Caitlin Long of Avanti Financial Group joins me to talk about Bitcoin, banking, rehypothecation and what Austrian Economists are missing. How much additional money is being created in the shadow banking system? What about ‘moneyness’? We also discuss Caitlin’s IMF working paper, and the recent OCC Interpretive Letter 1170.

Caitlin Long links:

• Twitter: @CaitlinLong_
• Avanti: AvantiBank.com

Sponsors:

• Swan Bitcoin
• Unchained Capital
• CypherSafe (Code: LIVERA for discount)

Stephan Livera links:

• Show notes and website 
• Follow me on twitter @stephanlivera
• Subscribe to the podcast 
• Patreon @stephanlivera

Podcast Transcript:

Stephan Livera:

Caitlin welcome to the show.

Caitlin Long:

Stephan, it’s an honor to be on your show. I’ve followed you for years and here we are. It’s good to be here, good to connect.

Stephan Livera:

Yeah, it’s glad. I’m glad we finally made it happen. I am very interested in the work that you’ve been doing. I think you’ve given some excellent presentations as well as offering some great commentary on Twitter. And I know you’re doing a lot of interesting work in the industry. So I’d love to just start with a little bit around, you know, why you got into Bitcoin?

Caitlin Long:

Well, it does relate to the financial crisis actually. I was at Morgan Stanley and had had a classic economics education hadn’t really questioned anything. And then all of a sudden I started seeing things that just didn’t make sense. And that really got me going on a deep dive ultimately found the Austrian school, but I did a lot of reading of all the various schools of economic thought, modern monetary theory before it became hip. Because I knew it was at the opposite end of the spectrum. And then, you know, the further end of the spectrum is, the Austrians and there then essentially everybody else is in between it as, as I like to put it some may disagree with me on that, but I read a lot about all of it to try to figure out what was really going on because I knew that the mainstream explanation didn’t make sense. And I like to point to one of the contradictions that really got me going was when treasury secretary Geithner made a comment on Charlie Roses show that interest rates were too low going into the financial crisis. And that was definitely a cause of the financial crisis. And then not even, you know, a week later or so he was interviewed arguing that the fed should cut interest rates. So that logical inconsistency to me made me realize there was more to the story and sure enough.

Stephan Livera:

Yeah. And then you got into all this. So let’s talk a little bit about what you see Bitcoin fixing about that financial system?

Caitlin Long:

Well, it’s a very practical reality that we are essentially forced into owning IOUs in all of our financial assets. Many people don’t realize that. Certainly I think that the Austrian oriented folks would realize that vis-a-vis the dollars we deposit in a bank, but where most people wouldn’t realize it is, that’s also true of the securities in our brokerage accounts. And it’s a vestige of history. I don’t think there’s anything nefarious per se, about the way the securities industry evolved. We just didn’t have the ability to settle the volume of transactions on a gross basis without creating huge paperwork problems back when wall street when stocks traded literally in paper and bonds you used to literally clip the coupon and take it down to the bank to redeem a bond coupon. It used to be all done physically.

Caitlin Long:

And as transaction volumes increased, and then technology came onto the scene, it just wasn’t capable of handling the volume of transaction storage was expensive, processing power was expensive. And so it made sense to net transactions. So all the buys and sells of your IBM stock were netted within your broker and then your broker netted against other brokers. And so you just reduce the amount of transactions that needed to be processed. But what it also did was essentially copy the centralized structure of the banking system. The Fed, as you know, came into effect in 1913 and the depository trust company is the equivalent or the analogy rather of the Fed it’s a central clearing house for the securities industry. And it does much of the same thing. And just like you’ve got in the banking industry, commercial banks, correspondent banks, and then your money center banks and your primary dealers in the securities industry.

Caitlin Long:

You’ve got that similar layers of intermediaries as well, different layers of brokers. And then you’ve got your custodians and then you’ve got the depository trust company. So in each the banking and securities industry, you’ve got basically the same structure and they’re both designed to help facilitate transaction processing. Now, probably in the last, certainly 15 years, the technological constraints that made it make sense for those systems to evolve that way no longer have been constraints. So why haven’t we actually really fixed things? And the answer is there are a lot of people who have an incentive not to fix things. And so, you know, the incumbents have, are earning, you know, rent that they wouldn’t be earning if the structure of the markets were different. And it’s, you know, we’ve made some strides when I came into the securities business in 1993 full time in ’94 stocks traded on a T + 5 trade date.

Caitlin Long:

Plus 5 days, then it went to T + 3, and then just last year it went to T + 2, we should be at T + 0. There’s no reason why we shouldn’t have at least same day settlement of stock trades. And the reason that we’re not is because again you know, with securities lending, there’s just so much activity happening that you don’t see behind the scenes in your brokerage account where your brokers and all the other intermediaries are making a lot of money off your assets, and unless they explicitly agreed to, they’re not paying you for it. And so that’s the sort of thing that creates an impediment to change,

Stephan Livera:

Right. And I want to touch a little bit on the payment latency part, or I guess, settlement latency as well, because I was reading one of your recent papers. It was actually an IMF paper. And you touch on this idea around contrasting between RTGS real time gross settlements, I believe versus say delayed settlements. Could you elaborate a little bit on the differences there?

Caitlin Long:

Sure.Well, first of all, it’s really an honor to be invited to be published with Dr. Manmohan Singh not the same name as well, same name as the Indian prime minister of a different person. Dr. Singh is a career staff economist at the IMF. And I’ve been following his work. He’s the one who ha who started writing in-depth reports about collateral hypothecation and reuse around about at the time of the financial crisis. So long before digital assets, it became, you know, on the radar screens of the mainstream. He and I were, I was reading his work and we finally connected several years ago. And then our work has evolved to talking about digital assets, because we’re talking about some of the same things. We certainly don’t agree on everything, but you know, it’s kind of, it’s just fun to have been invited to.

Caitlin Long:

Co-Publish on that, what an honor. And it’s, again, one of the things I said when, when I went down this path of starting a bank, there are going to be some strange bedfellows. They’re going to, there’s going to be some cognitive dissonance, because when you’re trying to build bridges between two financial systems, the purists in both sides are going to come after you. And that’s exactly what’s happened. But that’s a valuable bridge. We can, we can come back and talk about why it’s a valuable bridge later, but to your point about payment latency yes, in a perfect world, I like to use the analogy of trading baseball cards as kids, kids have it. Right, when you trading a baseball card, you both hold onto the baseball card and you let go at the same time. And so you don’t have settlement risk because you’re both the transaction settles. That the buy settles at the same time as the sell, and the problem is the adults screwed it up.

Caitlin Long:

We haven’t we went and put all these complex delays in settlements. And frankly, a lot of it is what we talked about in the very beginning, which is that there are layers of intermediaries and each intermediary has to, settle separately, unless there’s some sort of a shared infrastructure, aka a Blockchain, you can’t settle the trade with multiple parties the same time. And so what happens is each intermediary has to setle in sequence. And this is one of the big reasons why we haven’t been able to speed up settlement cycles to a faster cycle because so many different layers of intermediaries are settling. And until probably 10 years ago, maybe even as recently, in some cases, as five years ago, the payments were still batched. And so, you know, and settled after business hours. So you just really had inherently a sequential settlement process.

Caitlin Long:

That’s that delayed net settlement process that I was referring to. Real time gross settlement is what’s natural. There, there really shouldn’t be any delays in the payment system. You should be able to exchange your goods for money at the same time and not have unsettled transactions, but that’s not the way the systems work and we’ll get there. And when we get there, frankly, there are enormous efficiencies that will be unleashed. And that is what I think is one of the big, powerful aspects of Bitcoin and blockchain technology is just the efficiencies that will be unleashed in allowing for real time gross settlement of payments. But it’s certainly not the way the traditional system is set up. And those two things are very, very different. They’re antithetical to each other. You can’t inject a real time gross settlement payment method into a system where the whole thing is designed on delayed net settlement. And that’s part of the reason why I think the crypto financial sector is expanding independent of the traditional financial sector. You’ve got to have connectivity in order for it to grow, right, because people mostly get paid in dollars, mostly save in dollars in the US of course, other Fiat currencies elsewhere. So you’ve got to have those connection points in order for value to flow into and out of both systems. But they’re fundamentally going to stay separate because the nature of the systems is so different.

Stephan Livera:

We might naively think, well, okay, the bank has X number of dollars on reserve. And I think the person on the street isn’t really thinking deeply about, okay, am I operating in a full reserve system versus a fractional reserve system? They’re just you know, I’ve just got this many US dollars or this many Australian dollars in my bank account. That’s the amount of money that I have. But then I guess the people who don’t see that, that we’re actually operating in like a fractional system and that there’s actually rehypothecation occurring. Could you outline a little bit around how that rehypothecation occurs?

Caitlin Long:

Well, I’ll start by saying you’re right. The average person on the street doesn’t understand it, but the people who control the majority of flows in the payment world are actually businesses. It’s the treasurers of businesses and CFO’s of businesses. They control a lot more flow than you know, the hedge fund managers who are interviewed on CNBC, for example, but because they work for businesses, you just never see them on CNBC, but they definitely understand this. And the reason they understand this is because they’ve never been protected by deposit insurance. Deposit Insurance is really meant to protect individual depositors not you know, significant businesses. So if you’re a midsize to large business, you’ve probably got more than $250,000 in the bank. And therefore you have to do the work on understanding the counterparty credit risk of your bank. But I think the nature of your question is more for the securities industry.

Caitlin Long:

And that’s where I’ve found in the last few years, talking this, that the vast majority of even folks in the Austrian school, who you would think would be sensitive to this, hadn’t thought about it before. And it’s a lot of it is because the terminology is hard to understand if you didn’t independently read what rehypothecation was. And you read that if you bothered to read the gigantic, you know, pages and pages of terms and conditions with your brokerage account you’ll see the word rehypothecation there, you are consenting to rehypothecate, obligate, your securities, all the brokers make you do that. And even if you have, what’s called a separate account, they’re still going to rehypothecate your securities because they hold them in what’s called an omnibus account where they pool everybody’s everybody’s securities, you know outside your view.

Caitlin Long:

And I can share examples of the impact to you from that. But I, you know, candidly, I think this is one of those things that if the SEC were truly a hearing to its consumer protection mandate, it would be all over this because that is not a consumer friendly way to handle this. If you ask the average person on the streets, do you think your Apple shares should be lent by your securities custodian without your consent, and without you earning any income from it, of course, they’re going to say no. And yet that’s what the vast majority of us have agreed to without understanding it because that’s what’s in the fine print. It’s not explained there was an interesting court case in Wyoming, my native state, where we were working on the Blockchain bills and the president of the Senate, super sophisticated guy.

Caitlin Long:

He, he said, you know, there’s a Supreme court case in Wyoming that says rehypothecation is fraud. And I went looked at the Supreme Court case and sure enough, and that was a case of somebody rehypothecating an industrial diamond where he, he had pledged it as collateral for a loan and then turn around and pledged the same diamond as collateral for a separate loan, without telling the second, without telling either bank. The difference I think is that the securities industry would say, it’s not fraud because we’ve all consented to this practice. Whereas in that case, there was no consent. But the problem is that, does anybody really understand what that means? I think the vast majority of people do not. Even smart people they’ve just never taken the time to dig in and realize that’s fractional reserve banking on your Apple shares.

Caitlin Long:

That is absolutely what happens every day in the securities industry and it’s normal. And without it, the structure of the securities industry would be very different than it is today because the profit potential would be very different than it is today. But I don’t think this is fair. I, you know, we don’t have no rehypothecation companies in the securities industry because of the way the regulations work. It just, it’s the way the industry works. And so if you want to own your own securities, get the paper stock certificate, but good luck getting it because the SEC has done such a big job trying to get it all electronified and put in these centralized structures that your broker will, will not probably give you your paper stock certificate if you ask for it.

Stephan Livera:

Right. And maybe if we were to tease apart, some of the reasons why this is occurring, in some cases, as people talk about it’s that it may be being lent to somebody who wants to take out a short position. And in other cases, it’s more like they need it because they don’t want to, it’s just kind of the way it moves around in the system. And they need somebody to be able to lend it to them in a short period of time, that kind of aspect?

Caitlin Long:

Well, yeah, it started out as securities lending is exactly what you were talking about as just lending the securities so that someone could borrow them and put on a short position, but it’s moved well beyond that now all the different demands of, for securities lending they’re very varied. The biggest one is this is the way the broker dealers finance themselves. They don’t have, depositors like the big banks do for us dollars. And so what they do is they actually pool all the customer securities and their own securities, and they’ll just put them out for securities lending. So all the things that you’ve read about collateralized loan obligations, that’s just pooling and lending against loans, collateralized debt obligations, that’s pooling and lending against bonds. And even the ETF world. How do you think you get the leverage in ETF’s?

Caitlin Long:

It’s basically all through the securities lending market. So these markets are just gigantic and they are exactly how the securities you know, industry works with without securities financing, which would include repo margin lending and like there are a whole bunch of different products, but it’s really all the same thing. It’s secured lending using your securities as collateral or your bonds, or your loans as collateral. And you just put those up. These are typically one day loans. So typically they mature overnight. And then then the next morning you just take out the loan again. But in the last as I left the securities industry, there was a lot more, and that was in 2016. There was a lot more term repo happening now where where you were actually having a match on the financing, the secured financing, instead of it being overnight, it would be seven day or sometimes it would be multi year.

Caitlin Long:

And you know, of course the banks didn’t want to have to have all that overnight financing because we saw what happened to Lehman brothers. It lost its overnight financing as soon. And as soon as it was out of the overnight financing market, it was done. It couldn’t find fund itself anymore. So these, these games only work as long as the banks can continue to fund themselves. But these things are enormous markets and it is these that is literally the beating heart of the securities market is they now call it securities financing and it’s how the big banks finance themselves.

Stephan Livera:

Right? And it might also be fair to point out that were it not for some of these systems, the costs actually might be higher to the consumer. They might be paying a higher fee to use an ETF service or something like that. Because part of how that ETF service is making its cut is say, taking advantage of that time difference right?

Caitlin Long:

100%. And think the rise of passive investing, you know the index funds had a lot to do with that. We’ve now we now see the, the concept of a no fee mutual fund. Well, your asset manager has costs. There’s a lot of costs to running a mutual fund. So how is it that they have a no fee fund? Where are they making their money? This is where they’re making their money. They’re taking your securities and they’re turning around and lending them. And they’re probably not giving you a cut. And so as fee competition increased, especially with the rise of passive investing. This is what happened. Everybody essentially was forced into this, which is why it’s so ubiquitous. This is the only way they make money. And this is you know, now I think everybody’s in a pickle with this because nobody realized that it was going to become the tail that wags the proverbial dog.

Caitlin Long:

I mean, you have ETFs that actually trade much greater volume than the underlying. And so imagine, you know, how closely those ETFs actually track the underlying if the ETF volume is much greater than the underlying, they’re not tracking it very closely. And so it’s a real problem. I think this has become a challenge. And I think it’s also a challenge in the way the securities markets work. We definitely, there were a number of people who were warning Greenspan in the 80’s that you don’t want to have the government financing happening through the securities industry. And indeed Europe didn’t go that way. Europe doesn’t have that big of a bond market relative to the bank markets. The banks in Europe are much more dominant than the bond market. And in the US we went with securities market.

Caitlin Long:

The bond market, you know, became dominant relative to the banks. And so that’s when we saw the rise of shadow banking. And that’s when things started to get really difficult from a monetary policy perspective. It used to be in the 70’s that when the fed injected new, new money in the monetary base within six months, you pretty much knew what the money multiplier was. And you pretty much knew what therefore what the inflation rate was going to be. There was a direct causation between the fed injecting new reserves into the system and CPI going up, but that’s not the case anymore. Now we actually see the opposite. And a lot of that has to do with the very different mechanism of credit creation that happened in the securities market. I would say going, it really goes back to 1983, which was during the Volcker Fed, you know, the Austrians tend to, of all the Fed governors like him, the best of all the fed governors in recent years because he actually did shrink the money supply raise interest rates, you know, try to actually put a halt on this on the unconstrained growth of money and credit.

Caitlin Long:

And he did succeed a little bit, but I actually think he made an enormous mistake. And it was in 1983, which was when, instead of the Fed targeting the money supply, they decided to start targeting the price of borrowing money. You can target one, but not both. You can either manage the supply, which is what they did in the seventies off going, after going off the gold standard in 71, or you can manage the price of money and let the supply float when they were managing the supply, the price floated. And of course, that’s one of the reasons we got you know, interest rates at 21%. But in particular in 1983, when the Volcker Fed allowed this switch, they never announced it. It was, you had to go through the minutes of the FOMC meetings to find when they announced it.

Caitlin Long:

And of course ever since 1983, to put a puzzle piece together for you, the Fed has been targeting, what’s called the Fed funds rate, and therefore they just let the money supply float. But what that did was hand over the keys, the proverbial keys to the kingdom, to the financial industry, to try to determine what the supply of money should be. If the Fed was only managing the price, then the supply was the floating variable and the securities industry figured out a way to really increase the supply of money and credit through the shadow banking system without impacting the fed funds rate. And I think that was a colossal mistake. And as history as time goes on economists, I think will look back on that and, and realize that was as, almost as meaningful as as letting go of the gold standard in the postwar period. And then letting go of the gold exchange standard in 1971, letting go of the of the money supply targeting standard in 1983 was also a very important inflection point in US monetary history.

Stephan Livera:

That’s some really fascinating comments there, Caitlin, and I’d love to touch a little bit on this idea of privately created money, right? So because in the Austrian framework, we’re thinking, okay, the central bank has expanded the, you know, the money supply or as rather has permitted a certain amount of by having a low reserve ratio, et cetera, et cetera. Right. We’re thinking, Oh, okay. That just, that means the banks can lend out all this additional money. But I think the point that you’re trying to get to there is also that it’s not just central bank created money, it’s privately created money. And I think also Jeffrey Snider has been very vocal on this topic as well, talking about the Eurodollar system. So could you elaborate a little bit on what’s what’s this privately created money that we’re speaking about?

Caitlin Long:

Well, the privately created money comes from the private financial sector. So as we know that the Fed controls the monetary base and then the banking and securities industries create credit on top of that. One thing is you and I were chatting before we started the podcast that I think the Austrians would not have misunderstood this as much had Murray Rothbard still been alive, because I think he would have written a sequel to the mystery of banking, which is the mystery of shadow banking. He would have been all over the the mechanisms through which credit, money and credit is created, that doesn’t have that that impact on the CPI rate that it, that it used to have. And it basically created the illusion of some free lunch. And we’ve had a few decades of, you know, free lunch where we’ve had massive expansion in money and credit in the private sector that didn’t cause an increase in CPI. And a lot of the reason for that was the rise of the Euro dollar market. So you and I both follow Jeffery Snider. He’s one of the smartest macro analysts out there. And he’s, he like Dr. Manmohan Singh at the IMF has have been all over this from coming at it from a slightly different perspective, which is that, you know, that we really shouldn’t be watching the M’s anymore. M0,M1,M2

Caitlin Long:

Because the action is outside of the traditional banking sector, it’s in the shadow banking market and included in the shadow banking market is security so all the rehypothecation that Dr. Singh is such an expert on, as well as the Euro dollar market. Now, the Eurodollar market does have some overlap with with, with the repo market. But what it is typically thought of as dollars issued off shore. So these are issued by non US banks. And this is another one of the mistakes is we look at monetary history. And when you look at the when, when the fed sort of really truly gave the keys to the kingdom, to the financial industry, right about 1983, that’s when the securities market started to take off, but something else happened back then as well, which is that the Eurodollar market started to take off.

Caitlin Long:

And we started to see a big increase in the volume of us treasury issuance. So to finance deficits, and it was all financed in the securities industry instead of the banking industry. But then we also saw the Fed allowed the non US banks to carry dollar balances, and issue dollar balances. It used to be that only US banks could issue dollar balances. And now because of global trade increasing, they allowed non US banks to issue dollar balances, as long as they had a correspondent relationship with a US bank. So it all ultimately settles back to the Fed. But the problem, as you know, is that there is a velocity of the monetary base and the Fed doesn’t doesn’t measure, unless they’re directly regulating and measuring the US monetary base inside the traditional financial industry. This is the M0, M2 multiplier.

Caitlin Long:

They don’t know what the multiplier is in the Euro dollar market, because they don’t have insight into it. There have been a number of people who have tried to estimate it. But, but the other piece that got that complicated matters further is that other assets took on a so-called Moneyness. This is Doug Nolan’s concept. And I really like that concept as well, that the monetary base isn’t the only base money in the financial system anymore. US treasuries are also based money in the financial system. And so this is one of the other reasons why the, those who are predicting a dollar collapse as the fed increased its balance sheet, or those who were concerned to your question about the banks no longer having a reserve requirement, I’ll come back to that in a moment. And it didn’t show up as a dollar collapse or as hyperinflation because the mechanism is so different.

Caitlin Long:

It turns out that the base money of the system is really as much us treasuries and other effectively U S government guaranteed securities, like a Fannie Mae and Freddie Mac and Ginnie Mae mortgage backed securities, et cetera. All that paper is really viewed as fungible and is viewed as the same as US dollar cash. And in fact, actually just to bend your mind a little bit in some markets, it’s viewed as more valuable than US dollar cash. Why? Because you can’t rehypothecate cash. Only the banks can do that. That’s called fractional reserve banking, but you can rehypothecate securities. And so this is where Dr. Singh’s work at the IMF is so interesting. He has estimated how many times a US government bond, US treasuries included has been reused. That’s just the securities industries equivalent of fractional reserve banking.

Caitlin Long:

And so you see why it’s some people in the securities industry much prefer to have a US treasury than to have cash because they can multiply it, whereas with cash only the banks can multiply it. So yeah, I know this is a bit of a mind bender. We’re going into some pretty esoteric stuff here, but what I’m trying to convey is that there is a lot of complexity here, and that helps explain why the traditional simple model of every time a dollar got injected of M0, it turned into $10 of M2 that just doesn’t apply anymore. And let me come back and answer the question about reserves, bank reserves going to zero. There were a lot of people who were crying foul over that. And actually it makes no difference because no one has been, no bank has been worried about their reserves since 2008, the banks have shifted instead of regulating reserves to regulating capital.

Caitlin Long:

And the capital buffers are what matter the whole Basel 3 capital requirement and all the Dodd-Frank supplemental capital requirements. Those are all based upon the capital of the bank, not the reserves of the bank, the equity capital of the bank. And, so actually when that, when the fed relieved that it didn’t actually have an impact on on whether the banks would lever themselves up more. And that was, again, one of these subtleties that if you were thinking in the, simplistic model of the seventies, that once worked so well and applied so well, then you missed it. Based on what was happening today, where the action is off field, and it’s frankly much, much greater and much bigger concern, frankly, than than the way the old model used to work.

Stephan Livera:

So just to replay some of that. So you were mentioning how essentially banks have not been constrained by the reserve requirement. They are actually being nowadays being in practice more they are constrained by things like the Basel requirements, which means they have to hold a certain amount of, let’s say, a bonds or a certain, they have to hold a certain number of assets in relation to the amount of loans that they have issued out. And I think there’s, kind of into the technical weeds. There’s things like Risk Weighted Assets and so on, and that, that sets the actual amount. But I suppose the point is the kind of the initial naive understanding if you will, of just simply rehypothecating above from M0 to M2, and M3 and so on. That’s not the biggest factor anymore because of these other factors, such as the Eurodollar market, and this concept of Moneyness as well. I’d love to talk a little bit more about the Moneyness idea. So my understanding there is it’s sort of like different assets in the financial world. People have an incentive to try to sell them and push them to people with saying, yeah, look, this is actually even closer to money than you first thought, because it gives them more of a more power in some sense, right. Because they’re trying to say this is really, really good collateral, like I’m good for it, right?

Caitlin Long:

Yes, yes. Well, I mean, you saw that with the CDO’s of 2008 and guess what? They’re back. Well, I actually think that the ETFs are probably the modern equivalent of that you’re going to continue. You’re gonna work until it fails spectacularly, and we’re going to see that. I think we’ve seen it in a couple of times. There’ve been some ETF problems where the net asset value diverged drastically from the underlying, and it tends to happen in the leveraged ones. But again, the rise of passive investing has caused a lot more money to go into the, into the trackers than the actual assets themselves. And eventually those two have to have to have to hold it. It’s a, there’s an old saying in the financial market, you can stay liquid longer than you can stay solvent, and that’s what can happen now.

Caitlin Long:

That’s what can happen with ETF’s. They can, as long as people are continuing to trade them, it’s just a game of musical chairs. If the ETF doesn’t indeed have sufficient collateral and there are lots of different things. So I was talking earlier about all the securities financing. There’s the phrase often times is naked shorting. Where, ETF issuers read the fine print, go pick up the perspectives of your ETF market makers are allowed to create ETF units. And again, the way the lawyers phrase this, it doesn’t make it obvious what it really is, but this is what it is. They’re allowed to issue more ETF units than they have collateral those particular market makers who are bestowed with the ability to go naked short that that asset have the ability to earn extra rents. Because they’re allowed to create more, more assets than there is collateral to back it up.

Caitlin Long:

Doesn’t this sound familiar? This is another, just another version of rehypothecation of fractional reserve banking, where you don’t have a hundred cents of collateral backing your obligations. And it’s just another version of it. There are so many of those versions of it. And I should have added back on the size of the Euro dollar market, as you know, cause I know you’ve been following this, nobody knows how big that is. You know, the amount of dollars that are borrowed offshore with where the Fed doesn’t directly regulate the banks, the amount of bonds issued in US dollars by non US companies. And most, especially the amount of payables in trade that are payable in US dollars, because think about it, you know, oil, Saudi Arabia sells oil to China and US dollars. There’s no US party to that trade, but there are payables which are effectively short term, US dollar denominated debt that get created there, no one knows how big those are, because we just don’t have a way to, to measure it.

Caitlin Long:

And what that does. And this is really important as well for those who are really worried about a dollar collapse Raoul Pal has been really good on this topic that the gigantic U S dollar short that’s been created, that that really the Greenspan Fed is responsible for authorizing back in the 80’s that gigantic dollar short means that there is demand to buy the dollars at any price because when somebody needs those dollars, they have to get them in order not to default on their contract. And so there is price, insensitive price, inelastic demand for the US dollar out there. And that has kept the US dollar supported a lot longer than a lot of folks had thought. So be careful shorting the dollar. You know, certainly we all look at this economic environment and say, this is not sustainable.

Caitlin Long:

This is not real. We are way outliving what, we’re consuming a lot more than we’ve produced. We’ve been doing that since 1968. In fact, that’s the reason why the gold exchange standard was ended in 1971 because we were borrowing more than we were producing. And so, you know, this can’t go on forever and you know what? That’s right. It can’t, but be careful because the short squeeze that’s going to come in the US dollar is going to be staggering. And here, I would point to the book When Money Dies by Adam Ferguson talking about the short squeezes in the German currency, right before the hyperinflation between World War I and World War 2. And it just was staggering how the volatility that happened and the magnitude of the short squeezes that occurred in Germany in the mark against the dollar, sorry, not against the dollar against, I guess, the French franc back then as well as against gold and also against stocks, you would see you know, 5% moves in the stock market.

Caitlin Long:

And the amplitude of the moves of the currency against stocks, gold and other currencies that were sounder, went from from 5% to 10%, and then to 20%. And then towards the end, you’d see 50% intraday moves. And so we’re not there yet in the US dollar because we’re not seeing that kind of volatility. We started to see 5% daily moves back in March, but the Fed was able to get, you know, to get this revved up again, there’s still some balance sheet left that the US has to support continued issuance of claims on US dollar denominated assets, clearly because it hasn’t hit a wall yet, but at some point it will, we’re living on borrowed time. And actually what we’re really specifically living on is the equity capital that our grandparents and their parents and their parents bequeathed to us because we had a pristine balance sheet in this country until 1968. And we’ve been living off that accumulated equity ever since that’s how we’ve been financing, you know writing the checks, so to speak, to consume more than we’ve produced.

Stephan Livera:

Coasting on fumes hey? So I’m also interested to just chat about from an Austrian perspective the term money substitutes. And I think that is where the Austrian masters might speak of it in terms of, you know, the money substitute, theoretically, if it’s perfectly secure, it’s immediately convertible and it’s a par value claim to standard money. Right. That’s kind of the idea, right. So I guess let’s say that, you know, you’re a banker and you’ve got a certain number gold pieces in your vault, and you’ve issued a certain number of paper tickets that are, that are immediately convertible for that gold, I guess that’s kind of the high level way of thinking about it. Just a quick, I guess, example. In your mind, how does that change? Where are some of the pieces in the modern day financial system falling down from that? Would you say it’s something like, well, okay. They are meant to represent some kind of a money substitute, for example, like US treasuries. Yes, of course. But they’re it just that it falls down and not being immediately convertible? Or is it just kind of not par value or how would you think about that?

Caitlin Long:

Well, a US treasury is really just a dollar that pays an interest rate. You know, some would quibble with that and say, wait a minute, the fed is a separate legal entity. It’s, you know, owned by the banks. Legally that’s true. It’s not owned by the US government. But the market doesn’t see a distinction. The market looks at them both as risk-free assets, and that’s how they’re both treated under the Basel three framework and the liquidity coverage ratio. So yeah that’s the most obvious money substitute. And like I said, in some markets, you’ve actually the treasuries, because they’re securities can be rehypothecated by a non-bank the, they are actually more valuable than cash because a non bank can’t rehypothecate cash only a bank can create fractional reserves against cash.

Caitlin Long:

So that’s part of it and other US government guaranteed or implicitly guaranteed, you know, the GSE paper it also fits into that exact same category where I think it’s we’re seeing something really interesting develop though, is in stable coins, because those are backed by US government obligations, usually treasuries, and they’re meant to be backed one for one. And this is where the paper, the IMF paper with Dr. Singh is so interesting because he’s an expert on collateral reuse. And one of the things that’s challenging to central banks is that when you create collateral silos where the collateral is squirreled away, and can’t be reused, what you’re really doing is freezing the ability of the big banks to rehypothecate there, to fund themselves through wrap application, through fractional reserving on securities.

Caitlin Long:

And that is a major part of how monetary policy is effected these days. And so this is one of the reasons why the ECB wrote a very interesting paper about Facebook Libra and said, this could become a $3 trillion De facto money market fund that isn’t going to be rehypothecating collateral at the center of the European capital markets. And you know what they’re right it’s true. And so you think about a collateral silo. What that does is it freezes the fractional reserve banking. You can’t do it anymore because that’s supposed to be backed one for one. And so that the whole stablecoin phenomenon is interesting, but if the Fed were still following M3 stable coins would absolutely have to be in there. And I’m not sure how many folks really understand how much the stablecoin growth has just flourished in the since the spring Tether now has more than 11 billion outstanding, which doesn’t sound like much, but it’s annualized on chain volume is about 500 billion.

Caitlin Long:

Well, that starts to become pretty interesting, but the off chain volume that’s reported by all the crypto exchanges who are crossing tethers off the chain. So it’s not an on chain figure that we can verify that annualized volume is North of 15 trillion. 15 trillion is a lot that’s enough to catch everybody’s attention, right? So what’s going on here? We actually have what is effectively a money substitute it’s being treated like that in capital markets. So well, at least in crypto markets, but increasingly businesses are starting to use this because it is a superior US dollar equivalent settlement system. So in a way it’s almost like a new version of the Eurodollar market, except it’s outside of the banking market is cropping up. And what’s interesting about it, it is siloing collateral. It is squirreling away these us treasuries, which, you know, it’s, it’s counterintuitive, but because the US government is issuing so many of these right now, but there’s a shortage of them.

Caitlin Long:

Why is there a shortage of them? Because there’s a gigantic short position in the offshore markets, the Euro dollar markets, and the banks need to get ahold of those in order to be able to satisfy their obligations. And so you start squirreling away the collateral it causes problems. I think there’s an interesting opportunity for the Fed though at the time that Facebook Libra came out about this time last year, president Trump this was when he issued his infamous Anti-Bitcoin tweets. And he told Facebook, go get a bank charter. And, actually, I think this is one of the interesting ways that the Fed can pull all this back in because they don’t have the ability to directly control those collateral silos. And this is a real concern that central banks, generally, not just the Fed you know if collateral gets squirreled away and siloed, that’s going to impact their ability to effectuate monetary policy.

Caitlin Long:

And it’s going to mean that their balance sheets are going to have to expand. And I will say the Austrians might get it wrong again, if the balance sheets expand to offset a falling multiplier in the repo market, because now instead of four people having the same bond and so basically the base money got multiplied by four. Now it’s only three. Well, how are you going to offset that? If you’re effecting monetary policy, you’re going to have to increase the monetary base, ergo, the Fed’s balance sheet is going to grow. But the, Austrians think, unless you understand that piece, you’ll miss, you’ll miss it by saying, Oh, that’s, hyperinflationary the Fed’s printing money again. And it’s not going to happen. If what the Fed is doing is backfilling for a credit deflation in the private sector. So all this stuff, you really have to be careful monitoring it all and, and stablecoins are absolutely part of this whole equation. Now they have become material. And especially when, and if Facebook Libra gets going, this is going to become a, it’s going to pose a real challenge to to central banks all around the world.

Stephan Livera:

Right. And I’m sure we’ll hear the same stories about “Oh see Bitcoin price is being pumped up by tether” and so on. Right. I’m sure you’ve heard that story.

Stephan Livera:

Yeah. You know, I don’t know. I mean, the exchanges are, they certainly don’t have to comply with there are some good consumer regulations that, that stock exchanges have to comply with that relate to, you know, getting the best price and best execution and not trading against your clients. And you know, those kinds of practices that have been shut down in the securities exchanges have not been shut down in the crypto exchanges. So there’s definitely manipulation going on in the crypto markets. So buyer beware.

Stephan Livera:

Yeah. Look, I think this is an area where truthfully, I don’t understand it as well as you do. But I suppose as I understand it it’s also that we might, if you naively look at money supply on, say the feds, you know, FRED that Fed charting site, you might be missing the full picture because you’re not seeing the Euro dollar pot. You’re not seeing the Moneyness aspect that you were talking about. And so the reality of it is you were just looking at one part of the picture and it’s this kind of problem that very few people even understand. And as I listened to someone like Jeffrey Snider, he says, look, it’s not that he even knows the solution. It’s just, he’s trying to figure out what’s the problem. And people don’t even know what the problem is to begin with.

Caitlin Long:

Well, right. Because you can’t manage what you can’t measure as a, I think it was Deming who said that you know, and I’m sympathetic to the Austrian view that you shouldn’t be measuring this stuff because you shouldn’t be managing the economy. You should just let markets work. But but if your job is to manage something you’re supposed to be measuring and you can’t measure it, then how do you think you’re going to be able to do your job? And so that’s the challenge that the FOMC has right now for sure. And I’m sure they understand that they’re smart people. And generally speaking, I would also say they’re good people. They definitely don’t agree with the Austrian view of the world. Although, you know, Judy Shelton might I don’t, I’ve met her a couple of times. I suspect a lot of folks in this in your listener base have, and have followed her as well. So she ends up on the FOMC. It’s going to be interesting because she’s got a very different worldview. And I think the way she articulates it is also really effective because she depersonalizes the debate. And so it’ll be interesting to see if she can get through Senate confirmation.

Stephan Livera:

Bringing it back to the criticism that an Austrian might have of the, you know, of the fractional reserve banking. They might say something like, well, it’s because more claims have been issued to money than the actual money existing. That’s what drives the malinvestment or rather it drives this kind of false well, yeah, it drives a false signal of interest rates and to entrepreneurs to go out there and borrow and do projects. And what that does is creates the malinvestment and that creates the boom bust cycle. So I guess that’s kind of the high level way of thinking about it, but I guess it’s just that it’s sort of understanding where the malinvestment, or where that additional money is coming from is the part that not everyone is really understanding yet, would that be a good summary?

Caitlin Long:

Yes. That is exactly what the Austrians have missed because they didn’t or we collectively didn’t articulate very well that the traditional banking system is not where the action is. It’s in the shadow banking system, and there hasn’t been much Austrian scholarship even in the academic Austrian world related to this. And so I feel badly for the Austrians, I’ve actually donated a lot of money to try to get to, you know, to sponsor folks who would study these things and help educate on these things within the Austrian academic world, because I do think they have a lot to contribute. And I do think that the Austrians are painted with the wrong brush by the mainstream, because the results haven’t been right, there were a lot of people who were claiming the dollar would collapse the moment that the Fed that Nixon took us off the gold standard, and it didn’t happen.

Caitlin Long:

And then 2008 hyperinflation around the corner and it didn’t happen. And so the Austrians are painted with a brush of you know, wrong all the time and they’re going to be wrong until they’re 100% right. Is how I think about it. And in figuring out, and we, you know, we don’t know where that end point is. But in figuring out the mechanisms by which this system was, allowed to perpetuate as long as it has, that’s where, that’s where I think there’s a lot of misunderstanding. And, you know, that dollar short that’s out there is going to perpetuate the dollar for a lot longer than any anybody realizes this could, it could be not even during our lifetimes where we see a regime change. I think it will be during our lifetimes, because eventually the borrowed time, the borrowed literally the, you know, grandparents equity that gave us the ability to write checks and cash them to outlive our means, that eventually is gonna run out.

Caitlin Long:

But I just don’t know when, and it’s very, very, very hard to measure. So I don’t know if I answered your question very well on that. But yeah, I ultimately the other piece that I would, that I would say when you described the Austrian business cycle theory, which to me is, what’s so powerful about the Austrian world is it’s actually even simpler than the description that you gave. It’s basically that we shouldn’t control the most important price in the economy, which is the price of borrowing money that the price of borrowing money is the interest rate. And it is it is the traffic cop between time and between industries. And that’s how capital gets allocated. And as long as we have a controlled price of borrowing money, then we will have misallocation of capital.

Caitlin Long:

And I also like the way the Austrians lay it out. That the other piece that, that, that the mainstream can’t explain is why there are clusters of errors. Why is it that entire industries make the same misjudgment in their capital planning at the same time and in the same direction? There is no other explanation for that. Markets always have buyers and sellers, free markets do. So why is it that we have these clusters of errors? And the only explanation for that is that the interest rate was manipulated. And you don’t know whether the capital that you invested was going to earn a return higher than your cost of capital, because you don’t know what your cost of capital is. And as an entrepreneur, that’s a daunting concept. If you don’t know what your cost of capital is, then you don’t know how to allocate it.

Caitlin Long:

And you don’t, know if you’re, if you’re earning a return on it, or if you’re destroying value and the word malinvestment put another way is destroying value. You’re earning a return less than your cost of capital. That’s a project you never should have invested in, but because of the bad interest rates signals telling you to invest, you did, and you lost money because of it. And this is why you saw the entire home builder sector in 2008, lose money at the same time in the same direction. And I would say that the energy industry is sort of the poster child of this correction. Massive over-investment massive malinvestment in the shale boom and related energy projects that relied on gas prices being too high, but they had a cheap cost of funding because interest rates were held artificially low and a whole lot of money got invested in a sector where it otherwise clearly in retrospect should not have been. And so here we are we’ve, you know, burned some of our capital. And as a result, we’re all poorer for it. We just don’t know it yet.

Stephan Livera:

Yeah. I think that was a great explanation. So if we were to think about what might be you know, what kind of monetary world we might live under, if we lived under, let’s say a Bitcoin standard, and there were to be more close, something closer to a full reserve banking system. I suppose, part of the, why is people today don’t acknowledge that. But I think a really interesting point you were touching on earlier, and I’d love to chat a little bit about this is how corporate treasurers actually conceiving of that credit risk more. Much more so than an individual deposited. Right. So I guess, let me just play just the, yeah. Sorry. No, no, that’s certainly fine. I was just wanted to give a quick explanation. So I guess the way an Austrian might explain it, or think of it just for listeners who aren’t as familiar, you might be thinking well, as a retail individual, you normally would scrutinize your bank.

Stephan Livera:

You would say, Hey, is this bank legitimate? Are they really going to be good for the money when I want it? But it’s sort of like the government allays that fear by saying, Hey, we’ll put in the FDIC or an equivalent in other countries saying, look, you will be made whole, you don’t have to worry. And so then they now just kind of put their hands up and say, well, I’ll just put my money into any bank that has an FDIC, blah, blah, blah. Right. But I think the interesting point you were making is that corporate treasurers get no such assurance from the government.

Caitlin Long:

Right, because they’re all well in excess of the insured limit. And it’s not just in the US there’s similar FDIC type insurance in other countries. And I’m not an expert in all of those other countries, but in most of them, my understanding is that there’s a cap. And so if you’re a big business who’s managing, you know, tens of millions or hundreds or, or even billions, tens of billions of cash, right. Then you’re obviously, you know, the $250,000 FDIC insurance cap, isn’t meaningful to these tech companies and healthcare companies that are sitting on all these on all this cash. They absolutely have to pay a lot of attention. And I watched it, you know, and there’s a lot going on in the, in the capital markets behind the scenes that never gets talked about in the press because corporate treasurers aren’t talking about any of this, but one of the things that happened in the 2011, 2012 timeframe was when the Euro started to fall out of bed.

Stephan Livera:

And folks were really concerned that the Euro might not survive. It was before Draghi came in and basically gave his whatever it takes speech. And in probably the six to nine months before all that happened you saw corporates, US corporates. I saw pulling their cash deposits out of their European banks and putting them in US money market funds or US banks and swapping back to Euro’s. So what did that do economically? They still had Euro exposure cause they couldn’t take the accounting volatility. They didn’t want to bring it back to dollars, but that meant that their credit exposure was not to the European banks. It was to the US banks or to us money market funds. And they just got the Euro accounting benefit by swapping it back. So, yeah, I’ve seen that very behavior a number of times.

Caitlin Long:

There was also another example right after the financial crisis, the large corporates had a benefit of unlimited FDIC insurance. And that was extended into, I think maybe even 2011, 2012, something like that. And so for those few years, corporates could actually have unlimited FDIC insurance. What effectively the US government did was guarantee the banks at that point because it offered unlimited FDIC insurance and the FDIC is guaranteed by the US treasury. So the FDIC, if you look at its balance sheet is really small. It really could not handle a run on the whole US system. So what that really is, is a US government guarantee. And and they ended up taking that off in like 2011 or 2012, once things got back to more normal. But I remember at the time there was just billions of dollars of corporate money stashed in those non interest bearing 100% FDIC insured accounts at US banks. And then, you know, the announcement was made with maybe six months notice or so that, that was going to be discontinued and all the treasurers then had to move their money into other types of accounts. But that just goes to show you back then everybody was really worried about the credit worthiness of the system and the credit worthiness of their banks. And so they were willing to take no interest on their cash just to know that their cash wasn’t going to be defaulted upon.

Stephan Livera:

Yeah. Right. And as we were coming back to, it also reminds me again of that idea of the moneyness idea. So US treasuries that are obviously closer to money than, you know, physical cash and coins, let’s say, but in that example where the corporate treasurers were swapping via foreign currency swaps but you were mentioning that they were holding balances inside money market funds. So that is also arguably a form of monyeness.

Caitlin Long:

Yes, yup. Absolutely. Well, and those have had their string of problems too, right? Because it used to be that they were allowed to report that their value was $1. And then you started to see the reserve asset fund was I think the first money market fund in 2008, that so-called broke the buck. It was no longer worth $1, but it was always reported up until that point that money market funds were always worth a dollar. It’s kind of like stablecoins. I just see the same, you know, trends repeating stable coins are supposed to be worth a dollar, but are they really backed 100%? by if I quote unquote risk-free assets, right. We saw it in tethers case they weren’t. And yet the market frankly looked through a lot of that and didn’t seem to care during that time period. But you can see a pretty meaningful divergence.

Caitlin Long:

They don’t always trade at a dollar. And so one of the problems with stablecoins is that they are probably capital assets for tax purposes. Big disclaimer, I’m not giving tax advice. I’m repeating what I’ve read. Talk to your tax advisor, if you have a question. And the same thing is true on the accounting side. They’re not considered a cash equivalent because they’re not issued by a bank. And so again, fair warning, go get an accounting opinion from an accountant. But they suffer from some of the drawbacks of being volatile assets. So you’ve still got to do the tax reporting. Again, big disclaimer but you know, if tether’s trading at 1.01 that one penny is actually a capital gain and because there’s no exclusion on capital gains, then you have to report that one penny.

Caitlin Long:

And it doesn’t add up to much in terms of value potentially unless you trade a lot. But it creates a huge tax reporting headache. And so again, the IRS hasn’t totally clarified all this. And the same thing on the accounting side, you’re marking it to market. It’s not a big Mark to market, but we had that same issue with money market funds. Are they actually are they treated as cash equivalents for tax purposes and for accounting purposes? And it turns out that some of them are, and some of them aren’t. And indeed, I think that’s, what’s going to happen with stable coins. Some will be treated as cash equivalent and some will not, but it remains to be seen, but you can see that this is a whole new category of dollar equivalent assets. And they’re making their way into capital markets. They’re making their way in as collateral and what they really are, which is most likely securities.

Stephan Livera:

Right. I see. Yeah. So it’s, it’s a, it’s kind of this funny blurred line between being a security versus trying to be a money or be considered on that money spectrum. And I’m also curious to get your thoughts. So people might be thinking well, as Bitcoin grows up and becomes bigger, there is this increasing financialization. And speaking to a point you were mentioning earlier around the tail wagging the dog. So I guess a quick example, let’s say someday, a Bitcoin ETF comes and it would do you perceive that that could be a risk there in terms of the tail wagging the dog where let’s say the ETF has been so much more subscribed or so many more people are buying or selling that ETF, then people who can actually deal in the underlying real Bitcoin. Do you have any views on that?

Caitlin Long:

Oh, it’s already happening Stephan and this is, you know, 100% a problem. I’ve wrote a lot about this back two years ago on forbes.com a series of pieces on the bad type of financialization. There’s good type of financialization, which is real true liquidity coming in from a new group of investors. And then there’s the bad type of financialization, which is where it gets fractionally reserved. And we are absolutely seeing fractional reserving of Bitcoin happening full stop. And it is suppressing the price of Bitcoin. Full-Stop. Just like rehypothecation and other fractional reserving tools suppress the price and frankly, the rates in the dollar that is absolutely the case. And and so it’s going to create, you know, an unwind at some point, but I, as much as I’m concerned about rehypothecation and all the fractional reserving that is happening, the bad type of financialization that is happening in Bitcoin, I’m not worried about Bitcoin itself.

Caitlin Long:

Just to be clear. Often times I get that question is this, does this mean it’s bad for Bitcoin? No, it just suppresses the price in the short term. And it means that when the unwind comes, it’s going to be spectacular. And so, you know, you want to be long you know, if somebody wants to suppress the price in the short term and let me buy more, I’m happy. I’m happy with that as a longterm HODLer. But but, but I think it’s a dynamic that we can’t escape. And I, I will say I respect the companies that are at least outright acknowledging that they’re doing it, BlockFi, Celsius. And others, I don’t mean to single them out cause there are others as well. But I do know that the two of them have admitted, this is the case it’s in their terms of conditions and it’s outright there, it’s this they’re operating the same way that your brokerage firms do. It’s in the fine print. They have the ability to rehypothecate your collateral. And the interesting thing about those companies is they’re not regulated and they’re not audited, and there’s no visibility into their balance sheets. So it’s an interesting question. What’s the counterparty risk of those counterparties? And does the market have any idea how to price it? We’ll only know in retrospect. Yep.

Stephan Livera:

Yeah. I see. Alright. Also wanted to chat about the OCC interpretive letter 1170 it’s cryptocurrency custody for customers. So I’m sure you’ll have some views on this. So Caitlin, perhaps you just want to summarize a little bit, what are they getting at in this interpretive letter?

Caitlin Long:

Well, it is allowing national banks to provide custody services around digital assets. It’s a clarification of the type of assets that national banks can provide custody services for. And so it’s not a change in the law. They didn’t need to go to Congress to get a change in the law. They have the authority to issue the interpretive letter. It’s not a change in the rule either. It doesn’t have to go through any public comment period. So in the US we’ve got laws rules, and then interpretations of those rules. So three different layers. What an agency can do, without having to go get public comment or change the law is release an interpretive letter. In the SEC, they’re typically called no action letters and in the SEC, they’re called interpretive letters.

Caitlin Long:

They do have the force, I guess I’m mixing terms when I say force of law. But they absolutely are effective. And they typically are not reversed. And so, you know, this was a big deal. When I saw some of the announcements that Brian Brooks had early on that they were going to create a national FinTech charter and national special, sorry, national special purpose bank charter, which was exactly what Wyoming has authorized. I knew that that wasn’t real. They was going to need to go to Congress to get that changed, but this interpretive letter, he didn’t have to go to Congress and you didn’t have to do a new rulemaking process with a, you know, public comment period and getting it published in the federal register. This is effective immediately. So he did a big favor to the institutional adoption of crypto.

Caitlin Long:

And I think from everybody’s perspective, the real impact of this alongside the blog post, that Visa released on the same day, endorsing Bitcoin and stable coins as powerful payment technologies, all this means that the big incumbents are here and this narrative that’s been persistent, persistently wrong, but persistent that the US government was going to shut down Bitcoin, somehow. You and I know that wasn’t possible, and that ship sailed a long time ago, but the narrative was still there. I think at this point, anytime anybody raises that narrative with you just pshaw, you just laugh. I mean, it’s at this point with the big banks and visa getting in and endorsing this, you know, that ship sailed. It’s good for Bitcoin.

Stephan Livera:

Yeah, that’s fantastic. So I suppose up until this interpretive letter, it remained a little bit unclear what normal banks could do, correct?

Caitlin Long:

Oh, yes. No bank was going to try to provide custody services without getting express approval from the regulators. That is something you pretty much do need as a bank to go get permission from you. You have an open dialogue with your regulators and heaven forbid if you’re doing something they don’t know about it’s going to be a problem for you when they find it out. So this is one of those situations where clearly some national bank went and applied to do this. And as a result, now, all national banks can do this. There’s one other interesting aspect of it though. That’s a bit challenging, which is that the smaller banks will need to go through a full regulatory review before they can do this, the smaller national banks, the gigantic ones, the JP Morgans, the Citigroups, the UBS’, the bank of America’s.

Stephan Livera:

Their digital asset activities are probably not going to be deemed material in size, and therefore they would not rise to the level of affecting the safety and soundness of the bank. Therefore they can be in digital assets as of the, as of July 22nd, literally. And it’s unfortunate because those who are concerned about the power of the big banks, this is one of the ways that the rules work in their favor is that if they want to do something new and it’s not material relative to their overall business, they can do it immediately. When they get an interpretive letter like this right

Stephan Livera:

Sort of services. Could we see banks offer in terms of cryptocurrency? I mean, are we talking safe custody vaults to people can hold their hardware wallets in it, or are we talking more like they might literally start just offering Bitcoin accounts alongside other kinds of accounts.

Caitlin Long:

Who knows all of the above. Those would both be considered custody businesses, safe keeping of assets. So yeah, who knows there is going to have to be some degree of back and forth with the supervisor of whoever this bank is that wants to get into Bitcoin. They are probably, you know, not literally wading in immediately, but for a big bank to put in a request for an interpretive letter like this and make their regulators, you know, jump, they wouldn’t do it if they weren’t serious. Having started three businesses inside new banks and inside these big banks previously, I know what it takes to get that done. It’s a very heavy lift and for a regular, for a bank to ask its regulator for approval to do something, they have their ducks in a row before they even ask the regulator.

Caitlin Long:

So, you know, they’ve got a plan, whoever this is, and yeah they’re coming. And it’s going to be interesting because I think it’s going to shake up the existing crypto industry. And generally speaking, I think it’s good for the venture capital firms, because my guess is that there will be a land grab. There will be an M & A wave, and this might make some of your listeners cringe, but I think a lot of the native crypto companies are going to end up owned by banks before this is over owned by traditional banks. But the other side of this is that the crypto companies could go get a bank license. And I shared this with Anthony Pompliano on his podcast as well. This industry definitely tends to be critical of banks, and I think it’s more for monetary policy reasons than other reasons.

Caitlin Long:

I think, I don’t think the banks would disappear. Even if fractional reserve banking went away, we would just go back to a money warehouse, service provider type of, you know, fee-based service provider relationship that will always be there. And so here’s the punchline that I think is important for everyone to carry away from this part of our conversation, the banks have licenses that enable them to do certain things that non-banks cannot do. And so putting a bank wrapper around a crypto business makes a lot of sense. And so this, the notion of just a broad brush, you know anti bank approach to the world is not actually the right way for this industry to be thinking about things. It is the particularities of the way the banks business has evolved the traditional banks that I think we can be critical of.

Caitlin Long:

And I am critical of, but the but the bank license itself and actually working with, with the regulators, which are by the way, an entirely separate part of the Fed, then the FOMC those, those are different and should not be painted with that same broad brush. I think even if James Grant’s view of the world, which is privatize the Fed even if that were ever to happen, what the fed would effectively become the vast majority of employees at the Fed work in the bank supervision division, and that would essentially become a self regulatory organization. So it wouldn’t go away. It wouldn’t disappear.

Stephan Livera:

I see, so let’s chat a little bit about Avanti. What’s the latest there?

Caitlin Long:

We’re applying for a bank license. This is a wrapper around a traditional business. We’re very Bitcoin focused. If you look at who our tech team is. And, and we want to build a compliant bridge between the traditional banking industry and the digital asset world. We are going to be very different than a traditional crypto company. Most of the traditional crypto companies are what I would call, sell side focused. You know they collect fees for listing someone’s cryptocurrency. We won’t do that at Avanti. We are buy-side focused, we are customer focused. And so we’ll go where customers want us to go. And right now there’s no question. The biggest level of interest from a digital asset perspective is in Bitcoin. So I’ll be working to get new institutional investors into Bitcoin. I know a lot of your listeners are purists and think why on earth do we need any service providers, any intermediaries in crypto? And you know what, you’re a hundred percent right? If you don’t want to have an intermediary involved in your crypto transactions, Godspeed, you don’t have to. And that’s one of the beauties of Bitcoin. It is about personal financial freedom. It is a bearer asset if you’re willing to take that responsibility. But for those who choose not to, or for those institutional investors that cannot by law, self custody, their assets, they need a third party custodian. And until there is one that’s deemed institutional quality, they won’t come in. And so you know, again, a lot of folks think the pension funds and mutual funds and the like you know, it doesn’t matter to Bitcoin and in the long run, it doesn’t matter to Bitcoin whether they come in or not. But it’s certainly going to be good for the ecosystem if they do, these are not the big, bad institutional investors.

Caitlin Long:

These are, the cream of the crop. And frankly, I think they’ll help clean up when they come in, they’ll help clean up some of the bad practices that are happening, like all the front running that’s happening at the exchanges. Like the bad terms and conditions in, the contracts, go read the terms and conditions of your crypto service providers. And some of the things in there will make you scratch your head. They are not consumer friendly and, you know, one of two things causes, it causes the financial industry to be consumer friendly, either they’re forced into it by their customers, which hasn’t happened in this industry yet. Or they’re forced into it by regulators. And I, you know, I think that’s coming. I think there’s definitely going to be some crackdown there, there already has been at the CFTC, some crack down on some of the consumer unfriendly behavior.

Caitlin Long:

But one example that I’m alluding to here is there’s one major institutional player that defines Bitcoin quote, unquote, as a digital asset. Well, if all of a sudden that firm decided that it was in their interest to call Bitcoin Cash Bitcoin, there is nothing that you would be able to do about it because they have defined that term so broadly that you wouldn’t have a legal remedy. If you sued them and said, no, Bitcoin cash isn’t Bitcoin, Bitcoin is Bitcoin. They’re going to, the judge is going to say, well, then you should have negotiated a better contract. So the power is with the existing intermediaries in this space, they haven’t been pushed to real institutional quality terms yet. And I think that that’s coming and that’s going to be good for consumers.

Stephan Livera:

That’s fascinating stuff. I really enjoy chatting with you, Caitlin. I think it’s probably a good time to close it off here, but before we let you go Caitlin, where can listeners find you online?

Caitlin Long:

Well, Twitter is probably where I’m most active, LinkedIn as well, and caitlin-long.com. And then of course, AvantiBank, we’ll be making some more announcements in the coming months and hopefully getting over the finish line and getting ready to open up in the fourth quarter of this year.

Stephan Livera:

Fantastic. Thank you for joining me.

Caitlin Long:

Thanks Stephan. That was great fun.