Crypto is Easy, Issue #2 (April 2020): Financial Crisis and Bitcoin - Where We Stand Now
|Apr 8, 2020||5||3|
“There are decades where nothing happens, and there are weeks where decades happen.”
We have had a few of those weeks. While the world’s financial system teeters on the edge of collapse and deflationary depression, the cryptosphere is hyping bitcoin as a way to capitalize on the inflation from all the money governments are printing in response.
Talk about contrast.
I am not ready to look that far ahead. First, the world’s financial system needs to survive long enough for all that money to cause inflation. Then, bitcoin needs to survive long enough for the rest of the world to care about it.
Of all the things that keep me up at night, bitcoin is not one of them. I have my plan, it’s based on eleven years of human behavior, and I know what to do if it doesn’t work out. I will always keep you posted on any noteworthy developments and meaningful signals in Crypto is Easy.
Do you know what really worries me?
Namely, the collapse of debt markets. Read below for my thoughts on bitcoin, fiat, stocks, and debt markets.
Bitcoin: insulated from the chaos
Of all assets, bitcoin (and crypto as a whole) will probably suffer the least.
First, it’s a tiny, insignificant market. At $100 billion, bitcoin’s entire market cap is less than 1% of the S&P 500. Apple has enough cash on its books to buy every satoshi on earth (with money to spare).
Second, bitcoin’s price movements are not correlated to those of any other assets. It does not move in sync with stocks, bonds, commodities, or other investment assets. While some people say it’s correlated to the stock market now, there is no meaningful data to suggest that. Correlation is a statistical concept, not something you can see from looking at lines on a chart. You can’t compare six weeks of price movement and conclude it’s correlated. Did you know every warm day between March 1 - April 5, bitcoin’s price went down? How’s that for correlation? It’s sunny and beautiful as I write this—CRASH COMING?!?!?!?
Third, almost nobody cares about bitcoin. From conversations I’ve had with people in the money management space, most “institutional investors” have put no money into the markets. Of those that have any bitcoin, they’ve set aside a relatively small portion of their portfolios into it—enough to boost their portfolios if bitcoin succeeds, not enough to hurt their portfolios if it fails. Some of them undoubtedly sold a chunk of their position during the March 2020 crash, based on the research I showed you last month.
Fourth, bitcoiners tend to have more wealth and financial savvy than your average person. They’re also younger, on average. Many surveys and reports from exchanges show this. These are exactly the types of people who will suffer the least during the coming economic downturn.
When bitcoin’s price dropped in March, exchanges saw a flood of new money coming in. Over the next weeks, that money moved to private wallets. As I mentioned in an earlier update, HODL waves showed bitcoins flowing from people who bought in late 2018 - early 2019 to new wallets and OG wallets. This signals strength.
Thankfully, bitcoin is not a mainstream asset. It’s insulated from the turbulence. But if it can weather this storm, it will prove it deserves a place in mainstream portfolios.
Fiat: demand for stablecoins will boost crypto
Also, the recent financial panic drove many people into stablecoins like USDT, DAI, USDC, etc. For example, USDC market cap went up 50% in March. USDT spiked 35% from $4.5 billion to $6 billion.
Do you know why my recent airdrop opportunity, Linen App, slashed its payout? Because Compound, the platform it supports, saw tons of money pour into it last month. Linen no longer needs to raise interest rates to attract U.S. depositors—people from all over the world are pouring capital into its platform without those extra incentives.
Why are people buying stablecoins?
Everybody wants dollars, and it’s a lot easier for Asians and Africans to get USD-denominated stablecoins than actual dollars.
Also, some people prefer stablecoins. You can always access them—a nice assurance for anybody scared their banks will freeze withdrawals or fail outright.
While this stablecoin money has not flowed into bitcoin or alts yet, you can expect at least some of it will.
Stock market: not as big as deal as people think
Oddly enough, stocks do not correlate strongly to economic recessions and depressions. Sometimes, the stock market crashes before a recession, sometimes not. Sometimes the stock market booms during a recession, sometimes not.
Recessions come when production and revenue fall. In other words, when real business activity declines.
Stock markets do not reflect real business activity. Rather, they let investors speculate on the future success of the businesses that list on stock exchanges. Prices reflect confidence in the future.
Right now, according to people I know and the trade rags that cover financial markets, corporations have started selling shares and refinancing debt to include corporate assets like stock as collateral. While this should depress stock prices in the short-run, it’s a good thing for the long-term health of the market.
Does this mean the stock market will rebound immediately? Corporations won’t go out of business?
No. Stock prices will go down or stay roughly flat as businesses sell their shares into a weak market and investors stay on the sidelines.
You can expect investor confidence, corporate profits, and passive investment from workers to drop as the crisis deepens. How much and with what result?
Nobody really knows. “Expert” projections vary widely.
It’s the overall financial situation, not the stock market itself, that you need to worry about.
Specifically, the debt markets.
Debt markets: worry now
Debt markets matter more than stock markets.
These complicated, opaque markets hold trillions of dollars worth of corporate, government, and household debt, plus all the derivative financial products based on that debt.
On top of about $100 trillion in government debt, the world has at least $200 trillion corporate and household debt, plus at least $400 trillion in financial products that depend on everybody repaying their IOUs.
It’s a $700 trillion market.
(Possibly as much as $1 quadrillion.)
That’s a lot of debt, and that’s where the real trouble lies. China has an entire shadow banking system that’s largely unregulated while Europe’s banks have had trouble raising cash for a while.
While I will touch on some of that below, I’m going to focus mostly on the U.S. situation because it’s what I know about. Besides, the U.S. financial system drives everything else. You need to know about it.
Here are the problems I see (btw this is not an exhaustive list).
Many companies don’t make enough money to pay their debts.
So-called zombie companies have used cheap credit to raise cash and buy-back their own stocks without boosting revenue. On the surface, this makes their balance sheet look ok. The problem is, without revenue, these companies can’t survive without selling more equity or taking out more loans.
Now that economies have started shrinking, who’s going to put money into these businesses? Why would banks and investors put money into a crappy business that can’t make money instead of a business that’s lean and primed for growth? Even if they wanted to do so, where will that money come from?
If you’re really wonky, read “LEVERAGED LENDING AND CORPORATE BORROWING: Increased Reliance on Capital Markets, With Important Bank Links.” This report from U.S. FDIC, the quasi-governmental entity that insures bank deposits, warned about excessive corporate debt months ago.
Essentially, we have lots of big corporations with worse finances than your average start-up firm—lots of debt and cash but not enough revenue to survive without somebody else pumping money into them.
Now, nobody wants to pump money into them.
Banks running out of money
Banks occasionally end the day short on cash. When this happens, the U.S. Federal Reserve lends them money to balance the books and settle their accounts. The banks send the money back to the Fed the next day.
Normally, this is no worry. Banks have money coming and going all the time, it’s impossible for every bank to always have enough money to settle every account.
Last year, the Fed opened a $400 billion lifeline to banks that fell short of their daily balance requirements. That’s a lot of money. AND it was an open-ended program.
So, either lots of small banks or one/two large banks ran out of money.
Yes, that’s right. RAN OUT OF MONEY.
That is the only reason for the Fed to keep this lifeline so large and open-ended. As I asked on Twitter for months, why are banks running out of money after ten years of economic boom and record profits?
The Fed still has that lifeline open, with one change.
Instead of capping the lifeline at $400 billion, it removed all limits.
Last week, a West Virginia bank failed. How many more will follow?
Commercial rents drying up
With so many businesses on lockdown across the world, commercial landlords have had a terrible time collecting rent. They need this rent to pay their mortgages and construction loans, as well as any other financing for which their property is collateral.
(On top of their normal expenses.)
Without rent, commercial landlords can’t pay their lenders. As a result, the lenders can’t recycle their payments into new loans.
Credit markets have already started to freeze.
Sovereign debt markets still out-of-whack
Every big government has record budget deficits. It’s been this way for a long time, but for the most part, those debts followed a rational pattern: governments issue debt, investors buy debt, governments settle those debts, investors make money, investors buy more debt.
This system works because investors mostly believe governments will not default on their debts and many countries have grown fast enough to justify that belief. It’s why all the major economies can borrow essentially at-will—they only have to worry about losing investors to other countries that offer more attractive rates.
Last year, that whole dynamic changed.
Globally, negative-yield bonds reached a mind-boggling $15 trillion. Investors essentially paid governments to hold their money.
In October, U.S. treasuries saw an inverted yield curve, which suggests investors wanted to pay more for riskier, long-term debt than safer, short-term debt.
To boot, the U.S. Federal Reserve recently promised to backstop foreign debt defaults. This signals a G7 country is worried it will default on its debt, or perhaps the G7 countries worry about a default by some other big country with large debt obligations to the G7.
On March 25, 2020, rates on short-term U.S. government debt briefly dropped below zero. Investors worried so much about the value of other governments’ bonds that they took short-term losses to avoid exposing their wealth to foreign governments’ debt obligations.
Now, Southern European countries have started negotiating with Northern European countries on new “Coronavirus bonds.” Why do Italy, Spain, and the rest of the south need their northern neighbors cosign their loans? If Northern European countries really believe Italy and Spain can repay their debts, why don’t they sign on?
None of this is normal.
Derivatives at risk of margin calls
In normal times, derivatives hedge risks. They’re a form of market insurance, though some traders use them as speculative investment vehicles.
Often, businesses and traders borrow money to buy derivatives using margin accounts, a sort of credit account. As a result, they can cover the risks of market disruption or price spikes/crashes without spending too much money.
As long as the price of the underlying assets stay reasonably predictable, this isn’t a problem. For massively volatile assets, volatility gets priced in. For stable assets, stability gets priced in.
When markets went crazy last month, it sent the whole system off-kilter. Normal valuations fell apart. As a result, many businesses and traders could not cover shortfalls in their margin accounts. They had to either raise cash or sell their assets. Some analysts speculate these margin calls led to last month’s near-universal sell-off in literally every investment asset except U.S. dollars.
If this financial crunch continues, even “safe” assets like bonds, collateralized debt, and maybe even USD will get crushed as borrowers are forced to sell their positions to cover their loans.
Up to this point, the residential mortgage industry has not felt any ill-effects, at least in the U.S.—but everybody expects it will soon.
When homeowners lose their jobs and businesses, they can’t pay their mortgages. When renters lose their jobs and businesses, they can’t pay rent to their landlords, many of whom have their own mortgages (and lots of other costs involved in residential property management).
On top of that, real estate finance is incredibly complicated with many moving parts. For example, the Fed can bail out borrowers but mortgage companies would still be on the hook for making payments to investors who hold mortgage-backed securities. Propping up one part of the market could destroy another part of the market. It’s very vulnerable to butterfly effects.
U.S. government has taken extreme measures to backstop the mortgage industry with pass-through assistance, a new forbearance program, and a scheme to advance servicers the cost of missing payments.
Is it enough? Can the Fed implement these programs in a way that balances all the competing financial needs of all the different players?
We’ll see. My mortgage broker tells me lenders have started pulling out of some of these programs because they expect a wave of foreclosures this year . . .
Emerging markets on edge
Many developing countries, aka emerging markets, depend on Chinese investment and debt denominated in U.S. dollars.
Why would they take Chinese investment?
Because China gives them a sweet deal, often build infrastructure and technology at little or no cost. In return, China asks for their loyalty and a quasi-monopoly on trade.
Why do they repay their debts in U.S. dollars?
Because their creditors demand it. Investors worry emerging market currencies will lose too much of their value.
This explanation simplifies a more complicated situation, but it’s good enough for this post.
Why does this matter?
As the dollar rises in value, these countries find it harder to repay their debts. It costs them more of their own currency to buy dollars. As a result, they need to either make more money or sell more dollar-denominated goods like corn, oil, soybeans, etc.
You can see the problem, right?
If they all spend their currency for dollars, that will raise the price of the dollar while depleting their currency reserves. As a result, they will need even more of their own currency to buy more dollars at a higher price—and where will they get more money?
They could raise taxes and implement austerity programs, but these things will crush their economy and make their people really mad.
Alternatively, they could also simply print more money, but perpetuates the downward spiral. This approach led Germany to hyperinflation after WWI (its debt was denominated in gold not dollars, but with the same effect).
In other words, they have to either kill their economy or inflate their money out of existence.
Why don’t these developing nations produce more goods denominated in dollars or export more products intended for U.S. markets?
Because they worry about how China will respond. Besides, what happens if the U.S. uses tariffs and trade restrictions to shut foreign goods out of U.S. markets?
Hope and prayers
We don’t know how significant or extreme any of these problems are.
While all these problems have solutions, implementing and coordinating them is a delicate balancing act. Walking the tight rope.
Central banks are bailing out everybody they can while governments throw money at people. It’s all designed to keep the world’s economies afloat while everybody ramps up medical countermeasures to Coronavirus.
Somebody called this nationalizing the financial markets.
That’s basically what’s going on—governments and central banks are using public funds to buy trillions of dollars worth of debt and rig the markets until humanity has the capacity to treat people infected with COVID-19.
While this creates all sorts of moral hazards and unintended consequences, consider the alternative: pandemic disease, financial ruin, and widespread death all at once. At least with this intervention, they stand a chance of tackling each crisis one at a time.
The question now is what comes first: a collapse of the debt markets or the end of the pandemic.
Let’s hope for the latter and pray that when the time comes, we can all recover.
How this relates to bitcoin
The global financial system is having a heart attack. It doesn’t have enough money to pay for the surgery. Governments have agreed to save the patient now, then deal with the money problems later.
Meanwhile, everybody will suffer. You, me, and those we love. Every asset will see volatility in the coming months. Bailouts and defaults will make people really, really mad. At least one government will probably need IMF intervention. China or Italy might implode (hopefully not). It will get worse before it gets better.
Worse than 2008? Worse than 1929? Worse than 1873?
I wish I knew. There’s no reason to believe things have to get that bad or last that long. Even if some things go wrong, the world’s financial systems will probably be ok (mostly).
We just need to HODL tight, use bitcoin as we need to, and stack a few sats when we have money to spare. Bitcoin might serve as the backbone for a new financial system that doesn’t depend on any of the things people will grow to hate over the next year or two (namely, governments, banks, corporations). DeFi and payment platforms may soon have their time in the sun.
They’re not ready yet, but they’ll have to be.
If you saw my plan for the bull market, I’d love your feedback. As I said, it’s hard to explain it in a way that’s easy to understand. So, I’m working on that, with your input.
Tough times all around right now. Of all the things to worry about, worry about your friends, your family, and yourself.
When it comes to bitcoin, relax and enjoy the ride.