The Investment Scientist

The “GENIUS Act,” officially known as the Guilding and Establishing National Innovation in U.S. Stablecoins Act, represents a significant shift in the financial landscape. This legislation allows private entities, including banks, hedge funds, and technology firms, to issue payment US dollar stablecoins. This opens up a new frontier for financial transactions and investment opportunities.

What Are Payment US Dollar Stablecoins?

Payment US dollar stablecoins are cryptocurrencies designed to maintain a 1:1 value with the U.S. dollar. They are intended to facilitate seamless transactions with the stability of a traditional fiat currency.

Who is Eligible to Issue US Dollar Stablecoins?

Qualified issuers include subsidiaries of banks and nonbank companies that receive approval from the Office of the Comptroller of the Currency (OCC). A critical requirement for approval is maintaining a reserve that covers 100% of the stablecoin issuance. This reserve can consist of actual U.S. dollars or short-term Treasury bills with a maturity of less than 90 days.

Existing USD Stablecoins

The market already features several USD stablecoins. Tether’s USDT and Circle’s USDC are the two largest, with a combined market value of approximately $250 billion. The daily transaction volume of USD stablecoins exceeds $20 billion, primarily within the cryptocurrency ecosystem.

Intended Purposes of the Legislation

What has happened in the last few days was a mad dash out of the door of all US dollar-dominated assets to buy back Japanese Yen. Why so? I have to start by explaining the Yen carry trade.

For a long time, Japan’s Central Bank has maintained an extremely low interest rate policy of between 0% and 0.1%. If you were smart money with the right access, what would you have done to earn effortless money? You would borrow Japanese Yen and convert it to US dollars. By just investing the money in US treasuries, you could immediately earn more than 5%. This is called the Yen carry trade, essentially an arbitrage of the interest rate differentials of the US and the Japanese Central banks.

In any event, the result of the Yen carry trade has been the almost endless depreciation of the Japanese Yen, the appreciation of the US dollar, and an endless supply of additional liquidity to the US stock market despite the Fed’s tight money policy. This additional liquidity pushed up all manner of asset prices. But alas, all good trade has to come to an end.

In this article, I want to show how, in the last 15 years, the Fed’s money supply has driven stock prices higher and higher and how this situation going to reverse.

Prior to the 2008 financial crisis, the Fed kept the money in circulation in the economy relatively steady, just under $1T. Then the 2008 recession hit and to save the economy, the Fed began to “print” money. This action is given various lofty names like Quantitative Easing and Balance Sheet Expansion. The end result, however, was the same, about $1T was released into the economy. This is illustrated in spot (1) in the chart below.

Two weeks ago, I wrote about the retirement income nirvana that is allowing retirees to finally get some serious income from their savings, starting with Treasury bills. The money that goes into retirees’ pockets has to come from somewhere, so let’s look at this chart produced by the Saint Louis Fed.

It shows the interest payments the federal government has made every year up to 2023. One can see that, ten years ago, the interest payments came to about $400 Billion. Today, it’s over $900 Billion! Now, it’s true that some of these payments are to other government agencies like the Social Security trust fund or the Medicare trust fund. Even after adjusting for that, the NET interest payments by the federal government rose from about $225b in 2014 to $700b in 2023. 

The federal budget is a trainwreck waiting to happen – a disaster that would make the current government shutdown drama look like child’s play.  

In 2023, the actual federal revenue is $4.3 Trillion, but the federal expenditures total $6.2 Trillion, resulting in a budget deficit of nearly $2 Trillion. Since the government is short of this money, they have to borrow it. 

How does the government spend money? 

Barely a year and a half ago, the Fed fund rate for overnight lending stood at (annualized) 0.08%. Now it is between 5.25% and 5.50%.

This has tremendous positive implications for retirees who need a steady fixed income. Imagine that you are someone who has accumulated $1mm for retirement. If you didn’t want to take any risks and you invested your entire nest egg in the Fed fund (not that this is even possible), you would have a grand total of $800 a year! That’s why a year and a half ago, I had to expose my clients’ money to stock market risk, duration risk and interest rate risk just to earn some real returns. 

Then the Fed realized that inflation was out of control, and geopolitically the US needed to defend against de-dollarization, so since the middle of 2022, it has driven the Fed fund rate up. At the current upper rate of 5.5%, a $1mm investment will earn one $55,000 in totally safe interest income. $55,000 vs $800 – that is quite a difference! Who would have thought fighting inflation would be a blessing for retirees on fixed incomes? 

In this article, I will not discuss the Credit Suisse collapse and rescue that just happened less than ten hours ago, since I don’t understand the Swiss banking system as well as I understand the US system. Here in the United States, we have had a rapid succession of specialty bank collapses: Silvergate Bank, Silicon Valley Bank (SVB) and Signature Bank. Most of their depositors are super wealthy people or businesses whose deposits amount to much more than the 250k guaranteed by the FDIC. The majority of American banks do not have that kind of customer profile and the majority of American depositors have less than $250k in their bank accounts. Does that make the rest of the banks in America safe? I am afraid not. 

Though the depositor profiles may be different, all banks invest in the same “safe” government or government-backed debt securities, and all banks have unrecognized losses in those securities. By some estimates, the entire US banking system has $660B in unrecognized losses. 

During 2020 and 2021, the Fed printed $5T to combat a potential economic collapse caused by Covid 19. Some of this newly minted money found its way into Silicon Valley Bank (SVB) deposits. Since the short-term interest rate at that time was essentially at zero, SVB invested a large portion of the money into long-maturity mortgage-backed securities (MBS) that at the time were at least yielding somewhere around 1.6%.

If we look at the SVB Balance Sheet, this investment is classified as Held-to-maturity securities on the asset side (shown in green.) This means if they hold the securities until maturity, they will definitely not lose money. But if they are forced to sell before maturity in a rising rate environment, they will lose money. 

The following is a chart I grabbed from the St. Louis Federal Reserve website. It more or less explains why we are experiencing runaway inflation now, and why it may not easily go away.

The chart shows the total M1 money supply. Note that as recently as 2012, the total money supply was just over $2T, but now, only ten years later, it is over $20T. That’s a ten-fold increase. The majority of this increase came during the Pandemic when within a few short months, the money supply increased from $4T to 16T. 

Only after March of this year, when it became clear that inflation is not “transitory,” did that money supply begin to taper off slightly. It does not look like it will ever go back to the level it was at prior to 2020, though.

Since the beginning of this year, the stock market has experienced its worst six months in the last 50 years. At one point, the Nasdaq was down 30%, and the Dow and the S&P 500 were in bear market territory. From its lowest point, the market has recovered a bit, but after Chairman Powell’s Jackson Hole speech, the market seems to have resumed its slide. So the question is, will the market give us even deeper discounts on stocks?

Before we go into that, let me sum up my impression of Chairman Powell’s Jackson Hole speech. He has found his inner Paul Volcker! He has turned from a super dove to a super hawk when it comes to inflation.

In a previous article, I used the Quantity of Money equation to explain what the Fed had done to rescue the economy from imminent collapse at the onset of the Pandemic. Today I will explain why doing that caused inflation and why that inflation is not unlikely to be transitory unless certain things happen.