Where is the Smart Money Going?

One day we may wake up and realise that the party is over. Two weeks ago the media was bullish about the prospects for the S&P500 with headlines such as:

S&P 500 Will Break Past 3000 Quickly, Keep Rising: Blackstone

Here’s how one analyst sees the S&P 500 doubling in the next decade

Yesterday, the mood was totally different:

Dow plunges more than 800 points in worst drop since February …

S&P500 index falls 2.0 percent as US bond yields soar and investors …

Performance of the S&P 500 over the last 5 days. Graph courtesy of Google.

The fall in the S&P 500 is the result of rising interest rates in Government Bonds. President Trump’s tax cuts will put the US deficit to a trillion dollars. “Steven Mnuchin’s Treasury plans to borrow $770 billion in the second half of 2018, a more than 60% increase from the same period last year; and with the Fed actively reducing its own portfolio now at a $50 billion/month pace amid a sharp drop in pension fund and foreign investor buying, interest rates have nowhere else to go but up to attract buyers.”[1]

Put simply, the government continues to spend more money that it receives from taxes. Since 2008 it has lowered interest rates to increase the money supply through fractional banking. It has bought its own debt (quantitative easing) as a way of pumping more money into the system. Now these strategies have run their course it has to raise interest rates on its bonds (debt) in order to attract investors to fund its spending. As Eric Voorhees put it in a recent Tweet: ”So amazing that people continue to lend money to bankrupt governments…”[2]

This may not be the end of the party, but the party will end. Back in 1976 economist F.A. Hayek wrote a short paper call “Choice in Currency, a Way to Stop Inflation”.[3] In it he prophetically argued for a choice of currencies to prevent governments continuing to debase their own. With competing currencies people could choose the currencies they trusted not to lose value through the inflationary practise of printing more money. Hayek points out that only during the two hundred years of the gold standard (in Britain from about 1714 to 1914, and in the United States from about 1749 to 1939) were prices at the end the same as they were at the beginning. In every other period of history governments have progressively destroyed the currency by being unable to resist printing more.

Hayek’s historical analysis gives perspective to the current state of the fiat financial system — collapse may be tomorrow and it may be later, but the fundamentals have not changed. Governments continue to live beyond their means and at some point people lose belief.

The problem with the debasement of the fiat system is that most investments are linked to that system. Diversification is the cornerstone of any prudent investment strategy but where do you go to avoid the risks of the fiat financial system? Stock, bonds, commodities and tracker funds such as the S&P500 are all part of the system. Even property is denominated in fiat currency and property prices are closely connected with the expansion of money supply (the money has to go somewhere).

Traditionally gold has been the fiat-alternative. However gold prices are heavily manipulated and kept artificially low with the use of gold futures and other derivatives — themselves products of the fiat system.

So where does smart money go to diversify away from the risks of the fiat financial system?

Last week David Swensen, known as Yale’s “Warren Buffett” because of his investing success with the university’s $29.4 billion endowment fund, invested in two funds dedicated to crypto currencies.[4]

[1] https://www.zerohedge.com/news/2018-10-06/var-shock-back-global-bonds-lose-880-billion-one-week

[2] https://twitter.com/ErikVoorhees/status/1048982152665165829

[3] F.A. Hayek “Choice in Currency, a Way to Stop Inflation” printed in The Institute of Economic Affaires 1976.

[4] https://www.cnbc.com/2018/10/05/yale-investment-chief-david-swensen-jumps-into-crypto-with-bets-on-two-silicon-valley-funds.html?__source=sharebar|twitter&par=sharebar

David Swensen

Crypto currencies like Bitcoin, Litecoin, or Monero are not part of the fiat system. If the fiat system collapses tomorrow, as long as the Internet remains, these currencies will survive. Second, most crypto-currencies are capped — there is a fixed limit to the number to coins that can be generated. The cap prevents inflation, the destructive addiction of governments. Because of these two features crypto-currencies represent the kind of diversification away from the risks of the fiat system that smart investors seek.

David Swensen is not the only investor seeking this diversification. This year other institutional investors have been increasing their holding in Bitcoin using the Over the Counter (OTC) market to buy more of the coin than the exchanges can offer.

“Hedge funds have recently made some financial history, pushing ahead of the individuals with the high net worth that has predominantly ruled the industry. In private transactions, institutional investors are getting involved at around $100,000 worth of Bitcoin and other digital assets, according to the global head of trading at Cumberland, Bobby Cho.”[1]

However the financial discipline of crypto-currencies in limiting the supply of coins may create problems for the intelligent investor. Bitcoin will only ever have 21 million coins. When these are sold where will the investor go?

The project I work with, Bitcoin Enhanced, hopes to solve this problem. It is the first of a new class of blockchain token to provide investment-like returns with zero exposure to the risks of the fiat financial system. Token sales go live in December but interest parties can register on the website https://bitcoinenhanced.io/.

The way Bitcoin Enhanced works is that it derives its value not by underlying assets but by the belief of participants in the token. Belief, or perception of value, is the mechanism that gives every fiat and crypto currency its worth. Bitcoin Enhanced is the first to apply a currency’s method of establishing value to an investment-like product.

This lack of underlying assets enables Bitcoin Enhanced tokens to remain, like their crypto-currency counterparts, outside the fiat system. No brokers or financial instruments are required for the token to operate. Like Bitcoin, the value of the token would be unaffected by crisis in the fiat system.

Two tokens will be available in December each with a fixed supply of 4 million. This gives investors another opportunity to diversify away from the risks that, as Hayek pointed out 40 years ago, are inherent in the fiat system.

Today’s new headlines are really nothing more than enduring fundamentals: governments debase their currencies by spending more than they earn and diversification is the soundest way to spread risk. The headlines may change but the fundamentals endure. Smart money knows that.

[1] https://bitcoinexchangeguide.com/institutional-crypto-investors-are-sneaking-into-bitcoin-industry-via-otc-trading/