Michael Burry’s next big short? The ‘debasement’ this hedge fund says could make you a fortune

As a hedge fund manager at Scion Capital in 2005, Michael Burry began to notice structural weaknesses in the United States mortgage bond market.

By 2007 he had positioned for a $1.3 billion dollar big short – betting against the majority of Wall Street and the banks on the collapse of the housing market.

This excerpt from the Shortform summary of the Big Short book by Michael Lewis provides a good summary of how it all started.

“Burry saw that now was the time to act. Once the teaser rates on the subprime loans went away and borrowers started getting hit with higher interest rates (in roughly two years), there would be a wave of defaults that would bring the mortgage bond market to its knees. Once that started happening, lots of investors would be desperate to purchase insurance on the bonds they’d invested in, and the only way they would be able to do this would be through the credit default swaps that Dr. Michael Burry would own.

The rest is history. A major subprime lending crisis emerged and became what is now known as the 2008 Financial Crisis.

Burry’s investors made around $700 million.

He is personally believed to have walked away with around $100 million.

Will such an opportunity ever emerge again?

Well, one prominent U.S.-based hedge fund believes the next big short could be close.

What will be the next big short?

Cescat Capital is a respected macro hedge fund manager that counts some of the most wealthy U.S. families amongst its confidential list of around 190 clients.

In a recent investor letter, Crescat told clients it is positioning portfolios for what it describes as “the next big short”.

Much like Michael Burry’s observations on the mortgage bond market in the early 2000’s, Crescat says it’s seeing clear evidence of structural weaknesses in fiat currencies – evidence the rest of Wall Street appears to be ignoring.

The firm believes “fiat debasement” is now looming as the next big short.

“As central banks find themselves increasingly constrained by political pressures stemming from the exponential growth in overall debt, these institutions are likely to feel compelled to utilize monetary policy as a means of funding to uphold the financial stability of their respective government securities markets,” explained Kevin Smith and Tavi Costa from the Crescat investment team in the Investor Letter.

“Consequently, the debasement of fiat currencies is likely to emerge as a significant macro theme worldwide.”

The firm notes official data shows money printing both in the United States and China has surged recently.

Around $420 billion has been added to the monetary base in the United States over the past 12 months, while China added US$150 billion to its balance sheet in December 2023 alone, bringing its total increase to almost US$850 billion in just 5 months.

Michael Burry - Next Big Short - Fiat Debasement
Michael Burry - Next Big Short - Fiat Debasement

Crescent says although we’re being led to believe we are not in a quantitive easing phase, the money printing that’s happening now “unmistakably echoes the patterns of previous periods of monetary stimulus following the Global Financial Crisis”.

What’s more, Crescat believes global inflationary pressures are not easing.

“Three months ago, it was undoubtedly more challenging to predict the potential emergence of a second wave of inflation. However, with agricultural commodities reaching recent peaks, a surge in global freight costs, gold prices breaking out to record levels, recent upticks in oil prices, growing pressure on shelter costs due to a surge in illegal immigration population, and rising breakevens, it is becoming increasingly clear that a second wave of inflation is now unfolding.

“In the meantime, before the anticipated policy shift by the Fed, monetary conditions have already declined to the lowest point in one and a half years, concurrent with an ongoing rise in breakeven rates.”

The point is, the world is seeing rising inflation while money conditions are loosening (more printing, and rate cuts).

This, according to the Crescat thesis, will lead to the tumultuous loss of purchasing power and a loss of confidence in tradition currencies.

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How does fiat debasement play out?

It’s important to understand that fiat debasement is unlikely to occur in a ‘big bang’ such as the unravelling of subprime mortgages in the United States.

The fact is, one could argue the wheels of fiat debasement are already in motion.

Historically, when currencies were tied to precious metals, debasement occurred when Governments started using a reduced amount of precious metal (usually gold or silver) in order to create more money – thus, reducing the value of the money.

In modern times, our currencies are no longer backed by precious metals.

Debasement now occurs through major increases in money supply, as Governments print more money because they’re spending more than they earn.

Eurointelligence co-founder Wolfgang Münchau, puts it like this; “We trust that the government and the central bank won’t debase the money through imprudent policies — as has been happening persistently since the global financial crisis — through various central bank policies, from quantitative easing to lending practices that would have been considered reckless until recently.”

He believes right now fiat debasement is occurring in 3 ways:

  1. Quantitative easing (the purchase of government and corporate debt by central banks) is creating debasement through debt monetisation because new asset purchasing programmes are being launched before prior ones have been fully neutralised.
  2. Outright debt monetisation such as the U.S. Federal Reserve Bank Term Funding Program launched after the collapse of Silicon Valley Bank which is seeing the Fed lend against insufficient collateral.
  3. Reserve currency freezing which occurred when sanctions were imposed on Russian currency when the Russia – Ukraine war commenced in February 2022. This called into question the intrinsic characteristics of money.

“Modern day debasement is Subtle” warns Münchau.

“All of this will take time. Right now, there is no available alternative to the dollar as the world’s dominating currency, but it is debasement that makes it unsustainable.

“What makes this so treacherous is the time lag between the moment you debase and the moment of truth. To the current generation of central bankers and politicians — and to the Roman emperors before them — debasement looks like a free lunch… And we all know what happened to Rome.”

How to profit from fiat debasement

While Bitcoin or other non-fiat currencies might seem like the obvious play, this is not the route Crescat or Wolfgang Münchau recommend.

“Bitcoin is increasingly turning into an asset of the dollar-backed global financial markets,” says Münchau.

“Herein lies an irony. Bitcoin should, in theory, offer a hedge against debasement, but its fortune is increasingly tied up with that of the dollar”

So, how can investors profit from fiat debasement?

They should look to commodities and so-called hard assets according to Crescat.

It says a “great rotation” will soon emerge that sees investors pull money out of financial assets, into real assets. A situation that will resemble the 1970’s after the end of the Bretton Woods agreement that tagged the value of the USD to gold.

Michael Burry - Next Big Short - Fiat Debasement

“The continued influx of capital into technology, growth stocks, and long-duration assets, has created one of the most speculative asset valuation environments since the tech bubble. This a point we have been making at Crescat for the last few years, yet this imbalance has only become more extreme. We believe it is ripe for a sharp reversal,” Crescat says.

“The sheer magnitude of the current macro imbalances is laying the groundwork for one of the most bullish environments for owning hard assets that we have seen in quite some time.”

Silver, Copper, Gold, and in-particular gold mining stocks, are some of the ways Crescat is positioning for the fiat debasement big short.

“In our strong opinion, there has never been a more opportune time to build a portfolio of high-quality assets that offer leverage to metal prices than now. For us, the metals and mining industry, currently at one of its most undervalued levels in history, is the most attractive way to express this view in the markets.

“It’s worth noting that real assets have historically outperformed financial assets during inflationary decades like the 1940s and 1970s and also in construction-led commodity bull markets like the 2000s. We anticipate both of those environments directly ahead.”

Finally, it should be said Michael Burry himself has signalled he’s watching fiat debasement.

In a now deleted Tweet from 2021, he warned US debt is forcing “the debasement of the dollar faster than others.”

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