A Tale of Two Eurodollars
Storming of the Bastille, Jean-Pierre Houel 1789
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way - in short, the period was so far like the present period that some of the noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”
- A Tale of Two Cities, Charles Dickens 1859
France, 1788
The world was a volatile place following the Seven Years War (1756-1763).
If you’ve ever seen Last of the Mohicans, set in colonial America during the French and Indian War, that was only one front of a global conflict between British and French empires spanning five continents in a pre-industrial world war.
From the Americas to Europe, Africa, and India, the two empires battled nine years for global dominance with the British emerging as the victors while France lost colonies, tax revenue, and was burdened with high debt.
Decades later as the economic hardships intensified for the French, radical elements ran printing presses full speed blaming the monarchy and promising people a better life through enlightenment.
These Pamphlet Wars gave people an easy target to hate for their economic woes - their neighbor.
The Reign of Terror descended on France instead of the promised enlightenment as the Bastille burned and envy masqueraded as justice in the streets.
Tens of thousands were murdered to the cheers of mobs as the guillotine’s blade dropped for social justice and heads dropped with a dull thud into blood soaked wicker baskets.
Tired of chaos and living in fear their neighbor would name them an enemy of the new republic, the French welcomed tyranny for stability when Napoleon executed his bloodless coup in 1799.
After anointing himself Emperor, over one million French sons lost their lives as the 19th century dawned over Europe in the Napoleonic Wars.
Fast forward to today.
Over three billion screens now glow up into our faces, showing us content driven by artificial intelligence algorithms which target us at vulnerable moments based on our interaction with our phones.
We are in the midst of our own 21st century Pamphlet War.
Waged on us by robots, who constantly improve on how to manipulate us for additional profit, adjust our behavior, and shape our reality in a 6.1” screen.
Meanwhile our politicians and bankers continue to suppress volatility in the market and say they have nothing to do with the social consequences happening around us as people lose faith in our institutions, reevaluate what they value, and society fractures.
All to make billionaires richer, who no longer want money at all, but to challenge the old guard of politicians and bankers for power and control over us.
This is the world cryptocurrencies, stablecoins, and central bank digital currencies are coming of age in.
A world where billions of phones will soon be currency voting machines in the hands of people who no longer trust their institutions as they suffer from massive inequality driven by the actions of their politicians and central bankers.
As this is happening around us, our elderly policy makers look back to Bretton Woods in the mid last century, thinking a new common enemy, climate change instead of communism this time, will sustain the current global system into the 21st century.
They will likely be wrong.
Just like the Romans, French, and every economist, banker, and politician who thought World War I would stop when they ran out of gold bars.
And we are not better or smarter than any of those people who came before us, we just think we are as we stare into our iPhones.
All the capital in the world shown from safest assets at bottom to most risky assets at the top of Exter’s Pyramid. Demoncracy
The Road So Far
When volatility strikes global markets, financial institutions are unsure what their exposure is to other firms who might become insolvent.
None of them know who owns what or has exposure to who, specifically in the derivatives market which is $1 quadrillion, or 1,000 trillions.
A derivative is a bet between two financial institutions which they use as collateral for other bets in the derivatives market with other institutions.
During times of market volatility, institutions will stop lending money and hold tight to whatever high quality capital they have until they see what their exposure is to bad bets they may be holding from other institutions which might go to zero in the volatility.
When financial institutions do this, it causes liquidity in global commerce to stop flowing, and the capital pyramid starts to melt down as suddenly everyone now wants safer assets, causing riskier assets to be revalued lower and safer assets to be revalued higher.
People who are overleveraged and need money now start selling assets at fire sale prices to raise capital.
Equilibrium is once again reached in the capital pyramid as those who were wise and had savings in safer assets are rewarded with being able to buy assets which people need to sell who were overleveraged.
This is human nature, and it never changes.
In 2008 when politicians and central bankers did the first round of Quantitative Easing (QE1) worth $800 billion, backstopped trillions of dollars worth of mortgage backed securities in the bond market, and additional rounds of QE in the following years, they abandoned capitalism for suppressing volatility.
By 2020, quantitative easing (QE) became unlimited.
Global QE for 2020 is now well over $20 trillion, and the central bank backstopped the bond market again, this time corporate bonds.
The central bank now provides additional reserves to financial institutions with accounts at the Fed and convinces the bond market they are willing to buy all the bonds they need to support the market.
Financial institutions do not sell assets to buy safer collateral further down the capital pyramid in times of volatility now since they are receiving risk free reserves from the central bank.
Financial institutions are then supposed to lend money into the economy, creating dollars through debt.
What actually happens is the largest corporations get loans at zero or near zero interest rates from these financial institutions while small businesses and individuals remain cut off from lending during times of volatility or are forced into much higher interest rates.
Large corporations and hedge funds, now with a war chest of free money, begin to buy assets from small businesses and individuals who are now forced to sell since they remain cut off from lending or cannot pay the higher interest rates.
This is how suppressing market volatility increases inequality in our society.
As Stan Druckenmiller said,
“I don’t think there’s been any greater engine of inequality than the Federal Reserve Bank of the United States the last 11 years.”
Central bankers and politicians in effect have been transferring market volatility like stored energy into society for over a decade as inequality increases.
Views on money, trust, values, and risk have changed since no person can work hard enough to outpace a central banker hitting zeros on the computer.
People see those who already own assets being rewarded with higher asset prices from suppressed volatility while those who do not own assets are forced to work ever harder, trading more of their time for decreasing amounts of assets.
Realizing this, people now buy assets with increasing levels of debt and those who depend on income from their investments are forced to take on ever increasing higher risk investments as both money and time lose their value.
The end result of this is people are now individually more financially fragile as society fractures around us.
People understand the scales of capitalism are being held down on one side with those closest to central bankers and politicians winning while the rest of society loses, and they reach different conclusions on what to do to fix the problem.
One group thinks the answer is suppressing all volatility, not just market volatility. They see their health insurance going up 25% in the last two years, rent is up another 10% in 2021 alone, the average house price jumped another 24% for 2020, and they are treading water at best financially with no end in sight paying 50% of their take home pay in rent to hedge funds who received free money.
Others go the exact opposite direction, embracing the 21st century enlightenment of decentralization. They think the answer to institutions and leaders repeatedly breaking our trust and making us poorer for over a decade is to use technology to build a trustless society. After all, who would ever trust the same people that broke our society in 2008 and continues to suppress volatility while denying the effects it has on us.
Some study history and think eventually the insanity has to end, when it does, the best thing to own is the safest asset in the entire capital pyramid, a form of capital which has been used since before Rome razed Carthage to the ground, and is physical, not dependent on computers, and has no counterparty risk: Gold.
Another group, who I think of as the modern day Cato and Cicero, fight valiantly to hold the republic together as forces beyond their control continue to put pressure on all of us. This group knows the damage massive social and political volatility will do and try to get people to join them, to help fix the system, instead of splintering.
Then there is the majority of society, partying this summer, buying luxury goods, living for the weekend, and oblivious to all this. They will simply vote for whoever makes them feel comfortable and safe.
Depending on how the future plays out, while the journey along these paths are different, I think the destination can be the same.
For example, doubt it is a coincidence financial institutions prefer Proof of Stake over Bitcoin.
Proof of Stake allows financial institutions to buy up large holdings of coins, then hide behind a decentralized network while keeping centralized control through cartels, similar to how JPMorgan’s metal desk manipulated markets and federal prosecutors charged them with RICO as a criminal enterprise.
The only difference between oligarchs running a state controlled economy and financial institutions hiding behind decentralization in the potential future is how they convince the majority of society it is for their best interest.
A Divided World
A eurodollar is a US dollar held outside of the US banking system by a foreign bank or institution. Since most dollars originally held outside of America used to be held in Europe, they became known as eurodollars.
If you want the deep dive, recommend Eurodollar University by Jeff Snider at Alhambra Investments.
Foreign banks set their own interest rates for eurodollars off the LIBOR (London Inter-bank Offered Rate) since they are outside the US dollar system.
Typically the LIBOR interest rate is higher than the US interest rate.
If you have access to the US dollar system during times of market volatility, like through a swap line with the Federal Reserve, you do not need to borrow eurodollars from a foreign institution on the open market during times of volatility.
Swap lines are the soft side of US power. Countries we have a strong military, geopolitical, or stability interest in get swap lines for dollars.
A swap line works like this:
The European Central Bank asks to swap euros for dollars with the US Federal Reserve.
US Federal Reserve then swaps dollars created on their computer at no interest for the euros the ECB just created on their computer.
European Central Banks then credits dollars to European banks, who lend dollars out to keep global liquidity flowing and prevent the selling of riskier assets for safer assets further down the capital pyramid.
When foreign banks lend dollars out, this creates more eurodollars because of the interest charged on the loans. Dollars are created through debt.
Now look at all the black space in the world on the map above.
During times of volatility all those countries financial institutions, businesses, and individuals need dollars, safe assets, and liquidity just like everyone else in the world, only they do not have direct access to no interest dollar swap lines with the Federal Reserve.
This creates a divided world.
Countries without access to swap lines get to make hard choices during volatility.
Borrow at higher than LIBOR rates if they can get a dollar loan from a foreign institution, possibly get a loan from the IMF, pledge pieces of their country as collateral to China for a loan through their Asia Infrastructure Investment Bank, or inflate their currency, seize assets, and deal with the social and political volatility this causes.
Billions of people live in these countries, with this reality, and it reinforces in their mind the dollar is the strongest currency.
Stability and Stablecoins
The investment map above is John Fadool’s, a future Air Force officer and young geopolitical analyst who unlike me actually went to school for geopolitics.
We connected over Africa, you can find his writing here, and he covers everything from in depth geopolitical analysis of different countries to the importance of studying Venus.
I particularly like is how he breaks down his analysis to geography and climate, politics, finances, demographics, and cultural so I can see the different dynamics at play in society and how they combine to form a complex multidimensional picture of the country.
When I overlay John’s map with the swap line map, I think there is a real possibility 3 billion smartphones get turned into currency voting machines in the future and dollar stablecoins will be the preferred currency people want to use and spend.
I have personal experience in countries cut off from dollars. I was in Sudan when bread prices increased 100% overnight and the protests started, as people decided they’d rather fight with riot police and risk being shot than sleep in their car for four days waiting for gasoline.
All of which lead to the overthrow of Omar al-Bashir.
Similar to the Arab Spring, where grain prices jumped 30% in Egypt 2010-2011 with bread price up 37%, then the uprising began in January 2011.
While asset holders in the first world benefited from suppressed volatility, the last decade has been chaotic in a lot of the places and only served to reinforce to people cut off from dollars who live in these countries the importance of getting dollars.
To them dollars are like the gold standard, it can be a matter of life and death during volatile times as their own money devalues.
For an idea of how important dollars are overseas, Germany’s central bank estimates over 65% of all PHYSICAL US dollars are held overseas.
Depending on location, some people may not see the need for stablecoins because they rate the possibility of their bank cutting off access to dollars as remote while doing most of their business in dollars already.
Others in Asia are using dollar stablecoins because it speeds up commerce, turning a cross border dollar settlement into a local settlement transaction.
In Lebanon, people suffer horribly as they are cut off from their bank accounts and inflation is 110% per year.
After seeing what my guys and their families dealt with on a daily basis living through inflation and social volatility in Sudan, I can’t imagine trying to explain counterparty or liquidity risk in stablecoins and how a dollar stablecoin is not a real dollar to someone who had to risk being beaten by police for trading Sudanese pounds to US dollars and could instead use stablecoins on his phone to buy medicine for his daughter.
I know and care for people whose life will be infinitely better when they have access to dollar stablecoins on their smartphones, and I also understand what people in the first world are saying about the problems they have with the products and the speculation.
To build an ironman argument on the legitimate concerns skeptics have with stablecoins, listen to this episode with Rohan Grey on Hidden Forces.
He is correct that stablecoins are trying to be eurodollar 2.0 built on top of the public infrastructure and there are problems with this approach, especially due to lack of regulation on what assets will be allowed to back a stablecoin to make it worth a dollar.
This is a legitimate concern, especially looking at recent history from 2008. One of the major problems from that crisis is mortgage backed securities (MBS) were rated by their holders as safe assets, being further down on the capital pyramid. Only they were not at all and as assets backing those products went to zero, institutions who thought they were safe found out they were insolvent.
This is the concern currently with dollar stablecoins, what are the assets backing the stablecoin to maintain the value of the product at a dollar, and during times of volatility, will the value hold at a dollar?
The high interest rate being paid on dollar stablecoins I look at in two ways.
First, the market’s answer to the question of will the value hold to a dollar in volatility is the interest rate I am being paid over a high yield savings account.
My American Express high yield savings account currently pays 0.40% interest.
My BlockFi interest account currently pays 7.5% interest on Gemini dollars (stablecoin).
7.5% - 0.40% = 7.1%
The market is telling me there is a 7.1% chance the dollar stablecoin peg does not hold in market volatility, which is why I am being paid the premium.
Skeptics of stablecoins would point out two things.
First, most people do not look at stablecoin interest like this and are afraid people are playing Rumpelstiltskin, thinking they are spinning straw to gold and putting their emergency savings accounts (money they can’t afford to lose and certainly need during volatility) into stablecoins for the higher interest.
And second, the chance of stablecoins not holding their peg is higher than 7.1% so the market is not accurately pricing in the risk of the peg not holding during volatility because of the lack of transparency in the assets backing the stablecoin, and will point to 2008 with MBS when it was assumed those were safe assets and turned out during volatility they were not.
My answer to the first is well, we’re no one’s Dad.
I’m sure not everyone keeps their emergency fund in all cash with a loaded glock like I do, but we all get to decide what we are comfortable with and if we misjudge risk then we live with the consequences. That is life and pain is the best teacher.
For the second, I’ve put a lot of thought into this.
The unknown for me is the demand already in place overseas with dollar stablecoins.
Where 7-12% interest on dollars seems incredibly high to us in the first world and is viewed as fraud and speculation from our modern world with swap lines and ongoing volatility suppression, in the parts of the world I worked, people would gladly pay 10% interest for dollars because they are accepted by everyone, hold their value, and depending on what they are doing with them, can easily gain the productivity boost to make the math work.
For example, if you owned a bread store, and needed a new oven because you run out of bread by 9:30am, and know you could gain 25% more sales with a new oven, but you don’t have dollars and need dollars to pay for the oven to be bought, imported, then come across the one road into the capital from the Red Sea, if you can get dollars at 10% interest to buy that oven, you want to do it.
This is not an uncommon story in parts of the world, but I have no way of knowing to what degree this is already happening as people cut off from the current eurodollar system now use stablecoins. All I know is in places where the friction of getting dollars and doing cross border settlement is incredibly high, high interest rates are the norm.
I would also break tether apart from other dollar stablecoins, and for a summary of points the skeptics have concerning tether see this post.
In full disclosure, I do not use tether, but I am an American in the dollar system who has the luxury of not needing to use it.
I fully understand the demand for dollars overseas, so I don’t judge people outside the dollar system using tether for doing what is best for their families in a world where central banks trade reserves made up on computer screens with each other, continuing to suppress volatility while our societies lose.
For the rest of the dollar stablecoin world, personally I prefer GUSD. After reading GUSD and USDC audit reports, while I will use USDC if I must, I prefer not to as I did not like how they write their audit reports. I found Gemini’s audit reports to be more clearly worded, which I like, and while they do not breakdown the assets backing Gemini dollars, they at least hold dollars and short term treasuries to qualify for FDIC insured accounts.
Accept No Substitute
It is not coincidence that Australia, South Korea, and Japan all have dollar swap lines.
A pacific rim of dollar soft power to help contain China geopolitically by letting our allies in the Pacific swap money with us during times of volatility.
China is circumventing this with tether and it being adopted for cross border trade settlement in Asia.
Like making knock off Louis Vuitton purses and selling them at full price, but now applied to US dollars and geopolitical interests.
Same, same, but different.
With the technology to turn 3 billion cellphones into currency voting machines, and a world of people who have been conditioned for the last seven decades to think of the dollar as the strongest currency on the planet, I find myself wondering, why wouldn’t US politicians do US backed dollar stablecoins for worldwide trade and nuke this counterfeit problem out of existence?
Yes, this would open Pandora’s Box on weak central banks around the world too, some friendly to the US.
Their currencies would all be devoured by digital dollars as everyone from Lebanon to the Central Africa Republic consistently sold their local currencies for US digital dollars on their phones without the counterparty risk of trusting local banks not to freeze their accounts.
That is just how the world works. Speaking from experience, no one and nothing is above being sacrificed on the alter for the “greater good” as far as US policy makers are concerned.
I also think this fits well with Caitlin Long’s predictions for stablecoins which I agree with.
As stablecoins grow and silo high quality liquid assets, which are the same assets central banks like to use to suppress volatility, US will either fight against stablecoins or adopt them into the system.
Politicians love using a weapon against their enemies when it is disguised as an olive branch.
Bringing dollar stablecoins into the traditional system would not be striking at China or intended to destroy weak currencies and cement dollar supremacy, it would be for the good of countries and people currently cut off from dollar swap lines.
Like how that works?
Dollar stablecoins are just too good of a weapon for politicians to give up, and it lets central bankers continue to not be accountable while being in control of monetary policy since the implementation will likely be left to the same institutions who have accounts at the Fed now.
People around the world get a dollar stablecoin regulated and backed by the US, the Fed gains a whole new frontier to use to keep suppressing volatility with 3 billion phones now turned into currency voting machines all wanting to hold US approved dollar stablecoins on them, and US policy makers do not just have a Pacific rim of soft dollar power now, they have entire continents made into defacto dollar economies which hopefully make it harder for China to build naval bases on the Atlantic ocean side of Africa.
World, meet the new boss, same as the old boss.
The Game Continues
I recently listened to Dan Carlin’s “Death Throes of the Republic” on the generations of Romans who continuously broke their system in order to save it and in the end all they did was ensure they lost it. In my view this is because when you abandon your system, no matter the reasons, all you are really teaching people is the social norms, laws, and rules no longer apply.
As Mike Green recently said to Grant Williams on his podcast, The End Game, “There is no end game, the game just continues.”
Grant laughed at that, as did I, and it made me realize the most important thing for me to remember going forward is there is no more normal.
Things I wouldn’t have thought possible before will now not just be possible, but maybe even probable.
For me the focus is on watching how human nature being constant combines with 3 billion smartphones and AI algorithms in the future.
How that combination reacts to politicians and central bankers continuing to suppress volatility and if politicians and central bankers are able to find a new outlet (like US backed stablecoins) will be interesting to watch.
Something will eventually give because based on firsthand experience, when you keep manipulating the cost of basics people need to live (food, housing, medicine, value of money) eventually they hit a point where they fear the unknown from social volatility less than their current situation.
I had a hard time writing this one. Took me over a month, I didn’t like some of the things I was putting together, and would stop and think if it really made sense, or have to think about something else, but in the end this is where I arrived.
I think it can go a lot of different ways, and have no idea how it turns out.
I tried to be very fair to the different groups who all see the same problem of suppressing volatility in the market and have different solutions because I see myself reflected back in all of them.
I specifically didn’t talk much about bitcoin or gold in this article because I’m on both teams.
When none of us have any idea what the future holds, it makes no sense for me to be fully invested in one at the expense of another possible outcome.
For AI algorithms, I have deleted all social media, investing, news, and other apps off my phone.
It was strange at first, now I like it. I feel less stressed, have more time, and being able to fully focus in the moment makes my day infinitely more enjoyable.
I have realized there is nothing that important it cannot wait until I am back in front of the computer to do my “correspondence” like I am Thomas Jefferson at Monticello.
Looking at how suppressing volatility works, I think people and companies are loading up on cheap debt and trusting policy makers with their lives, some without realizing it. If they are leveraged, they are depending on central banks to continue suppressing volatility to survive.
I swore to myself years ago I would never trust policy makers again with my life, so I want no part of it.
I haven’t had any personal debt for years, since 2013 when I paid off the last of my $60k in student loans, and am really looking at companies that most would probably consider as being on The Fringes of Finance with new appreciation seeing leadership who have been steady on at the helm, ignoring the wailing calls of cheap debt, instead staying focused on their customers and continuing to build for the future smartly, with a combination of efficiency and durability.
So while taking a broad look at how things fit together, the effects it is having on the world and people, and some potential future outcomes hasn’t changed what I am doing with my finances, it has distilled down the WHY I am doing what I am doing, which I think is actually more important in life.
Good luck to all of us, I’ll see you out there.
Radigan