Slough

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The state of things

On the bench $17k. Behind it lies the separation of money from the state.

When asked, most people are quite comfortable that their elected government is in charge of the money supply. They remark, very reasonably, that “who else is going to do it......you?”. It is the right question because whilst we do not trust the government much, we have even less trust for new things that we do not understand and people that we do not know.

With Bitcoin, we do not need to trust anyone because order is maintained by the collective power of the network. The money supply is permanently under the control of democratic elections every 10 minutes when a new block is produced, that has been true now for 14 years.

The invention is so significant and the change so profound that almost nobody sees it. One day it will be obvious and it feels almost certain to me that the story of fiat currency will be told in schools in the same mocking tones that we now deal with witchcraft.

Along the journey though, there are fraudsters, charlatans and deeply vested interests who have a different goal. Things look bleak now, one of the biggest exchanges in the world has fallen over. Nearly every lending business in DeFi has gone broke and we must surely be approaching peak media negativity.

It’s all irrelevant though. The blocks keep coming, every 10 minutes, and when we look back, it will seem very obvious.

The spending stops

The first question you need to ask yourself when faced with an economic chart is: are the numbers adjusted for inflation?

That is the true economic cost of rising prices, most people don’t know where they stand vis a vis their own earnings and what things are costing them. In Australia, there was a fall in spending across every category apart from food in October. With a fully open economy department stores shouldn’t be experiencing 2.5% falls in spending when their prices are up more than 10%. It’s tantamount to a collapse in non-food spending. That might just be the strategy for Australians in 2023, let’s eat first and then work out the rest later. Budgets for households are like any other entity, the taps do not go off immediately but if we get entire nations of people reigning it in all at once “after Christmas” we might get quite the surprise in the other direction.

I’d like to say that the Reserve Bank is across all this data but given it was little over a year ago when they said no interest rate rises for at least four years, I think we can count their judgement to be little better than anyone else's.

I confidently predict that the RBA will over-tighten interest rates and the economy will decelerate very quickly. They will declare victory against inflation and then having completed a few victory laps, they will spend years trying to get the economy going again.

The solution of course is to allow the market to set interest rates but this kind of crazy talk must be reserved for another day and probably another decade.

CPI

There are many ways to get inflation down. The first and best one is to increase the productive capacity of the economy. You might build a road from A to B, products get there more quickly and they now cost less. Even if you charge a toll to finance it, if the road is good producers will use it and goods will cost less.

Another way is to increase the production of natural resources that you know you have but haven’t tapped yet. The course of human progress has been set by the selection of higher density energy sources. Start with wood, move to coal, then uranium.

In Australia, we have enough uranium to power the country until the end of time. We would be the Middle East of energy for the next millennium, our power costs would collapse and through the application of technology prices would fall. There are ancillary benefits to having global energy significance too, we could torture foreign dissidents and get away with it and probably host a few world cups too. It might be nice.

The third way to tackle inflation involves not making any difficult decisions and just cheating. This involves altering the basket of goods used to measure inflation. The government argues that the re-weighting is designed to reflect new products that we consume. For example, internet costs were not in the CPI in 1980 and now they are, reflecting technological and societal change. It is of course strange and perhaps suspicious that when these changes are made they always result in lower inflation. The government argues that is because the cost of technology (relatively) is always falling as we get better at making televisions and the like.

This is somewhat true, technology does keep improving. Take mobile phones. When I first bought a mobile phone I specifically recall it being £180 or $320. My last phone was over $2,000. A 6x increase far in excess of inflation. Again, the statistical argument here is that they are not comparable because my decades old first phone made phone calls and had that snake game on it and that was it. My latest phone could re-route a satellite if I had any idea how to use even 30% of its processor capacity. So in fact, prices have massively fallen despite the apparent increase.

This argument is actually correct, technology is massively deflationary. Many of the technologies we used to pay for are now as good as free (remember paying per text message etc.). We get better at nearly everything and yet prices do not fall because the amount of money printing undertaken by the government overwhelms the general economic improvement in the economy. The benefit of technological improvement to government seigniorage is absolutely enormous and nobody notices. It is a tax on human progress.

To be clear, the prices of things should fall because we always get better at absolutely everything. They never do fall though. Why?

BlockFi Falls

BlockFi, who I had previously declared bankrupt last week, are now …… bankrupt. Their business model involved taking bitcoin and other assets and paying a return to customers. Initially, they had a viable income stream with which to pay interest which involved an arbitrage trade closing the premium on the Grayscale Bitcoin Trust. It was totally unrelated to the assets involved but it was an income stream, even though it was disingenuous, it was real. When that trade ceased BlockFi moved deeper into lending. ‘Duration management’ they called it.

In the world of digital assets, fractional reserve doesn’t work. 10% of client balances on hand is ‘fine’ in banking where the lender of last resort can come and help you. 10% of client balances on hand is not exactly “duration management” in an industry this volatile. When the calls for cash came, BlockFi turned to FTX as a lender of last resort and FTX duly provided a $275 million dollar loan. The quid pro quo was that BlockFi used FTX as asset custodian. Allegedly, FTX then lost those funds making donations to politicians across the USA and generally gambling on wild trades, buying houses in the Bahamas and paying for perms for their CEO.

The entire sorry mess is well described below. I do have some sympathy with BlockFi as without FTX they would have been illiquid but not bankrupt. Their illiquidity led them to do a deal with the devil which then sealed their fate.

Euro-Trash

You might consider this column hyper-critical of the ECB so perhaps it is time to give them some credit. They do publish their responses to elected members of the European Parliament and this week there were lots of them. Most were boring, this was not.

Note the mention of ‘helicopter money’ in the penultimate paragraph. Apparently, the Governing Council has never discussed it and has not adopted a formal position.

Surely, saying that “we won’t print a load of money and simply drop it in people’s bank accounts because it's a totally insane idea” isn’t hard? They have one remit, stable prices. In managing that remit one of the things you absolutely can rule out is simply showering money on the economy from an airborne vehicle.

No formal position adopted

In other unrelated news I was provided with this picture of the ECB staff canteen this week. We have previously discussed the excellent reviews former staff have provided regarding the meal options. It’s so disappointing to see a layout like this though. The ECB HQ is a fabulous building in Frankfurt, I feel like they could have done a lot better than this.

Imagine owning the money printer and coming up with something so sterile. No wonder they haven’t had a decent idea in 25 years.

The ECB canteen fiasco was wonderfully predicted by the Poet Laureate John Betjeman in his 1937 Poem, Slough. 

In your service, I have posted a copy of the full copy of the poem to Ms Lagarde in Frankfurt.

Further information

Read Dan's analysis on the Grayscale Bitcoin Trust: Potential for 100% gains with a listed trust trading at a discount

Our October 2022 report to investors can be found here.

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