Forecast 8/15/22 - Separation of Finance and State
US Sanctions on Crypto Begin
I’m glad to be back from my “writing vacation.” This might sound weird but I actually had trouble staying away, and had to force myself not to write anything every time a piece of news came across my face or someone sent me something. It seems I’ve created a bit of a habit out of this substack thing. Anyways, it’s great to be back. I decided to make this post free so everyone can celebrate my return.
Please refer to the Backdrop Post and trade with mindfulness.
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Please refer to Definitions page for any terms or abbreviations that I use that you don’t understand. If a term is missing, please let me know.
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Please feel free to skip around or ignore certain sections if it does not apply to you. The Table of Contents is made to preserve your time in this manner. You can always simply read the conclusion if you are in a hurry.
All times given in this update are in US Central time (UTC-6 clock).
Song of the Week - Matisyahu - Jerusalem (Screwed and Chopped, Swishahouse)
Table of Contents
US Taxes 2022 and Beyond
Economic Calendar and European GDP
RBA Meeting Minutes
RBNZ Interest Rates
FOMC Meeting Minutes
Crypto Macro
Price Action
US Sanctions and Tornado Cash
Decentralizing Risk
Conclusion
1. US Taxes 2022 and Beyond
The big thesis of this substack has always been that the US treasury bond market drives the price of every investment asset. When the US government needs to sell more bonds than people want to buy, interest rates go up and the market tightens. When money is being printed to alleviate this (or when a surprise infusion of tax receipts comes in) the market loosens up a bit.
Governments fund themselves through tax income, or through selling bonds. When tax income goes down, they have to sell more bonds, when tax income goes up, they have to sell less bonds. 2021 was a great year for the US government in terms of taxes. Corporate taxes and capital gains taxes were at record levels, and an additional ~$850 billion entered the system in April 2022 from that tax year, and I suspect more is still outstanding that will be paid in September and October of 2022.
But looking ahead, 2022 looks like a terrible year for tax receipts. It’s unlikely that there will be very much at all in capital gains taxes. The year will likely have negative GDP growth in every single quarter, and most businesses will be laying people off in the last quarter of the year.
This is all of course happening during a time in which the US FOMC is raising interest rates, and allowing their holdings of treasury bonds to expire, without purchasing replacements from the market. This is all coming together to imply rates continuing to spike up to close out the year and for an even faster acceleration of secondary market lending rates in 2022. The amount of pressure this will put the US under will be enormous, especially if conflict in Europe is still continuing, or if conflict in Asia begins to pick up. Both of which I consider to be inevitable, but still unsure of if Asia will occur this year or not.
The US government has only a few choices, cut spending drastically (they won’t, lol), or raise taxes and stop raising the overnight lending rate. The government is hiring 87,000 new IRS agents in a desperate attempt to somehow plug the gaping hole that is coming. We were told that these agents aren’t targeting the middle class, but when given the chance to vote on the matter, the government refused to rule out new audits on those making under $400,000. The vote was strictly on party lines, of course. We’ve already seen the reporting requirements for transactions on 3rd party payment systems decreased from $10,000 to $600. Since the US legislature refuses to stop spending money and passing random bills to enrich 3rd party donors and plutocrats, the only choice for them is to go after the middle class, because that’s where the money is.
While you might think I point out the partisanship of the vote as a dig against Democrats, I’m not. I’ve learned my lesson. If Republicans were in power, maybe 12-16 republicans would still vote not to audit those under $400,000. The rest of them aren’t voting on principals and are instead voting to support their party while they’re in power. The Democrats are in power, so none of them will pretend to be your friend right now. If the Republicans were in power, most of them would stop pretending to be your friend too. If anything is to change, most incumbents will have to be voted out in both parties. This won’t happen in time for the current market cycle, if it will even happen at all.
You’ve probably seen the chart above, and if you swim in certain circles you’ve probably also seen other charts showing how this lines up with racial minorities and Native American reservations. That’s a simplistic and conspiratorial view of IRS audits. Realistically, IRS audits are not for people with W2’s who do nothing outside of work for someone else for money. These people are supremely uninteresting and obviously have nothing to hide. IRS audits primarily target those claiming $0 of income, and those with multiple corporate entities. It’s quite likely that many people receiving 1099’s, or in the gig economy are going to be targeted. And obviously, when it comes to targeting people, you typically go after those who can’t afford to fight back. Lawyers are expensive, and so is defending yourself from an audit. Someone making ~$100k a year very likely can’t afford to try to defend against an audit unless they are single, with no kids, and live well below their means. These are the prime targets for new IRS agents, of course they refused to vote to protect the middle class, that’s where the only money left to squeeze is. The new hires among the IRS have one goal, it’s to protect the chart below from coming true.
The chart above comes from this post in March. I simply added the orange dashed Support/resistance lines for your benefit so you could see what I was seeing when I drew the pink arrows.
The more taxes these agents can drum up, the more they can keep this chart from going too high, too fast. But eventually they are going to have no choice but to start printing money again, regardless of how many IRS agents they send after the middle class. We will (of course) be tracking the treasury markets for signs of a real struggle, but I expect this to begin coming to a head near the end of the year and for real significant pressure to be exerted in the first few months of next year. Of course, if you pay for a subscription, you’ve probably already seen a much more detailed BTC chart outlining my expectations for how the secular market bottom created by such an event might look. Though I drew that on the bitcoin chart, the timing of the market bottom will be the same for all assets. Struggling tax revenues from 2022 will be another big weight on the machine that will push markets in our favor at the expense of quite a lot of other people. Such is life.
2. Economic Calendar and European GDP
Refer to Economic Calendar Settings Post for filter settings used as well as a link to the site I prefer to use for this calendar.
A nice week to come back I guess, Europe’s GDP will always be completely irrelevant. They’re predicting a 4% annualized GDP growth for Q2 while the continent is embroiled in a trade war and they are rationing electricity. Yes, of course this number is completely fake as it implies that Europe had 14% growth in domestic production annualized before subtracting their 10% inflation. One has to simply google “Europe production halted” and you’re met with a slew of stories of plants shutting down or production slowing. Not to mention that Germany, which is Europe’s only productive country reported 0% GDP growth in that same period. This implies that France, Spain, Italy, and other European countries had GDP growth far in excess of 10% after subtracting inflation in order to counter Germany’s 0%. Complete bullshit.
BMW and Volkswagen plants halted
Michelin shuts down tire plants in France
Norwegian and Hungarian Fertilizer producers shut down due to high Natural Gas prices
Peugeot and Citroen halt production in France
Over half of France’s nuclear power plants have been shut down since March (and still are shut down)
Czech cyanide producer and Italian paper maker shut down European operations
Admittedly, most of the stories above are covering the preliminary shutdowns in March primarily due to either energy prices being high or necessary imports from Ukraine/Russia being cut off. But we know that those problems were not fixed since then and are still ongoing. Natural Gas prices in Europe are nearly as high as they’ve ever been. Anything that shut down over gas prices in March, is very much making similar considerations today, especially considering Natural gas supplies in Europe are far more scarce today than they were in March.
Consider the above chart, and then consider the following from November 2021. 40% of European Fertilizer capacity was already offline due to high prices in November 2021. What do you think they’re doing now?
This is a completely irrelevant continent, and I don’t know who they think they’re fooling when they say GDP grew at an annualized rate of 4% in Q2. As usual, we ignore Europe and await either a break-up of the EU, or for the member countries to succumb to their heroin-induced money-printing stupor.
If you’re a European and feeling offended by this, take solace in the fact that I reserve similar levels of venom for my own countrymen.
3. RBA Meeting Minutes
The meat of this post is reserved for discussing US sanctions on tornado cash and the long term implications. Apologies for keeping these sections short but not much has changed in Australia and New Zealand at the Central Bank level.
If you’ve been reading enough, you can probably guess what we’re looking for here. We’ll be looking for the same things in the minutes that we looked for last time with an eye for any hints of planned rate cuts occurring earlier than the end of 2023.
Please read the linked post above if you need more detail here or are new.
4. RBNZ Interest Rates
Current expectations from the RBNZ are for another 0.5% rate hike to bring the overnight lending rate in New Zealand to 3%. We are mainly looking for them not to change their tune here and to keep pushing rates higher. Previous statements from them have shown that they prefer to fight inflation over protecting the housing market, which is a good thing. We’ll be looking for them to maintain the same tune. I’m not expecting any surprises here.
5. FOMC Meeting Minutes
These minutes will be in reference to the US FOMC rate hike of 0.75% at the end of last month. In this meeting the FOMC dropped their forward guidance and stated that future meetings will be dependent on market data and rate hikes will no longer be guaranteed, as the Fed believes they are at the neutral rate. This is hopeful nonsense. What we are looking for in the minutes is confirmation about what their expectations and outlook are for the labor market, as well as if they may have expressed any hesitancy about the obvious recession the US has been in since the start of the year. Looking back at their previous minutes, we will also be looking for any change in tone in terms of inflation, the PCE, geopolitical risks in China, their outlook towards the Overnight Reverse Repo Facilities and whether they expect to be on track in the continuation of QT.
The minutes do not represent a live conversation so much as they represent a rehearsed and prepared script of what they want the US public, and the trading algorithms scanning these minutes to see. You’ll often see entire paragraphs repeated word for word one month after another. This is where we typically find the subtle changes to the Federal Reserve’s tone, as when an entire paragraph is copied, but one sentence has been deleted you can typically take that sentence to be of significant importance. For instance, back in March, the FOMC removed the commencement date for QT (which was originally planned to begin in February) from their minutes while repeating the rest of the paragraph about QT. From that we could glean that the start of QT was being pushed back, and it got pushed back all the way to July as we saw. This was a pretty big sign of weakness in the US market and gave us good insight about the treasury markets moving forwards. We’ll similarly be looking for any changes this week, especially in relation to GDP and recession, inflation, the PCE, QT, and changes to statements about the RRP. Concerning the RRP, I expect that liquidity to be released into the markets at some point early next year or potentially at the end of this year if another major shock occurs. This liquidity is one of the last tools the Fed has to keep interest rates down. After that, things really begin to accelerate… well, more than they already have anyways.
6. Crypto Macro
Price Action
If you are new to looking at my charts, please refer to my post on Basic Technical Chart Reading to understand how and why I identify certain zones as well as some of the basic information on the chart.
We are now in No-Mans Land. This is an area that has very little price structure within it as I covered before my vacation. As price moves upwards, we will be creating the structure that BTC will follow when it comes back down to create the secular bottom. For now, this area still presents good purchases on Bitcoin in the mid to long term time frame.
ETH/USD
This is a mostly bare chart. It’s really just a reminder that the ETH 2.0 merge is coming up with a nearly solid date of September 15th-16th. Heading into the merge you can expect price to keep pushing up and to outpace BTC. It’s quite possible we might get to 0.1 ETH/BTC, which might push ETH price up to $2,500 pre-merge. I’d expect ETH to sell off after the merge. This week I will have a separate crypto macro post dedicated explicitly to the ETH 2.0 merge to discuss more of the details and considerations for price heading into the merge. But for now, you just need to be aware that things are still bullish ahead of the successful merge, and it’s very likely that upon news of the successful merge, ETH will probably sell off and price will retreat.
US Sanctions and Tornado Cash
I briefly made a short post on this while I was on vacation, it’s very important and we need to talk about it. The eventual erection of a digital berlin wall has always been an inevitability. My very first posts on this substack have been about incoming regulation, and even prior to substack I have held that we had about ~2 years of runway before regulation really clamps down hard on us. Well, it’s been 1 year since then.
If I had to guess, the IRS and federal government will start tightening restrictions on centralized exchanges in 2023, with outright bans coming in 2024 or early 2025 after the elections. Meaning that you as an individual probably still have about 2 years where the convenience of a centralized exchange will still be available to you. Phrased another way… you have 2 years to learn. If you do learn, the governments ban on crypto will be absolutely meaningless to you. If you don’t learn, it will have a massive impact on your life.
Please make sure that you are updating your mental models for risk as time passes. You don’t want to be repeating to yourself still that “we have 2 years” and then 2 years passes and you are still saying the same thing to yourself. You’ll get blindsided. It’s time to move the clock forward and realize that 2023 is right around the corner.
So, as a quick recap. The US OFAC (Office of Foreign Asset Control) issued a blanket sanction on the contract addresses for Tornado Cash, which is a dApp on the Ethereum chain that allows you to mix Ethereum in a large batch of transactions with other users so as to obscure the source of funds when sending from one wallet to another. The sanctions bar any US person or citizen from transacting economically with any sanctioned entity, and this is typically the office that enforces sanctions on groups like the Taliban or countries like North Korea. These sanctions applied to the contract addresses and any wallet address that interacted with those contracts after the sanction.
So in the wake of the sanctions, a few things happened over the last week. Someone thought it would be funny, to send 0.1 ETH to a bunch of famous/doxxed wallets with ENS addresses through tornado cash, essentially making enforcement of the sanctions a much bigger problem for several famous people and large wallets. This is being called a “dusting attack.”
Then Circle blacklisted all wallet addresses from transacting with USDC that had interacted with Tornado Cash after the sanction. This was expected of course and was a risk outlined for the USDC and USDT stablecoins back in April’s stablecoin guide, and it’s why I prefer crypto-backed and algorithmic stablecoins despite the smart contract risk they present. After that Aave, and several other major ETH dApps that are currently dependent on US infrastructure in some way or another complied with the OFAC sanctions and blacklisted all wallets that had used Tornado Cash after the sanctions as well.
The founder of TRON (17th largest crypto by market cap) , for instance (Justin Sun) claims to have been affected by the dusting attack and is now blocked from using several Ethereum dApps. And in a further escalation, in Denmark, one of the coders behind Tornado Cash was arrested in compliance with the sanctions.
Although we make it seem like we can just meme a new reserve currency into existence, the truth is that any means by which an individual can securely transact in finance without state oversight represents a huge threat to the western world and the powers that currently rule it. You can participate in an international child sex trafficking ring and the US government will actively participate in sealing the customer logs so nobody gets punished, but if you code a neutral dApp for user privacy a few years ago, they’ll throw you in prison on a whim within a few days. I don’t say that to whine about “but muh Epstein,” I instead say that to point out just how important this is and to start to point out how we are going to be eventually fighting for control over the very dApps themselves. This may be one of the only things that matters to the powers that be within the next 1-2 years. We’re fighting over the separation of finance and state.
Many of us (myself included) may have missed this story from back in March. But Metamask (crypto browser extension wallet) and OpenSea were banning all users from IP ranges within US sanctioned countries. Venezuela, Iran, Russia, and citizens from several other countries one day woke up and lost access to their assets entirely. As I’ve stated many, many, many times on here; having a VPN is crucial, and it’s more important than ever to set it up when you don’t need it. If you wait until the day when you can’t transact without one, you’ve waited too long.
Decentralizing Risk
Why does Metamask comply with sanctions? Why does OpenSea comply with sanctions? Why do ETH dApps comply with sanctions? This is the centralization aspect of crypto. It’s not really their fault, at this point in time they essentially have to comply. Why do they have to? They use internet infrastructure, and tools from entities that are economic actors in the physical world. For instance, Metamask and several ETH dApps are dependent on a company called Infura for their API’s. Infura is under Consensys Inc’s corporate umbrella. Consensys is headquartered in New York City. Consensys does not have enough guns to withstand a federal raid, and I suspect they don’t want to have to deal with one. When the OFAC announces sanctions, consensys makes a choice, either they go out of business and their founder is arrested by Canadian Mounties, or they comply with the sanctions.
The existing corporate structure that these entities have shaped themselves to fit within makes them vulnerable to this exact type of leverage. Ultimately several things need to be further developed within the crypto space before we can actively fight back. For instance, most web-hosting goes through Amazon’s AWS. Amazon is going to comply with the sanctions, Tornado Cash had it’s front end hosted on AWS, Amazon has blocked the hosting in compliance with sanctions. Decentralized web hosting will eventually replace Amazon’s AWS, and it’s likely that sanctions will spur further developments here. As I mentioned in December 2021’s initial macro post:
How can a regulating body attack a website based in the island nation of Mauritius that scarcely even has a bank account or address and merely pays web hosting costs? They can’t really, and even if the government gets the web hosting platform to go after the protocol, there already exists decentralized file hosting, and as these protocols improve, we may see DeFi and other blockchain activities hosted wholly and fully away from the reach of these entities.
Consider Decentralized file-hosting to be similar to BitTorrent. I don’t know if any of you were into torrenting things back in the 2000’s, but it was how we got around the music labels when they went after Napster. I remember downloading my first copy of Rome Total War off of the Pirate Bay in 2006 and finding hacked CD key’s on web forums. Real exhilaration getting that to work. But essentially, the music labels went after Napster and other sites that allowed users to share music they had on their own computers. Eventually they won and shut down Napster, but what sprung up in it’s wake was the idea that you as a user would not provide the entire file to someone who wanted it, but only a piece of the file. This was bit-torrent, this was also how Limewire worked. Sites like Pirate Bay just mirrored a link to the torrent. Authorities could take down the centralized site, but another site popped up in it’s place in minutes, and they couldn’t deal with the decentralized nature of a single file having 54,022 people mirroring it around the world for anyone to download.
Much harder for the authorities to make legal claims that you provided a small chunk of a file that someone elses computer eventually put together with thousands of other small chunks which happened to create a full song, or the latest version of Adobe photoshop, or was the entire Pineapple Express movie. Yes, it was stealing, I know.
If I could download a car, I would. And if one of you comes up to me and tells me you are making pdf’s of my paid content and giving it to your friends instead of telling them to subscribe, I’m going to keep that same energy. You do you, bro. It’s not impossible to steal this content and I’m not trying to stop you, nor will I get especially mad at you if you do. Intellectual Property is not real. Nobody owns ideas, and anything that can be copied for free should be. Patent law is immoral. Imagine how far we would have gotten if the first caveman to create fire had a 50 year exclusivity right to start all of the fires. We’d still be shivering in those damn caves today. Ideas are meant to be shared and to be copied. Imagine if I showed you the first ladder and then you made a copy the next day and I had you tossed in the alligator pond (I admit I don’t know how they killed people back then) so that I could be the only person making ladders in the village. Its ludicrous, and more importantly it significantly slows down economic growth, but we all have accepted the concept because we were born into a world where this concept is already in place.
Anyways, tangent over.
Torrenting allowed for the hosting of illegal content to be distributed over such a wide network that it became impossible to stop it. Similarly, as decentralized file hosting gets faster, more convenient, and more widespread, it will allow for entire web sites to be hosted across such a broad distributed network that it becomes impossible to block content that governments do not want you interacting with. The financial network of the future will be built in such a manner. When that happens, we will see a true forking of on-chain activities. (Some might say, K-shaped). Some entities that are not structured legally to be immune to government pressure will choose the side of the financial internet that is under the governments thumb. And those entities and individuals structured to be immune to sanctions will be able to choose the free side of the financial internet. Which side out-grows the other will be entirely dependent on us and what the world chooses and prioritizes in that moment. That point won’t be the end of the fight, it will be the beginning. The separation of church and state may have began in the early 1500’s, but it took decades to set in and in the 1600’s the Pilgrims set sail to settle the new world to escape religious persecution because the separation of Church and State hadn’t completed by then.
Settle in friends, we’re in for a long one, but it’s worth your time, and may be the greatest work we can do on the planet in this time.
7. Conclusion
The Financial Protestant Revolution is here brothers and sisters.
What will you choose? The world your children, grandchildren, and great grandchildren live in will be dependent on the choices we make during this period and the opportunities we leave in front of them. All empires decay in time. This is a given. But we often forget that, hope lies in the smoldering rubble of empires.
1 By the rivers of Babylon we sat and wept
when we remembered Zion.
2 There on the poplars
we hung our harps,
3 for there our captors asked us for songs,
our tormentors demanded songs of joy;
they said, “Sing us one of the songs of Zion!”
4 How can we sing the songs of the Lord
while in a foreign land?
5 If I forget you, Jerusalem,
may my right hand forget its skill.
6 May my tongue cling to the roof of my mouth
if I do not remember you,
if I do not consider Jerusalem
my highest joy.
7 Remember, Lord, what the Edomites did
on the day Jerusalem fell.
“Tear it down,” they cried,
“tear it down to its foundations!”
8 Daughter Babylon, doomed to destruction,
happy is the one who repays you
according to what you have done to us.
9 Happy is the one who seizes your infants
and dashes them against the rocks.
Over the next year, you will get to see the digital berlin wall constructed before your very eyes, and you will have the option to choose. Let no man curse the hell that he hath chosen.
What does this have to do with Ukraine, with Japan, with 87,000 new IRS agents and with Central Bank policy?
Everything.
Welcome back! I missed your writing last week but I can understand wanting/needing to take a small hiatus. This was an excellent post, thank you for the reminder that we are further along than when we started. Seems like just yesterday I was eagerly anticipating your first post. Keep up the great work, and glad to have you back!
I kept Railgun when i sold most others bc the privacy aspect was interesting, your mention of the ETH split reminded me; I haven't kept up w what's happening with it though it could be dead. One of the BowTied accounts did a writeup a while back and it interested me more than monero for some reason.
Welcome back. Hope the court situation is cleared up BTW.