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Show Notes: The System Is Too Levered To Take Real Pain | Arthur Hayes
Episode Introduction
Arthur Hayes argues the US financial system is too levered to withstand aggressive policy pain, forcing concessions like tariff walk-backs and setting the stage for inevitable money printing that benefits Bitcoin.
Arthur Hayes Introduction
- Arthur Hayes introduces himself as the co-founder and former CEO of BitMEX, the platform known for inventing the perpetual swap contract widely used in crypto derivatives trading since 2016.
- He now runs Maelstrom, his family office, serving as Chief Investment Officer, focusing on early-stage crypto token deals and trading strategies.
Trump's Tariff Policies and Market Reaction
- Hayes outlines Trump's consistent political message: addressing the perceived negative impacts of globalization on a segment of America and aiming to reduce the US current account deficit (the difference between a country's imports/exports of goods, services, and investment incomes) and reshore manufacturing.
- Despite Biden continuing similar restrictive policies towards China (e.g., semiconductor restrictions), Trump's post-election maximalist tariff proposals went beyond market expectations, triggering a significant market downturn.
- Hayes observes that the swift negative reaction, particularly in the bond market, demonstrated the system's fragility. "The American financial system is so highly levered that it couldn't take one week of Trump's maximalist position on on tariffs," Hayes states, suggesting this forced the administration to quickly moderate its stance.
- The subsequent concessions (90-day pause, consumer electronics exemption, openness to negotiation with China) indicate, in Hayes's view, that the political and financial system cannot currently absorb the shock of such aggressive trade policies, leading him to believe the market bottom may be in for assets like Bitcoin.
US Strategy Towards Allies and China
- Hayes notes US Treasury Secretary Scott Bessent's stated strategy: unite US allies ("western values") to present a unified front against China, aiming to make the trade restrictions more effective than unilateral US actions previously were (which China circumvented via countries like Mexico and Vietnam).
- The goal is to co-opt allies into restricting Chinese intermediate goods, even if it causes them economic pain, to effectively isolate China economically. The success of this co-option remains uncertain.
China's Reaction Function and Historical Context
- Hayes provides crucial context on China's perspective, emphasizing the historical "century of humiliation" narrative deeply ingrained in Chinese policy and public consciousness. This period involved foreign powers imposing unfavorable trade terms and tariffs (e.g., the Opium Wars, unequal treaties).
- Given this history, Hayes argues that Xi Jinping faces immense domestic pressure not to appear weak or concede to aggressive US demands ("kneel kiss the ring"). Agreeing to terms perceived as dictated by the US would undermine the Communist Party's legitimacy, which is built on rejuvenating China's global standing.
- Therefore, Hayes believes China is unlikely to agree to a deal that significantly rebalances trade to the extent the US desires, especially given their internal economic challenges (balance sheet recession) requiring monetary stimulus.
Impact of US-China Embargo/Decoupling on Global Economy
- Hayes asserts that despite tariff rhetoric, a true decoupling is highly improbable in the near term because the global economy relies heavily on China's efficient, high-quality, and low-cost manufacturing capabilities. "It's the most advanced manufacturing setup in the world... Period," he emphasizes.
- He predicts that goods will continue to flow, potentially through less direct or "secret pathways," but at a higher cost. The tariffs will likely be inflationary globally but ineffective in fundamentally restructuring trade ecosystems until alternative manufacturing hubs can replicate China's scale, a process Hayes estimates could take decades.
Bitcoin as a Global Liquidity Asset & Potential Decoupling from Tech
- Hayes connects the macro policy back to Bitcoin. He argues that if Trump genuinely pursues reducing the US current account deficit, it mathematically implies reduced foreign demand for US financial assets (Treasuries, tech stocks), as the financial account surplus must shrink correspondingly.
- This structural outflow should negatively impact US tech stocks (like the Mag 7), which have been major beneficiaries of these inflows. Hayes states, "Mathematically if Trump is serious about reducing the current account to zero then foreigners have to sell stocks. Period."
- Simultaneously, if governments globally (including China, US, Europe) resort to printing money to cushion the economic blows of deglobalization and manage debt burdens, Bitcoin stands to benefit as a global liquidity absorber.
- Hayes suggests this dynamic could finally lead to Bitcoin decoupling from US tech stocks. While the rapid tariff walk-back prevented a clear demonstration this time, he believes the long-term narrative of US tech exceptionalism is fading due to factors like rising AI competition (e.g., DeepSeek from China) and potentially inefficient capital expenditure, drawing parallels to the dot-com bust. Bitcoin's outperformance would then stem from rising global liquidity, not just risk-on sentiment tied to tech.
The Role of the US Treasury (Yellen's RRP Drain, Bessent's Buybacks)
- Hayes highlights a crucial shift: market participants conditioned by the 2008-2019 era focus heavily on the Federal Reserve and Quantitative Easing (QE), but the US Treasury now holds significant power over liquidity dynamics.
- He explains how former Secretary Yellen utilized the Reverse Repo Program (RRP) – a Fed facility where money market funds park cash – by increasing Treasury Bill (short-term debt) issuance. Higher T-Bill yields incentivized funds to move cash from the RRP (considered outside active circulation) into T-Bills, effectively injecting ~$2.5 trillion of liquidity without formal QE.
- Current Secretary Bessent has signaled his tool of choice: Treasury buybacks. Hayes interprets Bessent's comments ("I've got plenty of tools specifically uh treasury buybacks") during market stress as a clear signal of intent. Both RRP drainage and buybacks are forms of "stealth QE" controllable by the Treasury, independent of the Fed or Congress.
Fiscal Levers: Treasury Buybacks Explained
- Hayes clarifies the likely mechanism for Treasury buybacks, based on insights from bond market contacts. The focus isn't necessarily on changing duration (like Operation Twist) but on improving market plumbing.
- The Treasury would buy back older, less liquid "off-the-run" bonds (bonds that are no longer the most recently issued for a given maturity) and issue new "on-the-run" bonds.
- This helps Relative Value (RV) hedge funds – major players in the Treasury market who trade pricing differences between related securities. Off-the-run bonds require more bank balance sheet capital (collateral) due to lower liquidity. By removing these, the Treasury frees up dealer balance sheets.
- This increased capacity allows RV funds to absorb more new Treasury issuance, effectively facilitating government borrowing even as deficits rise.
Implications of Increased Treasury Issuance & Buybacks
- Hayes anticipates Bessent will announce higher-than-expected borrowing needs in the upcoming Quarterly Refunding Announcement (QRA), citing factors like scaled-back spending cuts (the "Doge" reference likely alludes to budget discussions), potentially lower capital gains tax receipts, ongoing structural spending, and likely Trump tax cuts.
- The buyback program is crucial for managing this increased supply. By enabling RV funds (leveraged players) to buy more Treasuries, the government effectively finances itself through credit creation rather than savings, injecting liquidity into the system. Hayes sees this as fundamentally positive for Bitcoin.
The Fed's Role and "Stealth QE"
- Despite Chair Powell's hawkish rhetoric and stated conditions for QE (rates at zero), Hayes argues the Fed is ultimately reactive to market stress. He cites the rapid creation of the Bank Term Funding Program (BTFP) – a temporary emergency lending facility – during the 2023 regional banking crisis as proof.
- Hayes points to comments from Fed officials like Susan Collins during the recent "tariff tantrum" ("The Fed... stands ready to do what is necessary") as evidence they will intervene using various tools, even if not labeled "QE."
- These tools include adjusting the Supplemental Leverage Ratio (SLR), altering the pace of Quantitative Tightening (QT – the Fed reducing its balance sheet), and modifying Basel III bank capital rules. These actions can significantly impact liquidity without being traditional QE, making them less alarming to the public but achieving similar effects.
Supplemental Leverage Ratio (SLR) Exemption Discussion
- Hayes discusses the growing talk around reinstating the SLR exemption, a rule requiring large banks to hold capital against all assets, including ultra-safe Treasuries and reserves. An exemption allows banks to hold these assets without setting aside capital.
- Banks (like JP Morgan's Jamie Dimon) strongly desire the exemption because it allows them to borrow cheaply (via deposits) and buy Treasuries for a risk-free profit spread, leveraging infinitely without capital cost.
- The government finds it useful because it creates a captive pool of buyers (the banks) for the massive amounts of Treasury debt being issued, especially if foreign demand wanes. Hayes sees the alignment of bank and government interests making the SLR exemption highly likely.
Potential QE Triggers (Japan Carry Trade Unwind)
- When asked about catalysts for more overt Fed action or QE, Hayes identifies the unwind of the Japanese Yen carry trade as the most significant risk. This involves borrowing cheaply in Yen to invest in higher-yielding foreign assets (like US Treasuries).
- If US policy pushes for a weaker dollar (implying a stronger Yen) and the Bank of Japan raises rates, this trade becomes unprofitable or too risky. Japanese investors might rapidly sell foreign assets (Treasuries) to repay Yen loans or invest domestically.
- Given Japan is the largest foreign holder of US Treasuries, a disorderly unwind could destabilize the US bond market, forcing Fed intervention, potentially including explicit Yield Curve Control (YCC – the Fed targeting specific yields) or large-scale QE.
Central Bank Swaps as a Tool
- Hayes explains that Central Bank Swap Lines are a pre-existing tool to manage such crises. The Fed can provide unlimited US dollars to the Bank of Japan (BOJ), which the BOJ can then use to buy Treasuries from its domestic institutions, preventing a fire sale into the open market.
- He notes this mechanism effectively injects liquidity and supports the Treasury market but isn't technically QE as commonly understood, allowing intervention while maintaining a different public narrative. "They are printing money. It's just in a way that you don't understand," Hayes remarks.
Gold's Rally and its Drivers
- Hayes attributes gold's recent strength to several factors, primarily central banks diversifying away from US Treasuries. Key events accelerating this were the freezing of Russia's dollar assets in 2022 (highlighting political risk) and Trump's tariffs exempting gold (signaling its perceived neutrality).
- Central banks, particularly in the Global South and countries with current account surpluses (like China, Poland), view Treasuries as carrying political and potentially credit risk ("not risk-free"). They are increasing gold holdings as a neutral, stateless store of value with a multi-millennia history, hedging against geopolitical uncertainty and the debasement of fiat currencies.
Bitcoin vs. Gold: Central Bank Adoption Prospects
- While acknowledging Bitcoin's superior performance, Hayes expresses skepticism about near-term, large-scale central bank adoption of Bitcoin as a reserve asset bought directly on balance sheets. He believes central bankers understand gold's historical role far better and are not yet "mentally prepared" for Bitcoin.
- He sees a more likely path for state-level Bitcoin accumulation through mining, particularly by nations with surplus energy (citing China's state-level mining activity despite private bans, and potential in oil-exporting nations like the UAE). This frames Bitcoin as a way to store energy value rather than a direct replacement for Treasuries or gold in reserve portfolios, at least for major powers initially.
Conclusion
The core insight is that systemic leverage compels ongoing liquidity injections via Treasury actions and stealth Fed measures, regardless of official QE pronouncements. Crypto AI investors and researchers must track these non-traditional liquidity levers (buybacks, SLR, swaps) as they increasingly drive asset prices, potentially fueling Bitcoin's rise and decoupling from traditional risk assets.
