Redefining Bitcoin post COVID-19: A Macroeconomic Perspective
COVID-19 has impacted every economy on the globe, tanking stocks and sending financial institutions and governments scrambling to hold back the tide. In this article, we summarise the macroeconomic factors in a post COVID-19 era, and the role of Bitcoin in this new age.
Quantitative Easing (QE)
From Vietnam to Latin America, QE measures have been implemented by governments around the world in response to the pandemic. This monetary policy is characterised by the purchase of longer-term securities from the open market by the central bank in order to increase the supply of money. An example is the announcement of $700 billion worth of asset purchases by the US Federal Reserve in March 2020.
Purchase programs inject money and increase the amount of usable funds in the financial system. By increasing the supply of money, commercial banks and other financial institutions are more able to reduce interest rates due to the influx of “cheap” money, which in turn encourages businesses and consumers to borrow more and thus spend more, stimulating demand and enabling economic recovery.
Interest Rates
The Federal Reserve also announced interest rate cuts as the pandemic worsened. The intended purpose of this is to stimulate borrowing and create domestic demand, given that heightened transnational boundaries today have limited global trade and interactions. Some countries such as the United Kingdom have even issued negative-yield bonds. These results in even lower interest rates that supposedly promote borrowing and spending.
However, while lower yields incentivise borrowing, it also disincentives savings. In theory, this increases domestic consumption which can be beneficial to keep the world’s economies running. However, this exacerbates economic inequality, where the at-risk population of pensioners and low-income households will be less able to accumulate wealth, especially since lower rates do not directly translate into higher wages, especially given the current climate.
The extreme position of negative interest rates can backfire even more severely. For financial institutions, negative interest rates increase default risk, and squeeze their profit margins, discouraging lending activities. Negative interest rates also encourage physical handling of cash by individuals, reducing deposit levels with banks. As such, negative interest rates may not succeed as a monetary policy in the long run.
Growing Global Debt
As of September 2019, total worldwide debt represented $253 trillion (Amaro, 2020), boosted mainly by higher borrowing by governments and financial corporates. Low interest rates in many countries have also further increased the attractiveness of debt as a financing model, especially for businesses at risk and facing cash flow problems.
With the expected increase in global debt and the relatively lower costs incurred, default risk has increased extensively as debt financing has been undertaken for increasingly risky ventures. The IMF cautioned that 40% of corporate debt as of June 2019 (Schroeder, 2019) were at risk of default. With COVID-19 exposing the vulnerabilities of many industries to potential defaults, increases in provisions for loan losses have had to be made. Locally, DBS Q1 2020 profits have dropped by 29% after taking into account an increased exposure to loan default risk.
Inflation
Quantitative easing can cause higher than desired inflation if these expansive measures turn out to be excessive in the long run on the road to recovery. Another factor is the negative effect of the pandemic on supply chains, where increased costs or supply shortages could also result in general price increases for consumers.
As unemployment rises and real wage growth stagnates, inflation will gradually erode the purchasing power of consumers in a post-COVID-19 world, especially for those at the lower end of the economic spectrum. The value of savings would also gradually decrease in real terms. Uncertainty over future inflation rates could also discourage foreign investment in the countries most affected by inflation.
The case of Bitcoin
The Covid-19 pandemic has also sent investors scrambling for “safe-haven” assets. For centuries, gold has been the traditional safe haven in times of crisis. We previously compared gold and bitcoin as investment options in an earlier article. Yet bitcoin could potentially be the next big bet for investors.
The conception of bitcoin as an inflation hedge may appear dubious at first class. Bitcoin remains a volatile asset class that may spook traditional investors. Yet in the face of unprecedented expansionary monetary policies, bitcoin’s scarcity as quantified in the stock-flow model positions it as a potential hedge against negative bond yields.
The key tenet here is that bitcoin’s value is less exposed to macroeconomic factors such as inflation and interest rates. Bitcoin’s value is typically affected by two factors: the scarcity brought about by the limited supply of 21 million bitcoins and market speculation over the value of bitcoin. Bitcoin’s annualised inflation rate for 2020 is expected to be 1.8%, much lower than the global inflation rate.
Historically, the price of bitcoin has been weakly correlated with market trends. The correlation between the S&P 500 and Bitcoin has hovered between -0.2 and 0.3. This further reinforces that bitcoin is less susceptible to market-wide macroeconomic factors, hence presenting a case for its potential as a hedge.
Critics may point to the COVID-19 pandemic, during which the correlation peaked at 0.6 when bitcoin lost half its value during the March 2020 crash. This anomaly raised concerns over the value of bitcoin as a hedge. However, a theory for this anomaly is that many investors had to liquidate their positions in other asset classes, pushing down prices having received margin calls on their non-cryptocurrency positions. This is corroborated by Bitcoin swiftly recovering this month to its pre-pandemic heights.
In conclusion, the macroeconomic landscape for the next few years remains volatile and uncertain. In the long run, as home-based learning and workplaces become predominant, a generic trend of digitization is set to favour proponents of bitcoin. For investors, the time is perfect to explore new asset classes in consideration of the longer-term implications of COVID-19.
Sources:
https://www.thebalance.com/what-is-quantitative-easing-definition-and-explanation-3305881
https://business.financialpost.com/news/economy/imf-heightens-warnings-on-corporate-debt-following-central-bank-cuts-2
https://tradingeconomics.com/united-states/interest-rate
https://www.cnbc.com/2020/01/14/global-debt-hits-all-time-high-of-nearly-253-dollars--iif-says.html
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