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Evergrande, Credit Spreads And Bitcoin

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Greg Foss discusses, Evergrande, China’s high-yield market and his valuation model for bitcoin.

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In this episode of Bitcoin Magazine’s “Fed Watch” podcast, Christian Keroles and I welcomed back Greg Foss to the show to discuss the new articles he’s written on Bitcoin Magazine about Evergrande from a professional in the high-yield credit space. We get to know Foss a little better in this one and discuss, not only the facts of the matter on Evergrande and high yield, but also his beloved Canada and some predictions of the future.

Evergrande Contagion

Evergrande is an evolving situation, we probably shouldn’t even call it Evergrande anymore because it has spread throughout the Chinese high-yield financial sector and has caused the entire Chinese real estate market to teeter on the brink of collapse. We could call it the Chinese financial crisis.

Our interview follows the outline of his article “The Macroeconomic Implications Of Evergrande For Risk Assets And Bitcoin.” Foss started by comparing the size of Evergrande’s default to that of Lehman Brothers’. Strictly speaking of on-balance sheet size, Evergrande is approximately one-fourth to one-third as large as Lehman’s default. That is sizable, but should not destabilize the entire financial system. Foss pointed out what is more likely is a focused contagion within China and the emerging markets.

Foss pointed out that this Chinese financial crisis has already affected credit spreads in China to the point that they are priced like BBB-rated debt. If spreads continue to widen, debt from the second-largest economy in the world could trade like junk bonds. Investors will have to start asking themselves, if China is junk, what about all of the other emerging markets? The credit contagion will likely spread rapidly.

Bitcoin Valuation Model

Being a credit expert, Foss has a very interesting valuation model for bitcoin, which he has written about in depth on Bitcoin Magazine. The basis of his model is, “BTC is insurance on the decaying credit quality of fiat-issuing sovereign nations.” We discussed bitcoin as a long-volatility position since bitcoin has no counterparty or debasement risk.

His calculations are fascinating. I suggest you checkout his piece on Bitcoin Magazine linked above where he goes into detail, but suffice it for this podcast write up, he calculates bitcoin’s intrinsic value as the “current credit default swap (CDS) rates and total liabilities of the G-20 nations.” As the quality of sovereign credit fades in coming years, CDS spreads will widen and the value of bitcoin as counterparty-free insurance will increase.

How Fed Tapering, Energy Crises And China Blackouts Will Impact Bitcoin

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Potential Federal Reserve tapering, blackouts in China and global energy crises are sending markets into turmoil. How does bitcoin fit in?

In this episode of Bitcoin Magazine’s “Fed Watch” podcast, hosts Christian Keroles and myself, Ansel Lindner, gave an update on the Federal Reserve, the energy crisis in Europe and Asia, and Chinese blackouts. It is a very pivotal time for markets and things are moving fast. This episode was recorded on September 28 and things are moving so quickly that by the time of publishing, we might have a completely different scenario brewing. For that reason, we are going to be returning to our shorter turnaround schedule of 24 hours.

Federal Reserve News

Our first Fed news item is the resignation of Rosengren, president of the Boston Fed, and Kaplan, president of the Dallas Fed, over allegations of insider trading. This could cause a minor shake up at the Fed, being that both these voting members were on the hawkish side of monetary policy, meaning that they preferred less accommodative measures and faster tapering.

That leads us into talk about the Fed taper. Powell said in the September Federal Open Market Committee (FOMC) meeting that taper will begin “soon.” Pundits are claiming that means they will announce it at the next meeting in November, and we agree unless major circumstances change (which is very possible).

Energy Crisis In Europe And Asia

This was a wide-ranging discussion on the current status of the energy crises in Europe and Asia at the time on September 28, and we speculated as to the reasons. Different places on the planet will be affected differently by this crisis, that much is certain, but the fallout could be dramatic. The U.K. has less of a shortage and more of a distribution problem, but continental Europe is facing a true shortage, albeit one of its own making. Years of aggressive environmental policy has left it exposed to shortages like this.

Asia and Europe might seem like disconnected crises here, but they are very much connected. We traced a significant causal factor back to the Chinese trade war with Australia. Starting in January, China stopped buying coal from Australia, a change that has been rippling through the energy markets. The U.S. has taken up some of the slack from China, while Australia has found other markets in India and elsewhere for its coal. China faced a shortfall, so likely bought more natural gas from Russia and Iran, which themselves were facing low inventories brought on through 2020.

Things roll down hill. This diversion of supply met with the slowdown in supply chains to create a bidding war.

Source: Bloomberg

Links Mentioned In The Show

  • Rosengren and Kaplan resign
  • Powell’s comments on tapering
  • U.K. energy crisis at the pump
  • European and Asia energy crisis
  • Chinese power cuts
  • Chinese blackouts

Bitcoin, Evergrande And The Deteriorating Situation In China

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Evergrande cannot be viewed correctly except in the context of the overarching economic situation in China.

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In this episode of Bitcoin Magazine’s “Fed Watch” podcast, I discussed the emerging story of the week, Evergrande and the Chinese recession.

We first brought up Evergrande on episode 60, back on August 11, and at the same time I made the call that China would enter a recession within three months. Our position on “Fed Watch” has been bearish on China for over a year, and my personal position has been bearish since well before the 2020 coronavirus crisis began.

I started the podcast by describing what exactly is happening. Evergrande is in massive financial trouble, and likely to default on upwards of $300 billion in debt. But it isn’t alone. To meet its obligations, Evergrande has been trying to liquidate its assets, including land, apartment units, commercial real estate like its headquarters building, and more. All of this liquidation pushes prices down, which negatively affects the price of assets on other giant real estate developers in China. The contagion is spreading.

Seventy percent of household savings is in the form of real estate. The average person in China does not invest in the stock market or other financial assets, they strictly invest in real estate, gold and bitcoin, to a degree. More auxiliary homes are bought in China than first homes, as you can see consistently rising property values are very important.

Broad Economic Environment In China

Evergrande cannot be viewed correctly except in the context of the overarching situation in China. The backdrop for this Evergrande blow up is what I call the “Second Communist Revolution” in China. Marxism is a process which the CCP fully embraced back in the late 1970s. First comes capitalism to build up capital and wealth, to build the means of production. When the income inequality gets to a critical degree, the workers revolt and seize the means of production from the capitalists. In other words, a capitalist phase is necessary for Marxist communism. China is displaying a return to more strict communist principles. We’ve seen this shift toward more authoritarianism, starting with Hong Kong, but now reaching tech companies, fintech, IPOs, the education industry and entertainment.

There is no way that the CCP didn’t see Evergrande coming, or that it doesn’t know how to bail it out. What the CCP is wanting is a redistribution of resources away from giant housing projects and into industry. This is a very difficult task, one that requires the collapse of the property bubble in China.

Evergrande’s Effect On The Rest Of The World

The rest of the world is not immune from the Chinese credit collapse, however, it will affect different economies to a greater or lesser extent. The U.S. should be fairly insulated, while countries more dependent on the current international liberal trade order, like Germany, might be hit harder. I draw the parallel to the European debt crisis after the first Great Financial Crisis. At that time, the trouble was focused in Europe and the rest of the world simply slowed. This could be similar, China has a crisis and the rest of the world slows down.

We are already in a period of shortening supply chains, on-shoring, and realignment of trade partners. This Chinese crisis might quicken that process, cutting China off more from the world.

Evergrande’s Effect On Bitcoin

Bitcoin has no counterparty risk, and in a deflationary credit crunch, you don’t want to hold assets that are someone else’s liability. Of course, in the credit-based money system we have now, that is nearly impossible, but bitcoin provides an elegant and easy solution. Therefore, the dollar can rise in a liquidity crisis along with bitcoin. It is important not to rely on an investment thesis for bitcoin that relies only on inflation, because when people realize we’re stuck in a deflationary environment, the reason to buy bitcoin would go away.

I finished up the podcast with a discussion about the bitcoin price and the possibility that tether is exposed to Chinese commercial paper. That would be horrible for tether and altcoins, but relatively neutral for bitcoin, though it would increase some short-term uncertainty.

Reviewing The August Bitcoin Market

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Dylan LeClair discusses the bitcoin market, inflation and the Triffin dilemma.

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In this episode of Bitcoin Magazine’s “Fed Watch” podcast, we invited Dylan LeClair, writer at Bitcoin Magazine, back onto the podcast. LeClair is deep in the weeds of the fundamentals of the bitcoin market. After touching on the price crash of Sept 7, (the day of the podcast recording), our conversation turned to LeClair’s monthly Deep Dive, a large report he writes for Bitcoin Magazine’s exclusive members.

As we made our way through LeClair’s report, we stopped at several of our favorite charts. The first is “supply by liquidity cohort,” seen below. He walked us through the meaning and the takeaways. As you can see on the chart, the vast majority of the bitcoin circulating supply (all bitcoin mined so far) is illiquid, in the sense that it hasn’t moved in a prescribed period of time.

Bitcoin Charts In The Deep Dive

Next, we touched on a chart you may have seen floating around the interwebz, the “HODLer net position change,” measuring the amount of coins that have entered HODLers hands. We discussed several aspects of the below chart, of course, noting the recent increase as well as the net selling which occurred on the way up. This is a lagging indicator, plainly showing that accumulation precedes rallies at which time you get a short squeeze and distribution as price rises.

At this point in our conversation, we also talked about the Grayscale Bitcoin Trust (GBTC) and its possible effect on holding behavior and price. It wasn’t covered in the Deep Dive, but we had a good discussion bringing up several important points. I have written more about the GBTC dynamic here.

The chart we spent possibly the most time on was the hash ribbon chart. It is one of my favorite charts in bitcoin, because it simplifies the entire industry into one chart, with price and hash rate. You can find my version on the “Bitcoin Pulse” published through BitcoinandMarkets.com. Perhaps this indicator is an oversimplification, but the more versed in bitcoin you become, the more detail you can find in this chart.

LeClair, Christian Keroles and I went into detail on how unexpected drops in hash rate can signal a crash in prices as it did in March 2020 and again in May 2021. The period around the halving in May 2020 and again in October 2020 to November 2020, with the end of the rainy season in China, were expected.

Macro Charts In Deep Dive

In the August Deep Dive from Bitcoin Magazine, LeClair included a large section on the macro setting, from a U.S. perspective. And this is where we started to disagree slightly. He has charts for Consumer Price Index (CPI), Treasury bond interest rates, government deficit and more. Listeners should know Keroles’ and my views on inflation by now, but LeClair puts together some compelling charts and arguments for why the end of the U.S. dollar system is near.

LeClair also made a fantastic comment when covering his section on the Triffin dilemma. Paraphrasing, he said, “Robert Triffin’s proposed solution to the dilemma back in the 1960s was to adopt a Keynesian Bancor as international reserve currency. Today, we have bitcoin, which can fit that role.”

It is interesting that bitcoin is a perfect combination of a gold standard and a Bancor-like currency.

We can’t cover everything from the podcast here, you really must go and listen and watch on YouTube. We will be trying to get LeClair back on the show on a regular basis to discuss his deep knowledge of the bitcoin industry.

Unpacking The Fed’s Smoke And Mirrors In Jackson Hole

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Responding to Federal Reserve Chairman Jerome Powell’s comments at Jackson Hole through a Bitcoin lens.

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In this episode of Bitcoin Magazine’s “Fed Watch” podcast, we responded to Federal Reserve Chairman Powell’s comments at Jackson Hole on August 27, 2021. We listened to several important sound bites and discussed it along the way. Powell was expected to announce a Fed taper, where it begins to shrink its monthly purchase of securities in quantitative easing.

We have often said that Powell is somewhat of a straight shooter relative to other central bank leaders of the past and present. We also are hesitant to ever agree with a Federal Reserve chairman, but in this case, we find many points to agree on.

Bitcoin is beginning to naturally fit into every discussion on central banks and the international financial system. We touch on bitcoin throughout this episode.

Chairman Powell At Jackson Hole

We went very in depth with this analysis. In the first couple of sound bites, Powell introduced the anomalous nature of this recession. Namely, that average incomes rose due to fiscal stimulus. He made it clear that the unique interplay between rising incomes and unavailable services from the pandemic shifted demand from the service sector to the manufactured goods sector. This spike in demand and spending on manufactured goods as supply chains were effectively frozen caused huge distortions in the market and some prices to rise.

The volatile nature of these price moves are not captured entirely in a 12-month window in which consumer price index (CPI) is measured. Powell introduced an 18-month chart that corrects for some of the shortcomings of the 12-month version, by including the recession and recovery in whole.

We stepped through some charts showing how transitory price increases don’t necessarily mean a declining rate of change, but actual price declines. Prices go up and prices go down. As used cars, commodities, oil, gasoline, and copper, all go up and down.

The last two clips we listened to were about actual Fed policy. Powell described what is, in my opinion, the only Fed policy tool, anchoring inflation expectations:

“Our monetary policy framework emphasizes that anchoring longer term expectations at 2% is important, for both maximum employment and price stability,” he said.

Powell finally danced around the issue of taper, never saying the word. He reiterated what he has said before, that if significant and sustained improvement toward the Fed’s goals are made it might be appropriate to begin tapering this year. Co-host Christian Keroles and I went over this comment in depth. We see it as likely that Powell was searching for a way to keep taper very much on the table but also give the Fed an out if the global economy takes a dive in the next few months. That dive is looking more and more likely, by the way.

Powell’s Reappointment As Chairman Gets Political

For our second major topic, we stayed with the Fed. Chairman Powell is up for reappointment in February and it is getting somewhat political. The Fed is supposed to be apolitical, but Powell is coming under increased criticism from progressives in the government. They want a more politically-motivated central bank, to help them force in climate regulations and other progressive objectives.

Powell is caught here between growing pressure from politicians to be more of an activist and members from within the Federal Open Market Committee (FOMC) itself calling for tapering. He must find a way to walk a fine line if he wants reappointment.

China’s Credit Impulse And Purchasing Managers’ Index (PMI)

China’s economy is wavering. It was celebrated post-Great Financial Crisis (GFC) as the source of growth that pulled the global economy out of recession. If you had any illusion that that would happen again, this week’s PMI data has smashed your hopes.

These numbers show the contraction in China is serious and gathering pace. Remember, in a highly indebted economy, low growth is not enough to avoid a crisis. You need expansion to cover repayment of principal plus interest. If the Chinese average interest rate is 5%, it must have 5% growth or else defaults and contagion spread. As soon as the defaults become too numerous to deal with, bankruptcies could spread throughout its bubble economy.

Manufacturing PMI

Non-Manufacturing PMI

We hope you enjoy this episode. It is jam packed with Federal Reserve updates. If you like it please share and give us thumbs up on YouTube and a good review on iTunes.

Articles mentioned:

Politico: AOC, Tlaib, Pressley call on Biden to dump Powell as Fed chair

IMF: Climate Change and Financial Risk

Fed: Climate Change and Financial Stability

ECB: Climate change and monetary policy