Whenever a crisis hits, whether it’s the coronavirus pandemic or a financial crisis, it’s natural to look to precedent to find certainty. But the only certainty we can rely on is uncertainty, and that knowledge should fundamentally shape our outlook as investors.
When Thomas Pilkey heard the incessant banging and hammering from his neighbor’s workshop, it wasn’t so much irritation, but curiosity, that led him to wander over and see what the commotion was about.
Pilkey’s neighbor, Henry, was a hobbyist inventor and was always tinkering with some new creation or other in his workshop.
And while Pilkey had long grown accustomed to the strange sounds that could often be heard emanating from Henry’s workshop, on this occasion, Pilkey was drawn by a sound he’d never heard before in his entire life — a repetitive rattling and chugging sound that sounded very much like a powerful weaving loom was being worked with great speed.
Curious, Pilkey peaked into Henry’s workshop, where Henry, was busy at work on what looked like a horse carriage, but behind the carriage was a strange contraption belching out thick black smoke.
“What’s that you got there Henry?”
“Oh Thomas, thank you for stopping by, I call it the quadricycle. What do you think?”
“What do I think? This thing is way too low to hitch to the back of a horse.”
“No, no, no sir, it’s not meant to have a horse, it’s powered by gasoline!”
“No horse? Then how will it ever move?”
With a slight flourish, Henry ushered the doubting Thomas to the rear of the quadricycle and with a broad sweep of his arm,
“With this! An engine!”
“Oh Henry, this will never catch on! It’s so smoky and what a ruckus! It’s so noisy I can barely hear myself think!”
“But that’s the beauty of it! Imagine never having to rely on a horse ever again to get around!”
“Good luck Henry, but give me a horse and a carriage any day. This contraption you have here looks like a death trap!”
That contraption, the quadricycle, turned out to be the first car ever built by Henry, but it would hardly be his last.
In fact, Henry would go on to build so many more cars that his last name would grow to become synonymous with the American automobile, a name that endures to this day — Ford.
But at the time, Henry Ford didn’t just face skepticism from his neighbors, he was ridiculed by almost everyone he met in his quadricycle.
There was no shortage of objections to Henry Ford’s first car — it was too noisy, it was too slow, it belched out too much smoke.
Yet for all of its flaws, Ford’s quadricycle didn’t just revolutionize transport, it revolutionized the entire industrial process.
But it wasn’t at all obvious at the time that Henry Ford’s quadricycle had laid the foundation for the modern, mass produced, automobile.
At least not without being prescient.
But the problem with being prescient is that too often, we rely on precedent.
Driving With One Eye On The Rearview Mirror
Particularly in uncertain times, it’s natural for us to draw comfort from how previous generations handled similar crises.
But like someone trying to cross a river in the dark of night, we are only really feeling one stone at a time as we try to get across — knowing where we came from actually helps very little to help us get where we want to go.
And that goes for investors as well.
By all traditional measures, markets ought to have tanked by now, several times over.
Standard matrices for valuing stocks appear increasingly irrelevant to the point that some of the biggest names in investment like Stan Druckenmiller and David Tepper are weighing in, to warn that the risk-reward ratio of holding shares is at the worst that they have encountered in years.
Druckenmiller said that a “V-shaped” recovery — the idea that the economy will quickly snap back as the coronavirus pandemic eases — is a fantasy.
Tepper said that next to 1999, before the dotcom bubble burst, stocks are the most overvalued that he’s ever seen.
And Druckenmiller and Tepper are hardly alone in their assessments.
A growing number of Wall Street bigwigs are coming round to question the rationality of the markets or the strength of the economy, including Bill Miller, Paul Singer and Paul Tudor Jones.
Yet if investors are starting to worry that the U.S. Federal Reserve’s US$3 trillion stimulus may be insufficient to compensate for soaring unemployment and a wave of bankruptcies, the markets must have failed to get the memo.
Since its March low, the S&P 500 (a stock index representing a broad swathe of the American economy) has recovered some 26%.
Speaking at the Economic Club of New York, the 66-year-old Druckenmiller said that he’s never seen a time when the risk of owning stocks so outweighed the potential gain.
And billionaire investor Leon Cooperman said to Bloomberg,
“I’m 77 years old and I’ve never seen this level of uncertainty.”
“This cycle is different than the other seven bear market cycles I lived through because this is the only one where we had a broad scale shut down of the economy, which I view as a mistake.”
At least Cooperman is being candid about the novel nature of the markets today and how hard it is to fit our current period with one in history.
History is a proper teacher, but there’s very little it can teach us about our current age, what we can expect from stocks and what it means to hold an asset.
During difficult times, how well investors preserve assets is disproportionately related to their ability to make decent, long-term investment decisions, based on identifying what only becomes obvious with the benefit of hindsight.
History’s A Proper Teacher
To that end, it helps to compare the unprecedented central bank stimulus with another time in history, when the United States first gained the ability to essentially print as much money as it so chose — the 1970s.
In 1971, then-U.S. President Richard Nixon, took the dollar off the gold standard, which Nixon hoped would cap off increasing inflation.
Nixon suspended the direct convertibility of the dollar into gold and erected import surcharges of 10% to ensure that American products would not be at a disadvantage because of the expected fluctuation in exchange rates.
Overnight, the dollar could no longer be swapped for its equivalent in gold, which lead to the dollar plummeting in value and triggering a global financial crisis that few foresaw.
Because oil is priced in dollars, the actions of the Nixon administration slashed the real incomes of Middle Eastern oil producers, at a time of heightened geopolitical tension within the region.
Responding with uncharacteristic cohesion, the Middle East oil producers moved to cut production and the price of oil had quadrupled by 1974.
Given the geopolitical conditions in the Middle East at the time, no one could have anticipated that oil producers would act so swiftly and with such coordination.
And the oil price shock triggered an unexpected inflationary response in western economies causing many western banks and heavily indebted companies to fold — the exact opposite of what Nixon had intended.
Instead of getting rid of inflation, Nixon sparked a massive surge in inflation.
Could it happen again?
While investors may not be betting on it, some at least, are taking out an “insurance policy” on a return of inflation.
With major central banks slashing interest rates and ramping up bond buying and governments around the world dedicating over US$8 trillion in stimulus to cushion their economies from the coronavirus fallout, there is a growing number of investors wondering if their money wouldn’t be safer in Bitcoin.
The Fed’s balance sheet has already ballooned to over US$6 trillion and by some estimates, could top 50% of gross domestic product by the end of the year.
To be sure, it has been decades since western economies have experienced anything even remotely resembling runaway inflation, but that doesn’t mean that it’s impossible for inflation to return.
What Is Money Anyway?
Legendary macro hedge fund investor Paul Tudor Jones caused a splash when he acknowledged buying Bitcoin as a hedge against the inflation he sees coming from central bank money-printing.
In a letter to clients, Tudor Jones wrote,
“We are witnessing Monetary Inflation — an unprecedented expansion of every form of money unlike anything the developed world has ever seen.”
And for investors looking towards long-term investment returns, identifying long-term trends is crucial.
These trends are often driven by demographic, environmental or regulatory change and are little affected by the economic cycle.
And while the current coronavirus pandemic may feel like a turning point, it is really accelerating existing trends, which feed into the Bitcoin narrative.
Online shopping, which was already growing, is likely to take a permanently higher share of spending.
Take Amazon for instance, where global sales surged to US$11,000 a second as the coronavirus pandemic swept across much of the world.
And with the closure of bank branches because of the pandemic, our move towards digital banking will only accelerate, making it harder for banks to differentiate themselves, without the trappings of imposing architecture.
As our various touchpoints with “money” become increasingly digital, our perception of what constitutes “money” will evolve as well.
Tudor Jones’ foray into Bitcoin, especially in an environment where the Fed has said that it will “never run out of ammunition” could mean that more high-profile names come out in support of Bitcoin.
And while Bitcoin is well off its peak of almost US$20,000, it has continued to be one of the best-performing asset classes this year, rallying about 30% to US$9,500 while the S&P 500 has lost 11%.
But while few would argue against the devastating effects that the coronavirus pandemic has wrought on the global economy, its impact on inflation is still under debate.
In the near term at least, the pandemic has acted as a disinflationary force.
In March, inflation in the U.S. slowed sharply and a key measure of consumer prices declined in April by the most on record.
Part of the reason for that of course is that oil prices remain low.
And the other reason is that globalization has kept production costs low.
One of the reasons that rich economies have enjoyed relatively muted levels of inflation is that developing nations have continued to be able to churn out goods cheaply.
Global supply chains have allowed what would otherwise have been exorbitant goods to be made at affordable prices.
From smartphones to TVs, clothes to toys, the global supply chain has meant that wages have been kept in check thanks to a seemingly endless supply of cheap labor.
But the coronavirus pandemic has upended global supply chains and led some companies to consider onshoring their production closer to their home markets — this will almost certainly increase costs.
In a recent research report, Morgan Stanley (an investment bank) Chief Economist and Global Head of Economics Chetan Ahya wrote, that the coronavirus pandemic is likely to bring an end to a 30-year run of disinflationary forces and herald the return of accelerating inflationary pressure that’s likely to overshoot central bank targets.
Government efforts to contain the pandemic have accelerated already yawning income inequality and to deal with this, according to Ahya, policy makers will have to take action that ends up reorganizing the forces that have been putting downward pressure on prices for decades.
According to Ahya, that means upending trade rules, technology and the rise of the world’s corporate titans.
“Disturbing this trio will also mean disrupting the key structural disinflationary forces of the past 30 years.”
If U.S. President Donald Trump brought tariffs back in vogue, he was really responding to existing demographic and populist shifts that were already under way.
A raising of trade barriers will almost certainly increase inflationary risks and continue to unwind globalization as well as the hitherto established global world order, with the United States at the head of the table.
History is replete with examples of globalization, whether through advances in technology such as the steam engine, or establishing trade routes such as the Silk Road, and a retreat from those advances as well.
More recent examples of globalization also did not end well, with the first wave of globalization and industrialization in the 20th century ending in two global wars.
But since the collapse of the Soviet Union, globalization has been on a tear.
With the rise of China as the world’s factory, the digital economy has now become a major force for globalization, through e-commerce and digital services accessible from anywhere in the world.
But as this new wave of globalization is reaching our shores, many of the world’s people are turning their backs on it.
In rich countries in the west particularly, many middle-class workers are fed up with a political and economic system that they blame for inequality, social instability, and — in some countries — mass immigration, even if it also led to economic growth and cheaper products.
Protectionism, trade wars and immigration stops are once again the order of the day in many countries and if populists continue to control the narrative, inflation is almost certain.
As a percentage of GDP, global exports have stalled and even started to go in reverse slightly.
As a political ideology, “globalism”, or the idea that one should take a global perspective, is on the wane.
And internationally, the power that propelled the world to its highest level of globalization ever, the United States, is backing away from its role as policeman and trade champion of the world.
Individually, none of these trends would make a particularly strong case for Bitcoin, but viewed in totality, it suddenly makes sense why investors like Tudor Jones are stocking up on the cryptocurrency.
If the U.S. abandons its role as a global defender of the international rules of engagement and trade, the dollar then becomes a superfluous construct of a previous world order.
Against that backdrop at least, there’s more than a little reason for a large wager on Bitcoin.
This article was written by Patrick Tan, CEO & General Counsel of Novum Alpha a digital asset quantitative trading firm.
Exclusive access to this article is made in conjunction with Bitcoin Malaysia.
The information and thoughts laid out in this analysis are strictly for information purposes only and should not be regarded as an offer to sell or a solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be in violation of any local laws.
It does not constitute a recommendation or take into account the particular allocation objectives, financial conditions, or needs of specific individuals.
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