Bipolar and the Q2 2021 Z.1 

Doug Nolan


It was a rather glaring warning. 

Yet it was, of course, taken as just another buying opportunity – a rather easy one at that. 

It seems to only get easier. 

September 22 – Bloomberg: 

“China Evergrande Group injected a fresh dose of uncertainty into financial markets on Wednesday, issuing a vaguely worded statement on a bond interest payment that left analysts grasping for details. 

Evergrande’s onshore property unit said in an exchange filing that an interest payment due Sept. 23 on one of its yuan-denominated bonds ‘has been resolved via negotiations off the clearing house.’ 

While the comment helped trigger knee-jerk gains in some risky assets, Evergrande didn’t specify how much interest would be paid or when. 

That fueled speculation among some analysts that the developer struck a deal with local bondholders to postpone the payment without having to label the move a default.”

September 24 – Bloomberg (Chester Yung): 

“China’s central bank continued to pump liquidity into the financial system on Friday as policy makers sought to avoid contagion stemming from China Evergrande Group spreading to domestic markets. 

The People’s Bank of China has injected a net 460 billion yuan ($71bn) of short-term cash into the banking system in the past five working days, including 70 billion yuan on Friday. 

That’s helping ensure sufficient liquidity throughout the Evergrande crisis… 

The cost of borrowing overnight fell to 1.68%, the lowest level since late July, down from 2.28% last week.”

Of course Beijing has everything under control. 

The talk was that Beijing was orchestrating a restructuring, one that would ensure Evergrande suppliers get paid, and construction resumes on hundreds of thousands of apartments owed to buyers who have put down large deposits. 

Offshore bond holders will take big haircuts, but officials will ensure Evergrande doesn’t drag down the banks or Chinese economy. 

The more markets rallied, the louder the bulls scoffed at the notion of Evergrande impacting systemic stability.

And Wednesday from Chair Powell: 

“In terms of the [Evergrande] implications for us, there’s not a lot of direct United States exposure. 

The big Chinese banks are not tremendously exposed, but, you know, you would worry that it would affect global financial conditions through confidence channels and that kind of thing.”

Implications appeared more direct Monday: Global “risk off” sparked synchronized de-risking/deleveraging across markets – commodities, currencies, fixed-income, equities and derivatives. 

It is, after all, one gigantic, interconnected speculative Bubble. 

At Monday’s intraday lows, the S&P500 was down almost 2.9%.

September 20 – Bloomberg (Sam Potter): 

“The Monday stock swoon risks triggering forced deleveraging by volatility-linked funds, according to… Nomura Securities. 

As China’s real-estate crisis intensifies and infects global markets, the S&P 500 slumped as much as 1.7% at the New York open to test a key 50-day threshold. 

That intraday move breaks a level strategist Charlie McElligott warns will force selling from rules-based investors who allocate depending on how much stock prices swing around. 

A drop of that scale would spur between $15 billion and $40 billion of divestments from this breed of systematic fund, he said on Monday -- and more should the ‘volatility expansion’ endure.”

It's not difficult to envisage selling quickly overwhelming the marketplace – another self-reinforcing derivatives “Volmageddon,” an abrupt reversal of ETF flows, hedge funds dashing to the exits, online day trader panic, etc.

Back to Monday’s Warning. 

Risk premiums widened, notably across the board. 

Global Credit default swap (CDS) prices gapped higher, in what had all the makings of a destabilizing synchronized market dislocation. 

I’ll note two CDS moves in particular. 

China's sovereign CDS surged 11 to 47 bps, the high since October 2020 - and the largest one-day gain since the start of the pandemic. 

Thousands of miles away, U.S. investment-grade CDS jumped eight to 54.5 bps, the high since March - and the largest one-day gain since the start of the pandemic. 

The global Bubble comprises myriad individual Bubbles. 

Yet at its core, the “global government finance Bubble” is bipolar – Beijing and Washington. 

Abruptly, Monday’s global “risk off” turned systemic, with gap move dislocations in Chinese sovereign and U.S. investment-grade CDS. 

Preparing for the FOMC meeting, Chair Powell likely didn’t have his eyes fixed on the Bloomberg terminal. 

At least for a few hours, market links between Evergrande and U.S. finance appeared distressingly direct.

September 20 – Bloomberg (Caleb Mutua): 

“Corporate America put the brakes on a month-long borrowing binge on Monday as growing concern about spillover effects from property developer China Evergrande Group roiled markets globally. 

At least eight blue-chip companies that had planned to sell bonds decided to stand down, underwriters said… 

A key barometer of high-yield investors’ risk aversion, the Markit CDX North American High Yield Index, weakened.” 

From Monday’s trading lows to Friday’s close, the S&P500 rallied 3.5% (small caps surged over 5% at Thursday highs). 

Monday’s close call was quickly forgotten, with bullish imaginations concocting visions of uninterrupted Chinese growth, hundreds of billions of additional monetary inflation (PBOC and Fed), and endless market gains. 

After trading down to 1.29% in Monday’s “risk off” session, yields surged to 1.46% in Friday trading. 

There was talk of the “hawkish” Fed “dot plot,” the approaching “taper,” and even the possibility of a rate increase late next year. 

I'm just not convinced Fed policy is driving U.S. or global bond yields. 

The possibility of a bursting Chinese Bubble has pressured global yields lower, despite surging inflationary pressures. 

Beijing appears committed to reining in Credit and speculative excess, creating a precarious situation for China’s financial and economic systems grossly inflated from years of Credit excess (especially the past two years!). 

However, if Beijing gets cold feet and resorts again to reflationary measures – bonds have good reason to fear the type of massive monetary inflation necessary to hold China Bubble collapse at bay. 

Massive monetary inflation in an environment of already powerful inflationary forces should be unnerving to bond markets and us all. 

And speaking of (bipolar) massive monetary inflation, let’s take a look at the Fed’s Q2 2021 Z.1 “flow of funds” report.

Non-Financial Debt (NFD) increased a nominal $1.002 TN during Q2 to a record $63.254 TN. 

This would have been a pre-pandemic record expansion. 

On a seasonally adjusted annualized pace, NFD expanded $4.013 TN. 

For perspective, NFD on average gained $1.842 TN annually for the decade 2010-2019. 

NFD surged an unprecedented $8.755 TN over just the past six quarters ($1.459 TN quarterly average). 

While slightly below recent record highs, Q2’s 278% ratio of NFD to GDP compares to previous cycle peaks, 227% to end 2007 and 184% to conclude 1999.

Treasury borrowings continue to command system Credit growth. 

Outstanding Treasuries gained nominal $359 billion during Q2 to a record $24.302 TN. 

Treasuries surged $6.487 TN, or 36%, over the past two years. 

Treasuries to GDP slipped slightly during the quarter to 107%. 

This ratio ended 2007 at 41% and was up to 87% prior to the pandemic.

Agency Securities gained another $181 billion during the quarter to a record $10.408 TN. 

At $663 billion, one-year growth was the strongest since 2007. 

Agency Securities jumped $1.144 TN over the past two years. 

Combined Treasury and Agency Securities swelled an unparalleled $7.631 TN over two years to a record $34,709 TN (153% of GDP).

Total Mortgage borrowings rose $308 billion during the quarter, more than double Q2 2020 growth to the largest increase since Q3 2006 ($343bn). 

Home Mortgages rose $238 billion during Q2 (strongest since Q3 ’06) and $687 billion for the year (largest since 2006). 

Total Debt Securities (TDS) expanded $747 billion during the quarter to a record $54.539 TN. 

Debt Securities jumped $3.377 TN, or 6.6%, over the past year. 

Prior to the pandemic, 2007’s $2.671 TN was the largest annual increase in TDS. 

TDS swelled $8.794 TN, or 19.2%, over two years. 

At 240%, TDS to GDP compares to 201% to end 2007 and 158% to finish the nineties.

Total Equities surged $5.709 TN during Q2 to a record $75.392 TN. 

Total Equities were up $23.407 TN, or 45%, over the past year, and $24,624 TN, or 49%, over two years. 

For comparison, Total Equities peaked at $27.263 TN during Q3 2007 and $20.957 TN during Q1 2000. 

Ending Q2 at a record 332%, Total Equities to GDP compares to previous cycle peaks 188% (Q3 ’07) and 210% (Q1 2000). 

Total (Debt & Equities) Securities jumped $6.455 TN during the quarter to a record $129.931 TN, ending the quarter at a record 572% of GDP. 

Total Securities ended Q3 2007 at $56.192 TN (387% of GDP) and 1999 at $35.598 TN (360% of GDP). 

Total Securities surged $33.418 TN, or 35%, over the past two years. 

As I’ve communicated on a quarterly basis, the Household Balance Sheet is a focal point of Credit Bubble analysis. 

Household Assets jumped $6.196 TN, or 16.2% annualize, during Q2 to a record $159.342 TN. 

Household Assets inflated $24.269 TN over the past year. 

Household Liabilities rose $347 billion during the quarter to $17.674 TN, the strongest growth since Q1 2006. 

Liabilities were up $1.093 TN over four quarters, the strongest annual growth since 2006.

Household Net Worth (Assets less Liabilities) jumped $5.849 TN to a record $141.668 TN. 

Net Worth surged $23.176 TN, or 19.6%, over the past four quarters. 

For perspective, Household Net Worth gained $4.501 TN and $3.960 TN in boom years 2006 and 1999. 

Household Net Worth to GDP ended Q2 at a record $623%, having increased from 537% to end 2019 (pre-pandemic). 

This compares to previous cycle peaks 491% (Q1 ’07) and 445% (Q1 2000). 

House price inflation fueled a $1.218 TN (13% annualized) increase in Household Real Estate holdings during the quarter to a record $38.706 TN. 

Real Estate holdings jumped $3.901 TN, or 11.2%, over four quarters – surpassing 2006’s record $3.122 TN increase. 

At 171%, the ratio of Real Estate to GDP is up from cycle trough 125% (Q2 2012) - yet remains below the cycle peak 190% from Q3 2006. 

Meanwhile, Household Financial Asset holdings are inflating wildly. 

Household Assets jumped $4.552 TN during the quarter to a record $113.149 TN, having more than doubled from 2009 trough $46.780 TN - as well as cycle peak $54.377 TN (Q3 ’07). 

Household Financial Assets to GDP ended Q2 at a record 498%, up from cycle peaks 374% (Q3 ‘07) and 354% (Q1 2000). 

Household Equities (Equities & Mutual Funds) holdings ended Q2 at a record $42.780 TN, having increased $3.188 TN for the quarter and $13.239 TN, or 44.8%, over the past year. 

Equities holdings dropped to a cycle trough $7.768 TN during Q1 2009, following cycle peaks $15.023 TN (Q3 2007) and $11.532 TN (Q1 2000). 

Household Equities holdings ended Q2 at a record 188% of GDP – having risen from 142% to end 2019 – and up huge from previous cycle peaks 104% (Q2 ’07) and 115% (Q1 2000).

Banking (“Private Depository Institutions”) system assets expanded $227 billion during the quarter, or 3.8% annualized. 

Loans expanded $48 billion, with Mortgage loans up $50 billion and Consumer Credit surging $84 billion (2nd strongest Q ever). 

Meanwhile, Loans (not classified elsewhere/business) sank $87 billion. 

Why lend when it’s easier to simply own securities? 

Banking Debt Securities holdings surged $265 billion (17% annualized) during the quarter to a record $6.453 TN, with Agency/MBS up $125 billion (to $3.730 TN), Corporate bonds up $33 billion (to $833bn), and Treasuries up $93 billion (to $1.349 TN). 

Debt Securities holdings were up $1.224 TN, or 23%, over four quarters, led by an $809 billion jump in Agency Securities.

Banking’s Repurchase Agreement (“Repo”) Asset sank $295 billion during the quarter (to $577bn), as the marketplace shifted to the Fed’s repo facility. 

On the Bank Liability side, Total Deposits expanded $232 billion during the quarter to a record $19.938 TN. 

Total Deposits were up a stunning $4.4 TN, or 28.4%, over six quarters.

Federal Reserve Assets jumped $489 billion during Q2, the largest expansion in a year, to a record $8.258 TN. 

Treasury holdings rose $323 billion (to $5.597 TN) and Agency Securities jumped $143 billion (to $2.414 TN). 

Fed Assets were up $894 billion y-o-y (Treasuries up $789bn and Agencies rising $378bn) and $4.248 TN over eight quarters (Treasuries $3.281 TN and Agencies $829bn). 

Fed Assets have gained $7.307 TN, or 768%, since mid-2008.

The Liability side of the Fed’s balance sheet has become intriguing. 

The Treasury’s account at the Fed (“Due to Federal Govt”) dropped $270 billion during the quarter and $877 billion through the first half. 

Meanwhile, the Security Repurchase Agreement (“Repo”) Liability surged $909 billion during the quarter (to $1.261 TN) and $1.045 TN during the first half. 

In simple terms, the Treasury has spent funds held at the Fed, “money” dispersed throughout the markets and economy, only to be recirculated back into “Repos” held at the Fed. 

The Fed’s “Repo” facility has basically allowed Fed-created liquidity to be intermediated directly back through the Fed, bypassing the typical process of liquidity funneled to the banking system, where it would then be converted into bank “Reserves” held at the Fed.

Rest of World (ROW) holdings of U.S. Financial Assets surged $2.542 TN during Q2 to a record $43.592 TN. 

Amazingly, ROW holdings began year 2000 at $7.310 TN and first surpassed $10 TN in Q3 2004. 

ROW holdings to GDP ended Q2 at a record 192%, up from 161% to end 2019. 

This ratio was at 108% at the end of 2007 and 74% to conclude the nineties. 

ROW holdings of Treasuries ($7.202 TN), Agency Securities ($1.145 TN), Corporate bonds ($4.435 TN), and Total Equities ($13.321 TN) all ended Q2 at all-time records. 

In yet another incredible data point, ROW holdings of U.S. Financial Assets inflated $13.625 TN, or 46%, in just 10 quarters.

As always, Z.1 data are invaluable in shedding light on the historic U.S. Credit Bubble. 

Crypto’s Rapid Move Into Banking Elicits Alarm in Washington

The boom in companies offering cryptocurrency loans and high-yield deposit accounts is disrupting the banking industry and leaving regulators scrambling to catch up.

By Eric Lipton and Ephrat Livni

Credit...Dalbert B. Vilarino


BlockFi, a fast-growing financial start-up whose headquarters in Jersey City are across the Hudson River from Wall Street, aspires to be the JPMorgan Chase of cryptocurrency.

It offers credit cards, loans and interest-generating accounts. 

But rather than dealing primarily in dollars, BlockFi operates in the rapidly expanding world of digital currencies, one of a new generation of institutions effectively creating an alternative banking system on the frontiers of technology.

“We are just at the beginning of this story,” said Flori Marquez, 30, a founder of BlockFi, which was created in 2017 and claims to have more than $10 billion in assets, 850 employees and more than 450,000 retail clients who can obtain loans in minutes, without credit checks.

But to state and federal regulators and some members of Congress, the entry of crypto into banking is cause for alarm. 

The technology is disrupting the world of financial services so quickly and unpredictably that regulators are far behind, potentially leaving consumers and financial markets vulnerable.

In recent months, top officials from the Federal Reserve and other banking regulators have urgently begun what they are calling a “crypto sprint” to try to catch up with the rapid changes and figure out how to curb the potential dangers from an emerging industry whose short history has been marked as much by high-stakes speculation as by technological advances.

In interviews and public statements, federal officials and state authorities are warning that the crypto financial services industry is in some cases vulnerable to hackers and fraud and reliant on risky innovations. 

Last month, the crypto platform PolyNetwork briefly lost $600 million of its customers’ assets to hackers, much of which was returned only after the site’s founders begged the thieves to relent.

An ad for BlockFi at Union Station in Washington. Unlike a bank, BlockFi does not check credit scores, relying instead on the value of customers’ cryptocurrency collateral.Credit...Samuel Corum for The New York Times


“We need additional authorities to prevent transactions, products and platforms from falling between regulatory cracks,” Gary Gensler, the chairman of the Securities and Exchange Commission, wrote in August in a letter to Senator Elizabeth Warren, Democrat of Massachusetts, about the dangers of cryptocurrency products. 

“We also need more resources to protect investors in this growing and volatile sector.”

The S.E.C. has created a stand-alone office to coordinate investigations into cryptocurrency and other digital assets, and it has recruited academics with related expertise to help it track the fast-moving changes. 

Acknowledging that it could take at least a year to write rules or get legislation passed in Congress, regulators may issue interim guidance to set some expectations to exert control over the industry.

BlockFi has already been targeted by regulators in five states that have accused it of violating local securities laws.

Regulators’ worries reach to even more experimental offerings by outfits like PancakeSwap, whose “syrup pools” boast that users can earn up to 91 percent annual return on crypto deposits.

Treasury Secretary Janet L. Yellen and Jerome H. Powell, the chair of the Federal Reserve, have also voiced concerns, even as the Fed and other central banks study whether to issue digital currencies of their own.

Mr. Powell has pointed to the proliferation of so-called stablecoins, digital currencies whose value is typically pegged to the dollar and are frequently used in digital money transfers and other transactions like lending.

Jerome H. Powell, the chair of the Federal Reserve, has voiced concerns about innovations like stablecoins, even as the Fed and other central banks study whether to issue digital currencies of their own.Credit...Sarahbeth Maney/The New York Times


“We have a tradition in this country where, you know, where the public’s money is held in what is supposed to be a very safe asset,” Mr. Powell said during congressional testimony in July, adding, “That doesn’t exist really for stablecoins.”

The cryptocurrency banking frontier features a wide range of companies. 

At one end are those that operate on models similar to those of traditional consumer-oriented banks, like BlockFi or Kraken Bank, which has secured a special charter in Wyoming and hopes by the end of this year to take consumers’ cryptocurrency deposits — but without traditional Federal Deposit Insurance Corporation insurance.

On the more radical end is decentralized finance, or DeFi, which is more akin to Wall Street for cryptocurrency. 

Players include Compound, a company in San Francisco that operates completely outside the regulatory system. 

DeFi eliminates human intermediaries like brokers, bank clerks and traders, and instead uses algorithms to execute financial transactions, such as lending and borrowing.

“Crypto is the new shadow bank,” Ms. Warren said in an interview. 

“It provides many of the same services, but without the consumer protections or financial stability that back up the traditional system.”

“It’s like spinning straw into gold,” she added.

Lawmakers and regulators are worried that consumers are not always fully aware of the potential dangers of the new banklike crypto services and decentralized finance platforms. 

Crypto deposit accounts are not federally insured and holdings may not be guaranteed if markets go haywire.

People who borrow against their crypto could face liquidation of their holdings, sometimes in entirely automated markets that are unregulated.

From Pawnbroker to Bank

BlockFi’s extraordinary growth — and the recent crackdown by state regulators — illustrates the fraught path of cryptocurrency financial services companies amid confusion about what they do.

BlockFi’s business is not dissimilar to that of a regular bank. 

It takes deposits of cryptocurrencies and pays interest on them. 

It makes loans in dollars to people who put up cryptocurrency as collateral. And it lends crypto to institutions that need it.

For consumers, the main allure of BlockFi is the chance to take loans in dollars up to half of the value of their crypto collateral, allowing customers to get cash without the tax hit of selling their digital assets, or to leverage the value of holdings to buy more cryptocurrency. 

The company also offers interest of up to 8 percent per year on crypto deposits, compared with a national average of 0.06 percent for savings deposits at banks in August.

How can BlockFi offer such a high rate? 

In addition to charging interest on the loans it makes to consumers, it lends cryptocurrency to institutions like Fidelity Investments or Susquehanna International Group that use those assets for quick and sometimes lucrative cryptocurrency arbitrage transactions, passing on high returns to customers. 

And because BlockFi is not officially a bank, it does not have the large costs associated with maintaining required capital reserves and following other banking regulations.

Also unlike a bank, BlockFi does not check credit scores, relying instead on the value of customers’ underlying crypto collateral. 

The company’s executives argue that the approach democratizes financial services, opening them to people without the traditional hallmarks of reliability — like good credit — but with digital assets.

The model has worked for BlockFi. 

It is hiring employees from London to Singapore, while prominent investors — like Bain Capital, Winklevoss Capital and Coinbase Ventures — have jumped in to fund its expansion. 

The company has raised at least $450 million in capital.

But to regulators, BlockFi’s offerings are worrying and perplexing — so much so that in California, where BlockFi first sought a lender’s license, officials initially advised it to instead apply for a pawnbroker license. 

Their reasoning was that customers seeking a loan from BlockFi hand over cryptocurrency holdings as collateral in the same way that a customer might give a pawnshop a watch in exchange for cash.

Ms. Marquez of BlockFi called the sheriff’s office in San Francisco about a pawnbroker license, only to be redirected again. 

“No, pawnbrokers’ licenses are only for physical goods,” she recounted being told. 

“And because crypto is a virtual asset, this license actually does not apply to you.”

Flori Marquez, right, is a founder of BlockFi, which says it has $15 billion in assets, 700 employees and more than 450,000 retail clients who can obtain loans in minutes, without credit checks.Credit...Desiree Rios for The New York Times


Undeterred, she returned to the state’s banking regulators and persuaded them BlockFi qualified as a lender, albeit of a new variety. 

The company now has licenses in at least 28 states to offer dollar loans and transacts in cryptocurrency with more than 450,000 clients — many of whom are outside the United States. 

In the first three months of this year, the value of crypto held in BlockFi interest-bearing accounts more than tripled to $14.7 billion from $4.4 billion, a jump driven in part by the rise in the price of Bitcoin and other cryptocurrencies.

As the company has expanded, regulators have become increasingly concerned. 

New Jersey’s attorney general sent it a “cease and desist” letter in July, saying it sells a financial product that requires a securities license, with all the associated obligations, including mandated disclosures.

“No one gets a free pass simply because they’re operating in the fast-evolving cryptocurrency market,” the acting attorney general, Andrew J. Bruck, said.

BlockFi does not adequately notify customers of risks associated with its use of their cryptocurrency deposits for borrowing pools, including the “creditworthiness of borrowers, the type and nature of transactions,” officials in Texas added in their own complaint, echoing allegations made by state officials in Alabama, Kentucky and Vermont.

Zac Prince, BlockFi’s chief executive, said that the company was complying with the law but that regulators did not fully understand its offerings. 

“Ultimately, we see this as an opportunity for BlockFi to help define the regulatory environment for our ecosystem,” he wrote in a note to customers.

Breaking the Banking Mold

The regulatory challenge is even greater when it comes to other emerging crypto finance developers in the world of DeFi, such as Compound, SushiSwap and Aave as well as PancakeSwap.

They are all essentially automated markets run by computer programs facilitating transactions without human intervention — the crypto-era version of trading floors. 

The idea is to eliminate intermediaries and bring together buyers and sellers on the blockchain, the technology behind cryptocurrency. 

The sites do not even collect users’ personal information.

Founders of those kinds of platforms argue that they are just building a “protocol” ultimately led by a community of users, with the computer code effectively running the show.

Robert Leshner, 37, started Compound in 2018 after spending a year in a tiny attic office sublet in the Mission district in San Francisco with five colleagues, experimenting with a computer program that would become part of the foundation of the DeFi movement.

Compound — backed by prominent crypto venture capitalists like Andreessen Horowitz and Coinbase Ventures — now has more than $20 billion in assets. 

Each of the nearly 300,000 “customers” is represented by a unique 42-character list of letters and numbers. But Compound does not know their names or even what country they are from.

Mr. Leshner and others who helped set up Compound own a large share of its self-issued cryptocurrency token — known as COMP — which has surged in value, making him worth, at least on paper, tens of millions of dollars.

Mr. Leshner has been startled by the rapid growth. 

“At every juncture, the speed at which decentralized finance has just, like, started to work, has caught myself and everybody off guard,” he said.

Industry executives say concerns about the safety and stability of digital assets are overblown, but federal financial regulators are still working to get a handle on the latest developments.

A Bitcoin mining factory in Florence, Italy. The cryptocurrency banking frontier features a wide range of companies.Credit...Alessandro Bianchi/Reuters


DeFi protocols largely rely upon stablecoins, cryptocurrencies that are ostensibly pegged to the United States dollar for a steady value but without guarantees that their value is adequately backed.

The overall market of stablecoins has ballooned to $117 billion as of early September from $3.3 billion in January 2019. 

That has regulators worried.

“These things are effectively treated by users as bank deposits,” said Lee Reiners, a former supervisor at the Federal Reserve Bank of New York. 

“But unlike actual deposits, they are not insured by F.D.I.C., and if account holders begin to have concerns that they cannot get money out, they might try and trigger a bank run.”

One option worth considering, Ms. Warren said, is to ban banks in the United States from holding cash deposits backing up stablecoins, which could effectively end the surging market. 

Another possibility that some say could undermine the entire crypto ecosystem is the creation of a government-issued digital dollar.

“You wouldn’t need stablecoins, you wouldn’t need cryptocurrencies if you had a digital U.S. currency,” Mr. Powell, the Fed chairman, said in July. “I think that’s one of the stronger arguments in its favor.”


Eric Lipton is a Washington-based investigative reporter. A three-time winner of the Pulitzer Prize, he previously worked at The Washington Post and The Hartford Courant. @EricLiptonNYT

Ephrat Livni reports from Washington on the intersection of business and policy for DealBook. Previously, she was a senior reporter at Quartz, covering law and politics, and has practiced law in the public and private sectors.   @el72champs

Why is Gold Not Rising?

Many are asking why gold is not rising, as just about every other commodity makes new highs in the backdrop of inflationary tailwinds.

That’s a very fair question.

Some are even saying gold is dead, a silly and “barbarous” old relic of ancient times, ancient math and ancient common sense.

Needless to say, we beg to differ, not because we are Swiss-based gold bugs, but simply…well… let’s explain.

Current Price vs. Current and Future Roles

For those who see history and math as guides rather than “barbarous” and outdated disciplines, their convictions regarding gold’s role, and even price trajectory, do not wane or rise simply due to the paper price of gold.

To some extent, and despite Basel 3, gold remains openly manipulated by a handful of central and bullion banks who are terrified of gold’s shine for no other reason than it embarrasses currencies (and mad monetary experiments) falling deeper into discredit.

But we track the movement of physical gold every day, and can say with blunt clarity that the paper trade in gold has zero to do with the those otherwise “barbarous” forces of the actual supply and demand of this precious metal.

Zero.

In short, the paper price of gold has become a fiction accepted as reality, which is not surprising in a financial landscape (i.e., historically over-valued stocks, negative yielding bonds and central bankers allergic to transparency) which defies every measure of honest price discovery or basic capitalism.

As for the never-ending gold vs. BTC debate, it would be wrong to say Bitcoin hasn’t taken (or continue to take) some market share away from gold, but at less than $1 trillion, BTC is not going to destroy gold’s $10T market share.

In short, the current gold price is a less important topic than its current and future role as historical insurance against mathematically-failing financial and economic systems around the globe.

That said, we are not apologists for the falling gold prices, nor do we doubt that by the end of this decade, gold will price well above $4000 per ounce and greatly reward informed investors playing the long game rather than putting green.

More on that later.

Gold’s Three Roles

For now, let’s consider gold’s historical role as a hedge against: 1) recession risk; 2) market volatility risk; and 3) inflation/currency risk.

  • Recession Hedging

As for recessions, gold is like an emotional and mathematical barometer testing the temperature of over-heated monetary expansion.

As such, it moves higher even before policy makers add more inevitable “stimulus” (i.e., mouse-click fiat currencies) into the system.

By the time policy makers officially announce a recession, it’s far too late for most investors to react.

Fortunately, gold acts more quickly, anticipating monetary expansion even before the money printers start churning.

Long before the “COVID recession” of 2020, for example, the writing was already on the wall that markets and central bankers were getting desperate.

By late 2019, debt levels were off the charts, liquidity was drying up, the repo markets were drinking hundreds of billions of Fed dollars per month and an un-official QE to the tune of $60 billion per month was in full-swing.

Then came COVID in March. Markets and GDP were tanking and gold was already on course to see (in dollar terms) a 25% rise in 2020, after a 19% rise in 2019.

In short, as a recession hedge, gold was ahead of the central bankers in protecting investors.

By the way, the Fed’s record for calling recessions and warning investors is 0 for 10…

  • Hedging Market Volatility

We all remember March of 2020, when markets puked and gold fell along with it, primarily sold-off as a liquidity source for players facing margin costs which they were forced to pay off with gold holdings.

As in 2008 and 2009, gold initially followed the stock ship below the waterline—though not nearly as far as BTC…

But as mentioned above, gold reacted quickly, anticipating the money printing (and hence dollar debasement) to come, rising steadily for the rest of that fiscal year.

Of course, stocks rose as well, thanks to the unbelievable and historically unprecedented money creation witnessed in 2020—more QE in less than a year than all of the combined QE1-QE4 and “Operation Twist” which we saw from 2009-2015.

But thankfully, gold doesn’t just follow stock markets, it hedges them, as the past shows and the future will once again confirm.

Such monetary stimulus creates what von Mises would call a “crack-up boom,” and near-term such liquidity is just wonderful for stocks and bonds.

As we’ve written elsewhere, COVID—and the policy measures which followed– literally saved the securities bubble and made this “boom” even bigger.

But the “boom”-to-volatility to sequence to come from such risk assets reaching price levels which have absolutely nothing to do with valuation will be infinitely more painful (“crack-up”) down the road for those assets than for gold the moment when, not if, this horrific financial system implodes under its own and historically un-matched weight.

In short, gold will zig when the markets zag.

The anti-gold crowd, of course, will smirk and hug their bonds, reminding us all that gold is a yield-less relic while forgetting to confess that the “no yield” of gold is ironically preferrable to over $19 trillion worth of negative yielding sovereign bonds…

10 year government yields
  • Hedging Inflation & Currency Risk

Which brings us to the big question of the day, why is gold not rising when it should be ripping as a hedge against what is clearly an inflationary new normal?

Fair question.

We are asking this ourselves, as real rates (the ideal setting for gold) fall deeper into negative depths with each new day…

real treasury rates are negative despite gold not rising.

…as inflation, as well as inflation expectations, are on the objective rise:

Inflation expectations on the rise.

Last year, for example, gold saw this inflation coming and thus its rising, double-digit price moves reflected the same.

But this year, with real rates still diving and inflation rising, gold is showing single single-digit losses rather than gains.

What gives?

The Market Still Believes the “Transitory” Meme

Our ultimate opinion boils down to this: We think the market still believes the central bank myth (i.e., propaganda) that the current inflation is indeed, only “transitory.”

We’ve written ad nauseum as to why inflation is anything but “transitory,” yet we can nevertheless respect the deflationists’ argument.

The Deflationists

The deflation camp, for example, rightly argues that recessionary forces, if left alone, are inherently deflationist, and the signs of economic (rather than market) declines are everywhere.

But the key mistake which such deflation (or dis-inflation) narratives make is that these natural forces have not, nor will be, “left alone.”

In other words, deflationists are somehow ignoring the monetary and fiscal elephant in the room.

That is, more, not less, unnatural monetary and fiscal liquidity is entering the system at historically unprecedented levels, levels that are more than enough to quash such otherwise natural deflationary forces.

Why is gold not going up when M2 money supply is rising?

Stated even more plainly, moderation at the fiscal and monetary level died long ago.

Simple Realism—Inflation as Necessity Rather than Debate

Central banks are desperate to reach higher inflation to inflate their way out of debt without admitting the same.

This is nothing new for fork-tongued policy makers who once “targeted” 2% inflation as a ceiling, but are now effectively “allowing” 2% inflation as the new floor.

Just as Nixon said the closing of the gold window was “transitory” in 1971, or as Bernanke promised that QE would be transitory in 2009, the current lie from on high about “transitory inflation” is no less a lie in 2021 as those other lies were in 1971 or 2009.

Again, we all just kina know this, right?

Furthermore, we just need to be realists rather than dreamers to see the inflation reality now and ahead.

Central bankers, for example, may be dishonest, but they aren’t entirely stupid, just desperate and realistic.

In the U.S., for example, a staggering as well as openly embarrassing $28.5 trillion public (i.e., national) debt level quickly limits one’s options at the White House or the Eccles Building.

Not Many Options Other than Inflation

In this realistic light, let’s consider their options. 

Policy makers have four tools to address such debt, namely: raise taxes, cut spending, declare bankruptcy, or devalue their currencies through inflation.

The first two are already in play in the U.S., namely political efforts to raise taxes and ‘talk’ of cutting spending, both politically difficult options.

Taking bankruptcy off the table, leaves devaluing the U.S. Dollar as the favored option, which is achieved by deliberately taking real interest rates to extreme negative levels.

Allowing inflation to run while keeping rates low reduces the number of dollars needed to repay the debt.

This hurts regular folks, but as we’ve said so many times, the Fed is not interested in regular folks.

In other words, by decreasing the value of the U.S. Dollar, the U.S. is effectively paying off its current debt with devalued money. 

There are no permission slips needed from Congress, nor taxpayers.

Given such realism, let us be repeatedly blunt and clear: Unlike gold not rising, inflation is not, nor will it be, “transitory.”

Instead, deliberate inflation is an inherently and deliberately necessary tool used by the same anti-heroes who put us in this debt hole.

More Fed-Speak, Less Honesty

This means the Fed will come up with whatever excuses, words, phrases and lies to justify being more dovish despite publicly flirting with hawkish talk about a Fed taper.

Already, Powell is taking the Fed way beyond its mandate and talking about social and environmental activism, as these are nice phrases to justify, you guessed it: More money creation and more (not “transitory”) inflation.

As for me, hearing Powell talk about “labor market inequality” after the Fed has spent years making the top 1% richer at the expense of an increasingly poorer bottom-90% is so rich in hypocrisy that it makes the eyes water.

Wealth inequality is rampant.

In this opaque light, the notion of “Fed independence” is a complete and utter fiction.

Instead, the Fed is slowly crossing the line into becoming the direct financier to the entire nation—and the only way it can do this is via monetary expansion and deliberate (as well as much higher) inflation, which is a tax on the poor and bullet to the heart of the U.S. Dollar. Period. 

Full stop.

It’s All About Debt

Again, this all comes realistically back to debt.

When there’s too much unpayable debt (be it at the zombified corporate level or the embarrassed national level), rising rates becomes fatal.

The Fed has learned since 2018 that even a slight rise in rates kills the debt-saturated markets whose capital gains taxes are about all that Uncle Sam can declare as income in a nation whose GDP was sold to China years ago.

And yet… and yet… the markets somehow wish to believe the fantasy (and Fed-speak) that inflation is only “transitory.”

What’s Ahead?

We strongly think differently.

As blunt realists, we see the Fed perhaps raising rates nominally, but when adjusted by openly deliberate (yet openly denied) inflation, real rates will fall deeper as inflation rises higher.

This is because the simple reality (and choice) of nations with their backs against a debt wall is always the pursuit of inflation by design, not deflation.

As I recently wrote, nothing is real anymore, and all taboos are broken. The Fed, through QE and/or the Repurchase Program, will print more money as fiscal policy rises alongside—a veritable double-whammy for more “liquidity” to come.

This, of course, is crazy and ends badly.

The Fed, along with the White House, have tried since Greenspan to outlaw natural market forces and needed austerity in order to bloat markets, keep their jobs or win re-election.

Since we can never grow or default (?) our way out of the greatest debt hole in our history, the realistic playbook ahead is negative real rates—i.e., inflation rising higher and faster than repressed Treasury yields.

Once this becomes obvious rather than “debated,” gold will rise along side the money supply to levels well above it’s current, yet admittedly, low price.

Slowly, but surely, the $19 trillion in negative-yielding sovereign bonds will see outflows from that discredited asset and hence inflows into the “barbarous” asset: Gold.

For now, we are patient realists rather than apologists, as the market seemingly continues to price gold for only “transitory” inflation.

But once inflationary reality rises above the current “transitory” fantasy, gold will not only surge in price, but serve its far more important role of hedging against undeniable inflation and the equally undeniable (i.e., destructive) impact such inflation will have on global currencies in general and the U.S. Dollar in particular.

Gold is rising relative to the dollar

Gold: Biding Its Time

Despite such signposts from math, history and Real Politik, gold is currently under attack for not “doing enough,” despite two years of double-digit rises.

Gold investors, however, are not greedy, they are patient, and they hold this physical rather than paper asset for the long game, as previously described.

And as for that long game, the inflation ahead, as well destruction of the currency in your pocket today and tomorrow, means today’s gold price is not nearly as relevant an issue as gold’s role in protecting far-sighted investors from what’s ahead.

In the end, gold’s primary role is acting as insurance for a global financial and currency system already burning to the ground.

But for those naturally asking about price, forecasting and models, as any who worked in a bank know, such models are as complex as they are useless.

We keep things simpler and humbler.

By just tracking monetary growth rates with certain regressions, a realistic price target for gold based upon inevitable monetary expansion suggests gold at well past $4000 by the end of this decade.

That may or may not seem sexy enough for those chasing returns today, but when those returns convert into losses too hard to imagine as markets reach new highs, we must genuinely remind you that even with Fed “support,” all bubbles do the same thing: “Pop.”

We are not here to tell you when, as no one can.

We are simply suggesting you prepare, rather than react.

What Difference Did 9/11 Make?

When the next terrorist attacks come, will US presidents be able to channel public demand for revenge by precise targeting, explaining the trap that terrorists set, and focusing on creating resilience in US responses? That is the question Americans should be asking, and that their leaders should be addressing.

Joseph S. Nye, Jr.


CAMBRIDGE – The terrorist attacks of September 11, 2001, were a horrific shock. 

Images of trapped victims leaping from the Twin Towers are indelible, and the intrusive security measures introduced in the wake of the attacks have long since become a fact of life.

But skeptics doubt that it marked a turning point in history. 

They note that the immediate physical damage was far from fatal to American power. 

It is estimated that the United States’ GDP growth dropped by three percentage points in 2001, and insurance claims for damages eventually totaled over $40 billion – a small fraction of what was then a $10 trillion economy. 

And the nearly 3,000 people killed in New York, Pennsylvania, and Washington, DC, when the al-Qaeda hijackers turned four aircraft into cruise missiles was a small fraction of US travel fatalities that year.

While accepting these facts, my guess is that future historians will regard 9/11 as a date as important as the Japanese attack on Pearl Harbor on December 7, 1941. 

The surprise attack on the US naval base in Hawaii killed some 2,400 American military personnel and destroyed or damaged 19 naval craft, including eight battleships. 

In both cases, however, the main effect was on public psychology.

For years, President Franklin D. Roosevelt had tried to alert Americans to the Axis threat but had failed to overcome isolationism. 

All that changed with Pearl Harbor. 

In the 2000 presidential election, George W. Bush advocated a humble foreign policy and warned against the temptations of nation-building. 

After the shock of 9/11, he declared a “global war on terror” and invaded both Afghanistan and Iraq. 

Given the proclivities of top members of his administration, some say a clash with Iraq’s then-dictator, Saddam Hussein, was predictable in any case, but not its manner or cost.

What 9/11 illustrates is that terrorism is about psychology, not damage. 

Terrorism is like theatre. 

With their powerful military, Americans believe that “shock and awe” comes from massive bombardment. 

For terrorists, shock and awe comes from the drama more than the number of deaths caused by their attacks. 

Poisons might kill more people, but explosions get the visuals. 

The constant replay of the falling Twin Towers on the world’s television sets was Osama bin Laden’s coup.

Terrorism can also be compared to jujitsu, in which a weak adversary turns the power of a larger player against itself. 

While the 9/11 attacks killed several thousand Americans, the “endless wars” that the US subsequently launched killed many more. 

Indeed, the damage done by al-Qaeda pales in comparison to the damage America did to itself.

By some estimates, nearly 15,000 US military personnel and contractors were killed in the wars that followed 9/11, and the economic cost exceeded $6 trillion. 

Add to this the number of foreign civilians killed and refugees created, and the costs grow even more enormous. 

The opportunity costs were also large. 

When President Barack Obama tried to pivot to Asia – the fastest-growing part of the world economy – the legacy of the global war on terror kept the US mired in the Middle East.

Despite these costs, some say that the US achieved its goal: There has not been another major terrorist attack on the US homeland on the scale of 9/11. 

Bin Laden and many of his top lieutenants were killed, and Saddam Hussein was removed (though his connection to 9/11 was always dubious). 

Alternatively, a case can be made that bin Laden succeeded, particularly if we consider that his beliefs included the value of religious martyrdom. 

The jihadist movement is fragmented, but it has spread to more countries, and the Taliban have returned to power in Afghanistan – ironically, just before the 9/11 anniversary that President Joe Biden originally set as the target date for withdrawing US troops.

It is too early to assess the long-term effects of the US withdrawal from Afghanistan. 

The short-term effects of the chaotic exit are costly, but in the long term, Biden may come to be seen as correct to forswear the effort at nation-building in a country divided by mountains and tribes and united mainly by opposition to foreigners.

Leaving Afghanistan will allow Biden to focus on his grand strategy of balancing the rise of China. 

For all the damage done to US soft power by the chaotic manner of the exit from Afghanistan, Asia has its own longstanding balance of power in which countries like Japan, India, and Vietnam do not wish to be dominated by China and welcome an American presence. 

When one considers that within 20 years of America’s traumatic exit from Vietnam, the US was welcome in that country as well as the region, Biden’s overall strategy makes sense.

At the same time, 20 years after 9/11, the problem of terrorism remains, and terrorists may feel emboldened to try again. 

If so, the task for US leaders is to develop an effective counter-terrorism strategy. 

Its core must be to avoid falling into terrorists’ trap by doing great damage to ourselves. 

Leaders must plan to manage the psychological shocks at home and abroad.

Imagine what the world would be like if Bush had avoided the tempting rallying cry of a global war on terror and responded to 9/11 by carefully selected military strikes combined with good intelligence and diplomacy. 

Or, if he had gone into Afghanistan, imagine that he had withdrawn after six months, even if that had involved negotiating with the despised Taliban.

Looking forward, when the next terrorist attacks come, will presidents be able to channel public demand for revenge by precise targeting, explaining the trap that terrorists set, and focusing on creating resilience in US responses? 

That is the question Americans should be asking, and that their leaders should be addressing.


Joseph S. Nye, Jr. is Dean Emeritus of Harvard University’s John F. Kennedy School of Government and author of Do Morals Matter? Presidents and Foreign Policy from FDR to Trump.