$1M Bitcoin, Hyperinflation, and Dedollarization Oh My Part 2: The Timeline & BTFP Breakdown

$1M Bitcoin, Hyperinflation, and Dedollarization Oh My Part 2: The Timeline & BTFP Breakdown

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May 12, 2023
In Part 1, I laid out Balaji’s claims as to why the US dollar is doomed. These claims made waves, especially amongst crypto investors. Check it out if you haven’t already!

How Did We Get Here?

In this post, I’ll breakdown the bank failures that sparked Balaji’s interest, outline the Bank Term Funding Program (the Fed’s response to the bank’s solvency issues), and share what’s happened since.

March 8: Silvergate Bank Failure

Silvergate Capital was best known as a “crypto bank” because of their willingness to provide services to cryptocurrency companies when other banks wouldn’t. While deposits were skyrocketing at most banks following the payment of stimulus checks, this impact was magnified at Silvergate because a disproportionate amount of money from those checks went into cryptocurrency and associated products. FTX banked with Silvergate, so when FTX collapsed, the bank received significant scrutiny from regulators. That scrutiny scared other crypto companies that were depositors in Silvergate, which sparked a bank run. Silvergate was forced to sell those depreciated bonds we talked about in Part 1 and the losses that mounted led to failure.

March 10: Silicon Valley Bank

SVB suffered very similarly to Silvergate. SVB banked America’s startup scene, which flourished during the times of low interest rates. As interest rates increased, raising money got harder for startups, who started drawing on deposits. SVB’s FTX moment came when it announced that it liquidated $21B worth of securities, borrowed $15B, and would be selling more stock to raise another $2.25B in order to pay depositors and meet regulatory requirements. This was perceived as a sign of weakness, and sparked a single-day withdrawal of $42B, which was too significant to overcome.

March 12: Signature Bank

Different paragraph, same story. Signature was a crypto-friendly bank the fell to a single-day $10B bank run sparked by Silvergate’s collaps. Instead of failing, regulators seized it to protect depositors and limit further fear of collapse (”contagion” in banker speak).

March 12: BTFP

Depending on who you talk to, the Bank Term Funding Program (BTFP) is either brilliant, or just a clever way of kicking the can down the road. It was instituted to solve the unrealized losses on banks’ balance sheets caused by rising interest rates. I’ve outlined this issue thoroughly in previous posts. To understand the BTFP, you have to understand the problem it’s supposed to fix, so please read Part 0 if you aren’t familiar with how bonds work and how their value relates to interest rates. If you don’t understand the solvency issues that banks have dealt with, check out Balaji’s claim #1, which I outlined in Part 1.
In order to mitigate the risk of bank runs, which could force the sale of assets valued below their purchase price, the Federal Reserve has stepped in as a backstop by establishing the BTFP. They’ve offered to loan banks the mature value of their depreciated assets. The banks are forced to pay current interest rates (at the time of the loan), which locks in a small loss as long as the present interest rate is higher than the yield on the bond. However, banks aren’t forced to sell their assets at a loss, and therefore aren’t at risk of failure in the case of a bank run. These loans can be used to pay depositors cashing out, meet reserve requirements, or even purchase other assets that generate a yield.
The BTFP offers this loan to all US banks against all liquid assets purchased before March 12, 2023. The size of the loans to banks isn’t limited. The total value of eligible assets is ~$4.4T. The loans last up to one year, and banks can request these loans until at least March 24, 2024. All money given to the banks as loans is “printed”. Proponents of the BTFP claim this isn’t quantitative easing (QE), and isn’t inflationary in the medium term and beyond, because these loans will be repaid to the Fed with interest. Opponents claim that the BTFP will get extended indefinitely, and the banks will be backstopped by inflation as the value of eligible assets grows year after year.
I see the BTFP as a decent, yet imperfect, solution to a horrible problem. It successfully contains the fear of rampant bank failure by making banks fully solvent in the short term. However, it forces banks to either lock in losses if they choose to sit on the loans, or take on additional risk by buying assets with borrowed funds. Arthur Hayes, a hedge fund manager and crypto enthusiast, believes that the BTFP will cause bank stocks to seriously underperform by forcing them to lock in short-term losses. He also claims that it will cause housing prices to rise in the short term because banks will be desperate to buy high-yield mortgage-backed securities (MBS). This demand will force the MBS rate to converge to the rate that banks are paying on the loans from the Fed until all yield as been arbitraged away. This decline in mortgage rates is what will reignite demand in the housing market.
The dollar will also be strong, as the Fed has ensured the banks can’t fail, so demand for USD remains high. A strong dollar and housing market sound great… what’s the catch? The catch is that now, the US will have gone even further to stave off an imminent recession, and now will be dealing with an even stronger inflation pressure (because of all the dollars added to circulation by the BTFP and the booming economy), while also already being at higher interest rates. The Fed will have very few levers to pull, and none that can keep the house of cards standing. When the BTFP is about the expire in March of 2024, the pressure to keep it will be immense, and so it will likely be extended, which just adds more fuel to the fire.
I believe the BTFP is a good thing in the short term, as it successfully mitigates the largest issue, the solvency crisis caused by skyrocketing interest rates. However, there will be immense economic and political pressure to renew it next March, rather than ending it as scheduled. This will likely expand the scope to infinity in the long run and therefore devalue the dollar.
To read more about the BTFP and the entire situation, Arthur Hayes’ article Kaiseki is excellent (albeit long).

March 16: BitSignal

We covered the BitSignal thoroughly in Part 1. I wish that Balaji had addressed the BTFP in his initial arguments. His claims were built entirely around insolvency, which the BTFP addresses (at least in the short term).

May 1: First Republic

All eyes have been on First Republic since the Silicon Valley Bank collapse. The bank enticed wealthy depositors by offering them low interest rate mortgages and white-glove service. Wealthy depositors have a lot more to lose above the FDIC $250,000 limit, so the bank faced $100B in withdrawals upon news of regional bank failures. JPMorgan purchased the bank’s deposits, loans, and securities.
So why didn’t the BTFP save First Republic? Many of its investments were in real estate loans and municipal securities, which had also been devalued by rising interest rates, but weren’t as liquid as government bonds, and therefore weren’t eligible collateral for the BTFP.

What’s Next?

I hope this clearly outlined where we’re at today and how we’ve gotten here. Do you think there be more bank failures soon or has the BTFP shored things up? In Part 3 I’ll outline arguments made by Balaji’s opponents, many of whom believe the US economy is perfectly stable, and expect a mild recession at worst. We’ll talk briefly about mass psychology and tipping points, both of which are so important to this discussion. After that I’ll share my take on the whole situation and what actions I’m taking!