The Easy Economy
In a world where our economies are driven by central bank policies to historically high extent, and government budgets are bloated all over the Northern hemisphere, it is fair to say that in a sense our economies are more centralised than they have been since the 1970s.
A lot of this is not by design, and as such, it does not appear on traditional financial metrics of economic freedom. If this were designed to be the case, we would have seen major expansions of welfare programs, diminishment of property rights and a increase in trade protection policies. While this has been a trend over the last few years in typically capitalist countries, it's useful to see these policies as adding fuel to the fire rather than the ignition itself.
When I speak of centralisation of the economic system, I'm more alluding to the reliance of the world economy on government policy rather than the expansion of those policies, mainly because it includes the impact central banks have on economic activity, rather than ignoring them. I do this because central banks have extreme influence over one of the most important components of an economy: the price of money i.e. interest rates.
For those who are lost, the higher the interest rates, the higher the cost of money, and visa-versa. Naturally this creates a feedback loop between the market and the controllers of these rates, where markets respond to the incentives that central banks provide through these rate changes. The higher the rate, the more likely someone is to save, and the lower the rate, the opposite.
Naturally it makes sense that an economy would get used to an accommodative setting of the price of money over time, developing a dependence much like a person addicted to drugs, alcohol etc. Since 1970, this is what has happened, as the picture below demonstrates (US Federal Reserve target cash rate).
Every time interest rates tested that red line, they have promptly decreased, because the economy could no longer handle that price of money. It is a sign of our increasing dependence on easy money, and there's less and less room for error now more than ever.
The Commodity Super cycle Pivot
What the increasing dependence on easy money has allowed for is the embrace of new innovations and technology, the promise that they hold. It has promoted the advancement of ventures that promise fundamental performance far into the future over promises of such performances today. In today's markets, the story has taken priority over facts.
We have become enamoured by renewable energy, electric cars, AI, blockchain, biotech and other extremely promising sectors, and it has come at the expense of stable and 'unsexy' parts of the economy: Commodities.
While I am sure the 'sexy' sectors will justify current valuations eventually, the fact is, like in the dot.com bubble (although not nearly to the same extent) many investors may have become overly excited about the timeframe these technologies will have profound impact on our world, and have been rewarded for doing so by central banks around the world who have done everything to keep prices in ALL investment vehicles up.
Here you can see the manifestation of this. The above graph is the price of commodities compared to the price of stocks, but it can be translated to how far into the future the promise of an investment is being 'priced in'. Despite being three months on from the initial pandemic bust (in the graph above), investors still looked far into the future for promise. Why? Because central banks ramped up 'easy money' stimulus through money printing, as markets become addicted to a new level of support.
When this all comes to a head, one thing will definitely be true. There is room to grow for commodity based investment strategies where many others will falter.
Translation to Crypto
This is all very interesting stuff for cryptocurrency. I suspect in 12 months time we will truly understand a hell of a lot more about cryptocurrency as its design will be put to the test. I find it hilariously ironic that its prices are supported by the very thing it sets out to destroy. With predictions of high inflation and market crashes coming there are a number of questions we will have answers to.
In a state of decreasing confidence in fiat currencies, will investors flock to the safety of commodities or the allure of crypto and its proposed benefits? I suspect this will be a true test of its value. We could see Bitcoin lose 90% of its value and never test its heady heights again. We could see it sky rocket and leave the traditional commodities in its dust. So in a nutshell, the question that will be answered is, is Bitcoin really 'digital gold'?
Right now, if you asked me there are two parts of the equation. Firstly, 'easy money' has enhanced investors' risk appetite across the board, driving the value of cryptocurrencies. This means that once this risk climate is eliminated, people should expect extreme downside on cryptocurrencies. This means people have to sell, so where does that money go? Here's the second part of the equation. There two types of people that invest in crypto: people who believe, and people who see an opportunity to make money.
In the first group, some will have their will shaken, and will most likely dump their 'digital gold' for actual gold and other classic hedging assets, as it's consistent with their beliefs on the state of central banks and will look for a way to hedge against the woes of their policy. Others will most likely maintain their belief and re-enter the crypto markets. In truth there will be overlap, but I expect this 'believer' money to be more weighted towards gold-like assets than before.
In the second group: the opportunists, they belong to a much larger group of investors that are in real estate, stocks etc. Peter Lynch likens them to the people at a dinner party. Whenever they hear that he's a fund manager, the response varies from "The stock market is a casino," to "Stock's are a sure thing." Except it doesn't vary from person to person, but rather from time to time. Put simply, the opportunists won't be back for a very long time, because what they thought was a sure thing, is now how they lost their money. Except they had it under a different label:
-My daughter's university tuition fund;
-My son's first car;
-My retirement plan
You get the picture. What people think is a quick ticket to a better life, becomes the opposite. So investors who stay in the game won't be seeing this money in the system for a very long time. And that will be doubly true for the wild-west that cryptocurrency is associated with.
So all in all, my short-term hopes for crypto could are bleak, although my very long-term views are very optimistic. We are starting to see adoption from companies and major corporations. There may be variance on a regulation level across boarders on cryptocurrency, but its presence in our future has definitely been consolidated (more on that later). Its also perceivable that their will be a backlash against the government institutions if such a crash was to occur across markets, and crypto generally is seen as a rebellion of sorts against the policies that has led us to this place of trepidation.
Takeaways
Our financial system has become addicted to easy money, and now we are at the point where we may have to go cold turkey
This has resulted in record low valuations in the commodity sector
Crypto prices are being driven up by two forces: easy money and the rejection of that policy, and the former may disappear over the next 12 months which could embolden the second
Coming Soon...
Proof in Crypto
The Future of Central Banking
Thanks Oscar, curious:
- Do you feel a rise is coming in commodities prices ?
- What does 'cold turkey' mean in reference to easy money? No more printing?
- What does the red line in graph 1 indicate?