The financial markets have largely forgotten the pain experienced during the GFC. This time around with 0% interest rates and free money galore, all sorts of risk assets have been buoyed. Bitcoin came about during the depths of the GFC depression. Bitcoin at its core is a reaction against ways in which mainstream finance has been practiced over the past 100 years. Bitcoin feeds off of investors dissatisfaction with monetary and governmental regimes.
After 7 years of free money, cracks in the world economic edifice are beginning to show. I have identified three salient areas where instability might flare up this fall. While I can’t predict the exact response of global assets in each scenario, I am willing to wager that Bitcoin will benefit from chaos and instability.
The Federal Reserve Rate Hike
The Fed aggressively lowered interest rates and printed money via quantitative easing starting in late 2008. Now they are determined to show the world that they can raise interest rates and recover some of their tattered credibility. Through different mediums they have loudly telegraphed that 0.25% rate rise will happen by year end. The financial media has touted the party line that the US economy and in particular equities can handle positive short term rates.
I disagree strongly. When discounting any asset at 0%, even a small rise wrecks havoc on any discounted cash flow analysis. Even more troublesome, is what happens to companies who must now roll low interest debt into higher yielding debt. That is not a problem when the general business climate is improving. However, the collapse in the commodity complex tells us that end demand and real economic activity is falling worldwide. Many businesses only exist because yield starved investors have financed them at ridiculously low interest rates.
Important Dates:
Federal Reserve Open Market Committee (FOMC)
September 16-17
October 27-28
December 15-16
Grexit And Eurozone Turmoil
After Alexis Tsipras acquiesced to Germany’s bloodless coup, Grexit was temporarily taken off the table. For ordinary Greeks, the situation has become worse. Capital controls still remain, and business activity is grinding to a halt. Greece might still need a “time out” from the Eurozone to shave its unserviceable debt load.
Once European bureaucrats return from their Mediterranean beach holidays, the uncomfortable truths of a troubled Eurozone will appear once more. Spain and Poland have national elections this fall. Anti-EU parties are gaining strength. PM Rajoy’s People’s Party is being assaulted by Pomedos. Pomedos is campaigning on an anti-austerity framework. If Greece is able to receive debt relief, Pomedos will campaign for similar tactics to be employed by Spain.
Polish MP’s are up for re-election this fall. Dissatisfaction with the EU program could lead to a change in the makeup of parliament. Given that many of the EU bailout programs need domestic approval before the commitment of funds, a hostile parliament can spell trouble for Brussels.
Important Dates:
Polish elections October 25
Spanish elections before December 20
China
The drama surrounding the correction in the Chinese equities market, while entertaining, is not the main event in the Middle Kingdom. The real problems facing China are accelerating CPI food inflation, a slowdown in economic activity, and the mass exodus of capital.
Once you get past the glittering luxury store fronts on the eastern seaboard, Chinese poverty rears its head. The mass of poor people spend a significant amount of their disposable income on food, especially pork. Pork prices have been on a tear this year. Beijing and the PBOC are acutely aware of how food inflation impacts the majority of its citizens. The legitimacy of the Chinese Communist Party (CCP) is at risk during period of high inflation. As a result, the PBOC is hesitant to aggressively cut interest rates for fear of stoking inflation. Instead to prop up the faltering stock market, they must resort bans on selling stocks and directly buying the market.
Beijing recognises that China must transition from an investment to a consumer driven economy. The 10+% GDP YoY gains are a thing of the past. Many economists believe 3%-5% GDP growth is coming. Unfortunately the vast amount of debt underpinning many businesses and local governments need a high nominal GDP growth rate to paid back. The PBOC now must absorb these non-performing loans at a time when they can’t cut rates due to inflation fears. At some point, the government will have to allow selective entities to default and that will send a ripple through the Wealth Management Product (WMP) industry. WMP’s are high yielding debt instruments with implicit guarantees of the issuing banks and or local governments. If investor confidence is shaken in WMP’s, these funds will need to find a new investment vehicle (maybe Bitcoin?).
Finally, the capital flight from China is accelerating. The elites recognise the precarious state of the Chinese economy and their position in it. They are sending their spawn to America, Canada, Australia etc. to deploy RMB into real estate and other assets. The capital account of China is closed only to those without the right Guanxi (read connections). The PBOC has begun selling US Treasuries to offset the flow of capital out of China. If Beijing actually cracks down on the porous nature of the capital account, these funds will need to find another way to escape the RMB and China. Bitcoin is one option. It is still too illiquid to handle the tens of billions USD leaving the country each month, but even a small percentage of these flows going through Bitcoin could lead to a massive price rise.
The RMB strengthened against the USD and other Asian trading rival’s currencies for the past few years. Faced with the set of domestic financial challenges described above, the PBOC at some point may begin devaluing the Yuan. Chinese investors who want to protect against depreciation can turn to Bitcoin to protect a portion of their wealth.