In Part 2 I laid out the timeline of bank failures that sparked Balaji’s claims. I also explained the Bank Term Funding Program (BTFP), the Fed’s solution to the banks’ solvency issues.
“Balaji’s Claims Make Me Angry”
This is a quote by Ben Hunt, a former hedge fund manager and investment thought-leader. It represents the stance of many Fed-friendly economists and politicians. Balaji’s stance isn’t just pro-Bitcoin, it’s anti-government (which the Bitcoin maxis love). His claims have inevitably rustled some feathers, especially within the American establishment. Many have spoken out against these claims. Below, I’ll outline the most common arguments made to oppose Balaji’s position.
The BTFP Solves Insolvency
Balaji’s entire (initial) argument was built on the foundation that bank runs would force insolvent banks to fail. Opponents argue that because of the BTFP, the banks can hold their devalued bonds to maturity while still having cash on hand to pay depositors if needed. This is largely true, however many regional banks hold depreciated assets that aren’t eligible for the BTFP, and are therefore still at risk of failure in case of a bank run (see First Republic).
Dollar Outflows Won’t Go to Bitcoin
Balaji grabbed headlines with the $1M Bitcoin price “prediction”, which would give Bitcoin a ~$20T market cap (compared to around $2T USD in circulation currently). Many who agree with his concerns about the US financial system believe that people fleeing the dollar will prioritize other currencies, real estate, and precious metals, not Bitcoin. Jurisdiction is relevant to this argument, as many expect severe regulation on cryptocurrency by one or more governments.
A Fixed-Supply Banking System is Bad for Everyone
Based on Balaji’s claims, it seems clear that he believes Bitcoin taking over as the global reserve currency is the best outcome. However, critics point to the flaws that lead the US off the gold standard as reasons that a Bitcoin-based system isn’t desirable. They cite the government’s inabilty to react in extreme times, the economy’s inability to extend undercollateralized credit, and deflationary pressure imposed by a fixed-supply currency.
No Government Reactivity
Governments rely on the ability to change the money supply in order to curb inflation/deflation, limit unemployment, and/or minimize the impact of recessions. This was especially obvious with the stimulus checks sent during the pandemic in an effort to counteract the massive hit on productivity. While governments have clearly overstepped at times, the vast majority of economists agree that the ability to manipulate the supply of currency is beneficial to an economy in extreme times like wars, pandemics, or depressions.
No Credit
With a fixed-supply currency, reserve requirements increase dramatically, and the velocity of money plummets. In a fiat system, the same dollar can be deposited, borrowed, used, redeposited, etc… to simulate the “same” dollar being owned and utilized by multiple people simultaneously. With a fixed-supply currency, loans would have to be fully collateralized, or else at a very high rate, which would disproportionally impact the middle and lower-class, who don’t have the collateral to get mortgages, car loans, or student loans.
Deflationary Spiral Potential
Let’s say you have a mortgage (loan) for $100,000 and USD inflates 10x (a terrifying proposition). Your income and home value should nearly 10x to match the new buying power of the dollar, but your loan doesn’t change. This is a HUGE win, your house is now worth 10x the dollars you owe. Inflation benefits those holding a loan. Now imagine the opposite, that USD deflates 10x. Your loan is now 10x more than the house is worth. You’re in trouble, and the bank that gave you the loan might be too. Fixed-supply economies are at a higher risk for deflation. Money supply can’t match economic growth, so the buying power of one unit of currency goes further (deflation). Deflation can spiral and cripple an entire economy.
We Should Decide Not To Bank Run
Some critics call out just how horrible things will be if the dollar fails (I agree), and encourage citizens not to withdraw their deposits in an attempt to preserve the system. I think this is a weak, overly-idealistic argument. Two mental models help me assess this, the prisoners’ dilemma and tipping points.
The Prisoner’s Dilemma
The prisoner's dilemma is a concept in game theory that demonstrates why two rational individuals might not cooperate, even if it appears that it would be in their best interest to do so.
Here's the classic example:
Two people are arrested for a crime they committed together. They are held in separate cells (so they cannot communicate), and the prosecutor offers each the same deal:
- If Prisoner A stays silent (cooperates) but Prisoner B betrays (defects), Prisoner A will get 3 years in prison, and Prisoner B will go free.
- If Prisoner B stays silent but Prisoner A betrays, Prisoner B will get 3 years, and Prisoner A will go free.
- If both betray each other, each will serve 2 years in prison.
- If both stay silent, each will only serve 1 year in prison (for a lesser charge that can be proven without their testimonies).
From the perspective of each prisoner, betraying the other (defection) always seems like the most rational choice because:
- If they believe the other will stay silent, they should betray, as they will go free instead of serving 1 year.
- If they believe the other will betray, they should also betray, as they will serve 2 years instead of 3.
But here's the paradox: if both prisoners follow this individual logic, they'll both betray each other, and they'll each get 2 years in prison. This is not the optimal outcome. If they both stayed silent, they would only serve 1 year each.
The dilemma demonstrates a conflict between individual and collective rationality. Each prisoner individually "rationally" decides to betray, but the best collective outcome would be reached if both cooperated (i.e., remained silent).
Even if it is objectively best for everyone to cooperate (and not bank run), everyone still will in order to hedge their best interests against the actions of others.
Tipping Point
The concept of a "tipping point" refers to the critical point in a situation, system, or process at which a significant and often unstoppable effect or change takes place. A tipping point occurs both in bank runs (some news that ensures the bank run will occur) and bank failures (some level of failure guarantees significant future failures).
Regulators Were Right Not to Warn Us
Balaji demonizes US regulators for not raising alarm to consumers about the bank solvency issues. Critics argue that in a trust-based economy (all fiat-based economies), raising alarm is only ever a negative thing that doesn’t protect depositors, but hurts them by spreading fear and instability.
The US isn’t Blocking the Exits
Balaji claims that the US is gradually restricting the ability of citizens to exit to cryptocurrency. He cites the government’s role in the failure of Signature and Silvergate. Critics argue that the government did what it had to do with those failing banks, and that there’s is no evidence thus far that the US is limiting citizen’s access to crypto.
What’s Next?
Balaji’s received a myriad of critiques since sending out the BitSignal. Which did you find the most compelling? Does his position remain tenable? In Part 4, I’ll outline my stance and the actions I’ve taken in response to Balaji’s claims.
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