zaterdag 27 mei 2017

Paul Brodsky; On Gold, Dollars And Bitcoin

We have been bullish on gold, the barbarous relic; King Dollar, the modern hegemon; and Bitcoin, the crypto currency investors love to hate. One might say our feet have been planted firmly in the past, present and future. (We may not have three feet, but let’s go with it.) Are we hedging our bets, being too cute by half, or is there a cogent rationale that unifies bullishness for money forms most would consider incongruous and at-odds with each other? The short answer is we like:
1) gold, because central banks around the world own it and are buying more, ostensibly to devalue their fiat currencies against it someday, after they are forced to hyper-inflate in order to reduce the burden of systemic debt service and repayment;
2) the dollar, because dollar-denominated financial markets are broader and deeper than any other market and because the Fed is years ahead of other major central banks when it comes to normalizing policy and maintaining bank solvency (other fiats are in worse shape), and;
3) Bitcoin, the borderless digital currency that is already being perceived as a better store of value than gold and all fiat currencies, and potentially a more expedient means of exchange too.
# All three should win in different ways. It may be easier to accept this discussion by first reminding one’s self that monetary regimes come and go every fifty years or so. The last transition was in 1971 and the world is due for another. We have a high level of conviction that the evanescence of the current global monetary system is rooted in sound economics and already has been firmly established. A global monetary reset is necessary and likely. To understand why we must break down money into its two main components: a means of exchange and a store of value. When it comes to using money in exchange for goods and services, fiat currencies have it all over gold and crypto currencies presently. That’s because governments demand taxes be paid with their fiat currencies (legal tender), forcing producers and labor to demand compensation in those currencies. As a result, banking, payment systems and all goods and service channels are set up to use fiat-sponsored currencies. When it comes to a store of value, however, the factors of production may choose to save in whatever form of money they want. If the general perception is that government-sponsored, bank system-created fiat currencies will have to be greatly diluted in the future so that systemic debts can be serviced and repaid, then savers will migrate to money forms with capped floats, like gold and Bitcoin....


Prior to 1971, if a major government-sponsored currency was threatened with dilution, global sovereigns and savers and producers would exchange that currency for gold at a fixed exchange rate to the dollar. Or, they could simply exchange that currency for another currency less likely to be diluted. In the current regime, all economies are highly levered and all fiat currencies must be greatly diluted in the future. It comes down to timing and we think the US dollar is the best positioned of all major fiat currencies. That said, it will eventually have to be diluted too and will lose value in gold and Bitcoin terms. As mentioned above, gold is still owned by the world’s major treasury ministries and central banks. (In fact, it is effectively the only asset on the Fed’s balance sheet that is not someone else’s liability.) If US or global economic growth were to fall enough, or contract, and central bank monetary and credit policies were to fail to stimulate positive growth, then the value of all outstanding sovereign, household and corporate debt (and bank and bondholder assets) would become stressed.
The Fed would have no choice but to devalue dollars against its other asset, gold. Other central banks would either follow suit or go along with a coordinated plan to fix their currencies to the dollar (a new Bretton-Woods agreement). If this were to happen the price of gold in dollar terms would rise by as much as five to ten times current levels, in our view. (We arrive at this magnitude of change by taking the level of bank assets needed to be reserved and then using the Bretton Woods formula for currency valuation, base money divided by gold holdings.) The new gold price would reflect a level at which gold holders would be willing to exchange their gold for the diluting currency. This dynamic is basically what happened in another form with US interest rates in 1980/1981. US treasury yields were forced higher by the Fed (22 percent to 15 percent along the inverted yield curve), a level at which trade partners like OPEC would accept dollars with a floating exchange rate.
# Finally, Bitcoin. The BTC/USD exchange rate has gotten a lot of notice lately because it has almost doubled in the last month (see chart below)...


To listen to financial media commentary, the extraordinary move must be the result of unsophisticated financial rubes looking to get rich quick on the latest tulip fad. We disagree. While the dollar price of BTC may drop significantly any time as it reflects people’s understanding of dynamic global economic and monetary conditions and of Bitcoin itself, we are highly confident the exchange rate will appreciate dramatically from current levels over time. To be sure, faith in the flexible exchange rate fiat monetary system remains strong in G7 economies and those that actively trade with them. But major currencies require continued faith in perpetual growth without recessions and that highly leveraged, irreconcilable balance sheets will never have to be diluted. Meanwhile, access to Bitcoin takes only internet connectivity, it is free to store, and there is no need to hide it traveling across borders.
Bitcoin, itself or as a proxy for all crypto currencies, is quickly becoming a more reliable and accessible store of value for 5 billion people across the world residing in economies without major currencies, strong central banks or stable pegs. The store-of-value benefit is beginning to make itself clear to wealth holders in developed economies too, those becoming aware of the need for future fiat currency inflation by monetary authorities. Those unfamiliar with crypto currencies tend to fear bubble bursting outcomes. While this fear is understandable given its newness, complexity, past volatile market action and lack of a central or sovereign regulator, it is not reality-based. Bitcoin cannot be successfully hacked due to its underlying block chain recordkeeping system, which documents every transaction and every sequential custodian in the chain (all anonymously to the world). No one can create Bitcoins outside its system or sell Bitcoins that do not exist. Further, Bitcoin’s float cannot be diluted without the express agreement of 51 percent of all Bitcoin holders. Bitcoins are widely dispersed across the world and there is no central authority with a political agenda.
It is inconceivable why Bitcoin holders would agree to being diluted anytime soon. At a $50 billion total market valuation, of which Bitcoin is about $30 billion, crypto currencies have almost incalculable appreciation potential vis-à-vis fiat currencies. They should gain significant market share for store of value purposes, and this could be sped up if payment systems adopt Bitcoin, Ethereum, Litecoin, or another crypto currency as a global means of exchange. After all, global fiat money amounts to nearly $100 trillion. Many of us who have toiled over the years as professional investors are deluded with the explicit or subconscious expectation that the perception of wealth and markets will someday revert to what they were five, ten or twenty years ago. They will not, in our view. Yes, this time IS different (as it always has been). Our money will change (as it always has). Given the highly leveraged state of the current monetary regime, the most dominant variable for future wealth maintenance and creation, in our view, may not be asset selection but rather money selection. Something to think about....