Everything is a Bubble

Thank you for joining us for this edition of the NovaBlock newsletter. Here, we explore the intersection of technology, finance, politics, and of course, the crypto asset space.

Earlier this month, art aficionados and emerging stars congregated in Miami Beach for the country’s premier art fair, Art Basel Miami Beach. The event brought together more than 4,000 artists and 269 leading international galleries from North America, Latin America, Europe, and Asia to display significant work from the “masters of Modern and contemporary art.”

One of the more notable art pieces in the show was a banana duct-taped to a wall. Two of these pieces sold for a staggering $120,000 each. Perhaps as a form of mockery or derision, one attendee made a statement by promptly removing the banana and eating it.

The fact this piece can sell for $120,000 is a reflection of our society and what we value.  Exceedingly, modern art is produced to make a statement, not as a skillful expression of aesthetics or the deliberate work of thousands of hours of human determination. Today’s modern art is the ultimate expression of easy money and high time preference. As long as there is a willing and gullible buyer, there is more than enough supply haphazardly duct-taped together to meet that demand.

In previous issues, I’ve written about the effects of cheap money on long term decision making and resource planning. High inflation induced by a greater quantity of money floating in the system erodes a currency’s value over time. In the near term, this can stimulate the economy encouraging consumers to purchase more today, but the practice has long term consequences by discouraging multi-year investments and savings. Alternatively, a system based on a hard-money asset rewards patience and discipline, discouraging pump and dump behaviors as investors are not forced to pile into risky investments to preserve their wealth.  

Just last month, hedge fund titan Ray Dalio wrote a piece titled “The World Has Gone Mad and the System is Broken.” In his piece Dalio states:

“Because investors have so much money to invest and because of past success stories of stocks of revolutionary technology companies doing so well, more companies than at any time since the dot-com bubble don’t have to make profits or even have clear paths to making profits to sell their stock because they can instead sell their dreams to those investors who are flush with money and borrowing power.”

We find ourselves in a scenario in which investors are so flush with cash that financial markets have been driven to all-time highs and bond yields are approaching zero, even negative territory. As a result, expected future returns on equities, bonds, real estate, and most other investable assets are low. At the time of writing, the US Treasury 10-year bond has a yield of 1.82%. Assuming US dollar inflation meets the Fed’s mandate of 2%, the real return on the 10-year bond is negative. Thus, even holders of US treasuries are guaranteed to lose their wealth over time.

Fueled by cheap credit, artificially low interest rates, and Fed capital injections, the US economy is currently experiencing the largest financial asset bubble in history. For the last few decades, asset prices have greatly outpaced natural GDP growth, and the chasm is only increasing. 

According to Goldman Sachs Investment Research, we are in the midst of the longest equities bull run without a major drop on record.

As the Federal Reserve artificially pins interest rates near zero, companies are incentivized to borrow cheap credit and buyback their own stock, pushing asset prices even higher.

Data from Goldman Sachs

And the problem exists not only in the debt and equities markets, but also in private asset classes. According to this McKinsey report, the private equity industry’s net asset value has grown more than sevenfold since 2002 with total AUM of $5.8 trillion. The industry has grown twice as fast as global public equities. As fundraising has also grown, private equity funds are sitting on record levels of funds to deploy into the private markets.

Increasingly, deployment of this capital is fused with record levels of debt to finance private equity buyouts.

National residential real estate prices are higher than during the subprime mortgage crisis. This can also be attributed to artificially low interest rates subsidizing mortgages, as well as homeowners using their homes as their primary savings vehicle.

We are entering a new paradigm in which the Fed has no choice but to continue to engage in quantitative easing. The recent repo operations are direct evidence of just that. The repo market is vital to the health of the day to day operations of banks. The interest rate on these overnight loans between banks spiked to 10% in September, signaling the banks themselves did not trust each other or the collateral on their balance sheets. Ever since, the Fed has stepped in and injected billions of dollars to keep the market calm. This past Friday December 13th, The New York Fed announced additional operations designed to inject at least another $425 billion into the system. Remember, the Fed must “print” new money to fund these operations, which is the exact definition of quantitative easing. This announcement came after the Fed’s balance sheet reached a new yearly high of $4.095 trillion.

Enter Bitcoin.

Besides its technological capabilities, what makes Bitcoin so interesting is its macro monetary characteristics. Bitcoin is the hardest asset that exists as it is the only asset that has a truly capped supply. Its monetary policy is a function of social consensus, and its supply cap of 21 million units serves as its defining feature. Regardless of the whims of the financial markets, regulators, and politicians, Bitcoin continues to produce block after block of transactions every 10 minutes. It is operating exactly as designed and its inflation rate will only decrease over time. Instead of closely observing the 4-year election cycle, investors will do well to focus on Bitcoin’s 4-year halving cycle, an event that algorithmically halves its supply issuance every four years. When the house of cards inevitably comes crashing down, the best store-of-value will rise out of the ashes, and Bitcoin is well positioned to fill that role.

Quick Hits

  • The Bank of China has issued 20 billion Yuan ($2.8 billion) in “special finance bonds” for small and micro firms. For the issuance, the Bank of China used as self-developed blockchain bond issuance system. The bond is a 2 year fixed rate security with a 3.25% coupon, and the issuance was oversubscribed 2.7 times. After President Xi’s statement on prioritizing blockchain development, it is fascinating to see actual tangible financial deployments using the technology. The fact that the issuance was oversubscribed speaks to the growing demand for digital financial instruments generating yield for investors.

  • Twitter is going decentralized with blockchain. The social media giant is putting together a team to develop an open, decentralized standard for social media, with Twitter as one of its first clients, announced CEO Jack Dorsey. The current name for the project is Bluesky. Jack Dorsey continues to be one of the biggest public proponents of bitcoin and blockchain technology. Although many questions remain in terms of how Twitter and Bluesky will ultimately develop, it is encouraging to see one of the largest tech companies embrace open source distributed technology.

  • Nike plans to create a digital asset for its limited-edition footwear on Ethereum. Each digital asset represents an ERC-721 token with a unique footwear ID code that records ownership on Ethereum’s blockchain. Additionally, the digital asset records traits and attributes of the footwear, such as colors, styles, backgrounds, etc. Using blockchain technology, companies and customers can ensure limited-edition items are authentic and verify scarcity. Expect to see many different brands experiment with the technology to create exclusive items and events to increase customer engagement.