We're Gonna Need a Bigger Gun
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.
Wow, what a month it’s been. First and foremost, make sure to stay safe, practice good hygiene, and social distance as much as possible during these tumultuous times. Similar to viruses of the past, this too shall pass and basic common sense can go a long way to keep you and your loved ones safe.
Now, on to the markets.
Beyond becoming a global pandemic infecting hundreds of thousands of people all over the world, the coronavirus has spooked financial markets and may serve as the pin to finally pop the Everything Bubble. The chickens have come home to roost, and we must finally come to terms with the poor financial decisions and mass debt the global markets have accumulated in the past 60 years.
We are facing a massive liquidity crunch as the demand for dollars skyrockets and deflationary forces are depressing economic activity. In the hope of stopping the spread of the virus, many municipalities have mandated closures of small businesses such as restaurants, bars, gyms, movie theaters, and other social gathering areas. The food, hospitality, and airline industries have been hit the hardest as Americans hunker down and embrace isolation until the spread of the virus subsides.
Source: https://blog.sense360.com/covid-19-analysis-part-3-foot-traffic-in-food-industry
No asset class is immune, and the assets with the most liquidity have been hit the hardest. Investors have rushed for the exits, and selloffs in equities, commodities, gold, and crypto ensued. In times of economic hardship, all correlations trend to one as investors sell whatever they can and flee to the safety of cash. More specifically, in the last few weeks hedge funds and traders with levered long positions were forced to sell as they covered margin calls. This exacerbated the selloff and amplified volatility in liquid markets. In a liquidity crisis, you don’t get to sell what you want to sell, you are forced to sell what you can sell.
Gold is considered the ultimate safe haven asset. However, it has been selling off in lockstep with the rest of the market. In 2008, gold dropped more than 30% before the markets even experienced maximum pain.
Source: https://pomp.substack.com/p/the-liquidity-crisis-will-drive-monetary
Although gold did not act as a safe haven asset amidst the fallout of the 2008 financial crisis, the asset appreciated from ~$700 in 2008 to over $1,800 in 2011 post-crisis. As the US government intervened and injected unprecedented amounts of capital into the markets (in the form of bank bailouts and successive rounds of quantitative easing), investors flocked to gold because they were worried of US dollar debasement and the risk of the government defaulting on its debt. I believe we may see a similar phenomenon transpire for Bitcoin in the coming months and years, but more on that later.
Fundamentally, the Fed has two weapons to fend off recessions: (1) lowering interest rates and (2) printing money (quantitative easing). The Fed recently dropped the benchmark rate to 0%, ramped up liquidity injections into the repo market, and formally announced another round of QE in which it will purchase at least $700 billion of treasury securities.
Although the Fed signaled they are willing to deploy their full artillery to combat impending recession, equity markets have continued their selloff with no abatement in sight. Amidst the liquidity injections in the repo market that started in September of last year, The Fed’s balance sheet has been ticking up, currently standing at around $4.6 trillion. When all is said and done, the Fed’s balance sheet may very well be in excess of $10 trillion, and there is no guarantee these measures will have the same restorative effect as they did back in 2008.
The Fed is fighting a different war with the same weapons. Structurally, the current crisis isn’t a bank liquidity issue as banks have much stronger balance sheets than they did back in 2008. The main culprit this time around is excess corporate debt, fueled by cheap credit and artificially low interest rates. Leveraged loans, which banks extend to already indebted companies, have ballooned to $1.2 trillion, roughly double that of pre-crisis levels.
Source: https://www.fdic.gov/bank/analytical/quarterly/2019-vol13-4/fdic-v13n4-3q2019-article2.pdf
Furthermore, non-financial corporate debt-to-GDP has reached an all-time high.
Source: https://www.fdic.gov/bank/analytical/quarterly/2019-vol13-4/fdic-v13n4-3q2019-article2.pdf
Access to cheap credit has created an entire cohort of “zombies”, companies that earn too little to even make interest payments on their debt and survive only by issuing new debt. According to the Bank for International Settlements, the bank for central banks, zombies now account for 16% of all publicly traded companies in the US and 10% in Europe. The dystopian reality of empty restaurants and airplanes, canceled conferences and sporting events, and restricted access to vital supply chains will magnify the pain felt by over-levered businesses that are already struggling to meet their interest and operating expenses.
Source: https://www.bis.org/publ/qtrpdf/r_qt1809g.htm
As it became clear central bank actions alone are not enough to save the economy, governments have stepped in with fiscal policy measures to stimulate economic activity. These policies have ranged from corporate bailouts, reduced payroll taxes, delayed tax payment deadlines, increased commercial lending, free testing and waiving co-pays for corona-related medical visits, and even “free helicopter money” in the form of freshly minted currency payments sent to every citizen.
So far, stimulus packages have topped $6.4 trillion, and we are only in the very early innings of governments implementing such measures. In the coming weeks and months, expect successive rounds of capital injections and “free” money as companies go bust, workers are laid off, and political pressures force action. The last time “free” money was sent to Americans was in 2001, in which the Bush Administration sent out up to $600 to American taxpayers. Notably, this was from a position of fiscal strength, in which the federal budget had a surplus of $236 billion in 2000, a far cry from the trillion dollar deficits that are increasingly becoming the norm.
Back to Bitcoin.
Although Bitcoin was one of the assets that suffered in the latest market downturn, it continues to operate exactly as designed. The crypto markets have no market-wide circuit breakers or central planners to dampen volatility, and we are seeing a true free market in action. Many critics will point to recent market dynamics to suggest the Bitcoin as a safe haven thesis as being invalidated. However, as gold has exhibited in the past, Bitcoin’s true safe haven properties will emerge post-liquidity crisis as it responds to inflationary pressures caused by the unprecedented stimulus central banks and governments have already started implementing.
We are living in truly unprecedented times, and the normal toolkit of monetary and fiscal policy may prove to be ineffective. Whether it’s this year or at some point in the not too distant future, the 50-year-old experiment of the fiat monetary system, in which governments irresponsibly inject new capital into the system to paper over deeper problems, will suffer the consequences and a new structural paradigm will rise out of the ashes.
Quick Bits
EARN IT: the US anti-encryption bill that threatens private speech online. The new bill to fight child sexual abuse material and other risky services on the internet could come at a cost to online privacy. First proposed by the Senate Judiciary Committee and sponsored by senators Lindsey Graham (R-SC) and Richard Blumenthal (D-CT), the bill is a covert attempt to ban end-to-end encryption without needing to ban it outright. The government has long desired to ban encryption, one of the most important defensive technologies individuals and companies have to communicate and transmit information securely. Evident by the post-9/11 Patriot Act, government overreach is nothing new and citizens must be vigilant and fight back against such blatant attacks against civil liberties.
Bakkt raises $300 million and announces launch of crypto consumer app coming this summer. Bakkt’s physically-settled Bitcoin futures contracts have been steadily gaining interest amongst institutional investors, and this new capital raise can allow the company to focus on expanding its product offering. Bakkt’s consumer application will enable retail investors to “unlock the value of digital assets” via consumer payments, but also to diversify their crypto portfolio. To date, crypto users have indicated they would much rather hold than spend crypto. However, a payments application and robust network of merchants may urge users to spend crypto, adding additional utility to crypto assets.
Asset manager Wave Financial has partnered with tokenization platform Vertalo to tokenize a year’s production of Kentucky bourbon. Danville, Kentucky-based Wilderness Trail Distillery is tokenizing between 10,000 - 20,000 barrels of whiskey, worth up to $20 million, that will be made publicly available through a specialized digital asset fund. Investors can gain exposure to bourbon’s value appreciation and also share some of the proceeds from when the whiskey is sold wholesale to merchants. This new digital investment contract joins the ranks of Spencer Dinwiddie’s tokenized NBA player’s contract as one of the most innovative deals this year. Tokenization enables fractional ownership and enhances secondary liquidity, which will create a new class of investment opportunities previously nonexistent.