Every generation has its asset class. Could Bitcoin be the one for the current age?
W.When Julio Rodriguez was a little boy, he fondly remembers the Sunday meals his mother would prepare.
When Rodriguez returned from soccer practice one Sunday afternoon, he was greeted with the familiar aroma of his mother’s asado.
The son of a college professor, Rodriguez recalls that he grew up quite wealthy and what most would consider middle class.
In the mid-1970s, Rodriguez, who was just starting elementary school, noticed that things were changing in his family.
Instead of the best asado slices his mother would prepare on Sunday evening, leftover slices were used.
Instead of a bottle of wine, his parents now shared a small carafe.
And while Rodgriguez was too young to know better, the once abundant Argentine economy was brought to its knees under the combined weight of excessive government spending, large wage increases, and gross inefficiencies.
By the 1980s, Argentina’s debt had risen to over three-fifths of production.
The attempts by Buenos Aires to contain inflation by artificially tying the peso to the value of the dollar not only failed, but also led to inflation briefly exceeding 1,000% annually.
Successive regimes attempted to control inflation through wage and price controls, cuts in public spending, and restricting the supply of money.
However, those measures were thwarted when, in 1982, to distract a frustrated public, Argentina waged an expensive and ultimately ill-conceived war with the United Kingdom over the Falkland Islands.
And when millions of Argentines, especially those with fixed incomes like Rodriguez’s father, saw the true value of their income sink, the capital many turned to was gold.
The question that central bankers, especially the US Federal Reserve, are now showing that they are willing to tolerate ever higher inflation rates is whether or not investors should look to inflation hedges.
Wither Wander the Dollar?
Over time, the dollar has a close relationship with US inflation expectations and relies on the fact that a weaker dollar is inherently inflationary as it undermines the purchasing power of US consumers, investors and debtors.
Monetary and fiscal policy geared towards a weaker greenback could do much to reduce the debt burden through this inflationary effect – because a dollar borrowed by the US government today is worth far less if Washington eventually repays it (if at all) when inflation is high is.
Tax incentives also tend to weaken a currency’s medium-term prospects.
And with the Biden administration seeking a new $ 2.9 trillion stimulus package after releasing its $ 2.2 trillion stimulus package, the White House is showing an appetite to keep writing checks regardless whether the US Federal Reserve can ever redeem them.
The prospect of more U.S. deficit spending to combat the economic impact of the pandemic and fund other domestic priorities (because if you want to borrow money, you might as well ask for as much as possible) as well as infrastructure remains, the medium-term outlook for the dollar is subdued and may support assets like gold and bitcoin.
But gold bars or bitcoin?
With no alternatives to gold, one would expect gold to rise amid inflation concerns, but it is not.
Despite widespread belief in a new wave of reflationary economic growth and a historical amount of money pressures that are usually inflationary, gold has underperformed.
The demand for gold can be traced back to its perception as an asset against the devaluation of fiat currencies. When people worry about the long-term purchasing power of government-issued currency, they are willing to pay more for gold, which is viewed as a business of value.
However, over the past year, an alternative to gold has emerged – Bitcoin.
As investors become more aware of Bitcoin, so too is the growing chorus of voices promoting its ability to act as a check against the devaluation of the fiat currency.
And the election of US President Joe Biden only helped increase Bitcoin’s popularity.
Driven by fear of a hard left swing, more and more investors are turning to Bitcoin in the expectation that a democratically-run, free-spending government in the US will lead to systemic waste that can damage the long-term value of the dollar.
But beyond the anecdotes, there is evidence that some of the money that would otherwise have flowed into gold has flowed into Bitcoin.
Since last May, a steady outflow of funds from gold and gold-based ETFs (Exchange Traded Funds) has coincided with larger inflows into Bitcoin.
And while not all of the money that gold leaves has gone into Bitcoin, a significant portion of the changes have occurred.
Institutional investors, especially family offices, are making the decision to allocate at least some money to Bitcoin as a hedge against a fiat collapse.
Because while you may hope to never have to use a doomsday home, if the zombie apocalypse ever comes, you’ll be glad you built it.
Bitcoin’s performance over the past year has also shown that it is closely in line with bond yields – something gold did until recently.
When bond yields rise, so does Bitcoin – meaning the cryptocurrency benefits directly from what is known as “reflation trading” – the belief that inflation is just around the corner.
The same should be true of gold – profit when inflation fears mount and slip when such fears subside.
However, the opposite seems to be happening.
While Bitcoin has been positively correlated with inflation fears, gold appears to be negatively correlated, with the current drive in Bitcoin looking very similar to an offer to protect against currency devaluation through a measured transfer of gold.
Bitcoin’s recent hiatus also appeared to coincide with the hiatus in the bond market.
Although the benchmark yield on 10-year US Treasuries rose in late February, it has since stabilized and is essentially moving sideways – much like the movement of Bitcoin just below $ 60,000.
So could Bitcoin be the “precious” miners should really be working on instead of the shiny stuff?
In any case, maybe
Gold has at least one intrinsic use as a raw material for jewelry.
Bitcoin’s value lies in its ability to create a parallel system of values that could potentially one day replace established regimes.
But, as history has shown, incumbents generally do not take it well when their regimes are challenged.
That central banks are now in a race to issue their own digital currencies should be instructive – it is customary to fear what is feared first before co-opting the best pieces.
However, digital currencies issued by the central bank miss the point behind Bitcoin’s promise – safety and finality of value.
Bitcoin has been ingeniously designed so that the supply of new Bitcoin diminishes over time – it’s intentionally deflationary, but this also reduces the incentive to spend Bitcoin, which could lead to an ironic appreciation in value.
Money inflation, which is closely linked to the devaluation of the fiat currency, leads to rising valuations of financial assets.
Both factors speak in favor of Bitcoin.
As investors hold on to more Bitcoin in anticipation of a price spike, money inflation, which is driving the price of fewer assets up, tends to favor Bitcoin.
So far, the US Federal Reserve, Bank of England, European Central Bank, and Bank of Japan have all increased their debt stocks to nearly $ 24 trillion, which is 55% of their economies’ total GDP.
This incentive from the world’s four major central banks has resulted in excessive liquidity in global capital markets, driving up the valuation of stocks and even cryptocurrencies.
As long as central banks continue their strategy of increasing liquidity (and having little alternative due to the debt they create), investors can expect higher volatility in valuing risk-weighted assets and devaluing fiat currencies, factors that are likely to play well to Bitcoin’s story.
But maybe Bitcoin really does seem like it isn’t highly correlated to any other asset, whether inflation or not.
Bitcoin’s consistently lower correlation reinforces the greater diversification potential over a number of business cycles and provides efficient diversification to hedge the portfolio’s inflation risk, as well as sufficient upside potential.