“This would be a much better world if more married couples were as deeply in love as they are in debt.” *— *Earl Wilson

We live in a debt-based economy. That means, in order to produce we need credit. Debt by itself it’s not good or bad. Debt its just a tool, a powerful one. If it used properly, it could produce amazing results. If it’s used recklessly it could become a weapon of mass destruction.

When debt is used to finance activities that increase productivity, innovation and economic growth it is beneficial for the entity society. When debt is used to overstimulate consumption, encourage speculation or as political leverage, we end up with the world we have today.

As Ray Dalio explains in his book “Principles For Navigating Big Debt Crises” in a debt-based economy, expansions and contractions in credit drive economic cycles that occur for perfectly logical reasons. Borrowing money sets a mechanical, predictable series of events into motion. Lending naturally creates self-reinforcing upward movements that eventually reverse to create self-reinforcing downward movements that must reverse in turn.

During the upswings, lending supports spending and investment, which in turn supports incomes and asset prices; increased incomes and asset prices support further borrowing and spending on goods and financial assets. The borrowing essentially lifts spending and incomes above the consistent productivity growth of the economy. Near the peak of the upward cycle, lending is based on the expectation that the above-trend growth will continue indefinitely. But debts can’t continue to rise faster than the money and income that is necessary to service them forever. When the limits of debt growth relative to income growth are reached, the process works in reverse.

Asset prices fall, debtors have problems servicing their debts, and investors get scared and cautious, which leads them to sell, or not roll over their loans. This, in turn, leads to liquidity problems, which means that people cut back on their spending. And since one person’s spending is another person’s income, incomes begin to go down, which makes people even less creditworthy. Asset prices fall, further squeezing banks, while debt repayments continue to rise, making spending drop even further. The stock market crashes and social tensions rise along with unemployment, as credit and cash-starved companies reduce their expenses. The whole thing starts to feed on itself the other way, becoming a vicious, self-reinforcing contraction that’s not easily corrected.

Typically debt crisis occurs because debt and debt service costs rise faster than the income that is needed to service them, causing a deleveraging. While the central bank can alleviate typical debt crises by lowering real and nominal interest rates, severe debt crises (i.e., depressions) occur when this is no longer possible.

Classically, a lot of short-term debt cycles (i.e., business cycles) add up to a long-term debt cycle, because each short-term cyclical high and each short-term cyclical low is higher in its **debt-to-income ratio **than the one before it until the interest rate reductions that helped fuel the expansion in debt can no longer continue.

While short term debt cycles occur every 8 to 10 years, long term debt cycles can take 50 to 80 years to unfold.

One example of a short term debt cycle was the housing bubble of 2008 caused by excessive speculation in mortgage-backed securities fueled by years of low-interest rates. The leverage in the 2000’s crisis was generally pushed up to the banking and housing sector, creating the 2007/2008 crash. That took around 8 years to unfold.

When recessions occur the central banks will use different types of monetary policies to “help” reduce the economic pain and to try to “stimulate” a quick recovery. But in the majority of the cases, they do more harm than good. When the FED prints their way out, they are not allowing the economy to recover but just postponing the problem, and this creates a new debt cycle generally bigger than the last one. When this happens over a long period of time a long term debt cycle is created.

“Some say the world will end in fire, some say in ice” — Robert Frost

Today, the world’s total debt is at a record high of $253 trillion, or 322% of global GDP. That means the world generates $3.22 of debt to produce $1 of goods and services. The global economy is overheated.

As of June 2019, the nation with the highest debt-to-GDP ratio is Japan with a ratio of 253%. The U.S. has a national debt of $24.1 trillion or $194,613 per taxpayer. To put it into perspective, in 1980 the U.S. national debt to GDP was 34%, in 2000 it was 58% and today its around 110%.

National Debt as % of GDP

If you look at the domestic U.S. economy today, the levels of debt in all sectors are staggering.

Corporate debt is at record highs. U.S. nonfinancial corporate debt of large companies now stands at about $10 trillion dollars, 48% of GDP. This represents a rise of 52% from its last peak in the third quarter of 2008 when corporate debt was at $6.6 trillion. And if you add the debt of small medium-sized enterprises, family businesses, and other business which are not listed in stock exchanges, the total US corporate debt is $15.5 trillion, 74% of US GDP. In part, this debt was created in order to fuel stock-buy backs.

The 465 companies in the S&P 500 Index in January 2019 that were publicly listed between 2009 and 2018, spent over that decade, **$4.3 trillion on buybacks, equal to 52% of net income. **In 2018 alone, even with after-tax profits at record levels because of the Republican tax cuts, buybacks by S&P 500 companies reached an astounding 68% of net income, with dividends absorbing another 41%. When companies do these buybacks, they artificially increase the price per stock and deprive themselves of the liquidity that might help them cope when sales and profits decline in an economic downturn.

“The Everything Bubble”

On the other hand, total household debt in the United States, including mortgages, auto loans, credit card, and student debt climbed to $14.15 trillion in the fourth quarter of 2019, eclipsing the previous peak at the height of the great recession in Q3 2008 by $1.5 trillion in nominal terms.

Mortgage borrowing rose by $120 billion to total $9.56 trillion. Originations for 30-year-olds rose to $210.1 billion last quarter — the highest level since the end of 2005. Student debt increased to $1.51 trillion, up from $1.46 trillion at the end of 2018. About half of student loans are in deferment, in grace periods or in forbearance.

“The United States can pay any debt it has because we can always print money to do that.” — Alan Greenspan

So how did we get here in the first place?

A key reason long-term debt cycles can be sustained for so long is that central banks progressively lower interest rates, which raises asset prices and, in turn, people’s wealth, because of the present value effect that lowering interest rates has on asset prices. Monetary policy helps inflate the bubble rather than constrain it.

Short-Term Interest Rates

The FED sets interest rates. It controls the money supply. It is effectively the main lender to the United States Government and the lender of last resort to the banks.

Throughout the 1990s, the FED injected tons of money into the economy, which fueled a stock bubble, focused particularly on dot-com companies. In 2000-2001, when the stock market turned down and unemployment started to creep up, that was a correction. Readjustments in the economy involve short-term pain, just as the cure to a sickness often tastes bitter. Short-term pain, however, was unacceptable to the politicians and central bankers in 2000–2001.

Federal Reserve Chairman Alan Greenspan manipulated interest rates lower. This made borrowing cheaper, inspired more businesses to invest, and softened the employment crunch. But the economy wasn’t really getting stronger. That is, there weren’t more businesses producing things of value. As there were few good business investments, all this cheap capital flowed into housing. As housing values skyrocketed, Americans were getting richer on paper. This made it seems as if things were okay.

In 2006 -2007, the housing bubble popped and the United States experienced a collapse that sparked the worst financial crisis since the stock market crash of 1929. More than 8.8 million jobs were lost, the highest yearly job-loss total since World War II. Around 9.3 million Americans lost their health insurance. 11 million homeowners, almost 1 in 4, were saddled with mortgages higher than the value of their homes. The financial and economic crisis cost Americans $12.8 trillion. This is because when bubbles are built upon foundations of massive leverage, the burst brings real destruction.

*“In the long run, we are all dead”- *John Maynard Keynes

Contrary to what most people think, the Coronavirus is not the main reason for the economic collapse that is coming but the pin that popped the “Everything Bubble” created after years of kicking the can down the road.

The idea that you can keep blowing up bubble after bubble, regardless of the long-term consequences was the foundation of John Maynard Keynes’s economics. But imaginary wealth cannot indefinitely mask a weak economy. You can’t print growth. If you keep replacing one bubble with another, you eventually run out of suds.

Between 2008 and 2015, the Fed’s balance sheet, its total assets, ballooned from $900 billion to $4.5 trillion. In order to “save the economy”, they applied what is called Monetary Policy 2 or “Quantitative easing” (QE). That means printing money and buying financial assets, typically debt assets.

Federal Reserve “Quantitative Easing” Programs

But the Fed was not “providing liquidity” as many argued. They weren’t acting as a market maker for two way flow. They were a buy-side fund that was attempting to create artificial valuations across asset classes so investors don’t lose confidence in the U.S. markets, destroying price discovering in the process.

But over time, the use of QE to stimulate the economy declines in effectiveness because risk premiums are pushed down and asset prices are pushed up to levels beyond which they are difficult to push further, and the wealth effect diminishes. In other words, at higher prices and lower expected returns, the compensation for taking risk becomes too small to get investors to bid prices up, which would drive prospective returns down further**. **As a result, QE becomes less and less effective.

When policymakers faced these conditions in the 1930s, they coined the phrase “pushing on a string.”

At this stage, the only option available for policymakers it’s to monetize debt in even larger quantities in an attempt to compensate for its declining effectiveness. There is a real risk that prolonged monetization will lead people to question the currency’s suitability as a store hold of value.

The FED is able to “sustain” this QE to infinity because the dollar is considered the “reserve currency” of the world. In other words, all major governments in the world hold dollars. Global commodities, like gold and oil, are typically priced in dollars.

Those who lend to the U.S. government know they will get paid back with more borrowed funds. Once creditors begin to see the risk in this, they’ll start demanding higher risk premiums, in other world interest rates must go up. Tightening money supply and higher interest rates on Treasuries will drive up interest rates across the economy. But this time, companies, homeowners and banks are so levered, that raising interest rates will be devastating.

So right now, the FED is at a dead end. They have only two options: a) to finally contract the money supply and let interest rates spike- which will create an economic collapse worst than the Great Depression of 1930, or b) just keep printing dollars to infinity generating a massive currency devaluation, nationalizing the entire economy in the process with the potential risk of losing the status as the world’s major reserve currency.

“Some say the world will end in fire, some say in ice. Some warn that the world of high debt and low interest rates will end in the fire of inflation. Others prophesy that it will end in the ice of deflation”.

The Coronavirus just marked the end of a Long-Term Debt Supercycle that started after the period of the Great Depression of 1930–45 when USD became the world’ reserve currency. When President Nixon unpegged the US dollar from gold in 1971, for the last 50 years, the only thing underpinning the US debt, was the trust in the US Government.

A currency’s value is based upon faith and belief. When people lose faith in a currency, the typical reaction is to start using another one they believe is more valuable.

Bitcoin was invented in the aftermath of the 2008 financial crisis, and the crisis was a clear motivating factor for its creation. Numerous banks and other financial institutions failed across the world and had to be bailed out by governments at the expense of their taxpayers, in other words, the FED was avoiding the total collapse of a centralized financial system.

Bitcoin is a fully decentralized monetary system. There is no central authority that regulates the monetary base. Instead, an algorithm defines in advance, how currency will be created and at what rate. The result is that the number of bitcoins in existence will not exceed 21 million. This decreasing-supply algorithm was chosen because it approximates the rate at which commodities like gold are mined.

Bitcoin can be divided down to 8 decimal places. Therefore, 0.00000001 BTC is the smallest amount that can be handled in a transaction. The fiat currency is divisible to only 2 decimal places. So Bitcoin is more perfectly divisible than any of its fiat monetary competitors and more than capable of supporting a global economy.

Bitcoin Monetary Policy

Nobody owns the Bitcoin network much like no one owns the technology behind email. Bitcoin is controlled by all Bitcoin users around the world. It is possible to send and receive bitcoins anywhere in the world at any time. No bank holidays. No borders. No bureaucracy. Bitcoin allows its users to be in full control of their money.

The market sets exchange rates and interest rates, without exception and fractional reserve banking cannot develop, so liquidity traps are impossible.

Bitcoin vs Fiat System

In the 11 years since the whitepaper was released, Bitcoin has gone from an underground financial experiment in response to the global financial crisis to one of the most significant financial and technological innovations. To put it into perspective, consider that the number of wallets containing between 0.1 btc to 1 btc has grown from nearly 240,000 in 2014 to more than 2,000,000 as of January 2020. Also, since 2016 the industry’s asset under management (AUM) has soared nearly 100x from $190M to $18.9B.

Over the next few decades, Cerulli Associates estimates than more than $68T of US wealth is expected to change hands and mark the **largest wealth transfer in history; **$38T of which will be inherited by Generation X and the remaining $30T by the Millenials.

This development is expected to drive a major shift in investment trends, and Bitcoin stands to capture its share of investment as wealth passes to generations whose preferences, experiences and expectations align more with its fundamental characteristics.

The dynamic that creates long-term debt cycles it has existed for as long as there has been credit, going back to before Roman times. Even the Old Testament described the need to wipe out debt once every 50 years, which was called the Year of Jubilee.

There is no doubt that the actual monetary system is broken. Global debt is at record highs in all sectors of the economy. Central banks are going into negative interest rates policies in an effort to prevent the system to collapse. Increasing tensions between the U.S. and China, currency wars and now the COVID-19, is creating a delicate global geopolitical landscape with new risks and uncertainties. It is hard to think that the solution will come from a “Global New Deal”.

On the other hand, every time Central Banks bailout banks and financial institutions by printing money “out of thin air” the wealth gap increase. The main reason is these policies tend to benefit assets owners and not the general public. It is during such times that populism on both the left and the right tends to emerge.

As shown below, both inequality and populism are on the rise in the US today, much as they were in the 1930s. In both cases, the net worth of the top 0.1 percent of the population equaled approximately that of the bottom 90 percent combined.

U.S. Wealth Gap

Are we going back to the gold standard? I doubt it. Will the US dollar lose its reserve currency status in the coming years? Probably.

So what is going to happen with the global financial system in the next decade? Nobody knows, but one thing it's clear: there’s a new money in town.

Bitcoin is new money.