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Here comes the performance curve control
A key theme of our long-term Bitcoin thesis is the continued failure of centralized monetary policy at global central banks in a world where centralized monetary policy will likely not solve, but only exacerbate, larger systemic problems. The failure, pent-up volatility and economic destruction that result from central banks’ attempts to solve these problems will only further increase distrust in financial and economic institutions. This opens the door to an alternative system. We believe that this system, or even a significant part of it, may be Bitcoin.
Aiming to provide a stable, sustainable and useful global monetary system, central banks face one of their biggest challenges in history: solving the global sovereign debt crisis. In response, we will see more monetary and fiscal policy experiments evolve and unfold around the world to try to keep the current system afloat. One such policy experiment is known as yield curve control (YCC), and it is becoming more critical to our future. In this post, we’ll cover what YCC is, its few historical examples, and the future implications of increasing YCC release.
Historical examples of YCC
Simply put, YCC is a method for central banks to control or influence interest rates and the overall cost of capital. In practice, a central bank sets its ideal interest rate for a specific debt instrument in the market. They keep buying or selling that debt instrument (ie a 10-year bond) no matter what to maintain the specific interest rate fixation they want. They usually buy with newly printed currency which adds to monetary inflationary pressures.
The YCC can be tested for a few different reasons: keeping interest rates lower and more stable to stimulate new economic growth, keeping interest rates lower and more stable to reduce the cost of borrowing and debt payments by rate interest or intentionally create inflation in a deflationary environment (to name a few). Its success is only as good as the central bank’s credibility in the market. Markets must “trust” that central banks will continue to execute this policy at all costs.
The largest example of YCC happened in the United States in 1942 after World War II. The United States incurred massive debt outlays to finance the war, and the Fed capped yields to keep borrowing costs low and stable. During this time, the Fed capped short-term and long-term interest rates on short-term notes at 0.375% and on long-term bonds at 2.5%. In doing so, the Fed relinquished control over its balance sheet and the money supply, both of which increased to keep interest rate fixings lower. It was the method chosen to deal with the soaring and unsustainable increase in public debt relative to gross domestic product.
Current and Future YCC
The European Central Bank (ECB) has effectively engaged in a YCC policy that flies under a different flag. The ECB has been buying bonds to try to control the yield differential between the strongest and weakest economies in the euro zone.
Yields have gotten too high too quickly for economies to work and there is a lack of marginal buyers in the bond market right now as sovereign bonds face their worst year-to-date performance. This leaves the BoE with no choice but to be the buyer of last resort. If the resumption of QE and the initial bond buying is not enough, we could easily see a progression to a more stringent and long-term yield cap YCC program.
The BoE was reported to have stepped in to curb the gilts rout because of the potential for margin calls across the UK pension system, which has roughly £1.5tn of assets, most of which are they invested in bonds. Because certain pension funds hedged their volatility risk with bond derivatives, managed by so-called liability-driven investment (LDI) funds. As the price of long-term UK sovereign bonds fell sharply, derivative positions that were backed by those bonds as collateral became increasingly at risk from margin calls. While the details are not particularly important, the key point to understand is that when monetary tightening became potentially systemic, the central bank intervened.
While YCC policies may “kick the can” and limit short-term crisis damage, it unleashes a whole box of second-order consequences and effects that will need to be dealt with.
YCC is essentially the end of any “free market” activity left in the financial and economic systems. It is more active centralized planning to maintain a specific cost of capital on which the entire economy operates. It is done out of necessity to avoid total system collapse, which has proven inevitable in fiat-based monetary systems near the end of their useful lives.
YCC prolongs the sovereign debt bubble by allowing governments to lower the overall interest rate on interest payments and lower borrowing costs in future debt rollovers. Given the large size of the public debt, the pace of future fiscal deficits, and significant promises of entitlement spending in the future (Medicare, Social Security, etc.), interest rate spending will continue to occupy a larger share of tax revenue from a shrinking tax base under pressure.
The first use of yield curve control was a global measure in wartime. Its use was for extreme circumstances. So even the attempted launch of a YCC or YCC-like program should act as a warning sign to most that something is seriously wrong. We now have two of the world’s largest central banks (on the verge of three) actively pursuing yield curve control policies. This is the new evolution of monetary policy and monetary experiments. Central banks will try whatever is necessary to stabilize economic conditions and the result will be further monetary degradation.
If ever there was a marketing campaign to explain why Bitcoin has a place in the world, this is it. As much as we’ve talked about the current macro headwinds taking time to play out and lower bitcoin prices being a likely short-term outcome in the scenario of severe equity market volatility, the wave of monetary policy and the relentless liquidity that will have to be unleashed to rescue the system will be massive. Getting a lower bitcoin price to accumulate a higher position and avoid another potential significant decline in a global recession is a good play (if the market offers it), but missing the next big move up is the real opportunity lost in our opinion.
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