What does it mean to say the Fed is “out of ammo?”

A (properly sized) thread on how interest rates are, in the end, the only bullet.

Oh, and also a Bitcoin love letter...

(thank you to @RaouGMI for being a thinking partner here) 1/

2/ Amidst the current madness, many have said “the fed is out of ammo.”

Sounds ominous, but since I’m not really counting on Jerome defending my tomato patch out back, how - specifically - does this matter?

3/ To understand this, we have to go back to a more primal time. A time where Baby Boomers ruled the earth, and foraged its fertile financial plains with impunity.

Obviously, I’m talking about the 70s.

4/ As previously discussed, money supply the way we do it now is (or rather, was, at the start of the prehistoric Boomer era) constrained by collateral. And way back when, collateral meant gold.

In the beginning, Gold was the philosopher’s stone of money.

5/ But the Boomers, with their huge numbers and locust-like proclivities (I kid. Sorta.), needed more money. One of gold’s features is supply constraint so as a practical matter, gold simply wouldn't do.

A new philosopher’s stone was born, and it’s name was Bond. T-Bond.

6/ There was a lot more of this collateral, which caused a brief issue that a nice man who liked to smoke cigars in front of politicians fixed for us (RIP - you were truly a titan).

Once that settled down, we discovered that T-Bond had 2 new collateral abilities gold hadn't.

7/ Both of these powers were alchemical. The first power was that the ruling bodies could simply issue more of it by growing the deficit. The Boomers felt uneasy about this and debated for their whole lives whether it was good.

Ensuing generations didn’t really give a shit.

8/ The second alchemical power was the ability to grow or shrink the collateral’s size. This works by “adjusting the interest rate.”

When the interest rate goes up, the size of the collateral shrinks. When it goes down, the collateral gets bigger.

9/ In fact, this is why our nice cigar smoking man had to whipsaw interest rates up and down for a while: he was trying to find the proper size of total collateral for the economic moment he was in.

As the First Alchemist, he had to do it by feel.

He was very brave.

10/ As this settled out, things were fine for a while. Collateral was adjusted as needed to fuel society. But slowly, at first, and then with increasing speed, a pattern emerged.

Over time collateral trended bigger.

11/ And this was fine! When society got into a pickle they just goosed collateral a bit. To understand why, we need to understand how a deflationary cascade happens.

12/ A cascade is when insolvency at the fringes of the system starts to snowball. As people sell to cover their debts, this starts to lower the value of *everything* and leads to a state where there’s not enough “real value” representing the “nominal value”

It’s a math illness

13/ Because America experienced one of these episodes in 1929 that left huge scars on the psyche of the country, goosing the collateral to bump up “aggregate real value” to the level of “nominal real value” whenever a problem hit seemed fine.

Better than a depression, at least.

14/ Now, some of the Boomers saw that eventually we’d run into the “zero bound problem” - where rates are at zero and collateral can’t get any bigger.

But a Boomer named Alan who wore glasses and seemed smart said “zero is just a number, baby” and they all sighed with relief.

15/ In time, some places did get to the zero bound. And they tried to push that lower in, accordance with the Gospel of Alan. But a funny thing happened: nothing.

It kinda didn’t work.

16/ For, you see, alchemy is a bit like witchcraft: it has dark side effects.

And one of the side effects here appears (note: evolving alchemical understandings afoot!) to be that if we try to push collateral bigger than the zero bound, the whole system begins to decay.

17/ What is the nature of this decay?

I don’t know that we’re sure, but smart people are probably already commenting here to help tease it out. For one, the decay appears to randomly murder banks and other institutions like some Jack the Ripper character, skulking about.

18/ Banks and bank-like things have a tendency to suddenly explode in flames, and it really is quite frightening.

We’re not sure what to do about it.

And personally, this is why I do value the theories that put forth something like Bitcoin as a collateral option.

19/ Because you see Bitcoin as collateral would be both hard and infinitely extensible.

The supply is fixed, but it has digits: it can self-extend to infinity.

And what’s more, we could simply allow the market to self-serve on more or less of this collateral at will.

20/ If there’s a lack of collateral to issue debt against, we can simply use smaller pieces of it.

Using smaller pieces would cause the aggregate to more valuable, which would build in an incentive for savers too.

What a nice idea right now!

21/ This also handles the legacy objection that the Boomers were worried about (obviously none of us care anymore, just sayin’) in that the moral hazard of centralized collateral issuance goes away. Bitcoin self-issues.

So that’s kinda grand.

22/ So while I do think the Fed is in a real pickle right now, and it’s all very worrying as The Ripper continues to eviscerate our financial infrastructure…

I do see the raw ingredients for a very hopeful path forward.

And they’re endlessly fascinating.

If you are a filthy pedant like me and are angry this was incomplete, read this bit: https://twitter.com/coloradotravis/status/1299465345418231808?s=20