Macro Risk, Bitcoin And The Safe Haven Asset Narrative
By Philip Hoeller on ALTCOIN MAGAZINE
When Confucius was asked 2,500 years ago what a ruler needed to govern a country, he said credit, faith, or sincerity, food, and an army.
But if he could only have one, it would be the first.
Today, US dollars are backed by the full faith and credit of the United States Government. Before that, they were backed by gold, and other currencies were in turn pegged to the US dollar.
The Bretton Woods agreement governed global exchange rates from 1944 until it was ended by President Nixon in 1971, effectively abolishing the gold standard. Ever since, the US Treasury has the ability to print practically limitless amounts of money (in the form of global reserve currency, no less).
Since the financial crisis of 2008 (which gave rise to Bitcoin), US monetary policy has been defined by low interest rates (cheap to borrow money) and quantitative easing (aka QE, which involves injecting money directly into the economy by printing it and buying treasury bonds. This is most beneficial to those closest to the money spigot, such as banks).
This “easy money” environment led to a long period of growth starting in 2008, which some argue has already distorted asset prices. The Trump Administration’s tax cuts have since fueled additional price level increases by enabling businesses to buy back their own shares (which unlike investing in research and development doesn’t actually create underlying value). This sparked fears of an overheating economy which is usually counteracted by raising interest rates (which makes borrowing money more expensive and slows down economic activity).
When Jerome Powell (Federal Reserve Chairman nominated by Trump in February 2018) began modestly raising rates in March 2018, Trump publicly berated and pressured him to reverse course, challenging the notion of central bank independence. Rates are now set to be cut again at the end of July, which echoes other late-stage “hail mary” interest rate cuts which have preceded recessions in the past.
In Buddhist philosophy, one thing is known for certain: What goes up, must come down.
Over the last decade, we’ve witnessed the longest bull run in economic history. Are we in an economic bubble? When will it burst? What could trigger another downturn?
The sharp 20% sell-off in stock markets that began late in Q4 of 2018 revealed major, latent volatility and a harshly polarized sentiment on future prospects. Apparent perma-bulls argue there is still room to grow, while money managers such as PIMCO’s Scott Mather are worried about declining corporate debt quality: “We have probably the riskiest credit market that we have ever had.’’ [1]
The precarious recent “truce” in the trade war with China has traders wary of Brexit burdened with even more uncertainty. It is clear that momentum in this late stage business cycle will inevitably turn and key indicators are already flashing red:
In April 2019, the so called yield curve inverted for the first time since 2007. It is used to measure bond investors’ outlook on risk. An inverted yield curve indicates markets have more confidence in the (less predictable and generally riskier, thus higher yielding) long term than they do in the short term and an inversion has preceded every recession since 1971. Meanwhile, Europe is experimenting with negative interest rates, which shows investors are willing to lose money by parking it in relatively safe assets such as German bonds.
Many of these factors are combining to form what some have described as “A perfect storm brewing[2]” for Bitcoin, which has persisted against >80% draw-downs and established itself as a digitally native safe haven asset — offering relief from currency debasement, arbitrary censorship or stringent capital controls imposed by authoritarians. Bitcoin has proven valuable as a hedge against systemic risk [3] and since the hash rate[4] reached record highs in June 2019, the network (and the value of it’s immutable record) is more secure from attack than ever. Choosing not to consider any capital allocation is beginning to suggest neglect of fiduciary responsibility.
“Bitcoin’s history of positive returns and uncorrelated nature make it potential candidate for traditional portfolios. Despite its high volatility (81.5% annualized since January 2014), we find that adding a small portfolio allocation to Bitcoin (BTC) increases the overall expected return and improves a portfolio’s risk-adjusted returns (or Sharpe ratio).” [5]
Modern portfolio theory advocates diversification as a means to maximize returns and Bitcoin (as the highest performing asset class of the decade) presents an asymmetrical upside opportunity. In 10 volatile years, it amassed a $200 Billion market cap (too big to ignore, yet still economically insignificant). It’s up 150% since bottoming out at $3200 per coin in January and piercing through heavy psychological resistance at the $10,000 mark.
Over the last two years and since many declared it worthless or dead, Bitcoin has scaled, infrastructure has matured and reputable custody solutions have emerged. While fiduciaries across the globe face the prospect of negative interest rates, the algorithm governing bitcoin is set to halve the mining reward from 12.5 to 6.25 bitcoins per block on May 20th, 2020 — predictably and transparently throttling supply and diminishing inflation. To date, over 18 of 21 million BTC have already been mined and what ultimately matters in a capitalist society is determined by the laws of supply and demand.
Most would agree that gold is a safe haven asset, however it has not kept pace with the digital revolution and no longer deserves to hold this title uncontested. Gold cannot be sent over the internet. Large quantities need to be kept in vaults with armed guards and nobody knows how much of it really exists. Unlike the shiny metal, Bitcoin has a verifiable, hard cap supply with auditable provenance (a little known fact that actually benefits law enforcement, accountants and regulators — particularly relative to cash)
So, why is the gold market worth $7.7 Trillion? If Bitcoin continues to eat away at gold’s market share, the retail FOMO driven all-time-high of $19,783.21 (December 2017) is likely to be eclipsed by institutional FOMO as the $200 million Bitcoin market cap approaches the same order of magnitude as gold. At the end of the day, both assets are only as strong as their narratives and the buy-in these generate with people on an individual level.
The idea that stores-of-value, like commodities, should compete on the open market is one of the tenets of Austrian School economist Ludwig Von Mises and the basis of ‘sound money’[6] which also emphasizes the natural and subjective nature of price discovery on the open market (which is exactly what we are witnessing). Large institutions led by the likes of Facebook and Fidelity are getting into the game and the public is paying attention.
Does anyone know where markets are headed? No. Yet the case for Bitcoin is stronger than ever — especially considering the wider economic and political risk factors currently shaping global monetary policy. If you want to step outside the box of systemic risk and plant a foot in the world of decentralized, non- sovereign money — then you probably already know it might be time to #getoffzero.
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[1] https://www.bloomberg.com/news/articles/2019-05-29/credit-market-probably-the-riskiest-ever-pimco-s-mather-says Credit Market ‘Probably the Riskiest Ever,’ Pimco’s Mather Says, May 29, 2019 by James Crombie and Jonathan Ferro
[2] Such as by Anthony Pompliano on May 30th, 2019 at Off the Chain: https://offthechain.substack.com/p/the-perfect-storm-for-bitcoin-is
[3] https://finance.yahoo.com/news/china-state-run-media-agency-140632653.html
[4] The term hash rate refers to the speed of completing an operation on the blockchain. In other words, it refers to how much computing power miners lend to network. At the end of June that equated to a mind-blowing 68,638,992 trillion hashes per second.
[5] From Galaxy Digital Global Research: https://medium.com/galaxy-digital-global-research/a-modern-portfolio-theory-case-for-bitcoin-c6d6ba609efa
