to fall against the Swiss franc (from 1.46 to 1.26). Within two years, investments in foreign currency mushroomed from $50 billion () to $216 billion () by the end of 2010. That year, the SNB lost $27 billion () on foreign investments. Early that year, newspapers such as der SNB warned of “concentrated risks” and “harsh losses” due to outsized positions in foreign currency.

Doubling down

On September 6, 2011, the SNB that it would “set minimum exchange rate at CHF 1.20 per euro” as “the current massive overvaluation of the Swiss franc poses an acute threat to the Swiss economy and carries the risk of a deflationary development”. It announced, “With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities”.

Foreign exchange markets are characterized by enormous trading volumes. An average of are traded per day. This number is ten times larger than the annual Swiss GDP. Central banks have attempted many times to influence exchange rates. Most attempts have failed. To be fair, some succeeded such as the to weaken the dollar and the to stop its decline. Note that successful attempts always involved multiple central banks.

Unfortunately, the SNB took its decision unilaterally, without help from the European Central Bank (ECB). The ECB a statement it had “taken note of this decision, which has been taken by the Swiss National Bank under its responsibility”. This is central banker speak for “good luck – you are on your own”.

The Swiss franc’s of world currency reserves is less than 3%. It was pure hubris to think the SNB could manipulate the exchange rate of the Swiss franc given how much larger the euro (20%) and US dollar (60%) happen to be.

Did SNB contribute to negative German yields?

For the SNB, a dilemma presented itself: what to do with all the euros purchased? Remember, this was in the middle of the euro crisis. Greek government bonds were yielding over 20% but they were risky. Losing money on such bonds would have looked terrible. Therefore, German government bonds were the go-to solution. This helped drive German government bond yields even lower, increasing the spread to “peripheral” sovereign issuers — the so-called PIIGS; Portugal, Italy, Ireland, Greece, Spain.

Understandably, the ECB was not particularly happy about Swiss purchases of German government bonds. And it led to another problem: acquiring German government bonds at negative yields would effectively be a transfer of wealth from the Swiss to the German taxpayer.

This forced the SNB to venture into other currencies still offering positive yields, like the US dollar, and, by extension, US stocks. At the end of 2021, its exceeded $11 billion in Apple, $9 billion in Microsoft, $5 billion in Amazon and $3 billion each in Tesla, Alphabet A (formerly Google), Alphabet B and Meta (formerly Facebook). In total, the SNB owned 2,719 different US stocks worth $166 billion, a sum of $19,000 per Swiss inhabitant. Among earlier were also 1.8 million shares of Valeant, a healthcare company that turned out to be an accounting fraud, which subsequently saw its stock price fall from over $260 to below $10.

Should a central bank invest in foreign assets?

A central bank generates seigniorage gains by pushing zero-yielding currency into circulation while investing the proceeds in assets, usually bonds, carrying a positive return. If your counterparty is domestic, the transfer of assets stays “within the country.” Some income is being transferred from those domestic counterparts to the central bank. The central bank makes a profit, pays salaries, and transfers the rest to the government. It’s a kind of tax.

Indian Equities, Global Markets: What Is the Story?

READ MORE

But if you do the same with non-domestic counterparties you are “taxing” other countries’ citizens. US shares purchased by the SNB are not available to other investors or, if they are, then only at a higher price. Perhaps the SNB even contributed to the bubble in technology stocks. Because the SNB was forced to invest its euros and dollars it became what is called a price-insensitive buyer. It had to buy something with the money printed. Price-insensitive participants distort market prices. When an individual distorts markets, he will go to jail. Central bankers face no such consequences.

Negative effects on large-scale purchases of foreign currency are not limited to the asset side of the balance sheet. For every euro, dollar or yen purchased, the SNB sold a corresponding amount of Swiss franc, thereby increasing the amount in circulation dramatically. Such a move, if left unsterilized, can provide the kindling for inflation driven by monetary expansion.

SNB meets Waterloo, causing chaos in markets and billions of losses

Despite massive interventions the SNB was unable to prevent the Swiss franc from strengthening against the euro. By the end of 2014, its foreign currency investments had mushroomed to $540 billion (, or 76% of GDP. On January 15, 2015, the SNB had to its 1.20 CHF/EUR exchange rate barrier it had vowed to defend with “”.

Sultan Recep Tayyip Erdoğan’s Erdonomics is Driving Turkey to Disaster

READ MORE

The announcement occurred during European trading hours (10:30am CET) on a Thursday. The Swiss currency briefly by a staggering 40% against the euro. Postfinance (Swiss postal bank) had to foreign currency trading for its customers. Swiss stocks the most in 25years. Shares of lost 23% on rumors of currency losses. FXCM, the largest US retail FX broker, needed a cash infusion after customers were unable to repay losses incurred. Citigroup, Deutsche Bank and Barclays lost a combined . Everest Capital, a hedge fund, lost virtually all its as it had bet on the Swiss franc to weaken. Homeowners in , and were thrown into financial trouble as they had taken out mortgages in Swiss francs to benefit from low interest rates. Swiss franc-denominated loans accounted for 15% to 35% of total mortgages in those countries.

Could not wait for the weekend

Market-moving decisions are usually released on weekends, when all financial markets are closed, allowing investors enough time to analyze the news. Publishing a dramatic decision in the middle of a trading day is highly unusual and unprofessional. What could have convinced the SNB to do so, nevertheless? The weekend was only one day away. Why couldn’t the release wait, given the mayhem it was bound to cause?

The most likely explanation is that the imminent publication had leaked. Swiss franc futures contracts traded in Chicago show a suspicious burst of activity 39 minutes before the announcement. On the following Monday, Christine Lagarde, then the managing director of the International Monetary Fund, that “very few people were informed of the move ahead of time. My understanding is that very, very, very few people were informed ahead of anything.” It seems that some of those people used inside information for personal gain. Once a leak occurred, rumors would have started flying, and the SNB would have been asked to comment. This would have forced their hand to immediately release the fateful statement.

“Poor advertisement for Swiss reliability” a story in The Financial Times. The entire episode does not shine a good light on the SNB. In addition, no lessons seem to have been learned, as the balance sheet continued to grow after this debacle. At the end of 2021, the SNB’s balance sheet exceeded $1.1 trillion , equal to 144% of GDP. Foreign currency investments of around 130% of GDP, and 30% in foreign stocks, can hardly be described as prudent. In of balance sheet size relative to GDP the SNB exceeds the Bank of Japan (129%), the European Central Bank (67%), the US Federal Reserve (34%) and the People’s Bank of China (32%).A large balance sheet relative to the GDP limits potential future moves in case of economic or monetary turmoil. It also amplifies losses. The SNB’s is to “act in accordance with the interests of the country as a whole. Its primary goal is to ensure price stability.” Engaging in failed currency and balance sheet adventures on a massive scale seems contradictory to its mandate. The supervisory board of the SNB should put an end to this casino mentality, or risk losing the independence of the Swiss central bank.

The views expressed in this article are the author’s own and do not necessarily reflect 51�Թ�’s editorial policy.

The post Is the Reckless Swiss National Bank Endangering Its Independence? appeared first on 51�Թ�.