There are a number of excellent articles and books that make the case for Bitcoin, notably Saifedean Ammous’ The Bitcoin Standard, Nick Szabo’s Shelling out, Vijay Boyapati’s The Bullish case for Bitcoin and @100trillionUSD’s Modeling Bitcoin’s Value with Scarcity (all highly recommended reading).
I thought I would write about Bitcoin in a way that juxtaposes the need for it with current worldwide and geopolitical events. It’s highly recommended that one reads the above articles as well to get a fuller understanding, as a lot of details are glossed over here in the interest of covering a lot of different areas quickly and not being repetitive.
Whirlwind tour of World Monetary History
The world has gone through many monetary systems over the last few thousand years ever since mankind invented a common vehicle, money, to solve the problem of double coincidence of wants and divisibility with Barter. The more notable among them are Gold, Silver, Tally sticks, Paper notes or IOUs backed by Gold and Silver and finally Fiat money which is money by decree of an authority, usually a Government.
The US dollar has pretty much been the World’s Reserve Currency since the 1940s, a privilege it received as one of the victors in World War II with an almost intact industrial base. It was also backed by Gold until 1971. Its ties to gold were severed in 1971 and it continues to be the reserve currency to this day. All currencies have their exchange rates to each other determined by a system of freely floating currencies, meaning it’s all relative at this point.
Prior to 1971, countries could redeem their US dollars for Gold, so every currency had a link to Gold through it’s exchange rate with the Dollar. This was no longer the case. There is currently no underlying hard money or asset, on which the values of these currencies are moored.
Making sense of the World financial system, post 1971
What then gives our currencies value? How have we been able to survive with such a system for close to 50 years. While the case has been made that in this new post-1971 system, the value of a country’s currency is backed by it’s resources + the productive capacity of its people, there are some pretty serious caveats that make this statement almost a useless truism.
The main caveats are:
A. The fiscal policy of the government i.e. it’s deficit spending, tax collection and fiscal prudence is one side of the coin, it’s resources and the people’s productive capacity being the other. A bad performance on this front can thrash the people’s productive capacity + any resources a country may have, and hence the currency in quite a brutal fashion. Argentina, Venezuela and Zimbabwe are a few notable names that comes to mind.
B. The monetary policy of the government i.e it’s money printing and setting of interest rates drives people’s saving and spending behavior, as well as business investment decisions. Interest rates are signals that tell businesses the price of money and what can be invested in profitably given the current demand and supply of money from the banking system. It also regulates people’s propensity to consume VS save i.e. one might save more if interest rates are higher. Savings is the vehicle from which Investment and Capital formation follows.
Manipulation of the interest rates by the Central bank of a Country to serve mandates of targeting Inflation (measured as they choose to) and/or Unemployment targets, distort investment signals and severely curtail or impact the people’s productive capacity. Lower interest rates provide a false signal that causes malinvestments into sectors that would have otherwise never received investment, leading to the inevitable bust once the cycle has run its course.
C. While the notion that the value of a country’s currency is backed by its resources and people’s productive capacity does hold some truth, notwithstanding the serious caveats listed above, there is one notable exception and that is the United States, being the holder of the world’s reserve currency.
Due to this historical role, the US dollar has become deeply embedded into the financial plumbing of the world: Central banks hold it in their reserves, Most trade is conducted in it, A lot of Debt worldwide is issued denominated in US dollars. The United States dollar is being effectively backed by the World’s resources and productive capacity, with most of the benefits accruing to the holders of US dollars (See Exorbitant privilege)
The US dollar: Prone to censorship
The US is currently using its control of the reserve currency and the financial system via SWIFT to sanction those it deems its enemies. Iran and Russia are the two countries that come to mind. Imagine being Iran, unable to sell the one commodity that you have, Oil, without skirting sanctions and physical blockades, always looking for alternate payment mechanisms.
The word 'Sanctions' has a better ring to it than 'War'. After all, it's not an all-out conflict, and yes, that is by far the worse alternative. That's of course assuming you have only those two options (Diplomacy, Trade, Friendship, Peace anyone?). Sanctions means a country is blocked from trading with the world, unable to provide food, heating, shelter and basic security to its citizens.
To have two countries, say India and Iran, being unable to trade with each other because of a blockade on the US dollar system seems pretty unfair. The need for a censorship resistant money that bears the mark of no nation (One must watch this 2 minute clip of French president Charles De Gaulle in 1965) starts to make a lot of sense with this backdrop.
Turmoil in the financial world
As if the above weren’t enough, here are other important things happening right now that every living being on this planet needs to pay attention to.
$17+ trillion of bonds yielding negative interest rates: The central banks of the world, most notably in Europe, have gone so overboard in their push to boost inflation and get economic growth going again that they have lowered interest rates below zero. This means that the holder of the bond will receive less than they invested to buy the bond when it matures. Why would someone invest in such a thing? Speculation that interest rates are going even more negative, which would boost the value of the bond and allow them to sell. This is the current madness we live in. How does it end? Not a person has a clue because we have NEVER been here before.
REPO madness: There is a process within the US financial system where banks that are short of cash borrow from other banks to make sure they have adequate reserves. They do so by using assets on their balance sheets: US Treasury bonds, Corporate bonds and others. This is usually common practice and no big deal. Until now, that is. Most recently, Banks that have had large borrowing requirements have been unable to secure what they need from other banks.
This caused the central bank in the US, the Federal reserve, to have to step in and provide liquidity. They have had to do so to the tune of $400 billion in a very short span of time. To provide some perspective, they have backstopped about 50% of the entire 2008 financial bailout in a matter of days (or close to 10% of their balance sheet which took 200+ years to build up to this point!). The program is expected to run through October to the end of November at last count. Quantitative easing or QE4 is back. Perhaps in a different guise, but it’s here. And it will be much bigger than anything we’ve seen thus far. Read this excellent article by Caitlin Long to understand this crucial issue in depth.
Trade wars: China and the US are now engaged in what looks to be a never-ending trade war. Whilst, the logical conclusion is that the US has a lot more arrows in their quiver, given their large trade imbalance with China (more carrots to snatch away than can be taken from them), this will not be without consequence for the US. Witness the postponing of tariffs to post-Christmas, over concerns of sticker shock, as the inevitability of high prices for imported goods hits the American consumer. China is trying to deal with this Trade spat while it’s internal economy lies in shambles AND there is an ongoing uprising in Hong Kong. The timing could not have been worse for them. Or a coincidence.
Their banking system is teetering in terms of Non-performing loans, and almost every other metric. The real economy is suffering from over expansion and over capacity. The Chinese central bank money printers put their American counterparts to shame, having injected Trillions of Yuan into the economy over the last several years to keep the party going. Their current main focus is to stop capital flight i.e the ability of her citizens to move their money overseas as this would lead to a collapse in their currency. They are trying to clamp down on this with Hong Kong as well.
US deficit spending: While the US is still seen as the safe haven and remains relatively strong in the face of all this worldwide turmoil, there is a concerted multi-year effort (and it will take many more years) for the world to move off the Dollar standard. US politicians, be they Democrats or Republicans, have not shown an inkling of understanding of this Seismic shift (with the notable exception of this guy) or Fiscal / Monetary prudence. They’re unable to cut their Budgets or Deficit spending by sub 1% percentage points. The military and welfare budgets continue to grow year on year.
This deficit spending will take off like a rocket ship, should one of the Democrat contenders win in 2020, not that Trump is a fiscal hawk. Debt servicing (the interest paid on the debt) is around $450 billion right now, and is expected to grow to nearly $800 billion by 2024. This is larger than the current US military budget and will suck up close to 20% of all tax revenue. Social security and Medicare entitlements are multiples of the national debt, and are not even factored into this financial time bomb. A financial reckoning may be closer than we think (hit the “translate tweet” link to get the English version)
Bitcoin — A Peer-to-Peer Electronic Cash System
What does all of this mean for you and where does Bitcoin fit in. First thing is, it’s key to understand that the current Fiat monetary regime we have had in place since 1971 is broken and is in it’s terminal stages. Even the International Monetary Fund (IMF), that has every incentive to keep this charade going as long as they can admits “The world of fiat money is in flux, and innovation will transform the landscape of banking and money.” on their blog.
There will be bail-outs like in 2008, there will be bail-ins like in Cyprus in 2013. There will likely be the end of economic units, or experiments such as the European union.
Closer to home in India, self-inflicted wounds such as demonetization of currency notes will become the norm. Crises such as those recently seen with PNB bank and the PMC bank crisis will be the rule rather than the exception. Indian Stock markets may rise as equities tend to do well during monetary debasement, but they also may fall as US dollars leave Indian shores to go to perceived safe havens overseas (US treasuries etc.). The only thing for certain: There will be volatility.
What is one to do in this situation: The traditional answer has been to buy Gold and Silver and it continues to be the case. It is working quite well. In fact Gold just recently breached an all-time high in Indian rupees and has done so with nearly 70 currencies. One cannot go wrong investing in Original money.
Gold however suffers from a few disadvantages such as being more easily confiscatable by authorities. The free flow of it or it's use in trade can be more easily stopped as authorities can overtax and criminalize jewelry stores, traders and other physical establishments that buy and sell precious metals. Don’t underestimate the lengths that governments will go, to keep this current system from imploding. One hopes it does not come to that, but it’s one’s personal responsibility to make sure they are adequately protected financially. No one else will.
The type of asset one would want to invest in (spoiler alert: It’s Bitcoin), in this climate is something that
A. is censorship resistant. No one can stop a holder of Bitcoin from sending it to anyone else in the world.
B. is limited quantity hard money that cannot be manipulated. 21 million is all that will be made, and it’s dictated by computer code. No government or organization can change that.
C. does not have counterparty risk. You just outright own an asset i.e. you are not dependent on someone holding it for you and it’s not debt with 2 parties: a lender and a borrower.
D. is non confiscatable, being digital or virtual.
E. is worldwide non-sovereign money. No country or government controls it, thus forming the basis for Trust between 2 countries.
F. is easily transported. Sending it means recording a transaction to the Blockchain, easily done from any computer or mobile device with some basic wallet software.
G. is generally uncorrelated to stocks, bonds, real estate or other asset classes
Bitcoin is the asset that not coincidentally fits all of the above criteria, having been created for this very purpose, and it behooves every individual to allocate some portion of their net worth (between 1–5% is the oft quoted number. Usual disclaimers: I’m not a financial adviser, look at your own situation yadda yadda) in an asset that will likely serve as a bridge as we move from one financial system to the next.
It also very importantly has an asymmetric risk profile, if you follow the 1–5% allocation i.e. You will either lose 1–5% of your net worth if it goes to 0, or it will save your wealth and restore what you lost on the rest of your portfolio (and then some), when the expected financial crisis materializes. Will you be ready?
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CEO / Founder, Indra Crypto Capital
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