Luke Gromen Inflation Argument

I asked several AIs to explain Luke Gromen's argument.  I liked Deepseek's version best and include it below:

The Debt That Grows When You Print

Luke Gromen's argument that America's unfunded liabilities are inflation-indexed — and why he says that makes the US look less like a normal indebted country and more like Weimar Germany with its gold reparations, or Israel in the early 1980s with its indexed debt.

If you have never read a single thing about sovereign debt, you can still follow this argument, because at its core it is very simple arithmetic wrapped in one unusual observation. The observation is this: the United States does not owe its citizens a fixed number of dollars. It owes them things that get more expensive when the government prints money.

That single fact changes everything about how the debt is likely to end. Normally, inflation is a debtor's friend — it shrinks the real value of what you owe. If you owe someone $100,000 at a fixed interest rate and prices double, you effectively owe half as much in purchasing power. That is why governments historically have been able to inflate their way out of trouble.

Luke Gromen's argument is that this escape hatch is largely closed for the United States, the UK, and much of the West, because so much of what the government has promised is already indexed to inflation, or denominated in real goods and services. When you print in that situation, the size of the debt in your own currency goes up, not down. You print to pay it, which makes it bigger, which forces you to print more. That is the trap.

He draws two historical analogies to make it concrete: Weimar Germany, whose reparations were payable in gold, and Israel in the early-to-mid 1980s, whose government debt was heavily indexed to the cost of living. In both cases the printing was not a policy choice made from strength. It was something the debt structure compelled.

Start here: what an "unfunded liability" actually is

Governments keep two sets of books, roughly speaking.

The first is the official debt — the Treasury bonds you read about. Every dollar of it is a contract that says: we owe you this many dollars, on this date, at this interest rate. That number sits around $38 trillion for the United States.

The second set of books is the promises that have been made but not formally reserved or accounted for. These are the unfunded liabilities. They are the healthcare you will be given when you are old, the pension you were promised, the disability payment, the veterans' benefit, the hip replacement, the knee replacement, the months of a doctor's time in a hospital bed.

Gromen's point is that this second pile is enormous, and that it is not written in fixed dollars. It is written in real things. As he puts it, "we don't owe boomers dollars. We owe them hips and knees and doctor's time and social security is inflation adjusting."

"These entitlement obligations look like Weimar German gold reparations, war reparations, right? They're off balance sheet and we don't owe boomers dollars. We owe them hips and knees and doctor's time and social security is inflation adjusting."

Luke Gromen, on the structure of US unfunded liabilities — youtube.com

He adds the demographic layer: the wealthiest generation in history is now the generation drawing down the most from government. Roughly four-fifths of government money flows to retirees in one form or another, and those flows are medical, inflation-adjusted, and politically untouchable.

The twist: these liabilities are not fixed in dollars

Here is the crux, and it is worth slowing down for, because it is the whole argument.

A normal government bond is a nominal obligation. It is denominated in currency. Inflation reduces its real burden. A government that owes a lot of nominal debt and is willing to tolerate inflation can grind that debt down relative to the size of its economy.

But an obligation to provide a hip replacement is a real obligation. It is denominated in a surgical procedure, a piece of titanium, a hospital bed, and the labour of trained people. Those things are exactly the things whose prices rise fastest when you print money. Healthcare, insurance, and services are the most inflation-sensitive parts of an economy, because they are labour-intensive and supply-constrained.

Social Security is even more explicit: it is legally indexed to inflation. Every year, the cost-of-living adjustment mechanically raises the dollar amount owed. It is, by construction, a debt instrument that grows with the CPI.

Type of obligation	Denominated in	What inflation does to it
Treasury bond	Fixed dollars	Shrinks the real burden — inflation is the debtor's friend
Inflation-indexed Social Security	Purchasing power	Grows the nominal burden automatically each year
Medicare / health entitlements	Real goods & services	Grows with medical inflation, which typically outruns headline CPI
Veterans' and disability benefits	Indexed / statutory	Grows alongside cost-of-living adjustments
Public pensions	Often indexed, often underfunded	Grows, while the assets backing it may fall in real terms

So the government's liabilities sit on the wrong side of inflation. Printing does not dilute them. Printing makes them larger in the very currency the government is printing.

Why Weimar Germany is the analogy

After the First World War, the Treaty of Versailles required Germany to pay reparations. Crucially, the obligation was not expressed in ordinary paper marks that Germany could inflate away. It was tied to gold — the debt was effectively payable in gold marks, a fixed quantity of metal, not a fixed quantity of paper.

Gromen's framing is that this created a doom loop with no exit. The German government printed paper marks to make its payments. As it printed, the mark fell against gold. But because the debt was denominated in gold, the falling mark meant the debt now cost more marks to settle. So it printed more. Each round of printing increased the nominal size of the obligation it was trying to pay, which required more printing.

That is the structural insight Gromen is importing into the present day. The problem was not simply that Germany printed money, or that it had a big debt. The problem was that its debt was denominated in something its printing could not devalue.

"This is very similar to what Weimar Germany was in... the allies said, 'Hey, you owe us money, but you owe it in gold.' And so the Germans would print money and gold go up. And that's what we're doing."

Luke Gromen — youtube.com

The one-sentence version of the mechanics

When your liabilities are denominated in real things rather than fixed dollars, printing money raises the price of those real things, which raises the size of your liabilities, which makes you print more. The feedback loop runs in the wrong direction.

Why Israel in the early-to-mid 1980s is the closer analogy

Weimar is the dramatic case, but Israel in the early 1980s is the structurally closer one, and Gromen reaches for it for that reason.

Israel in that period had a large stock of government debt that was indexed — linked to the consumer price index so that lenders would not be wiped out by inflation. On top of that, a meaningful share of the country's obligations was denominated in foreign currency and was not something the shekel printing press could dissolve. The result was a debt structure where inflation did not reduce the burden. It fed it.

The consequences were severe. Inflation in Israel accelerated through the late 1970s and early 1980s, running into the hundreds of percent annually at the peak, before a stabilisation programme in 1985 finally broke the spiral. The lesson Gromen takes is not about Israel specifically. It is about the shape of the trap: once your liabilities are indexed or foreign-denominated, the printing becomes self-reinforcing, and the inflation must get worse before any solution can get better.

The uncomfortable translation to the present: America's version of indexing is not a formal clause in a bond contract. It is the nature of what has been promised — healthcare, indexed benefits, and age-related services. The indexation is baked into the substance of the liability rather than its legal wording, which makes it harder to see on a balance sheet and no less real.

The doom loop, step by step

This is Gromen's argument laid out as a sequence. Note that each step is caused by the one before it.

1. The government's liabilities are mostly real, not nominal. Healthcare, indexed benefits and services rise in price with inflation. Printing does not reduce their real cost — it raises their nominal cost.
2. Receipts barely cover the mandatory spending. Gromen notes that this year the US is set to spend almost $5 trillion on interest and entitlements alone, which is close to all of its receipts. There is almost no margin.
3. Any shock that cuts receipts creates an immediate funding gap. In a recession or credit event, tax revenue falls. As Gromen puts it, "we can't cover interest and entitlements if receipts fall at all without printing money."
4. The government prints, because the alternative is not politically survivable. Gromen is emphatic that no government will choose to means-test retirees, cut defence to zero, or default on payments. "There is zero chance that's going to happen. Here's how it's really going to go: crisis, we need to do something, print."
5. The printing shows up first in asset prices and necessities, then in wages and benefits. Real goods, healthcare and energy reprice upward. Because entitlements are indexed, the government's obligation in dollars rises with them.
6. The liability grows faster than the money supply. This is the crucial divergence. In a nominal-debt world, printing outruns the debt. In an indexed-liability world, the debt outruns the printing — because the debt is priced in the things being inflated.
7. More printing is required, and the loop repeats at a higher level. Gromen calls this "wash, rinse, repeat." The exit is some form of default in real terms — either explicit restructuring, or years of inflation that quietly destroys the value of everything denominated in cash.

Stripped of the historical analogies, the conclusion he states plainly is this: "So either print the money or default. That's it."

"Western sovereign debt, it's not even a question. It is unrepayable in a deflationary whoosh... the very bedrock of the sovereign debt that underpins the entire banking system of the entire western world, they're unrepayable in anything resembling real terms. So either print the money or default. That's it."

Luke Gromen — youtube.com

The current arithmetic: why 2026 looks like the point of no return

Gromen's structural argument would be interesting but abstract if the numbers did not currently line up. His case is that they do.

The debt stock is roughly $38 trillion. Gromen's summary of it is blunt: "we ran up $38 trillion in debt and we got a giant pile of nothing to show for it — a couple of bailouts, a couple of stupid wars." Interest and entitlement spending together are approaching $5 trillion a year, which is nearly all federal receipts. There is no fiscal room left for a recession, a war, or a financial accident.

His framing for how healthy the economy otherwise looks is a famous line borrowed from a theatre review: other than that, how was the play, Mrs. Lincoln? If you ignore the sovereign debt situation, he says, everything looks fine.

"If you ignore what's going on with sovereign debt, everything looks pretty good, which is sort of like other than that, how was the play, Mrs. Lincoln?"

Luke Gromen — youtube.com

He also points out that high debt-to-GDP — he cites a figure around 125% — removes the policy tools that would normally be used to fight inflation. Raising interest rates to crush inflation would slow growth, damage the value of AI and technology stocks, and push the deficit wider through recession, making the debt problem worse rather than better.

The uncomfortable conclusion he draws is that the central bank will eventually do the opposite of fighting inflation: it will cap bond yields by buying bonds with printed money, a policy known as yield curve control, because there is no other way to stop a global bond crisis once it starts.

What he says will happen to the reported inflation number

"People need to be ready for double-digit inflation. Powell's just going to come in. He's going to cut rates. Inflation's going to soar, but they're going to lie about it. Inflation'll be running 12 to 15% easy, but they're going to tell you it's four, four and a half."

youtube.com

The mechanism matters more than the exact number. If the government's biggest obligations are indexed to the real cost of living, and the real cost of living is rising faster than the official index, then the official index itself becomes part of the problem: it determines how much the government has to pay out, while understating how fast the underlying costs are actually rising.

The bond market is already voting

Gromen's structural argument is backed, in his telling, by what the world's central banks are doing with their reserves.

Gold has overtaken US Treasuries to become the second-largest reserve asset held by central banks — roughly 27% of global reserves against 22% for Treasuries, according to European Central Bank data. For decades, Treasuries were the definition of the world's risk-free asset. Central banks voting with their feet is, to Gromen, a signal that the buyers of last resort are walking away.

"Gromen's answer starts with gold, and the data has caught up to him. As of this week, gold has overtaken US Treasuries to become the second-largest reserve asset held by central banks, at 27% of global reserves against 22% for Treasuries, per the ECB."

— tftc.io

The second half of that story is that major foreign holders are no longer net buyers of Western government debt. Japan, Germany, Korea and the UK are shifting from bond buyers to bond sellers as they finance their own defence buildouts. In a world where governments are no longer absorbing each other's debt, the marginal buyer of Treasuries becomes the central bank — which is to say, the printing press.

"Japan, Germany, Korea, and the UK are shifting from bond buyers to bond sellers as they finance their own defence buildouts."

— podlexicon.com

Gromen's term for what happens when a government loses control of its bond market is "getting Liz Trussed" — a reference to the 2022 UK gilt crisis, when an unfunded fiscal plan caused yields to spike violently within days. His argument is that the US Treasury and the Federal Reserve will not sit still for that outcome, and will instead cap yields by printing. He claims there is essentially "zero chance" they will accept market discipline on the sovereign.

The wrinkle: AI makes the whole thing arrive sooner

One part of Gromen's argument is unusual and worth flagging separately, because it cuts against the simpler inflation story.

He argues that artificial intelligence is powerfully deflationary. It lowers the cost of producing software, analysis and eventually physical goods. But that deflation is, in his words, "simply incompatible" with the financial system as it currently sits — because the entire system is built on the assumption of growing nominal revenues, growing nominal debt service capacity, and modest inflation.

The effect, in his view, is to bring the moment of decision forward. An economy that is deflating sharply in the productive sector, while carrying a debt load denominated in real goods and services and indexed entitlements, faces the "print or default" choice sooner than it otherwise would.

"AI brings that decision forward... AI's deflation is problematic enough, but the pace of AI deflation is simply incompatible with everything we know in the financial system as it sits today."

Luke Gromen — youtube.com

What he says to actually do about it

Gromen is careful to present his advice as a balance-sheet strategy for someone who is not a trader, not as a set of trade recommendations. He describes the target as being "conservative, liquid, and nimble."

• Overweight cash and gold. Cash provides optionality; gold provides protection against the printing that he expects to come. He is explicit that this is his own personal positioning and he describes himself as "probably sitting... between cash, gold, and a little Bitcoin."
• Be cautious on Bitcoin for the first leg. He believes Bitcoin goes down initially in a crisis, because a deflationary "whoosh" forces liquidations across all leveraged assets. He admits he is "on record for being probably too cute on that front," i.e. he may be over-thinking the timing.
• Keep the balance sheet unlevered and healthy. His reasoning is that the downturn may last "months, probably more like weeks," and that during that window assets will be available cheaply to whoever has cash and no debt. That is the "great opportunity for Steve."
• Own your health and your sovereignty. This is not incidental to his argument; it follows directly from it. If liabilities are real obligations for medical care, then the price of that care is what inflates. "Whatever you're paying for health care now, it's going to go up, and it's going to go up, and it's going to go up."

"I think financially it makes sense to be overweight cash and gold right now... I want to keep my balance sheet really good, conservative and liquid, because this debt here... means that as this debt problem gets acute and we get some sort of whoosh, it's going to last for maybe months, probably more like weeks."

Luke Gromen — youtube.com

The honest caveat, in his own words

Any fair summary of Gromen's argument has to include the fact that he repeatedly refuses to forecast the path. His structural claim is that the debt is unrepayable in real terms and that printing is the likely resolution. His practical claim is that nobody, including him, can time it.

"If anybody tells you they know exactly how this is going to go, run in the other direction, including me. Like I have no freaking idea the path."

Luke Gromen — youtube.com

He also brackets the timeframe loosely: not six months, probably twelve to twenty-four, "I don't think it's thirty-six months, it might be." And he is clear that there will likely be a deflationary crash first, before the printing response arrives — which is exactly why he wants cash alongside gold.

Where a sceptic would push back

To be useful, an explanation of an argument should say where it is vulnerable. Four objections are worth holding alongside it.

• The Weimar causal story is contested. Economic historians debate how much of Germany's hyperinflation came from reparations denominated in gold versus domestic deficit financing, political instability, and the loss of productive territory. Gromen is using Weimar as a structural analogy, not making a claim about the precise historical cause.
• "Unfunded" liabilities are long-dated and can be legislated. Healthcare and pension promises are not bonds with a maturity date. Congress can change benefit formulas, eligibility, and indexation. Gromen's response to this is political rather than economic: he considers it close to impossible that a government will make those cuts, at least not before a crisis forces it.
• The deflationary possibility. If AI genuinely drives deflation, and if a debt crisis produces a scramble for cash, then the near-term outcome may be falling prices and rising real debt burdens rather than out-of-control inflation. Gromen concedes exactly this, which is why his own positioning is not a pure inflation trade.
• Indexing can be a stabiliser as well as an amplifier. Indexed debt reduces the incentive for lenders to flee and can shorten an inflationary episode by restoring credibility once a credible stabilisation programme is announced — as arguably happened in Israel in 1985. Indexation makes the spiral worse, but it can also make the eventual exit cleaner.

The argument in one paragraph

The US government's real obligations are not fixed dollar amounts. They are healthcare, indexed benefits, and services whose prices rise when money is printed. That makes the debt structurally similar to Weimar Germany's gold-denominated reparations and Israel's indexed debt in the early 1980s: printing does not devalue the obligation, it enlarges it. With debt near $38 trillion, interest and entitlements consuming nearly all receipts, and foreign central banks turning from buyers into sellers of Treasuries, there is no room to absorb a shock. Governments do not default nominally; they print. So the printing will come, the inflation will run hotter than the official numbers admit, the indexed liabilities will grow with it, and the cycle will repeat at a higher level — while the sensible individual response is to stay liquid, hold gold and some cash, avoid leverage, and protect their own health, because the cost of real necessities is what is going to rise fastest.

Sources & further listening

• Luke Gromen on the end of the debt cycle, Weimar analogies, and personal positioning — youtube.com
• Luke Gromen on sovereign debt, the "Mrs. Lincoln" framing, and double-digit inflation — youtube.com
• "Luke Gromen: The Bond Market Says Tick-Tock" — gold overtaking Treasuries in central bank reserves, per ECB data — tftc.io
• "Luke Gromen: Yield Curve Control is the Only Way to Stop a Global Bond Crisis" — transcript and summary, including the shift of Japan, Germany, Korea and the UK from bond buyers to sellers — podlexicon.com
• Episode notes for the same conversation — listennotes.com

Not financial advice. This is a summary and explanation of one commentator's argument, written for a reader with no prior background in sovereign debt. Figures and quotes are taken from the linked public sources. Any decision about savings, investments, or personal finances is yours, and you should consult a qualified professional who knows your circumstances.

Fiscal Dominance and Nothing Stops This Train

 

Fiscal policy is the impact of government actions on the economy.  Monetary policy is the impact of central bank actions on the economy.

The situation the USA now finds itself in is being called Fiscal Dominance.   The idea is that when not in fiscal dominance the central bank can adjust the money supply by controlling how much money it lends to banks which then lend into the economy.  So adjusting the interest rate the central bank lends at can control the money supply and the inflation rate.    But in fiscal dominance the main factor is the central government's huge debt and deficit levels which cause them to sell lots of bonds and spend lots of money into the economy.   The central bank raising or lowering the interest rate will not really impact the rate at which the central government spends money.   In fact, higher interest rates will increase the governments interest expense and make them spend even more money.  The government will lean on the central bank to keep a lid on interest rates to keep their interest expenses lower.  So in this "fiscal dominance" situation the central bank can no longer control inflation by raising interest rates. 

Lyn Alden has popularized the term Fiscal Dominance and also the phrase nothing stops this train.   She points out that the only real cure is for the government to drastically cut spending and that there is no real chance of that happening, so nothing stops this train.  She wrote a book Broken Money that covers this. 

I still think the death spiral view is the best way to look at it.  The government needs to sell bonds to get cash to do all the deficit spending it does.   If the world does not want to buy as many bonds as the government is selling the central bank will be forced to print money and buy bonds.  However, as they do this they make the bonds even less attractive to investors because it will make more inflation.  So more people run away from bonds.  This causes the central bank to print faster, and people to flee bonds faster.  You get a death spiral and out of control inflation.

Trump's trade bullying makes the world less inclined to hold US bonds.  I think this brings the death spiral closer.  

 

30 Year Treasuries

 

The interest rate on 30 year US government debt has gone from a 40 year down trend to an up trend, though the last couple years are flat.   As the interest rates go up the value of existing bonds drops.  The death spiral danger is that people start selling and bond prices go down further (interest rates up further) and the Fed decides to "correct a non-functioning market" or some other BS and starts buying bonds.  The other way to look at it is the central government sells bonds to get cash to operate on and if interest rates get high they are clearly bankrupt so the Fed has to buy the bonds to keep the rates lower.  But if the Fed is printing money and buying bonds, then it really is unwise to hold 30 year bonds, so more people sell.  The faster people sell, the faster the Fed has to print money and buy bonds, but the faster the Fed prints, the faster people will sell.   This is the death spiral that is hyperinflation.  

It looks like conditions are ready for the death spiral to start at any time.   Trump wants lower interest rates and says debt would not be a problem at low interest rates.  Trump put Warsh in charge of the Fed.   I expect that Warsh will be printing lots of money soon.   

 

 

Why Bitcoin is Valuable

 

One of the most difficult questions is "Why is Bitcoin valuable?".   In many ways it looks like a "greater fool" mania.  People who own Bitcoin are not paid dividends, so it is not like a profitable company.  With a company you can figure out how big a loan those earnings could pay off and have some estimate of the value of the company.  We don't have anything like this with Bitcoin.   Given no way to estimate an intrinsic value for Bitcoin, many experienced investors think Bitcoin does not have value. 

 To make matters worse there are around 20,000 other crypto coins and many are clearly jokes or scams.  Some jokes and scams are worth billions of dollars, so some cautions people group the whole category as jokes, ponzis, or scams.

All of the above is clear and easy to understand.   It is harder to explain why Bitcoin has value but since this is a really important and common question, I am going to try.   Will list some arguments below.

Faith in money

    The dollar used to have value because it was backed by gold.  However, since 1971 it is not backed by gold.  Now the Federal reserve assets are mostly Treasuries.  Treasuries are just future dollars.   So the dollar is backed by future dollars.   This is really just faith in dollars.   If the faith goes away, there is no gold or anything to prop up the value.    The dollar does not have any intrinsic value.  During the revolution America had "The Continental Dollar" (stressing that a big continent should not be ruled by the little island of England) but after they printed too many, the value went to zero.

     If enough people have faith in Bitcoin as money that may be all it really takes.  Over the last 13 years Bitcoin has been growing in converts fast.  Projecting the trend seems reasonable.

     There have been many strange things used as money in the past.    At some point in the future using pieces of paper where governments could print as many as they wanted will seem stranger than Bitcoin with a fixed limit of 21,000,000 Bitcoin.  Also, you can not counterfeit Bitcoin but paper money has a problem. So in some ways it is easier to have faith in Bitcoin.

     There are people who would buy more Bitcoin if the price got below some certain price.   There are people who would sell some Bitcoin and buy a beach house if it got above some price.   Large numbers of such people gives Bitcoin a bit of stability and over time I would expect the stability to get better.

The root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.

– Satoshi Nakamoto

Secure Accounts

     Having an account that no government can easily grab is valuable.  In the normal financial system governments can grab money in accounts.   It used to be you could get a numbered Swiss bank account that no government could bother, but those days are gone.

     With Bitoin you can make as many different accounts as you want on your own.  Nobody else gets to know what accounts are yours.   This is kind of nice.

   The Bitcoin miners updating the blockchain with new transactions is the most secure accounting system ever developed.  Nobody can modify or forge this record of transactions.   There is value in having a secure set of books.  It is an important service.   Particularly when regular Fiat money may be running into high inflation trouble. 

Untaxed Income and Investment

     If someone pays you for a job in Bitcoin, and neither of you report it, there is no bank involved to report it.   So the government need not know about this transaction.   If you just keep the Bitcoin you might have saved 30% on your taxes.   Years later a normal investment would be taxed when you sell it.   The value years later might have mostly gone up due to inflation (dollar going down) but you are taxed on the whole "profit".   This can make it where investors have a very hard time to get ahead.   If you are invested in Bitcoin you could go to a tropical island, like Anguilla, walk up to an ATM and cash in some of your Bitcoin.  No government collects any taxes at that moment, or for the years that you held the Bitcoin.

      Given how bad the tax on fake profits normal situation is, this Bitcoin savings/investment is far better.

Moving money is cheaper/faster

      Compared to credit cards, wire transfers, western union, etc. Bitcoin is a cheaper and faster way to move money.   There is also no waiting in line and paperwork.    The old system sucks life out of commerce at a high rate.  Businesses that keep using that will have a disadvantage compared to those that use Bitcoin.

Fair money

     With US dollars the government and large banks can borrow money from the central bank at crazy low interest rates compared to what normal people have to pay.   Also the money the regular people have ends up going down in value (inflation).   This is unfair and gives extra advantage to those already big and rich companies and hurts the common man.   This is so unfair that many people want to "opt out" and use some other money.   Bitcoin has worked better for people most of the time since it came out. 

     To get an idea of the scale of this, the USA has printed trillions of dollars.   This really steals value from all existing dollars, all around the world, and gives value to the government that printed the new dollars.   It is best to think of this as an "inflation tax".   The USA collects an inflation tax on most of the world, without most of the world understanding that.  Diabolical. 

    The cost that Bitcoin miners spend on electricity to run their equipment is trivial compared to the scale of theft in legacy money.

 

Simple Secure and Scalable

    Bitcoin has a simple blockchain that can fit on an ordinary computer.  It is something that people have checked over very carefully.   The computation that goes into stamping each block makes it incredibly secure.   Still the fees for on chain transactions are only around $2 most of the time recently.

    With Lightning Bitcoin scales to any number of transactions and with really low fees (like a penny) that finish in a second or two.   It is sort of like having armored trucks that move money around and electronic wire transfers that move money between accounts.   

     These two together have solved the online payment problem.   It is such a good solution that it is possible nothing will be enough better to get people to switch for decades.  Payments in 1 second and for a penny are just hard to beat by enough to matter to anyone.

     Note that to use Lightning you have to setup a channel using some Bitcoin on-chain.   So using Lightning sort of provides a demand for Bitcoin.

 

When fiat fails

     I run some Bitcoin ATMs in Anguilla (see bitcoin.ai).   There are people here who send Bitcoin to family in Venezuala.   The fiat currency there is failing.  The government is taking a cut on money wired in by using a fake exchange rate.  They don't get a cut on Bitcoin sent into Venezuala.   The government also has price controls on things sold in the local currency at stores and shelves are usually very empty.  But you can call a guy and order groceries and pay in Bitcoin and they deliver what you want.   So Bitcoin is helping people get by when their local fiat money is failing.

    If the US dollar fails, nobody is going to trust other fiat money either.   The only real alternative will be Bitcoin.    Even if you think there is only a small chance of the dollar failing (I think it is a large chance) having some Bitcoin can be a form of insurance.   If more and more people are buying Bitcoin as insurance against a failing dollar, then the price of Bitcoin will go up.

Simple Supply and Demand

The supply of Bitcoin is currently only growing by 6.25 every 10 minutes and this rate is cut in half every 4 years.   Currently this comes out to about 1.7% per year (6*24*6.25*365/19000000).   It will keep cutting in half every 4 years though.  The number of people using Bitcoin is growing at a much faster rate.   If demand is growing faster than supply, then we should expect the value to trend upward.

 Tax Evasion is a crime

    Mish points out on twitter that some of the above can get you in trouble for tax evasion.   So lets be clear that I am not giving out any tax advise.   In Anguilla there is no income tax or capital gains tax.

    Let me also point out that in hyperinflation it can be impossible to both follow the laws and survive.  The population ends up having to use a "black market" to trade without deadly amounts of inflation tax or other taxes.   Note that black market really means free market, but breaking laws.   So maybe just think back on  this post if/when your survival depends on buying stuff on the black market.  

    To be clear on the eventual problem.  Imagine you buy potatoes for $1000/bag and the next day sell them for $2000/bag.   The government will claim you owe them tax on a $1000 profit.   Then you go and try to buy more potatoes and your supplier is now charging $3,000/bag.  So really you did not make any profit.  If you follow all the laws you will be broke very soon.   So the people who live through hyperinflation are the people willing to break the laws.

    So if the world gets hyperinflation the fact that Bitcoin can help black markets operate without government approval is an advantage and will increase demand for Bitcoin. 

Sanctions Evasion

    People inside Russia can no longer use their Visa and Master Cards to pay for things online.   They could use Bitcoin to pay for things.  Countries (say India and China) want to buy gas and oil from Russia but SWIFT payments are blocked.   Both these oil buyers and the consumers inside Russia could get around the sanctions by using Bitcoin.   There has already been much talk of using Bitcoin and I would not be surprised if it has already started.  I would also expect it to grow really fast as people explain to their friends how they were able to order stuff.

    The fact that no company or country can stop this makes Bitcoin valuable. If Russia were to announce that they are selling oil in Rubles or Bitcoin it could make Bitcoin go up in value more than it made the Ruble go up. 

Properties of Money - Best Money So Far

    A good money needs to be:

          1)  store of value

          2)  medium of exchange

          3)  unit of account

   To store value it should not be something that governments can print unlimited amounts of or that is easy to counterfeit.   Bitcoin can not be counterfeit

   An ideal medium of exchange could be sent electronically anywhere in the world without needing help or permission.   Bitcoin is far better than anything else.   You don't need banks wire transfer, or western union, or express mail, to send Bitcoin.   It can not get lost or stolen in transit.  Nobody can censor/block Bitcoin transactions, while normal money can need government approval for movement.  It is trivial to check that you got paid with good Bitcoin.  In contrast you really need to spend effort to check paper money or gold to be sure it is real and still run a risk of accepting a fake. 

   While Bitcoin has gone up in value for people who hold it for years, it can be very bad at storing value over short periods.   So currently Bitcoin does not do so well on this.   There is reason to hope that as it gets more and more users it will become less volatile.   Fiat money looks like it is becoming such a bad store of value that the world may be looking for a replacement.

    Unit of account.  Bitcoin is more Fungible than any previous money.  Can divide it down to 1/100,000,000th trivially.   All parts are identical.   Difficult to get gold below a gram.

    In the coming years Bitcoin may be viewed more and more as the best money.  The best money should win in the long run.

Bitcoin Age VS  US Dollar Age

    It is sometimes argued that Bitcoin is too new to trust and that the dollar has been around far longer.   The original dollar was backed by gold but since 1971 it has not been backed by gold.   So the current form of the dollar is only 51 years old.   Bitcoin started in 2009, so only 13 years ago.  However, it is open source so people can inspect every line of code.   There are no secrets in how Bitcoin works.  Computers check digital signatures and add transactions to the blockchain every 10 minutes. 

The Fed has humans making decisions and they are clearly flawed.  They said "sub prime is contained" and "inflation is transitory" and were wrong.  No human choices with unknown motives or reasons, like with the Fed.  Also, the Fed has not allowed any audit of their gold holdings, so we can not be really sure how much gold they have.  It was really the gold they had in 1980 and the fact that it got to 800/oz that saved the dollar then.    So you could even say that it is only 42 years that it has been unbacked.

Things on the Internet with open source mature faster.   It is sort of like 1 Internet year is equivalent to 4 regular years in finance.  If there was some problem with Bitcoin software it really should have been exposed by now.   

The problem with the humans running the Fed is they can let inflation get out of control.  The history of unbacked Fiat money shows this time and time again.  It really seems like the risk of failure for the dollar is higher than for Bitcoin.

You don't need a bank so no risk from bank failure

Before the global financial crisis Anguilla had 4 banks; however, 2 of them went bankrupt due to GFC.   This is half the banks in my country going bankrupt.

 

With Bitcoin, you don't need to use a bank.  You can accept payments or send payments anywhere in the world just using your Bitcoin Wallet software and the Internet.   

 

With Bitcoin you are not at risk from a bank failure.   In my experience, this is about a 50% risk over the last 30 years.  So Bitcoin seems much safer to me.  You may have different statistics in your country.

Migrant Money

If you are leaving a country because of high taxes, corrupt government, or unsafe environment, Bitcoin can be the best way to get your money out.  You can easily send Bitcoin to a friend at your final destination.  The government, banks, or criminals along the way can not grab this Bitcoin.  It may be nearly impossible to get money out any other way.   The friend could send you some Bitcoin as you needed it which you could convert to local currency at Bitcoin ATMs along the way.

Option on next world currency

If Bitcoin becomes the next world currency it will be far more valuable.   If you buy some today you might make many times your money.   If you were to estimate a 3% chance of Bitcoin getting to $1 million, and ignored interest, you might estimate it is worth $30,000 even with a 97% chance of going to $0.  If you think it has a much higher chance, and the price was lower, you might decide it was a reasonable gamble.

Similar Articles found after writing above

1. Why is Bitcoin Valuable?   -  NYDIG
2. Why do Bitcoins have Value?   - Invetopedia
   
3. Why do Bitcoins have Value? - Ryan Haar - time.com
4. Why does Bitcoin have Value? - binance.com

 

Update July 18, 2022

Bitcoin can not be turned off or have its monetary policy adjusted.   The Fed has a bunch of humans that try to influence the market both with "verbal guidance" and buying and selling different things, and adjusting the Fed Funds rate.   Their adjustments can help and hurt different people and companies.   Predicting what they will do, or being told, can make a huge difference to your financial future.  Bitcoin is not at the whims of humans.

 

Fed Has A Recursion Problem

Terra made two coins, Luna and UST, that depended on each other.  They both crashed recently.   I made the following graphic:

 

The Fed has a similar design problem.  The Treasuries are measured in US Dollars but the Fed backing for the US Dollar is mostly Treasuries.   In this kind of setup both parts can go to zero in terms of real world things.  

The Real Bills Doctrine says that if a bank loans out short term against real things that it can be safe.  But if a bank loans out long term in its own currency it can get into trouble.   This is very old wisdom.   Young folks today did not learn this stuff in school.  I think the Fed will be giving the world a demo on how this fails.

In computer science we would call this a recursion problem.  In computer science you can have a function that is defined in terms of itself but there needs to be a base case that does not need further recursion.  With Luna/UST or Treasuries/USD there is no base case.   So the results are "not well defined".   So it did not and will not end well.

Originally by law the dollar base case was gold.   The Fed originally had 40% gold backing and anyone could turn in $20.67 in dollars and get  1 oz of gold.   Then in 1933 only other countries could redeem dollars and only 1 oz gold for $35.  Then after 1971 no one could turn in dollars for gold.   In 1980 gold got up to around $850 per oz and the Fed still had enough that at that price their gold helped stabilize the dollar.

The Fed's Can Opener

The Fed talks as if "the neutral rate" is 2.5% and they just need to get the Fed Funds rate up to that and all will be fine.   As Larry Summers points out this is a logical error very much like the joke about economist assume we have a can opener. 

Joke from Wikipedia:  President Ronald Reagan told the joke to students and faculty at Purdue University on April 9, 1987 saying: "It seems an economist, a chemist, and an engineer were stranded on a desert island. And between them they had only a single can of beans, but no can opener. The engineer suggested that he climb a palm tree to a precise height, then throw the beans at a precise distance, at a precise angle. 'And when the can hits,' he said, 'it will split open.' 'No,' said the chemist. 'We'll leave the can in the sun until the heat causes the beans to expand so much the can will explode.' 'Nonsense,' said the economist. 'Using either method we'd lose too many beans. According to my plan, there will be no mess or fuss and not a single bean will be lost.' Well, the engineer and the chemist said, 'We're certainly willing to consider it. What's your plan?' And the economist answered, 'Well, first assume we have a can opener.'"

From transcript of Powell's May 4, 2022 press conference and video:

"And the current estimates on the Committee are sort of two to three percent. And also, that's a longer-run estimate. That's an estimate for an economy that's at full employment and two percent inflation. So really the way, really what we're doing is we are -- we're raising rates expeditiously to the -- what we see as the broad range of plausible levels of neutral."

They are assuming there is no inflation in their target estimate of the "neutral rate",  even though in the real world we have high inflation.  This is wrong.    It is like the joke, "first assume we have no inflation, then we just need to get rates to 2.5%".  

They have not given us an estimate of the neutral rate for the real inflation conditions we are in, let along a rate that would tame inflation. 

Their mandate is to maintain stable prices and in their plan they are just assuming  we have stable prices.  This is crazy bad.  They are not doing their job. They are not taking the tough steps needed to get from where we are to stable prices.  To lower inflation you need to get interest rates above the inflation rate.   In the real world we have high inflation and even 2.5% will still be a very negative real rate and so stimulative, not neutral.  Many months inflation has gone up 0.5% or more and the Fed has ruled out raising rates faster than that.   They are far behind and it is not clear they will ever catch up.  Runaway inflation is a real possibility.

 

 

Scaling Bitcoin With Lightning

 

There are many people who understand that Bitcoin can only do a certain number of on-chain transactions every 10 minutes and so think it can not scale.   The Bitcoin scaling solution is off-chain transactions with Lightning.  I am going to try to give you a way to think about this that might help people understand.

Think of on-chain Bitcoin transactions as being like an armored truck carrying money from one place to another.   With a certain number of armored trucks you can only do so many visit per day.   If a transaction is on the blockchain then it is like the funds have been physically moved to the other place.

However, this does not limit the number of financial transactions.  Banks have a huge optimization.   It is not necessary to send money for every transaction between two banks, at worse you just need to send the net different between money going one way and money going the other.   In the SWIFT wire transfer system it is really just a bunch of banks that have accounts with each other so they can "move money" mostly by doing debits and credits on accounts and not physically moving the money around.  A wire transfer might pass through several different banks along the way to its destination.

You can think of Lighting as similar to the SWIFT wire transfer network.  There are links between nodes that can effectively move funds between them just by updating an account balance between them.  However, instead of taking a couple days and costing on the order of $100 (humans are slow and costly) it takes about a second and costs on the order of $0.01 (computers are fast and cheap).  So around 10,000 times cheaper and 100,000 times faster than a bank wire transfer.  This is a very compelling improvement.

People complain about how much energy blockchain transactions take.   This is like worrying about how much gas the armored truck is going to burn to clear your wire transfer.   The vast majority of the financial transactions do not require any gas for any armored truck.  The same is true, or will be true, for Bitcoin.   There might be more off-chain Lightning transactions than on-chain Bitcoin transactions already but as the lightning transactions are confidential I don't think we can really tell.   

It is easy to imagine banks working together to net-out payments and so minimize the number of armored truck trips and so lower their costs.  Bitcoin/Lightning works like this.   If the on-chain transactions get too expensive, then people work a bit harder to use Lightning or use it for larger amounts.    It is a nice feedback for keeping Bitcoin on-chain fees in check.   So while Ethereum still gets crazy high "gas fees" the Bitcoin on-chain fees are steady and low.

Since Lightning transactions are not stored on the blockchain, the Bitcoin blockchain does not grow too fast and can still fit on an ordinary computer with ordinary Internet service.   Other cryptos that have more data to store get too large for normal computers and Internet feeds.   So others, unlike Bitcoin, can end up not being true Peer-2-Peer, and so easier for a government or other adversary to attack.  

It really seems like the Bitcoin/Lightning scaling system will be the winning payment system.   With lightning it has the lowest fees and fastest execution.  It is the most true P2P system.   It is the oldest and has the largest market share.   Like Google or Facebook, it has the dominant network effects. It is hard to imagine something else coming that is enough better to really threaten Bitcoin/Lightning at this point. 

 

Update May 13, 2022 

The recent stablecoin trouble and this video made me think.  Bitcoin/lightning use a blockchain to really solve the P2P Internet payment problem.  The 10,000 alt-coins that have come after really can be viewed as scams.  Most of them don't have any reasonable claim to doing anything better.  Some are centralized things just using a blockchain to trick investors.  When markets go down the scams become clear.  We will see many scams in the crypto area.   As Buffet says, “You don’t find out who’s been swimming naked until the tide goes out”.

 

Update June 5, 2022

I was watching a video where Elon say that a level 2 layer like Lightning you can scale Bitcoin to handle huge amounts of financial traffic but he would like to see if the base layer could scale further.   This is sort of like saying, sure by clearing transactions electronically between banks we can handle huge numbers of transactions, but I would like to see if we can get bigger armored trucks and drive them faster.   Why?  What is the point?   It does not improve things.    With lightning there is some incentive to run your own full node, it is nice that a full node can fit on a regular PC with a regular Internet connection.  

 

Update July 17, 2022

This tweet shows how many times channels were reused as of last year for one company.  For the cost of an on-chain transaction to open a channel you can do hundreds or thousands of off-chain transactions.   These numbers should get better and better over time.   These off-chain lightning transactions are very cheap and fast.   More and more traffic will move to lightning, in particular if on-chain fees are high.

Update Oct 5, 2022

After scaling, the other vector other coins might have been better than Bitcoin on was "privacy".   However, with lightning and "submarine swaps" or using "coinjoin" you can get good privacy just using Bitcoin.  So it really does not seem any other coin could be enough better in any way users care about to get them to switch.   Seems Bitcoin will be it forever.

 

Further reading on Bitcoin/Lightning

1. A Look At the Lightning Network by Lyn Alden
2. 
   

The Fed and Goodhart's Law

Goodhart's law is:  When a measure becomes a target, it ceases to be a good measure.

The most common measure of when a recession is coming is the inverted yield curve.  I believe the Fed is now targeting this measure.

In the past when inflation got too high and the Fed needed to tighten monetary policy it would raise the Fed Funds rate.  This increases short term interest rates.  If short term rates were higher than long term (the dreaded "inverted yield curve"), it meant the Fed was tightening monetary policy and a recession would soon come.

So the Fed thinks that "inverted yield curve" is the cause of recessions.  So the plan now is to tighten monetary policy without inverting the yield curve, which they think will avoid the recession that usually comes from tightening.  The way they will do this is by leaving short term rates low and selling off bonds they bought during Quantitative Easing (QE).   This is being called Quantitative Tightening (QT).   When they sell bonds they will raise longer term interest rates.   If the Fed Funds and short term rates stay low, then the yield curve will not invert.  

Again, they think as long as they don't invert the yield curve they can get the mythical "soft landing" and avoid a recession.   They are wrong.   It is the monetary tightening that causes the recession, not the "inverted yield curve".

When rates are lowered it makes monthly payments on loans smaller so people and companies can buy things sooner.  We say "it brings demand forward".  Imagine someone can buy the $40,000 car of their dreams sooner if the Fed drops rates from 10% to 2% and so reduces the monthly payments.  The problem is that eventually this makes too much inflation and they have to let rates go back up.   This pushes demand backward.  Someone who was about to buy their dream car with a 2% loan now has to wait much longer when loans are at 10%.  The demand being pushed backward is the recession.   It is the rates going up that causes demand to be pushed backward, not the inverted yield curve.

Of course, if they don't tighten monetary policy they will get "run away inflation" and then hyperinflation.   So the Fed does need to tighten.  But doing it in a way that avoids the inverted yield curve will not avoid the pain of the tightening or result in a "soft landing". 

There is also a real risk that once people understand that bond prices will be falling as the Fed tries to dump bonds that everyone will "not fight the Fed" or "front run the Fed" and try to sell bonds before the Fed does.   For the last 40 years bond prices have generally gone up as interest rates went down.  Now with rates going up and bond prices going down we could see a rush to sell and indeed panic selling.   The saying is "the market takes the stairs up and the elevator down".  This is probably true for the bond market as well.  One should not expect bond holders to keep holding as bonds go down for years and years.  A bond crash makes more sense. 

So far the Fed has just recently stopped buying bonds and only raised Fed Funds by 0.25%.   But the markets anticipate the future and so have gone up significantly already.   The 30 year mortgage rate has gone from a low last year of 2.65% to 4.16%.

The 0.25% fed funds hike makes it seem like the Fed is not serious about fighting inflation.   But really it is probably just that they don't want to make the dreaded inverted yield curve.   We will see how serious they are when they start selling bonds.   If they let bond interest rates go way up, they are serious.  There is still some chance.

We will soon get the first recession without an inverted yield curve, because the Fed targeted this measure.  So the measure will cease to be a good measure.

 

 

Crashing Without a Net

 

"It ain’t what you don’t know that gets you into trouble, it’s what you know for sure that just ain’t so."

    The Big Short

 

Today people "know for sure" that the more money the Fed prints the more the stock market goes up.   Using Fred Graph we can make the following: 

 

With this view people may think that the Fed can always print money and always make the stock market go up, but this just ain't so and will get them in trouble. 

A more accurate way to think about it is that stocks are correlated to long term bonds but a bit more volatile (here we use 1.5 factor).   This Fred Graph shows this:

 The Fed can often manipulate the bond market by buying/selling bonds and adjusting the Fed Funds rate.   As the Fed buys bonds they are printing money and driving up the price of bonds (and lowering interest rates).   The stocks go up as the bonds go up.   So often the Fed printing money does make the stock market go up, but again that is too simple a way of thinking about it and will get you in trouble.

The trouble comes when inflation comes, as it has now.   By law the Fed has to fight inflation.   The way to fight inflation is by not printing so much money.  If they are not printing so much money then they are not buying so many bonds, so bond prices will come down.   As bond prices come down, stock prices will also come down.

The famous Fed Put is where the Fed steps in and stabilizes markets.  This does not work when there is high inflation and interest rates are already at 0%.    In previous market crashes the Fed could lower interest rates and so make bond prices and stock prices go up.  However, with interest rates already at 0%, the Fed can not lower them any more.   Bonds are already at historic highs, so they can not be driven up any higher.  High inflation tends to push bond interest rates up and so make bond prices go down.  In previous market crashes inflation was low so the Fed was cleared to print money.   Today we have high inflation, so the Fed's hands are tied.   The Fed Put has expired.

In previous crashes the Fed was able to step in and halt a crash, making for a quick bounce back.   Current investors believe the "Fed has their back", but this just ain't so.   Today we are crashing without a net.  This crash will probably be worse than anything in recent memory.

PS.   Powell understood the danger of low interest rates making the current bubble and yet did it anyway.  Here is Powell from 2016:

 "... it’s plausible to me that rates will have to remain very low for a very long time to achieve stable prices and full employment, but that such low rates will drive excessive credit growth and create irresistible upward pressure on asset prices, including real estate prices. I’m thinking of a situation in which a broad range of asset prices are moving up well beyond what fundamentals would justify; where the other tools we have don’t seem to be addressing the problem or have failed to do so; and where low interest rates are pushing up asset prices and driving credit to excessive levels, probably over many years, and thus are a principal cause of the threat. Recalling that we have had two major real estate blowups in the past 25 years, ..."

Deep Reasons for Current Trouble

 

There are a few deep reasons for the trouble coming to the USA which I will go over here.

At Best a Necessary Evil

There is some minimal government with police, courts, and defense that is sort of a necessary evil.  While such a government is a cost to the economy, it is better to pay this much cost than to suffer anarchy.   After this, the more government the less real economic growth.   The USA devotes too much of the economy to government and so not enough to real growth.   At this point, the size of the US government is far beyond optimal.

Dutch Disease and Resource Curse

There are the related concepts of Dutch Disease and Resource Curse.  Countries that have some valuable natural resource tend to suffer worse governance and to suffer in other areas of their economy.   Back in 1711 the Spectator wrote, "It is generally observed, that in countries of the greatest plenty there is the poorest living."   It is easier for a bad government to get control of some natural resource and then stay in power.  If they have to tax the general economy there will be some resistance to government excess.   So when there is a valuable natural resource, the odds of having a bad government go up.  

The US ability to print the world reserve currency is like having a valuable natural resource.

Triffin Dilemma

The Triffin Dilemma is the problem of a country with a world reserve currency.  For the country's own benefit (say when there is a Pandemic) there is a huge advantage to printing lots of money.  But if done too much this harms the rest of the world and makes them not want to keep using that currency as the world reserve currency.   You can view inflation as a tax.  The country with the world reserve currency can impose an inflation tax on the whole world.  However, if the inflation tax gets too high, the world can rebel and stop using that currency.   Taxes always cause modifications in behavior.  

The current inflation is reported as a CPI of 7%, but really the inflation is over 10% (the owners equivalent rent component of the CPI is a cheat) and going up fast.  This is an intolerably high inflation rate for a world reserve currency. 

Alternatives to the Dollar

If countries don't want to keep paying the inflation tax to the US they have to reduce their usage of dollars.  Many people can not conceive of any alternative to the US dollar but there are some.   

Central banks in other countries could use gold as reserves instead of dollars. Before Bretton Woods central banks each kept their own gold reserves.   Imagine that country X has 75% dollar reserves and 25% gold reserves.  In this case, if the dollar were to get hyperinflation and go to near zero, their currency would drop by a factor of 4 and then stabilize.  They would have suddenly moved to a gold standard.   So countries may end up moving to a gold standard without planning to do so.   At this point, it would be wise for central banks to have some gold just in case.  It seems central banks around the world are increasing their gold holdings.  If central banks only have dollars then if the dollar gets hyperinflation their currency will also get hyperinflation.

If people live in a country where the central bank is still only using dollars as reserves, they could save in Bitcoin instead of the local currency.

Spain and New World Gold

Spain took huge amounts of gold and silver from the New World.  Since gold was the world reserve currency then, getting all this gold was a bit similar to the US ability to print the world reserve currency.   This did cause prices, measured in gold, to go up by about a factor of 6 in 150 years, but this is only 1–1.5% per year.  While Spain was bringing in the gold and silver they had significant power but after the flow stopped they were a shadow of their former selves.  Similar to the resource curse, the rest of their economy was sort of hollowed out.

Dollar Losing World Reserve Status

It is in the interest of other countries to move away from the dollar, and so not pay the dollar inflation tax.  As countries do this the dollar will be less and less used.  China and Russia have worked to de-dollarize their economies.    The same amount of dollar creation will create more inflation when there are fewer countries using it.  But more inflation will push countries to flee the dollar even faster.   So there will be a positive feedback loop and leaving the dollar could happen very fast.

USA Just Another Banana Republic

If the dollar is not the world reserve currency, then the USA becomes just another Banana Republic that is printing way too much money.  Half their spending power comes from printing money.  The US will effectively lose a huge amount of its power, similar to when Spain could no longer bring gold from the New World.  The USA will be a much weaker country.  

The US manufacturing in 2021 was $2.3 trillion.    The Fed's balance sheet has on average increased by more than this per year in the last 2 years.  I think it is fair to say that money printing contributes more to the US economy than all of manufacturing.  

Without reserve currency status, it is nearly impossible to keep spending  twice what comes in as taxes without getting high inflation.    However, it is probably not possible for the USA to cut spending back to the level of taxes they will be collecting once things go bad.  Also, much of their spending is indexed to inflation and some of the bond payments as well.    Sadly, the USA is probably headed for hyperinflation.