Noelle Acheson is a veteran of company analysis and CoinDesk’s director of research. The opinions expressed in this article are the author’s own.
The following article originally appeared in Institutional Crypto by CoinDesk, a weekly newsletter focused on institutional investment in crypto assets. Sign up for free here.
After the market storms of the past couple of weeks, we could all use some (relatively) good news. And it’s this: Storms bring destruction but also clarity.
As I write, bitcoin (BTC) is bouncing, but who knows what wild swings it will have gone through by the time this is published? So, bitcoin’s price is not where to look for clarity now. It’s more existential than that.
Out of the chaos of the last couple of weeks, in which everything moved together, a clearer distinction has emerged between asset classes.
Greater clarity itself may be good news, but what we’re seeing is not.
Let’s walk through the new fundamentals.
Come rain or shine
First, equities: Expected earnings are down across the board, possibly by a whopping amount. A couple of weeks ago, in the U.S. and Europe, business was humming along, albeit with trepidation. Now, bars and restaurants are closed in many population centers, events have been cancelled, shops are shut, planes are grounded…. The list of sectors impacted by the necessary virus precautions is long and alarming.
Next, government bonds: If there’s one thing the bond market hates, it’s inflation. The unwinding of globalization as a result of constricting supply chains will push up manufacturing costs which will feed through to prices. Liberally sprinkle money around the system in the hopes of stimulating spending, in a supply crisis, and you add to the inflationary pressure. Nominal yields on public debt are at historically low levels; inflation will push even more real yields into negative territory.
As for corporate bonds, the sharp drop in earnings coupled with increasing costs could trigger a wave of defaults.
What about gold? The traditional safe haven will probably do well in the medium term as investors remember its anti-inflationary properties. Gold traditionally outperforms in low-rate environments – no shortage of those these days. Plus, its lack of income makes it less vulnerable to drops in economic activity.
And then there’s bitcoin. Its high volatility makes it unsuitable for many investors. But those who think gold makes sense in this world gone mad are most likely going to take a closer look, especially after the perspective-changing storm we’ve just weathered (with probably more to come). Even those skeptical of gold’s place in a diversified portfolio are bound to be curious about a digital alternative that solves for some of the metal’s weak points while revealing relationships with the broader economy that no other asset has.
For those worried about inflation, bitcoin is even more resistant than gold. Its hard cap and pre-programmed supply are immune to fluctuations in price. A sharp jump in the price of gold, however, is likely to bring more supply onto the market as production ramps up, and could even impact the estimated supply limit as alternative mining methods become profitable.
For those worried about a sharp economic slump, bitcoin is practically the only asset not directly impacted by macroeconomics. There’s no income to cut and no supply chains to hinder access. External factors such as energy costs and supply chains can impact miner economics, but bitcoin itself adjusts for shifts in the maintenance of its network. When miners close down, bitcoin becomes cheaper to mine, which eventually makes the enterprise profitable again.
Save it for a rainy day
What makes bitcoin even more of a unique asset class is it can be indirectly impacted by macroeconomics, in a big way. The impact will come from many vectors, but especially loose monetary policy, the currency markets, emerging economies and populist tendencies.
1) Loose monetary policy: With central banks around the world hitting the markets with whatever they can, money supply constraints have been thrown out the window. As this crisis unfolds, the amount of money that will enter the system to help out not only markets but also citizens and companies will dwarf what we saw in 2008. Back then, the markets were threatening to drive the economy into a wall, so reassuring them was paramount. Now the threat to the economy is driving markets into the wall. The usual tactics that assuage market panics aren’t going to stimulate demand that is reeling from mandated shutdowns, job losses and generalized fear.
Printing money could perhaps help if it actually gets into the hands of the consumers, but that will create inflationary pressure in an economy with no tools left to fight it. The usual anti-inflation weapon is raising interest rates – but doing that in a heavily indebted environment could trigger waves of corporate and even sovereign defaults.
Growing inflationary pressures and steady currency debasement will most likely increase interest in disinflationary assets such as bitcoin and gold that can also be used for payment in some circumstances.
2) Currency markets: Investors around the world are fleeing into dollars, pushing up its value relative to other currencies. This could help the U.S. consumer by making imports cheaper, if imports weren’t disrupted by supply chain constrictions. But with a stronger dollar, U.S. manufacturing will become uncompetitive, and foreign holders of dollar-denominated debt could get pushed into default. Other countries' import and debt service costs will skyrocket, weakening their currencies and pushing up the dollar even further.
The ballooning demand for dollars could lead to a currency liquidity crunch – the swap lines extended to foreign central banks in last Sunday’s Fed intervention were expanded even further on Thursday, a worrying sign that the initial measure wasn’t enough to relieve the strain on the FX markets.
Calls are growing for concerted action similar to the 1985 Plaza Accord, but getting economic powers to follow the lead of an “America First” government whose leader based much of his campaign on promises of a wall is going to be a much harder challenge than in the post-stagflation desperation of the late 20th century.
With fractures in the global currency order becoming increasingly apparent, economists and investors will be asking what the next monetary order will look like. Bitcoin may or may not be part of that solution but it is a new tool in the box.
3) Emerging economies: The sharp escalation of dollar-based prices, combined with a demand crunch, could push non-dollar economies into recession, which is likely to lead to social unrest. In some parts of the world, this could be met with swift retaliation or even regime change. The confiscatory bias of political parties navigating a power struggle could intensify interest in a liquid and semi-private store of value.
4) Populist tendencies: While more established democracies will deal with recessions and social unrest through negotiations and trade-offs, even they could veer towards populist tendencies. These will most likely take the form of additional support for overwrought health systems, as well as for citizens and companies hit hard by mandated shutdowns and resulting slump in demand.
To keep up the pretence of balanced budgets, this support is likely to be paid for through fiscal policy, which means tax increases. While bitcoin should never be used to avoid taxes (never, ok?), investors in some jurisdictions may feel that the risk of stiff penalties when caught is worth it.
But more importantly, fiscal measures are generally more lenient on capital gains than on high incomes, in the spirit of encouraging investment. This could push high-net-worth individuals towards assets with a high risk-return profile.
In a market where everything goes up, the resulting dust can blur big-picture vision. After a drenching storm there is damage, but the dust is gone. Edges are sharper and colors are more vibrant. To stretch a metaphor even further, maybe the sun won’t be out for a while, but as we look anew at previously held assumptions, it is likely investors around the world will see in bitcoin attributes that until now have not been so important.
This is not investment advice, obviously, and all investors work under different risk-return parameters. It is a reminder that we should all question assumptions, get informed, ask different questions and think things through. And now is a better time to do that than ever before.
Disclosure: Nothing in this newsletter should be taken as investment advice. The author is a long-term holder of a small amount of bitcoin and ether. Her opinions are her own and do not necessarily reflect those of CoinDesk.
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