Why a "Crypto-Yuan" Won't Threaten the Dollar | Daniel Lacalle (2024)

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The recent acceleration of inflation in the U.S. has undoubtedly caused most Delawareans to see the difference between nominal or money income and real income or what their income actually buys. The loss in purchasing power of Delaware households because of inflation is compounded by the fact that Delaware, like several other states, has a progressive income tax and doesn’t adjust its income tax brackets for inflation.

Delaware’s income tax brackets have remained the same since 1999. So, when nominal household incomes rise, those incomes are taxed at higher rates. This in turn results in lower disposable household incomes. This phenomenon is referred to as “bracket creep.” The loss in real income or purchasing power because of bracket creep is in addition to any loss in real income that results if the rate of inflation exceeds the increase in nominal income.

In this essay, I examine the extent of bracket creep in Delaware between 1999 and 2019 and then review the implications of this bracket creep. Figure 1 shows the change in the price level as measured by the U.S. Consumer Price Index (CPI), the mean Delaware Adjusted Gross Income (MEAN AGI), and the revenue generated by the Delaware income tax (Tax Revenue) for the period 1999-2019. All variables are index values expressed as percentages of their respective 1999 values.

The data in Figure 1 indicate that the mean adjusted gross income over the period 1999-2019 increased at an annual rate of 1.79 percent or by 45 percent over the entire period. This was less than the rise in the consumer price index which increased at an annual rate of 2.06 percent or by 53 percent over the entire period. Hence, the mean adjusted gross income failed to keep up with inflation, resulting in a loss in the purchasing power of Delaware taxpayers.

This loss in purchasing power was further diminished by the increase in personal income tax rates as households were pushed into higher tax brackets by inflation. While the real average adjusted gross income of Delaware households declined over the period, the tax revenue generated by the personal income tax increased by an average annual rate of 3.31 percent and nearly doubled over the period 1999-2019. In other words, the state of Delaware was able to nearly double its revenue from the income tax without legislating any tax increases.

Sources: Data for the mean adjusted income (Mean AGI) are from the Federal Reserve Bank of St. Louis (https://fred.stlouisfed.org/series/MEANAGIDE10A052NCEN). Data for the Consumer Price Index are annual data for all urban consumers and are from the Bureau of Labor Statistics (https://www.bls.gov/) and data for the tax revenue are from the Delaware Division of Revenue.

Table 1 shows the impact that adjusting the tax brackets annually for inflation would have had on the tax liability of households with varying levels of taxable income for the year 2019. Column 4 of the table denotes the percentage by which the tax liability for households with varying levels of taxable income would have declined in 2019 if the tax brackets had been adjusted for inflation.

The data in table 1 clearly indicate that the failure to adjust tax brackets for inflation results in lower after-tax incomes for households at all levels of income. However, the most adverse effects are felt by households which had incomes of $30,000 or less in 2019.

Bracket creep creates a number of problems. First, it results in a loss in the purchasing power of taxpayers which reduces the amount of income available for savings and capital investment in the private sector. As the Austrian economist Ludwig von Mises noted "progressive taxation of income and profits means that precisely those parts of the income which people would have saved and invested are taxed away." This in turn leads to a decline in the rate of economic growth and a lower standard of living for future generations.

In addition, bracket creep requires taxpayers to pay a higher percentage of their incomes in taxes without requiring any action by the state. Instead of forthrightly increasing taxes, the state relies on inflation to push households into higher tax brackets in order to increase tax revenue and the size of government. As Thorndike noted bracket creep is “a convenient way to raise more revenue—painful for the hapless taxpayers but painless for the gutless lawmakers.”

Higher income tax rates also incentivize higher income individuals and households to migrate to lower tax states. In fact, an increasing number of states are lowering or eliminating their income taxes to stem out-migration and spur in-migration and economic growth.

Finally, since higher income households are already in the highest tax bracket, bracket creep tends to make the after-tax income distribution more unequal as lower income households are pushed into higher tax brackets over time. It also discourages less skilled lower income workers from entering the workforce, resulting in lower labor force participation rates. This negative effect is particularly important for a state like Delaware because of its relatively low labor force participation rate. Delaware’s labor force participation rate of 60.2 percent in December of 2022 was in the lowest quartile of U.S. states. Given this, it behooves Delaware to look for ways to incentivize, not disincentivize, higher labor force participation rates.

It's time for Delaware to adjust its income tax brackets for inflation each year to prevent the negative consequences of bracket creep. If the executive and legislative branches of Delaware’s government want to take more of the taxpayers’ money, they should be required to do so by transparently raising tax rates. This is not such a novel concept. Even the U.S. Congress recognized how deceitful the use of bracket creep was as a means of raising revenue. As a result, in 1981, it voted to pass President Reagan’s Economic Recovery Tax Act which included a provision to adjust tax brackets for inflation.

Tennessee Gov. Bill Lee has signed a measure into law that would empower the State Treasurer to invest state funds in physical gold and silver.

House Bill 1479, introduced by Rep. Bud Hulsey, passed out of the House of Representatives on Monday with a 98-0 vote. A week later, the same bill received a 33-0 vote in the Senate.

In an exclusive comment to the Sound Money Defense League, Rep. Hulsey said, “Gold and silver have been real currency for the past 5000 years. [Passing HB 1479] not only provides a hedge for the State, but gives us varied options while facing a shrinking dollar and the threat of CBDC’s.”

Passing with strong grassroots support and backing from the Sound Money Defense League and Money Metals Exchange, the bill defines “bullion” and “specie” and provides that “subject to appropriation, the state treasurer may purchase and sell gold or precious metal bullion or specie that will be directly owned by the state, and in the custody of the state treasurer.”

Additionally, the twin bills would allow the state treasurer to “make and enter into contracts, trust instruments, agreements, and other instruments with a person to effectuate this section, including, but not limited to, financial institutions, accountants, auditors, attorneys, consultants, and other contractors.”

Lastly, the measure calls for “physical gold and precious metal purchased under these acts to be custodied by the state treasurer in a state depository, and maintained in a vault within the state depository's banking facilities in accordance with accepted industry standards for secure storage, and within the geographical boundaries of Tennessee.”

States that help set up the infrastructure to protect state funds with the monetary metals will help further to bring gold and silver into use as an alternative to the inflationary paper-money system, as well as buttressing state funds, many of which are invested in risky paper assets.

Rep. Hulsey continues to be a powerful voice for sound money in Tennessee, earning him the 2022Sound Money Legislator of the Yearaward last year for his tireless work on eliminatingTennessee's state sales tax on gold and silver.

After ending the state sales tax on gold and silver, Tennessee shot up the 2023 Sound Money Index rankings to earn a 9^th place finish. Tennessee also recently ended its state income tax on sales of all capital assets, including gold and silver.

Several other states are considering their own sound money bills this month, includingAlaska, Idaho, Maine,Missouri,Mississippi,South Carolina,Vermont, Iowa, Kentucky, Oregon, and more.

At the Austrian Economic Research Conference (AERC 2023) event in Auburn, Alabama, behind a wooden podium once used by Ludwig von Mises, I presented my paper: The Instability of Stablecoins.

Whether it’s called a pyramid, ponzi, shell game, or a grand delusion containing fraudulent elements, there’s something peculiar going on in the stablecoin industry; almost too familiar, and it requires explanation...

As of time of writing, CoinMarketCap shows the top three stablecoins by market cap being: Tether (USDT), USD Coin (USDC), and Binance USD (BUSD), valued at $79 billion, $33 billion, and $8 billion respectively.

These stablecoins work as follows:

You have $100 USD. You deposit this money with the Circle company (operator of USD Coin). In exchange, they create 100 USDC coins and give them to you. You are now free to use the coins at your discretion by holding them in a digital wallet, depositing on a crypto exchange, sending to friends, or making purchases online at participating retailers.

“Stability you can trust,” is a heading on USDC’s website, as explained:

Known as a fully-reserved stablecoin, every digital dollar of USDC on the internet is100% backedby cash and short-dated U.S. treasuries, so that it’s always redeemable 1:1 for U.S. dollars. USDC reserves are held in the custody and management of leading U.S. financial institutions, including BlackRock and BNY Mellon.

They didn’t include Silicon Valley Bank as a leading institution, but more on that in a moment.

Tether and Binance tout similar claims. According to Tether’s main page:

All Tether tokens (USD₮) are pegged at 1-to-1 with a matching fiat currency and are backed 100% by Tether’s reserves.

According to Binance’s main page:

All reserves are held 100% in cash and cash equivalents; hence customer funds are always available for 1:1 redemption.

Sounds promising! The depositors simply exchange US dollars for newly minted stablecoins, supposedly always redeemable, on demand at a rate of 1:1 with US dollars. Hence the term stablecoins.

The natural due diligence to follow is to examine each company’s reserves to see what exactly comprises their asset base. Here’s Tether Holdings Limited Independent Auditor’s Report on the Consolidated Reserves Report, as of December 31, 2022.

Unfortunately no footnotes were provided that elaborate on what comprises Corporate Bonds, Funds & Precious Metals, Other Investments, or Secured Loans. However, readers should see the potential problem, which, Dr. Jonathan Newman recently articulated when referring to the banking sector:

When banks practice this kind of maturity mismatch—potentially immediate-term liabilities (deposits) backed by long-term assets (loans and Treasury securities), it is called “fractional reserve banking.”

The propensity for there to be a “run” on a stablecoin or discounting the price below 1:1 on the US Dollar should be considered an ever-present threat.

During the week of AERC, the banking crisis dominated news headlines. After a tumultuous weekend, on Monday, March 13 CNBC wrote:

Last week Circle said that $3.3 billion of its cash reserve is with SVB. After the bank’s collapse,USDC lost its $1 peg, falling as low as 86 cents on Saturday, according to CoinDesk data.

Despite the Fed not being in the business of bailing out stablecoin operators, USDC coin was saved because the Fed unveiled a multi-billion dollar bailout for collapsing banks. The intervention secured USDC’s cash reserve and the coin went back to par with the US Dollar.

Yet the pyramid is still being built!

As illustrated through BlockFi, a crypto exchange that filed Chapter 11 as of November 28, 2022, who once paid interest on stablecoin deposits just like a checking or savings account, customers could deposit their USDC at BlockFi and earn a rate of interest.

Unfortunately, these weren’t term deposits, as the fine print details:

You may make a request for complete or partial withdrawal of principal from your Crypto Interest Account at any time.

Once again there exists the same maturity mismatch between liabilities (customer’s stablecoins) due on demand against what could only be longer dated assets (e.g., US treasuries) providing interest income to BlockFi… until the scheme imploded.

In a world full of hope and desperation, in which demand deposits have become a risky endeavor, this offers very little confidence; first we must hope the crypto exchange can honor the deposit, then that the stablecoin company can honor the deposit… and in 2023 we must now hope the bank can honor the deposit!

Stablecoins offer valuable insights into how a truly free banking system could look; understanding that in a truly free banking system, there would be no bailouts. While lots can be said about stablecoins, the real systemic threat doesn’t lie within these private companies voluntarily offering services to customers. Rather, the real instability will come from an involuntary, legal tender, forced upon society – stablecoin – known as a Central Bank Digital Currency (CBDC)... Coming soon whether we like it or not.

Leave it to the Federal Reserve to throw a knuckleball when the batter is expecting a fastball. These last few weeks have been just that, with the Fed saying nothing of abandoning their Quantitative Tightening (QT) position while engaging in what appears to be a Quantitative Easing (QE) position.

The general public may be familiar with the term QE, but it’s nothing more than inflationism as public policy, with known detriments as old as money itself. But inflationism or currency debasem*nt doesn’t sound as appealing as Quantitative Easing, and so selling economic destruction as a cure-all is more of a successful branding initiative than anything else.

In the last two weeks, the Fed has almost completely undone a year of balance sheet wind down, conjuring up $400 billion as of last Thursday’s data release.

The problem is that QE or QT is not “economics” per se. There’s no credible theory behind money printing nor are there any guidelines which determine what exactly constitutes these terms.

If the terms QE/QT are broadly given to the direction of the Fed’s balance sheet, then we could say that in the last two weeks, they’ve been doing QE, since the net change to the balance sheet was positive.

However, if the terms are more narrowly defined to only mean the change in US Treasury holdings and Mortgage-Backed Security holdings, then we could say that the Fed is still engaging in QT, since they are still rolling off these securities. The net balance sheet increase has only been due to lending programs that temporarily help banks out of this current crisis.

Yet the magnitude and length of time must also be considered.

On Monday CNBC announced that First Citizens Bank will purchase “around $72 billion of Silicon Valley Bank assets at a discount of $16.5 billion.” The role of the Fed and FDIC is instrumental to this bank merger, with the final cost of the bailout still not known.

The [FDIC] regulator added that the estimated cost of SVB’s failure to its Deposit Insurance Fund (DIF) will be around $20 billion, with the exact cost determined once the receivership is terminated.

By simply making available new funding programs for banks and FDIC, it appears the threat of bank runs has subsided, for now. And if we’re really lucky, the Fed’s lending schemes are nearing the end, stopping at only a few hundred billion and not several trillions of dollars.

Again, “if” the money the Fed loaned is paid back promptly, and “if” the banking crisis subsides, the balance sheet should resume its downward trajectory. Then history would consider this as still part of the QT phase. Conversely, if this lending program is only just the start of much longer and larger programs to come, history will show QE began two weeks ago.

Regardless of whether this is QT or QE, we remain in uncharted waters with nothing but a promise of a bigger storm ahead. Should these lending schemes be hailed a success, then it stands to reason that when the next bank fails, the Fed will go back to the same playbook, again and again…

As for what tomorrow brings, no one knows. But Minneapolis Federal Reserve BankNeel Kashkari continues to have no shortage of foresight for the problems he helps create, as told to CBS over the weekend:

He said that banks holding commercial real estate assets could also see losses in the future.

And in his own words saying:

But right now it's unclear how much of an imprint these banking stresses are going to have on the economy.

Noting that it was too early to determine the impact on inflation.

Clearly the Fed remains on standby, ready and willing to create money to prop up failed banks, at the same time staying committed to reducing its holdings of US government and mortgage debt. And so, the Fed really is the lender of last resort, functioning only in terms of “need” for the big banks. So long as no bank asks for money from the Fed, the Fed won’t give them any. But the minute a bank needs the Fed, the Fed will be there like any other insurance company… with an infinite amount of cash on hand, prepared to inflate dollars at little cost to them, but at a big cost to society.

Critics of the increasingly bipartisan consensus of conflict withChinaface a difficult task. For the (fake)Chinathreatis not a single concrete thing that can be pointed to or otherwise signified. Rather, as a manufactured thought climate produced by a series of interlocking incentive structures, like Kafka’s Castle it looms inscrutable but no less ominous.

Upon close inspection, however, the inner workings of the (fake)Chinathreatreveal nothing new about the anatomy of the state.

First, it serves as a legitimating device, a new reason for the continually climbing defense budgets, new toys for generals and admirals, overseas bases, the meddling by comfortably ensconced state department officials in the affairs of other states, and the existence of an intrusive national security apparatus. Stoking the fear, representatives of the state spin conflicts they seek as looming threats to everyday Americans in order to justify their continued position of power over them, with a well-funded network of think tanks and the corporate press helping prescribe the acceptable limits of public discourse in order to marginalize dissent.

Second, the (fake)Chinathreatserves as a convenient scapegoat for the end results of the bad policies Washington itself pursued. America deindustrialized?China’s fault. Millions of Americans hooked on drugs?China’s fault. The Saudis and Iranians don’t want the Americans around anymore?China’s fault.

Et cetera.

There is one element of truth to the (fake)Chinathreat, however. That is, the existence of an independentChina(or Russia) is athreatto Washington’s accustomed privilege of being able to do more or less whatever it wants wherever it wants.

But the existence of an independentChinais already a fact.

Refusal on the part of Washington to accept it will cause more than theoretical problems.

Amidst the wreckage of bank failure grow lucrative deals. Shares of New York Community Bank Inc. surged with the announcement that the FDIC had made NYCB a “sweetheart deal” as the deposit insurer “priced the assets to move quickly,” wrote Wedbush analyst David Chiaverini in his upgrade of the stock, as reported in Bloomberg. “In exchange for the $2.7 billion discount on acquired loans [assets], plus the interest income earned on the loans and securities, NYCB will give up only $300 million in equity appreciation rights to the FDIC,” added the Wedbush analyst.

Plus, the takeover didn't include Signature's $4 billion in crypto-related deposits, included all of Signature's branches, and some of its loan portfolio, reports Business Insider. Emphasis was added because Signature didn’t have to take any bad loans.

"With New York Community's addition of certain deposits and assets of Signature's Bridge Bank, NYCB's balance sheet could be improved with less reliance on higher-cost wholesale funding. NYCB's loan-to-deposit ratio should decline from a high 119% in Q4 with the assumption of Signature deposits, while $12.9B in loans were bought for $2.7B, which equates to a 79% haircut," Bloomberg Intelligence analyst Herman Chan commented.

The FDIC killed two birds with one stone with the move, moving cherry-picked assets and deposits from a failed bank (Signature) to one that was overleveraged (119% loan-to-deposits) and possibly headed for trouble (NYCB).

Of course, sweetheart deals are nothing new. Post the 2008 crash, Rialto (a division of homebuilder Lennar) bought a 40 percent share of $1.2 billion in loans from failed banks for 40 cents on the dollar, with the FDIC carrying a loan for $1 billion of the deal at zero interest for seven years.

This was called a partnership, however, when a government entity carries its partner’s share at zero percent interest for seven years that term doesn’t seem to apply. The RE Action Committee explained at the time:

Lennar (Rialto) acquired indirectly 40% managing member interests in the limited liability companies created to hold the loans for approximately $243 million (net of working capital and transaction costs), including up to $5 million to be contributed by the Rialto management team. The FDIC is retaining the remaining 60% equity interest and is providing $627 million of non-recourse financing at 0% interest for 7 years. The transactions include approximately 5,500 distressed residential and commercial real estate loans from 22 failed bank receiverships.

Attorney Bryan Knight, in 2011, called the Private-Public Investment Programs (“PPIP’s”), such as Lennar/Rialto “ the biggest waste of government spending and most damaging program to the American public.”

Knight wrote:

Rialto was given a $600 Million interest free non recourse loan by the Federal Government to purchase assets of failed banks. Therefore, Rialto has no risk in collecting on assets because no interest is accruing and Rialto is not liable to pay back the loan since the loan is a non-recourse. This gives Rialto even more incentive to refuse loan workouts and to collect asset management fees. It is not rocket science, a bank that has risk of taking a loss is more likely to work with a borrower. Here Rialto has no risk.

How the FDIC hands out favors is described perfectly by Patrick Newman in his book Cronyism writing:

Cronyism [is] when the government passes policies to benefit special-interest politicians, bureaucrats, businesses, and other groups at the expense of the public.

He continues:

The rewards of cronyism take the form of monetary gains, particularly increased incomes and profits for individuals and businesses, or psychic gains from greater power and authority.

The case of Silicon Valley Bank is especially egregious cronyism. Joseph Wang, the CIO at Monetary Macro who previously was a senior trader on the Fed’s open markets desk told Roger Hirst on Real Vision:

So, the bailout of Silicon Valley Bank was, in a sense, the bailout of millionaires and billionaires who weren't the clientele of Silicon Valley Bank. Those are guys who mismanaged your cash badly and wanted to bail out. Now, if you were going by the rule of law, you'd say that yeah, you guys. You can take it, and these are the rules. But these guys were also politically connected and very loud in social media and in the press. And so, they have influence and they can, I guess, encourage the government to bend the rules in their favor.

Winston Churchill and later Rahm Emmanuel famously said “Never let a crisis go to waste.” Cronyism never does.

Despite the fears that Artificial Intelligence will disempower consumers, companies find it easier to keep up with ever changing preferences of consumers by applying AI technology. Companies apply AI to the infinite areas of business operations, production, pricing, customer experiences, and manufacturing processes. Firms are racing one another to integrate AI applications into their business practices to meet consumer needs.

The reality is that consumers do, in many ways, steer the production and prices of economic goods and service offerings. The consumer is sovereign in a market economy; unfortunately, some still think otherwise. Why? Because artificial intelligence is mediating streams of knowledge between buyer and seller, exposing consumers to changing market conditions, prices, and circ*mstances. There is an antimarket camp; this camp is not keen on the fact that consumers steer the direction of pricing and production. The result is that AI integration into business practices is strikingly on the consumer's side.

As far as businesses entities are concerned, unsurprisingly, a 2023 customer poll found that "the majority of consumers (73 percent) believe there is potential for impact on customer experience, particularly in digital settings," according to Businesswire. With firms increasing their uses of AI in operations, finance, sales, and production, it becomes apparent that the simplest input into AIaas will likely tilt toward maximizing consumer demand. Techcrunch said in a recent article, "Every organization has their gold-standard employee, and AI learning can analyze employees' traits and behaviors in customer interactions, raising the bar for all." Another tool to used to maximize human productivity within a company! On the bright side, “AI can learn from top performers and share what makes them so great,” The author added, "Every employee can be a top performer.” Ludwig von Mises said, "the consumer is sovereign and cannot be replaced in a marketplace economy." Similarly, a recent Forbes article projected positive AI trends in 2023 and beyond; the author listed ten trends to look for in the use of AI in 2023, except one of the most important, unsurprisingly, the betterment of consumer sovereignty. Consumer sovereignty is not coercive in the exchange relationship between buyer and seller. Instead, it happens “only by serving the consumers, since again, the sale is voluntary on the part of both producers and consumers,” according to Murray Rothbard.

Along with AI technologies, human touch, and interaction are required and expected in many buyer and seller transactions. However, AI will assist business owners in a big way, providing enhanced customer experiences via the use of AI-powered websites, apps, manufacturing, et cetera., and other services that consumers demand. Despite all mounting evidence showing that AI-enabled applications can address customer uneasiness in a market economy because AI is a consumer-centric tool that maximizes consumers' market information, the antimarket camp does not believe that the consumer is sovereign. We must understand that AI is a maximizing tool with generative output data. In other words, AI will allow consumers and producers to spontaneously adjust their actions in market cooperation. Artificial intelligence adapts to consumer preferences and learns the top choices within data input units over time. AI learns via natural learning systems, which virtually enlarges its storage that adjusts to preferences and parameters of pricing and production, especially in reducing cost and adopting price changes.

Therefore, the economics of information – perfect or imperfect information – does not hold in the epoch of AI—spontaneous information dispersed with the aid of AI technology between buyer and seller reigns supreme. However, the spontaneous flow of information aided by AI goes against the precepts of mainline economics that support the economy of information and the so-called equilibrium. AI is an institution of the extended order in a market economy; it drastically changes the perfection or imperfection of information, spontaneity, or stagnate forms of knowledge of market conditions. AI enables consumers' sovereignty by enabling firms to reach and satisfy customers in different places, times, and circ*mstances giving sellers and buyers more or less information and vice versa, precisely as F.A. Hayek and Mises have preached for so long.

After raising rates by 25-bps on Wednesday, in addition to lending$300 billion to bankrupt institutions last week, Federal Reserve Chair Jerome Powell reassures the public that the banking system is “sound and resilient” to quell concerns over recent bank failures. Reiterating:

In addition, we are committed to learning the lessons from this episode and to work to prevent events like this from happening again.

Talk of bank runs never happening again is pure fantasy. Anyone following the financial system long enough realizes such talk is akin to putting an end to stock market crashes or recessions. It’s an impossible claim, unless a central bank would commit to always supplying unlimited funds to the market…

When asked if the Fed has “considered changing reserve requirements,” currently at zero, Powell responded:

Yeah, we know that we have other tools in effect, but no, we think our monetary policy tool works…

This crisis illustrates the problematic nature of the fractional reserve banking system, which relies on the central banking system. In a truly free market, there would be no mandatory reserve requirements because there would be no Federal Reserve. If/when a bank fails, there would be no central bank to step in with a bailout. It stands to reason that full reserve banking would be the viable solution.

Yet we don’t have a free market. Rather, when the fractional reserve banking system fails the Federal Reserve acts quickly to socialize losses by way of monetary inflation, hurting the poorest members of society the most.

Powell shows no regard for the free market solution. Instead he offers to “strengthen supervision and regulation,” as a viable alternative. This would grant the Fed more power but not fix the inherent problem with fractional reserve banking.

The world according to Powell is easy, as explained:

So, at a basic level, Silicon Valley Bank management failed badly, they grew the bank very quickly, they exposed the bank to significant liquidity risk and interest rate risk, didn't hedge that risk...

So, as for us, so for our part, we're doing a review of supervision and regulation, my only interest is that we identify what went wrong here. How did this happen is the question. What went wrong? Try to find that. We will find that. And then make an assessment of what are the right policies to put in place so that it doesn't happen again…

We’ve seen this before: A bank becomes insolvent, whether by ignorance or error. The Fed saves the financial system by giving the same failed bank more money; this is socialism-lite, it is not capitalism.

Any system which works great until it collapses, then requires a government/central bank bailout is neither sensical nor sustainable. Anyone holding a position in academia should not support this; but many do because it works so well for those on top. So here we are.

As far as putting an end to bank runs are concerned, only two fool-proof methods exist: either a bank adopts full reserve banking so that it will never be short on client funds, or we are forced to adopt Central Bank Digital Currency (CBDC). The first method requires no Federal Reserve while the second absolutely does. The Fed didn’t speak much about CBDC’s during this latest crisis or in Powell’s press conference. But we can bet that within the highest ranks of the Federal Reserve, they are waiting patiently for the release of their new digital dollars.

A few days from now marks the one-year anniversary of the article: Will You Buy the Dip? It was there I told everyone I know that eventually the Federal Reserve will conclude its Quantitative Tightening (QT), and a new round of Quantitative Easing (QE) would emerge. This was both inherent and inevitable due to the inflationary nature of central banks. So the idea was to buy the stock market once the Fed resumed the QE process.

The question is: Did last Sunday’s announcement of the Bank Term Funding Program usher in a new easy money era, i.e., was this the dip / pivot / stock market buy signal?

Consider the last two years of the Fed’s balance sheet. Between March and May of 2022, the Fed’s assets topped out at just under $9 trillion. Since then the Fed began its slow descent into QT, where last month it reduced its balance sheet, composed mostly of US Treasuries (UST) and Mortgage-Backed Securities (MBS), by around $80 billion a month. During this entire round of QT the broad stock market made no new highs and has instead slowly declined.

The Fed’s balance sheet has also become quite interesting as of late:

Incredible! It took one year for the Fed to reduce the balance sheet by $600 billion, and in just one-week, from March 8-15, the balance sheet increased by $300 billion!

This is what I was referring to, some event or crisis occurring that would be used as an excuse to get the Fed to return to the market… but human action is complex, and nothing seems to go according to plan.The increase in the balance sheet is not a result of the Fed buying-up more US debt or mortgage securities. As far as the public is aware, the Fed is still committed to QT via rolling off its existing UST and MBS holdings.

The balance sheet increase actually came from the loans the Fed granted for troubled bank relief. Details in the Fed’s notes reveal the elements comprising the $8.689 trillion balance.

Loans amounted to $318 billion, whereas a week prior, it was only $15 billion. The current $318 billion consists of Primary credit ($152 billion) and Other credit extensions ($142 billion). The new Bank Term Funding Program only accounted for $11.9 billion.

On one hand the Fed is reducing ownership of securities owned (loans to government), but on the other hand it’s creating money to loan to banks. It would be great to know how large this temporary one-year program will get, but we’re not privy to this information. However, with no limits on how much the Fed could create, it could amount to trillions of dollars.

Like the World Bank and IMF which grant loans to bankrupt nations, only to make them worse off by ending up in more debt, the Fed appears to be engaging in a similar scheme. By lending to bankrupt institutions, the hope is that within a year from now these failed banks will be better off than they are today, paying back the Fed in full plus interest.

The new funding program may very well push the Fed’s balance sheet to new all-time highs, and if it were to expand by a few trillion dollars more, one could expect to see this reflected in asset prices. But having no idea as to how big these bank loans will get, coupled with the Fed’s continual shredding of UST and MBS holdings, I still lack conviction that the Fed is serious about pumping the stock market back to new highs at the moment. Good luck in your trades.

“How does a bank collapse in 48 hours?” Asks the CNN headline. Especially a bank that reported a profit of $3.4 billion just last year. Murray Rothbard answered the question years ago in What Has Government Done To Our Money?, “No other business can be plunged into bankruptcy overnight simply because its customers decide to repossess their own property. No other business creates fictitious new money, which will evaporate when truly gauged.”

If you watched the Fed Chair Jerome Powell testify before the Senate and the House this month you heard over and over that banks are well capitalized. The non-sequitur inspiring the Shakespearean quote “Methinks you protest too much.”

The very next day after the hearings, shares of SVB Financial Group, parent of Silicon Valley Bank, fell 60 percent (the bleeding continued in after hours trading) after a Wall Street Journal article revealed, the bank “had sold large portions of its securities portfolio and would raise fresh capital, highlighting a broader problem for U.S. lenders who have seen rising interest rates hammer the values of their bond holdings.”

A day later Silicon Valley Bank depositors ran for the exits attempting to pull $42 billion out on Thursday, leaving the firm with a negative cash balance of almost $1 billion, regulators said. joining shareholders the same day the WSJ article appeared. The FDIC promptly closed the bank Friday morning saying: "Silicon Valley Bank, Santa Clara, California, was closed today by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. To protect insured depositors, the FDIC created the Deposit Insurance National Bank of Santa Clara (DINB). At the time of closing, the FDIC as receiver immediately transferred to the DINB all insured deposits of Silicon Valley Bank."

Almost Daily Grant’s wrote “Total deposits stood at $175.4 billion, with $151.6 billion of those uninsured. Those with deposits in excess of the FDIC’s $250,000 insurance threshold will receive a receivership certificate for their funds, with payments to follow as the regulator sells down remaining assets.” (emphasis added)

Roku, Roblox, and Blockfi are among the companies that had millions on deposit at SVB, uninsured. “The company’s deposits with SVB are largely uninsured,” Roku said. “At this time, the company does not know to what extent the company will be able to recover its cash on deposit at SVB.”

Overseas this weekend, leaders of roughly 180 tech companies sent a letter calling on UK Chancellor Jeremy Hunt to intervene.“The loss of deposits has the potential to cripple the sector and set the ecosystem back 20 years,” they said in the letter seen by Bloomberg. “Many businesses will be sent into involuntary liquidation overnight.”

While SVB was a lender to the venture capital industry and tech sector, the investments that did the bank in were bonds backed by the full faith and credit of the U.S. government. However, the value of those bonds has plunged as interest rates have increased dramatically.

Banks are able to use a little accounting trickery pokery as it concerns bonds designated “available-for-sale,” as opposed to “held-to-maturity.” The available-for-sale label allows banks to “exclude the paper losses on those holdings from its earnings and regulatory capital, although the losses [do] count in equity.” Held-to-maturity allows banks “under the accounting rules to exclude paper losses on those holdings from both its earnings and equity.”

This problem is not particular to the bank serving techland.

The Federal Deposit Insurance Corp. reported that U.S. banks’ unrealized losses on available-for-sale and held-to-maturity securities totaled $690 billion as of Sept. 30, up 47% from a quarter earlier, reported the WSJ.

Bank analyst Christopher Whalen wondered in a tweet, “Is it possible that nobody has asked Chair Powell about the deteriorating solvency of US banks due to QE? Where do you think that -$600 billion number will be at the end of Q1 '23” (emphasis added)

MarketMaven’s Stephanie Pomboy weighed in on the same subject with this tweet, “I'm puzzling to understand how THIS isn't the only thing people are talking about today????????? Someone tell me about the rabbits. and fast!”

But again on Capitol Hill and at the Eccles Building no one was uttering a discouraging word. However, FDIC Chairman Martin Gruenberg said in a December 1, 2022 speech, “The combination of a high level of longer-term asset maturities and a moderate decline in deposits underscores the risk that these unrealized losses could become actual losses should banks need to sell investments to meet liquidity needs.”

Now Gruenberg’s prophecy is coming to fruition. Silicon Valley said it decided to bite the bullet and sell holdings and raise fresh capital “because we expect continued higher interest rates, pressured public and private markets, and elevated cash burn levels from our clients as they invest in their businesses.” The fresh capital could not be had at any price.

Rothbard reminds us, “The bank creates new money out of thin air, and does not, like everyone else, have to acquire money by producing and selling its services. In short, the bank is already and at all times bankrupt; but it's bankruptcy is only revealed when customers get suspicious and precipitate ‘bank runs.’”

So the banks are well capitalized Mr. Powell? Bank depositors and ex-depositors will decide that. Silicon Valley Bank is the first this cycle to fail, but likely not the last.