Breakouts or Fakeouts

In the process of rewriting the next article in my series, it expanded into a 43-page whitepaper that I’m keeping private until I figure out how to proceed because I’m moving forward with it as the new direction in my life. 

In the meantime, despite my intention to not write about markets anymore, I’ve been forced into my Rethink Room by this move higher in yields to determine whether my view that a hard landing is inevitable is early or whether my entire worldview is wrong. In the process, I’ve come to the conclusion that I’m early and a soft landing is impossible, but I will point out the one variable that would make me change my mind. For the people who are like “hard landing?- we just had blowout jobs numbers - what is he talking about?” I’m referring to structural flaws akin to termites gnawing away beneath the surface. 

At the core of the hard landing question is whether or not we entered a “post Covid, post QE” new world or whether we’re still in the old world and nothing fundamentally has changed. As you will see, I believe the answer lies in whether or not there will be a gap in time before the real, game changing AI innovations cause a lasting economic boom similar to the internet. Getting that right is likely to be the key variable. 

First, if you believe we are in a new “post Covid/QE” world, then what you are saying is QE worked and it was an effective tool to bridge the broken economy of the GFC with a new economic frontier that is strong, sustainable, fully healed, and will no longer need assistance. For example, the last time we had this level of debt/GDP was post WW2, which involved a prolonged period of Fed/Treasury financial engineering followed by a sustained period of innovations that created everyday goods, produced jobs, and improved efficiency, particularly household appliances, radios, TVs etc... The financial engineering of that era was the government reaction function to keep the ship from sinking to bridge the economic hardship with the new frontier that surely awaited - they hoped (and they were right). The everyday innovation era that followed was how we organically grew our way back to a manageable level of debt relative to GDP, but the most important variable of that era was that we manufactured all those integrated-in-our lives goods ourselves. 

In our current environment, the shining ray of hope is AI and the renewal of our energy infrastructure it necessitates to process all the data. However, thus far, the only innovations out of AI have been more like an assistant for already existing products and services. Whether that and the energy transformation for the data processing is enough economic growth IS the core of the question of whether we’re in a “post Covid/QE” world or not because if it’s enough, then rising yields will be sustainable by a lasting economic boom created by the proliferation of these new innovations, therefore the deficit can be reduced without any adverse effects of hurting demand since private sector activity will rise as gov’t intervention falls and our debt/GDP can be reduced over time similar to post WW2. However, if these AI innovations are not enough, then rising yields will expose a still broken economy by squeezing the profit margins of businesses and the discretionary income of consumers as both are forced to maintain, roll, or initiate new debt at higher rates, which will cause an economic contraction that leads to declining earnings and layoffs in a downward spiral of recession. 

If the AI innovations of today are enough of an economic engine for The Great Handoff from gov’t dependency of the last 15 years to private sector flourishing, the equity market might sell off to price in a higher risk premium to compete with treasury yields, but it will stay contained to a correction. If the AI innovations are not enough to sustain The Great Handoff, then an equity market selloff will likely lead to a bear market and the deflationary effect of falling asset prices will cause more Fed and Treasury intervention and reveal that we’re still in the same pre-Covid world of QE supported markets - for now. Any notion of an in-between won’t last long - it will ultimately be one or the other. We’re either in a QE-is-still-necessary-world or we are in the early stages of The Great Handoff. 

Another consideration is that yields are not rising because we’re in the midst of the real economic expansion of The Great Handoff, rather, it’s an unwind of Yellen’s yield curve control in anticipation of Bessent’s coming attempt to normalize issuance back toward the long-end, so the question is: did Yellen shorten duration for political reasons (or whatever excuse she makes), or was there a bond auction or two that made her nervous? Meaning, it’s quite an assumption to think the long end can absorb all the issuance that’s built into mandatory spending over the next decade. What if it’s not possible to normalize duration? This too begs the question of whether we are in a new “post Covid/QE” world because if the private market can’t absorb the issuance, or they demand a yield the economy can’t handle, then we’re not in a “post QE” world because the Fed will eventually be forced to monetize that debt, which will happen as a response to a deflationary recession with falling equity prices leading to layoffs and reduced consumer spending etc.. 

This idea of the Fed being unable to save the equity markets due to inflation is only valid at the top of a bull market because this economy is so financialized, when the stock market is getting crushed, inflation expectations will be too. This is a key variable the inflationists got wrong for a decade: QE does not inflate consumer prices - it inflates asset prices. However, as Jim Bianco points out, after every recession the world changes in some way. I believe what changed this time is they figured out how to cause inflation by sending insane amounts of money directly to consumers, so if that is the form QE takes, then most likely we’ll see a repeat of the last few years, but at some point the long end is not going to fall for it, so the Fed will have to pin the long end and raise rates on the short end to dampen demand. This is too far ahead. There’s plenty that can go right to avoid this. 

The main way to avoid that recessionary scenario is if the AI innovations create enough real economic growth that it leads to rising tax receipts, real economic expansion, and an ability of the private market to absorb a normalized duration issuance (of a path of spending that goes straight up - without a recession), which will then allow deficits to be reduced as The Great Handoff lifts us to the fabled soft landing glide path higher. (btw, this is how I define a soft landing - it's a complete exodus of gov't intervention like the post WW2 era).

Here’s the key variable, though: the reason I worry about a gap in time that prevents this is because I'm assuming in order for AI innovations to have a similar post WW2 effect they’ll need to be actual everyday products in our lives like robots and robotaxis, and virtual reality devices as contact lenses etc., which requires solving AGI first. This is the crux of the issue. There’s no Great Handoff to a new “post Covid, post QE world” unless it’s driven by genuine economic innovations that allow deficits to be reduced and higher yields to be sustained broadly without adversely affecting earnings that leads to layoffs. The question is whether or not the economic activity from the evolving AI developments along the way to the everyday integrated-in-our-lives innovations of the future is sufficient, or whether there’s a gap.

 

The same applies to energy. The planned nuclear sites are solely for data processing and will still take 5 years, so is the economic activity from the investments in energy infrastructure sufficient to broadly absorb higher interest rates, even though there will likely be a greater demand on energy than available supply during the process, which should cause energy prices to rise and squeeze discretionary income etc...  I’m referring to electricity more than oil or natural gas, although, rising oil prices due to geopolitical tensions if Trump can’t end the war on day 1 certainly needs monitoring. 

I am not surprised we didn’t have a recession for the last two years because the stimulus put the consumer in good shape, but I am surprised we still have rising yields and strong jobs and increasing inflation expectations. The call of the inflationists and bond bears for a resurgence off the lows was the correct one, especially heading into the first few months of the year and possible tariffs. But now we’re back to the key question regarding inflation: is it self-fueling? And I adamantly, table poundily say it is not. The reason is because unlike a deflationary mindset that doesn’t require anything else, an inflationary mindset is meaningless without money. It requires money. If the consumer has no stimmies and they hit their credit card limits, there’s nothing left to spend. 

I wrote thousands of words on this, so I will sum it up succinctly as follows: Wall Street has co-opted the term inflation to mean rising consumer prices, which is inaccurately misleading because it combines both supply side and demand side causes into one concept, but they have opposite economic effects. I understand the horse is out of the barn on the semantics, so it’s your job when someone says inflation and they’re referring to rising prices to translate it in your head to distinguish whether they mean actual inflation which is more money than available goods that leads to an economic boom for as long as the money is flowing, or supply side causes like rising oil or interest rates or tariffs which leads to an economic contraction from squeezing margins since it lacks the monetary expansion to pay for the rising prices. 

Obviously, Trump is wrong that tariffs are a tax on the other country, but a lot of people have been calling it a tax on consumers, which assumes the business can pass it along. If you’re thinking on the level of general economic concepts, you are not operating on the transactional level where every business has different pricing power, market share, and balance sheets, so each business will have to independently decide how much they can pass along without hurting their own sales, and how much they have to absorb, which will force them to trim other expenses to make up for it. 

Since a feature of our system is the constant changing of the guard, overseas businesses can also choose to pivot to other markets or wait out the Trump presidency and NOT move back here, which is yet another assumption people are making. They're assuming a business doesn’t have other options and Trump can pull a bunch of levers and make them do what he wants when the reality is that an irreversible global system is emerging, driven by technology, and a carnival barker with an idea that would have been great in 1994 is not going to stop it. By the way, if tariffs were erected in 1994 it would have had the same effect as gold, meaning, it was only a matter of time before the pressure from companies with global ambitions pursuing their own self-interest would have broken the restraint of tariffs and we’d be in the same situation today. It’s remarkable how many people willfully choose to ignore that it's not in the best interest of these overseas companies to come back here when cheaper locations with policies lasting more than four years exist. Maybe everyone calling for deglobalization can gather the millions of people who lost their jobs and lead a rally on the Atlantic coast so you can keep promising the ships with all the manufacturing equipment coming home to restore their jobs are right over the horizon.

A global interconnected system of technology is the force in charge. 

Let’s look at some charts.  Are these breakouts or fakeouts?  

SPX is not only forming the dreaded head and shoulders pattern, it’s on the edge of breaking out to the downside. To be fair, when a technical pattern like this fails, it tends to be a great signal in the other direction, so it’s not over yet, but there’s so much uncertainty ahead and so many things that can go wrong, and this is exactly what a top would look like, so it should at least have everyone’s highest attention, especially since the first few months of the year have tended to run hot on CPI as yearly prices reset. A completion of this pattern would be the first lower low since the Nov 23’ backtest reversal off 4200 (a lower low meaning a pullback that didn’t make a new high - this one retraced 78%).

IF stocks break down, particularly if it happens on a hot CPI that causes yields to rise (that’s 2 IFs), the equity market will shift to a mindset of selling the rips and it won’t stop until the downtrend it creates is definitively broken and becomes an uptrend again. All the thoughts I just wrote about and all the thoughts in your head will evaporate into the arbiter of truth: price. If you think about the nastiest thing that could happen, it would be two days of rally back into range and then a terrible last 3 days closing the week with a clear breakdown bar. If the market isn’t ready to fall, this week needs to be a banger to the upside to shift the whole psychology of it morphing to the dark side. The question is: if Yellen’s yield curve control and Powell’s pivot allowed stocks to rally this much, what does the unwind of YCC and Powell’s pause do?  Or will optimism over the coming policies mute these concerns? Just asking questions. 

GOLD - it is exceptionally interesting that gold and silver rallied WITH yields and solid data. What this means, to me, is that either gold is not a believer The Great Handoff is underway and we’re still in the old world, so rising yields means an eventual breaking of the economy that will cause a collapse in yields and more QE, or it was a market-maker-conventiently-disappeared-for-the-morning fake out.

Gold is currently trying to break out of this triangle, but if the CPIs are hot, it could rather quickly retest the lows. If gold and silver continue ignoring hot data and rising yields, look out when they break the economy.  I'm thinking if gold gets killed on CPI, I’ll be looking for a breakout of this triangle from the bottom, or seeking a therapist if it breaks down from there.  

10-YEAR YIELD - while I expected a bounce in yields at the first rate cut in September because that’s what happens every time, I thought yields would be contained by the down trendline, which is clearly wrong, so wrong in fact that it prompted the rethink that led to this article (remember, I’m not writing these anymore). I don’t have a level that would interest me in duration, but if the combination of an economy that won’t quit + deficit spending + tariff fears + normalizing issuance somehow causes a 6 handle I don’t see why I’d ever take risk again, except for the fact that equities would be so cheap I don’t see why I’d ever own treasuries again. I’m trying to be as open minded as possible to the outcomes, given Trump’s policies. 

OIL - This is also testing an important trendline. If the economy defies all headwinds and remains strong, and oil breaks out, it will become yet another test of the economy’s resilience. Meaning, I can justify no recession when consumers and businesses had stimmies to offset rising prices, but if rising energy and rates still have no effect, then I would be forced to consider whether QE worked and the new frontier of AI innovations and The Great Handoff is here. That would be a complete letting go of the inevitability of a debt/currency crisis. I honestly cannot imagine this as possible at the moment, but that’s what it would look like. 

Anyway, those are my thoughts in the most dispassionate expression possible. The timing would be nice, but it’s not as important as understanding the forces at work and having the patience to wait for it to play out, and, of course, recognizing what will prove you wrong. I’ll put a number on it: if the SPX touches 4450, then it’s not a new world, although still debatable, but if the SPX touches a deep 3 handle anytime in the next few years, it’s the same old QE world and nothing has changed. I'm trying to be done with these, so best of luck to you.

Calling an Audible

Earlier this week I had an epiphany about a much better way to structure the article I was going to post today, so I'm going to wait until I write that version. I happen to be extra busy for the next few weeks or so, which means it might take until after the holidays to finish. 

I have a lot to say about the markets, but I'm kinda exhausted, and since everything can change completely based on the election results, I don't see the point.  Clearly, so far, there was no selloff into the election. Now that Opex is over, maybe we get a down tick, in fact, the most bullish thing that can happen for a six month time frame is putting everyone who bought the breakout after Fed day underwater and then a big reversal day, which, of course, needs follow through to new highs.  The reason I say that is because in the medium term I think the market goes way down. In the long term it goes way, way up. So the question for me is when does the medium term start and peeps might be like: why way down? 

I listened closely to a soft landing person the other day and I can articulate the difference between our viewpoints.  She was saying inflation came down without unemployment going way up, so that's a soft landing.  That's not my view at all.  Inflation was never the problem. It was always going to come down due to the nature of its causes.  This particular soft landing person is the typical mainstream, micro, individual stock focused perma bull, which is the right way to be, except that she doesn't distinguish between "the economy" from the 90s, 00s, 10s, and now. Her subsconscious assumption is it's all basically the same. 

As you know by now, my view is you can't replace stable, well paying manufacturing jobs with all the benefits that go with it for the less educated masses with Uber and Lift gig economy jobs.  The economic hole this creates is only sustainable by negative real rates and/or huge deficits, which are both unsustainable.  This is where the rubber meets the road. Man, I didn't want to do this and now I'm writing an article. 

Everyone is giddy about the Fed in a rate cutting cycle helping to support stocks, which is fine, makes sense, I get it.  However, the Fed is only cutting with stocks at all-time highs to get closer to neutral. Some people make the case that neutral is higher and stocks, gold, and now silver are ripping because the Fed is still not restrictive, so they worry about inflation coming back.  You already know I think that's impossible unless money is broadly distributed.  I keep asking the inflationists to explain how there will be an imbalance of supply and demand for broad general prices and no one answers the question. They just say I believe inflation is coming with no explanation.  I'm open to changing my mind but not without a better explanation than you believe it.  That doesn't mean bond yields can't rise from supply concerns. 

Anyway, the point is once the Fed gets closer to what they think neutral is, why would they keep going?  We will be right back in the old Fed playbook of only easing if the data requires it, but if the data deteriorates enough to require it then stocks will be falling.  In other words, there's only a brief window of time with the Fed easing into all-time highs.  

So if I'm correct that the economy is nonfunctional, and I can prove it with one question: what do you think would happen if Congress balanced the budget so we had zero deficit spending?  I think the economy would implode.  This is the key variable behind my view of a soft landing is not even a possible outcome.  You might argue yes but deficits are baked in the cake for as far as we can see.  And that's fair, but now we're talking about timing and not the inevitability of the waterfall we're headed for.

There's a few things I think are most important to monitor.  One is what Eric Basmajian and Warren Pies keep an eye on, which is residential construction employment.  The idea is when rates were historically low and stimulus was flowing and remote work was gaining steam, the backlog of new housing built up, and all of those houses financed at low rates took the last two years to work through, which means we should be now entering the period of time when rates started rising and kept going (or stayed high) from March 22' until last month.  So we get to see how much residential housing activity was initiated during that time of high prices and high rates.  And that period lasted 2.5 years.  Since housing is such a huge component of an.economy it makes sense that a sustainable layoff in that sector that keeps going would lead to a downward spiral, which is what happens in recessions.  If there's no slowdown there, it seems unlikely that there will be a slowdown in general, so I think watching new starts, building permits, and layoffs in that area is a key variable as the most leading indicator that we're headed for trouble in 3-6 months. 

Secondly, here's a video I recommend watching of Michael Howell on Adam Taggart's show about liquidity.  It's an hour long so if you're going to not watch it, the main point is the global economy has like 350 trillion dollars of debt to rollover at an average maturity of 7 years, which equates to around 50 trill a year.  A lot debt was refinanced at the historic low rates, but we are still headed for the wall of maturity that will force refinancing rollover debt at much higher rates than the last 15 years.  This combined with the housing backlog being over is the definition of the lag effect.  Meaning, there isn't a soft landing until you get through the wall of maturity for both housing and corporate refinancing without causing layoffs and/or hurting earnings at historically high valuations. 

Now throw in the years of stimulus that created excess savings which are now gone so the lower half of income earners have no buffer, no job stability, and limited credit card. 

This is what I mean when I say the plane never left the tarmac.  These deep structural problems are being masked by all this stimulus and deficits and low rates.  I do not believe this economy can handle anywhere close to the rates we have now, and, in fact, my predication is by the end of 2026 we will be back at ZIRP and QE.  This is what gold and silver see.

Put it like this.  The patient is depressed for a decade and on meds (low rates, QE).  Then a terrible event happens (the pandemic), so the doctor prescribes ever higher doses of morphine (stimmies).  Then the doctor realized he administered too much, so he started the process of weaning the patient off (raising rates), but the effects of the morphine injections kept going, so the doctor got really aggressive.  In October of 2022, some of us recognized this is peak inflation, and that's never going to happen again, so from here forward all assets will go UP because the doctor can only raise rates so far, so essentially this is pricing in the end of the rate cycle even though it's 9 months away.  And that was the bottom in gold and stocks.  

Now we're at the exact opposite situation. The economic effects from the historic low rates and stimmies have completed.  Obviously, this is not an exact science like on this date the data will turn down, especially with stocks because they're irrational.  However, with multiples at the high end of historic range any further advances will require actual earnings beats in excess of estimates, which is why global companies have the best chances and NVDA who sells new tech to those same global companies with all the cash flow.  Most likely though there will be a point where the new gen isn't that much better so they'll wait.

With the debt ceiling approaching again in Jan-ish there will be a drain from the TGA which should increase liquidity.  What most people tend to do is way overweight the current data and the current emotions.  I'm looking 6-12 months out.  It's perfectly reasonable if nothing really bad happens with the election results that these forces I'm describing take until spring to manifest.  Then we get to see the lag effects of how much of this economy can handle these rates.  Technically, Michael Howell's work says the real wall of refinancing isn't until 2026, but you have to be way ahead of that.

Here's the thing.  What supercedes all of this is price action.  The market doesn't just decide one day to go straight down for two years.  Typically, tops are long processes and often have a classical pattern like a head and shoulders or a double top etc.  If you want an example of what that would look like just look at the SPX now.  If this were the top we would move down to the low around 5400 and then on the ensuing rally you'd be on the lookout for forming the right shoulder. Technically, the pattern isn't activated until that low gets taken out, but that would mean we would be forming the head now (I'm not saying that's happening - just making an example).  Other times there's a strong impulse move down like in 2022, then you keep an eye on the fib levels of the retracement, but there's has to be something bearish going on like everyone knew we just started a rate hiking cycle - at the moment there's nothing bearish like that.  

So the question is what are you going to do about it anyway?  Are you a trader or an investor?  Personally, I would never be able to be 100% long stocks, except if the world was ending and we were in the depths of a bear market.  It's easy to be tempted into the opposite where you're most long at the top and puking up your position at the bottom.  That means your position size is too big or you're not diversified enough in something non correlated that you can sell at the equity low and buy at cheap valuation.  Nothing worse than having lifetime buying opportunity but you have nothing to buy with.  

I do think there's a case to be made, probably the base case, of a rally into spring barring some freak election or geopolitical event.  But I believe there is a giant waterfall ahead when all these forces of low end consumer/lag effects/liquidity/economy-can't-handle-higher-rates-but-Fed-will-be-late collide.  That could be totally wrong and I am the type of person who changes his mind, but I just don't see how it's possible for a soft landing to occur, meaning, like a permanent condition that's just interrupted by slight disturbances going forward.  

What we'd all like to happen is the data deteriorates so obviously that everyone knows a bear market is about to happen but stocks are still at the highs so we can casually sell.  Unfortunately, by the time it becomes obvious in the data and emotions of the present it's way off the highs and you're stuck.  One thing I toyed with was what if I was a 100% long only stock person, how would I manage that?  All I could come up with is fading the extremes.  So when the market is raging bull you want to be dollar cost average selling high beta growth and buying low beta dividend paying defensives or covered call funds, then when the market goes down in the depths of the bear market you sell your defensives and go 100% in high beta growth.  Anyway, I'm not going to do that because I have such a large allocation to gold and silver, so it's not possible for me to be 100% stocks.   

Okay, gotta go.  I'll let you know when I finish my last two articles.  Maybe I'll have the time for a more coherent last post on the markets.  The last two are the whole point of the series.  I want to get them right.  Hopefully, I made sense today.  Later. 

The Unit of Account Problem

 (5700 words) 

Intro

Here I go again, making new friends. Since this is a sensitive subject, I’d like to overemphasize two points: 

1. I have nothing against Bitcoin as a trading vehicle to make money. I hope it goes to a million so everyone’s dreams come true.  I would buy it on a breakout to new highs as a trade with defined risk, but I’d prefer to buy it after a deflationary collapse causes the QE liquidity machine to resume. My thinking in this arena has always been an exploration of ideas to solve our monetary problem, which Bitcoin is incapable of doing. 

2. In the Michael Saylor section, I’m not being critical of him as a person, I’m being critical of the things he says about Bitcoin. 

The Unit of Account Problem

The chart that shows Bitcoin adoption going from the lower left to the upper right is misleading because there has been almost zero adoption of Bitcoin in its 15 years, and there’s a very good reason. What that chart actually shows is the adoption of people who are speculating on its adoption. Real adoption would be people using Bitcoin in everyday transactions as money, but that isn’t happening in any meaningful way because it doesn’t work on any level for anyone, and anyone that tries will quickly realize its limitations. Proponents who say the developing world needs Bitcoin to protect their savings from devaluation when a stablecoin would serve the same purpose without the volatility reeks of a conflict of interest. 

Money satisfies three functions: a store of value; a medium of exchange; and a unit of account (what goods and services are priced in). This world doesn’t have money. Fiat currencies are the medium of exchange and the unit of account, but they aren’t a store of value. Gold is a store of value, but it’s not the medium of exchange or unit of account. Bitcoin is none of them. A store of value doesn’t have periodic 80% drawdowns - speculative assets do. It's easy to conflate price going up with value.

  

There are 3 main economic entities: consumers, businesses, and the government. Together their transactions create our economy, so expecting any of them to use a form of money that is not the unit of account brings foreign currency risk into every transaction.

Consumers get paid in the unit of account because no business is going to add the complexity of paying their employees with a foreign currency; however, a consumer could immediately transfer their paycheck into Bitcoin every week and simulate the same outcome. Since everything they buy is priced in the unit of account of their domestic fiat currency, they would be introducing foreign currency risk into all their transactions. When Bitcoin is up, all their expenses would be discounted as they transfer it back to fiat to pay their bills, but when Bitcoin is down, they’d be paying a premium, so there would be no escape from the discount/premium dynamic of when to buy anything. When do you buy the new car? Bitcoin is up 20% this month, but let’s wait till next month in case it goes higher, oops, now it’s down 30% as the discount becomes a premium. This is foreign currency risk, and if you think consumer sentiment is finicky now, try introducing that additional stress into every transaction. 

From the point of view of the business, accepting a form of money that isn’t the unit of account creates a level of complexity no one has the time or willingness to deal with. Why not ask every mom and pop hair salon, restaurant, and car mechanic to accept Yuan or shares of NVDA as payment? Since all their expenses are priced in the unit of account of their domestic fiat currency, the only way to avoid a world of headaches is if their revenue is priced in the same unit of measurement. And no one is going to risk their profit margins accepting a form of payment that isn’t the unit of account, especially one as volatile as Bitcoin. 

It doesn’t work for lending either. Imagine taking out a home mortgage in a currency you’re not paid in. Let’s say Bitcoin is $100k and you borrow 3 Bitcoins for a $300k mortgage at 6% over 30 years and during that time Bitcoin rises by 10x to $1M per Bitcoin. Since you’re getting paid in US dollars because no one wants to deal with a foreign currency, you now need to earn $3M USD to pay back your 3 Bitcoin loan. On the flip side, if Bitcoin lost 90% of its value during that time and traded at $10k per Bitcoin, you’d only have to earn $30k in USD to pay off the mortgage of 3 Bitcoins. Banks aren’t going to take this risk and neither are consumers. Taking out a loan in Bitcoin would bankrupt you if it keeps rising; it’s the same as being short Bitcoin.

Clearly, the government isn’t going to accept foreign currency risk in its tax revenue collection either.

This is the reason Bitcoin isn’t being adopted. It doesn’t solve the unit of account problem, not to mention it also incurs a capital gains tax every time you spend it. Once you realize Bitcoin doesn’t have the characteristics to function as money, all that’s left is its utility as a payment network.

The novel invention of Bitcoin is how it solved the double spend problem with a proof-of-work protocol that allows it to operate without a central authority. It’s a decentralized Paypal that has a native token it forces everyone to use to facilitate the transfer. The fact that it’s decentralized causes people to create all kinds of beliefs about its native token as money because it taps into a very deep mistrust of centralized authority ingrained in our DNA, but if a decentralized Paypal had its own token with a capped supply that it forced everyone to use to transfer value would anyone be saying one day PPAL is going to be a global currency adopted as a settlement layer by central banks? Would anyone be calling it a “monetary system with rules?” If PPAL existed, it would have the same unit of account problem getting adopted outside its payment network as Bitcoin. Solving the double spend problem doesn’t make it suitable to function as money. It makes it suitable to function as a decentralized payment network with all the trade-offs that come with it. 

Since Bitcoin can’t be money due to its inability to overcome the unit of account problem, let’s return to our central premise of life: all that exists are viable business models and the commodities they use. There’s mature businesses with discounted cash flows and there's speculative growth businesses hoping to become mature businesses with discounted cash flows. If Bitcoin was a viable business model it would be designed so the miners distributed their profits to the token holders like a dividend. The miners would subtract their energy bills, rent, labor, and other expenses from the rewards they receive for validating blocks, and the cash flow generated from providing this service would be discounted to derive a value per Bitcoin, which would be grounded in the operation and viability of its utility against competing centralized payment networks and other cheaper-to-run decentralized proof-of-stake protocols to determine if proof-of-work deserves a premium or discount. 

The Bitcoin Maxis creatively rationalize why using so much energy is necessary, but there’s no proof that it’s true; it’s just another sales pitch to recruit new adoption. Both of the main types of protocols can centralize over time if they aren’t designed with limitations to prevent it. Whether it’s consolidating mining pools centralizing around really expensive hardware that acts as a high barrier to entry and therefore prevents a more levelized distribution of block validation, or the consolidation of funds in ever increasing stake pool sizes, there needs to be a limitation built-in or there will always be the possibility of collusion, which might be unlikely, but a global monetary system can’t be built upon “unlikely”.

Eventually, the incentive to keep holding any investment is being the recipient of a sustainable cash flow generated from consumers of its product or service, which Bitcoin lacks, so what’s the plan when everyone who wants to own Bitcoin, owns it? A lending business to generate yield won’t work due to the unit of account problem, and most of the yield in crypto is self-referential, unsustainable, and doesn’t come from consuming the crypto as a commodity, product, or service anyway. A true yield comes from profit margins.

Bitcoiners like to say its volatility will decrease as it becomes a more mature asset, but age is not the reason investments become less volatile, and there’s no evidence Bitcoin will be an exception. The reason deeply established businesses with products or services embedded in our lives become less volatile is because there’s little to no growth left to speculate on, so the revenue projections are fairly well known and efficiently priced as profits get distributed in the form of a dividend, which incentivizes investors to stay invested. Since Bitcoin can’t become embedded in our lives due to the unit of account problem, and it has no cash flow as a yield from its block validation, all that’s left is the price appreciation game, so even if it becomes less volatile one day, is everyone supposed to hodl as a self-sacrifice to support the network and ignore better risk/reward returns of other investment options elsewhere, particularly as we move toward an exciting era of AI potential? This is certainly a long-term concern but it reveals the model isn’t viable because it violates investor incentives.

Bitcoin isn’t art; it isn't a collectible (which are also subjective price appreciation games); and it can’t be adopted as a currency. For Bitcoin to have value it needs to either evolve into the model of a cash flowing business, or become a commodity used by one; otherwise, it’s just a price based on beliefs with no objective value. It’s like a growth company with wild projections of future cash flow that can never materialize. Real assets derive their value from being grounded in economic activity and relationships with other assets grounded in economic activity. That’s what gives them the value to function as collateral. Narratives, false beliefs, and greed can disconnect price from value for a long time, especially in manias, but they inevitably reconcile. Bitcoin is just people trying to get rich, which is fine, go for it, I am with you, but if there’s nothing grounding an investment in objective economic reality based on observable metrics, how do you distinguish it from Tulips? The greatest enemy an investor or trader faces is their own beliefs. “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. “ – Mark Twain

What I’m describing are investment principles like physics that govern this world. They can be bent by psychology but not broken. The problem with investments based on belief is beliefs change. I don’t need to believe in the utility of my iphone. It would take a new invention of communication, or a nuclear battery that lasts a lifetime, to hurt its value for Apple and the cash flow it generates. Even then, viable business models have to continually adapt to changing markets as price fluctuates wildly around value based on sentiment and evolving economic conditions. Nearly all businesses one day don’t keep up with changing technology and fail. 

The higher Bitcoin goes in price, and the longer it takes, the closer we come to the emergence of the next monetary system, so eventually the risk/reward will skew negative as a critical mass of people realize most of the price appreciation gains are gone and there’s better returns elsewhere. That’s when Bitcoin will be forced to seek its intrinsic value based on the utility it provides with its unique value proposition among competing payment networks as beliefs and narratives about its role as money evaporate into the reality of economic and investor incentives. The exact price where the risk/reward shifts permanently downward is anyone’s guess - it does not seem imminent at the moment. It might be caused by a series of long-term well-known hodlers all deciding to move on in short succession.

Let’s address a few of Michael Saylor’s claims in his No Second Best presentation because at this point he might as well tattoo the Bitcoin logo on his face. The first thing to notice is how Bitcoin Maxis are forced to believe proof-of-work is necessary to run a decentralized payment network. The reason is because it’s the only differentiating quality that makes Bitcoin unique. Yes, there are other proof-of-work cryptos, and yes there are others with limited supply, and yes you could create an infinite number of them, which is why the limited supply of Bitcoin is disingenuous. What it really boils down to is adoption and brand, so the Maxis have to constantly make their case to attract new money by attacking other approaches because it’s not a sustainable business model producing cash flows that self-fuels its own organic adoption by providing a better product or service to incentivize migration away from legacy systems.

Instead, its adoption is facilitated by an army of economic actors pursuing their own self-interest like the promotion mechanism of a multi level marketing machine. The evangelists include: miners profiting from validating blocks; exchanges and brokers profiting from transaction fees; newsletter writers and Youtube channels profiting from subscribers; venture capitalists and other hodlers; advertisers from ancillary services like swaps, lending, hedging etc etc... It’s a whole ecosystem based on a technology that has not yet proven itself to be viable, which I choose to view, positively, through the lens of helping to awaken the general public to the problems with our monetary system that people can feel but can’t articulate. At some point, though, we need actual viable solutions and not a payment network masquerading as one.

The only non-replicable feature Bitcoin has is its first mover advantage, so the strategy of Bitcoin Maxis is to proselytize the case that proof-of-work is necessary because what you’re buying when you buy Bitcoin is the proof-of-work protocol. The problem is we don’t have to speculate on this - other protocols like proof-of-stake already exist and they’re working perfectly well. To think Bitcoin is not a security and the rest of them are is the epitome of conflict of interest, especially when all kinds of layer two applications are being built upon Bitcoin too. There’s nothing that can be done on the Bitcoin network that can’t be done on others, but there’s plenty that can be done on others that can’t be done on Bitcoin because it wasn’t designed to be built upon from the ground up.

One of the more bizarre rationalizations of using so much energy on proof-of-work is how Bitcoin miners are incentivized to seek the lowest cost energy in remote places, which they call “stranded energy.” Since Bitcoin can’t integrate into our lives due to the unit of account problem, and it’s not designed to scale as the host of thousands of Dapps, this “stranded energy” argument is no different than going to the Arctic and setting up power generators that don’t connect to anything. They just burn energy for no purpose.  

You might ask why anyone would do that? Because the people buying the generators (the miners) who are paying for the low cost “stranded energy” to run them are receiving even larger amounts of money (block rewards) from the people who are speculating that one day this particular inefficient network will connect to some kind of sustainable economic activity, but there’s two problems with that: once a critical number of Bitcoin is mined, the miners will need to earn their rewards from transaction fees in excess of their operational costs (which grounds us back in the reality of competing payment networks); and the hodlers of the Bitcoin token need to receive a yield from the operation of that network (even higher transaction fees) that exceeds risk-free yields and/or the dividends of other investment options with better price appreciation and total return potential. Without high enough transaction fees to satisfy both investors and miners there’s no incentive to validate blocks or tie up money holding Bitcoin. This is the inevitable realization of a model based on unproven economics. What prevents the Maxis from seeing this is a misguided belief that the native token has value outside its network without any of the characteristics or functionality that would give it value, so they have to invent narratives to keep new money coming in, and they point to the price as validation of their perspective, but price doesn’t validate a thesis. 

Say Say calls Bitcoin “digital energy,” which is his best attempt at defining Bitcoin as a commodity (if you missed my Taylor Swift reference, shame on YOU). He does get credit for creativity, and he’s been very clear on his story. Microstrategy was in decline and faced the choice of pivoting or dying. He pivoted to Bitcoin, which thus far has worked out quite well, but since he’s all-in on the Bitcoin, he has no choice but to conjure up arguments why a token with no value outside its network has value outside its network. He’s kinda like a defense attorney who’s forced to defend a serial killer caught on video who shows up to court with blood on his shirt and a knife falls out of his pocket. Calling Bitcoin a commodity is problematic mostly because it’s not a raw material used by any business, which is kinda the definition of a commodity. If “digital energy” was a commodity there would be businesses whose operations were fueled by it, so they would constantly need to buy Bitcoin to run their business, and they would hedge their future digital energy needs like the players in oil, copper, and other commodity markets. Or consumers would need “digital energy” to power their computers or houses. The fact that Bitcoin requires energy doesn’t mean it’s backed by energy if that energy doesn’t have a real world use like powering everyday products or services. When a currency is “backed by” something it means it can be redeemed for it. (To be fair, I’ve said the US dollar is backed by the US military, our system of governance, and our assets, which is also not accurate.)  

Say Say then compares Bitcoin to “land” or “property,” which is a much better argument because what will give cryptocurrencies actual value and utility are Dapps built upon them that get utilized in our everyday life, so if this is the new Bitcoin thesis, which is exactly what the Maxis criticized about “shit coins” for years, there’s far superior technology that was designed for this purpose from the ground up to scale better than Bitcoin. 

Micro Saylor calls Bitcoin an entirely new asset class, which is an attempt to rationalize the investor incentive problems I’m pointing out as not pertinent to the Bitcoin, but even new inventions don’t supersede the laws of economics and the incentives of investors who will only stay as long as there aren’t better returns available elsewhere. This same problem applies to all cryptocurrencies no matter what proof-of protocol they use. The only way they are sustainable in the long-term is if they eventually provide a yield generated from the utility they provide, which means the staking reward in proof-of-stake can’t come from existing supply, or even new supply created for that purpose. The yield must come from the consumption of its utility, or it would be like Palantir deciding to get into the oil business so it can distribute a dividend. I recently saw someone proposing that Bitcoin could be used as collateral to earn staking rewards in the proof-of-stake systems, which is just more evidence that Bitcoin has no utility on its own. This is the entire point. Value comes from consumers using the product or service, which generates its own self-sustaining yield from the profit margin, not people speculating on its price and conjuring up schemes to manufacture a yield.

The way a crypto network could work as more than a casino game is if thousands of Dapps were built upon it, and each one generated transaction fees or subscriptions from its users that were distributed to the holders of the layer one token who would be participating in the cash flow of the network’s operation. If this causes a problem with security laws, then security laws need to change because this is the only path to real world sustainability. Each Dapp would have to be a better mousetrap than existing non-decentralized apps that perform the same function, otherwise why would people adopt them? If it’s a payment network Dapp, then it needs to be cheaper, safer, and faster than Paypal, Zelle, Chime, Cash app, Venmo, Apple Pay, Google Pay, etc., but in order to be adopted by actual users, this new “feature” of decentralization needs to solve an existing problem in a way that incentives migration away from the centralized legacy apps. 

Are there so many people getting ripped off by Paypal and Apple Pay that we can’t trust a third party to handle our payment transfers anymore? Is there such an intense and widespread urgent need for instant settlement that it’s not worth waiting a little longer for the security of an accountable publicly owned business to ensure the transfer happens without fraud? The huge trade-off using a decentralized service is the lack of recourse if anything goes wrong, whether it’s user error, or theft, so if we expect a mass migration of users to adopt cryptocurrencies for the only utility they currently provide, the “better mousetrap” nature of it needs to be so much better that actual users (not speculators) overcome the learning curve to adopt it, and use it, which requires everyone to stay on the cutting edge of wallet security or risk getting hacked and losing all your funds, so carpe diem grandma. I’m sure Nancy Pelosi and The Regulators (a blues band from Detroit) won’t mind the rampant fraud that would ensue since they probably have Bitcoin wallets in Belize accepting anonymous donations from big hodlers to look the other way, but that won’t last long because if Bitcoin ever got adopted for actual use the political pressure to regulate the theft will turn them into the legacy system we have now. Isn’t that a depressing thought. 

The sole value of the invention of Bitcoin is the decentralized payment protocol. All the additional value people ascribe to its native token to facilitate the transfer is the Tulip part of the equation because it lacks the characteristics to function as money outside the network, so all the value projected onto it is the groupthink of a mania. If you’re part of the Bitcoin religion and want to see how those of us who are more pragmatically minded view your beliefs, listen to the Michael Saylor presentation again, but every time he says the word Bitcoin replace it in your mind with Tulip. It’s quite amusing, and, no, it’s not a fair comparison because the Bitcoin protocol is an actual invention that solves the double spending problem, so that part has objective value (and there's always hope it can evolve as a host of Dapps).

Essentially, Crypto is just a new way to crowdfund ideas. The token is not much different than a stock certificate, so Bitcoin is a non-dividend paying stock certificate of the novel invention of a decentralized payment network that must compete for market share like any other invention, or be driven by fanciful beliefs that will one day run into reality - unless it evolves. The Bitcoiners will say I don’t understand, Bitcoin is______. And Michael Saylor proves you can insert anything in that blank, but eventually the rubber meets the road and an invention is what it does, and what Bitcoin does is transfer value, so the economics of the transaction fees will need to work for investors and miners based on that in the context of competition. The thesis that Bitcoin is an escape from dollar devaluation in an era of ever increasing liquidity certainly makes sense, but without any meaningful external adoption as money, or any objective cash flowing utility as a payment network, that’s a greater fool price appreciation game. 

 

There are currently over twenty thousand global commercial banks and 180 currencies recognized as legal tender in 195 countries (per Chat GPT). In the US, our banks spend billions every year on security measures for customer protection. We also have FDIC insurance. Our credit card processors also spend enormous sums to protect their networks and the businesses and customers who use them, which includes an arbitration process for chargebacks and fraud for both businesses and consumers. Their processes have evolved to the point of automated texts or calls if there’s suspicious activity on your account, and if you get hacked they refund the fraudulent charge. Every single economic actor of the legacy system is a point of failure that could individually disappear without taking down the entire system, although, to be fair, our largest banks are still too big to fail. 

In comparison, crypto has zero consumer protections, and worse, if we moved the entire financial system onto a proof-of-work or proof-of-stake protocol and it somehow failed it would cause an unprecedented human catastrophe because the entire financial system would go down. The only way crypto could work as a financial system is if it was coded to be mathematically impossible to hack the system, the owners of the system received a yield, and comparable (if not better) protections for consumers and businesses existed, oh, and there needs to be a way for a higher authority to reverse transactions and make changes to wallets. In other words, the whole premise of crypto is incompatible to function as the foundation of a financial system or as money. People who don’t see this are being blinded by a desire to get rich or rebel against the status quo and not objectively analyzing how the system would function in everyday transactions amid a world of fraud. I recently saw someone comment about criticisms of crypto: “who cares if everything crashes in 5 years, I’ll be rich by then!” Again, I’m not against people trying to get rich, but I care. I’m trying to solve the problem, not leave behind a burning inferno as I lay in the sun on the beach. Layer ones do not have the characteristics to function as money, but they can be the decentralized base layer a more thoughtfully designed monetary system can be built upon. 

Here’s what would change my mind on Bitcoin becoming money and having value beyond its payment network utility: if that chart showing Bitcoin adoption going from the lower left to the upper right was businesses and consumers choosing to transact in Bitcoin, I would be among the most fanatic advocates out there. But it’s not, and I just listed half a dozen reasons why it’s not only improbable, but most likely impossible to occur because the characteristics of money and the basis of a monetary system are way more complex than solving the double spend problem with a limited supply of an immutable chain. 

One of the weakest arguments to promote Bitcoin is an attempt to compare it to gold by saying it’s a store of value and pointing out how the price of gold is also based on belief because only a small percentage of it is used industrially or as jewelry. And while there’s some truth to that, it’s not the same. Essentially, gold is just a yellow rock. The reason it has value is because its innate properties made it the best choice to function as money for thousands of years, so it was adopted by businesses and consumers to transact and save in. Bitcoin is attempting to mimic this value creation through brute force of will, but a group of people can’t decide something has value and then try to convince businesses and consumers to adopt it as money so they can get rich. That’s backwards. Value comes from adoption by businesses and consumers first. Without that, there is no value to store; it’s just narratives and beliefs. 

Ever since gold has been demonetized it has maintained a relationship with the dollar and/or real rates from its long history functioning as money, so over long periods of time it accounts for money supply expansions. It’s lagged over the last decade because the dollar bottomed in May of 2011 (the same month silver topped) (and 3 months before gold)), so it’s actually done quite well for battling such long-term dollar strength, particularly through the recent rise in real rates. This is how assets grounded in actual economic relationships behave. The proper way to think about gold is the value of its purchasing power never changes because it rises with nominal prices, unlike fiat currencies that devalue over time.

During the secular devaluation of fiat currencies we’re currently living through, gold will certainly race too far ahead at times as well, fueled by sentiment, and undergo wicked periods of correction because that’s how markets work, but its function as an accounting mechanism for monetary expansions makes its repricing higher much more likely to stick with the permanently rising nominal prices of Slowflation. I don’t see why Bitcoin won’t continue to benefit from these flows as well because all the flaws I’m pointing out have existed from the beginning and continue to be overridden by FOMO, greed, and a genuine misunderstanding of a complex topic, but the bottom line is best expressed by a famous investment axiom: the voting machine of price is adoption by speculators; the weighing machine of value is adoption by the marketplace. Gold is an investment; Bitcoin is a trade. 

When I get invited to speak at the Bitcoin conference (besides promising to wear all white with blue suede Pumas), I will close my presentation with two questions for the Bitcoiners: 1. By show of hands, how many of you use your Bitcoin to buy everyday goods and services?  2. If the most Bitcoin-educated people on Earth aren’t using it as money, how will it ever get adopted? 

This is the unit of account problem.  

Revisiting The Universal Stablecoin

The exciting promise of blockchain, of course, is its potential to develop a decentralized financial system outside credit card processors and the Swift network, and beyond the reach of politicians, but it needs to seamlessly integrate with the legacy system in a way that solves the unit of account problem, or it will forever remain a separate island created on a foundation of beliefs not grounded in everyday economic activity. A truly independent monetary system doesn’t mean it can’t involve sovereign fiat currencies, in fact, it must involve them or it’s dead on arrival. The inevitable monetary Dapp that runs on a layer one network doesn’t need to be decentralized if it runs on a decentralized network and has built-in protections to prevent the abuse by a higher authority that motivated the creation of decentralization in the first place. 

The idea is to resurrect the three functions of money by restoring its store of value while retaining the current unit of account and medium exchange status of sovereigns in a way that allows consumers and businesses to seamlessly use them in everyday transactions, but without the perpetual erosion of purchasing power. This would be a much safer check on government spending than MMT, and it would transfer power back to the people where it belongs. 

Two years ago, I proposed a universal stablecoin structured as a version of the SDR based on weightings of the world’s sovereign currencies (plus gold), designed to maintain a stable value through a mechanism that countered one component going up (USD) with an offsetting component going down (EUR, etc.) so the currency unit (Unis) as a whole always equalled one, which would reinstate a store of value to our money. The addition of gold was to offset all sovereign currencies going down together against real assets. 

Since then, I’ve had new insights that revealed a flaw, but also a solution. If the currency units (Unis) were issued for use in everyday transactions they would have the same unit of account problem as any other foreign currency like Bitcoin or gold, so I had a new epiphany and rethought it, and in the process I realized every cryptocurrency is approaching the problem the same way. I can’t say what that is without revealing too much of the idea, but there’s a good chance the government would not be able to stop this, nor would they want to. I am mindful of the possibility that I’m missing something critical, so what this needs is a group of people to beat the idea with a stick, then test it inside an algo simulated environment. If there isn’t a flaw, this could be the programmable money that functions as a layer two application because it resolves all of the objections I’ve expressed above. 

Since we’re still very early in the penetration of blockchain into our lives, this idea likely requires migration of certain parts of our current system onto decentralized platforms before it could be implemented in a way that’s beyond the reach of the government, but it’s the most promising idea I’ve ever come across. And to be honest, there is no functional monetary system the government, or even Big Tech, couldn’t stop, so this isn’t a war; it’s a cooperative partnership. As enticing as a truly decentralized system sounds, how could it ever be implemented without the permission of Apple and Google to operate on their hardware at the point of sale, or the permission of the government for businesses to accept the payment as legal tender? No one is going to add another device to their life for this purpose, so it will have to run on phones, and businesses will need an auditable trail for tax purposes and accounting. Fortunately, the monetary incentive will be enormous, but running on phones is still a central point of failure if the government wants to prevent it. With that said, think about how transformative it would be if we had a completely independent monetary system that ran parallel with fiat currencies but integrated with them seamlessly in everyday transactions.

 “And that’s all I have to say about that.” - Forrest Gump 

In three weeks, we’ll explore a path of how it could happen in The Proposal, but first let’s get a little provocative with The Flaw of Humans next week.