How the crisis makes crypto a better investment (1/3) - icoinic
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Imre Molnar - Algorithmic Trader - Team Icoinic B.V.
Imre Molnár
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How the crisis makes crypto a better investment (1/3)

Economic disease and the proposed painkiller for it

The recent economic turmoil changes the perspective of almost all investments and crypto is not an exception from this. Icoinic publishes a blog series to explain why we think crypto is a better investment now than ever before and how crypto and Bitcoin especially can be the answer to the problems with the indebted and vulnerable economies. This post will examine the health of the economies today and describe the proposed solution from the FED.

After the month of February when the virus started to erode the stock market and Bitcoin and gold dipped down, 2020 March went into history as the grand finale of the longest bull run of the stock market. At this downturn, the amount of debt accumulated in the economies will be a heavy burden to carry. If the world economy goes into depression then it will be questioned how we got here and probably this time the discussion will go farther than releasing a few movies about what happened. The accountability and fairness of the system are definitely two topics that will be examined. Concluding the discussion does not look easy, as there is serious tension between countries and social layers which will at least affect the way the outcome will be formed. How the social discussion is led and finished, and how the tension is managed will serve as ground for the economies in the post-corona era.

Similar to the world economy, Bitcoin also arrived at a decisive point. Eleven years since its start, it has transformed from a niche technological breakthrough to a household name speculative asset, and it has achieved that without any marketing activity. The question for the coming years is whether it can become a globally used digital currency which would provide an alternative option to the ever-inflated fiat currencies. To see how crypto and especially Bitcoin are affected by the corona crisis, it is worthwhile to have a look at the big picture since it seems that for the first time in crypto history, there might be vastly impactful factors which are external to the crypto eco-system.

Economic health and collapse

The measures to slow down the spread of the virus are economically devastating. First China published its February statistics on the slowdown of its economy. On a yearly basis, retail sales crashed 20%, industrial production collapsed 13% and fixed asset investments plunged 25%. All three values are the first negative values in history. One might think that the Chinese values are so extreme due to the Draconian corona measures and that the European or the American ones are less extreme. This is probably not the case as in the last 2 weeks 13 million unemployment claims were filed in the US.

“That’s up from 3.3 million initial claims in the previous week which was itself a huge record. Before Covid-19, the previous record was below 700,000 for any week.” One week ago The Guardian wrote.

That’s 16 million people who lost their jobs accounting for 5% of the population, within 3 weeks.

Europe is also taking a big hit and the GDP is expected to contract between 5-11% this year. Now top EU state leaders are discussing the possibility to issue “coronabonds” to raise funds for mitigating the economic damage. The leader of ESM indicated that setting up an institution which could issue the bonds would take 3 years.1 Other than the financial hit, the EU is also struggling to mitigate the rising Euroscepticism in Italy 2

It is clear that the current recession is a massive negative shock in the corporate revenues as the daily lifestyle of the world has changed almost overnight from globalized to quarantined. Everybody at the same time stops traveling, going out and instead wants computers, food, masks and pharmaceuticals. Industries and supply chains are not able to cope with the speed of this preference change. The losses occur as we speak but in relation to the future, the main question is how can they deal with the stress situation? Do they have enough reserves to bridge a few difficult months? Or could they raise funds from the public, from banks or from the government? In overall how is the general health of the economies today?

Since the ’08 financial crisis, interest rates have been kept extremely low for 11 years. Cheap credit was available for big corporations, governments could easily finance their budget deficit at a low cost and people in big cities could buy their new homes as mortgages were historically cheap too. These gave great opportunities to make investments and grow quickly as capital costs were minimal.

Some, like the tech giants, did so and produced outstanding results quickly. 3 On the other hand, many companies funded their stock buybacks 4, made costly takeovers5 or financed their enormous growth plans6 and these investments have not delivered positive results yet. One metric to check is the prices per sales ratio. The ratio is at a historically high-level signaling that the sales of the companies are lagging behind their stock prices.

Graph 1: The chart exhibits the divergence of the sales of the companies and their prices

This suggests that most of them could not turn their investments into cash flow generation during the good times and now they will be in a difficult situation to finance their debt as revenues dry up.

Similarly, governments had the possibility to finance themselves at low rates but did not take the opportunity to decrease their debt amounts. Quite the opposite, the global sovereign debt has soared in the last decade. 7, while GDP growth did not reach high levels. It is also important to distinguish between countries who are dominantly indebted in their own currencies and those who have foreign currency debts. The latter group might find itself in a debt spiral, if they are not able to obtain US dollar from trade or selling treasuries. They will need to print more and more of their own currency to buy it, which might lead to extreme devaluation of their own currencies.8

The populations also took more loans in the last years: mainly personal loans and mortgages to buy their homes typically in cities where housing prices skyrocketed since the last financial crisis. Most of the households have very little savings and for the ones who do, a big part of them is in pension funds which are invested in stocks and in corporate bonds.

Moreover, there is a neo-feudal level of inequality between the rich and the poor in most of the countries. From one side, the gap might become smaller as asset prices plummet, but it will be also important how the economic stimulus packages will be structured and who gets how much from the pie in order to avoid social unrest.

One positive point compared to the ’08 situation is that the major US banks are well-capitalized and standing stable for now. However, this cannot be said about their European counterparts and furthermore, there are other technical risks in the financial system like the large exposure to BBB bonds which might become junk during the crisis. The downgrade would push the issuer companies further down on the slope.

To conclude, it seems fair to say that the economies are in a terrible shape to absorb the shock. As central banks around the world put interest rates around 0% after the financial crisis, companies, governments and the public took the cheap loans. Since the extremely low interest rate environment persisted, savers had no other choice than lending at low rates and taking unusually high risk for tiny returns. Currently it looks that almost everything was lent out in the return-hunting of the last decade, which might have led to serious malinvestments and there are hardly any reserves left in the western economies.

Looking at this picture and knowing that a deep economic downturn also has serious a impact on public health, it is a fair question to ask whether it is better to lift some of the measures before they lead to an even worse economic disaster. In either way, corona has done its damage, trade has slowed remarkably, and millions already lost their jobs. These might lead to cascade effects of company losses and defaults 9 in economies where companies have no reserves, people live from paycheck to paycheck and governments have gigantic debts.

Solution, will it work?

The problem is clearly global but for a simpler analysis, we will only analyze the US and China, as these two together have the same GDP as the next 20 countries combined, plus they have their own currencies and the US dollar is the world reserve currency. Moreover, they are clearly political leaders in finding a world solution to corona.

As the FED learnt from the example of the Great Depression and the ‘08 financial crisis, the sooner they act, the better and they shouldn’t limit themselves when it comes to the size of the stimulus and bail out packages. In 2008, they prevented that financial institutions would fall like dominos by cutting interest rates by 5%10 and by printing more than 2.5 trillion dollars and could prevent. They also bought the toxic assets, and societies around the world paid for it.

This time they did an emergency 1.5% rate cut and then they started the printing press again. The government then launched the CARES program which is a 2 trillion dollar fiscal stimulus to bail out companies and plan to give $1200 to each citizen. Moreover, the FED entered many more financial markets with their market operations than ever before such as the bond and ETF markets, and started supporting prices and providing liquidity.11

The package includes aid for companies and 500 billion dollars will go to help big corporations. The 500 billion could be levered up to 4 trillion in FED loans. There are so many companies asking for help, that one might get the feeling that corporates wanted to become “too big to fail” during the last bull run.12

China is also printing money and based on their data it seems that their economies are somewhat more robust.13 They gave 5.15 trillion-yuan ($732 billion) loans to their real economy in March 2020.

The question is: will this work?

Major problems with the proposed solution and how crypto comes into play will be described in the next episode of the blog series. If you wish to read the series in one go, navigate to our Medium page.

Footnotes

  1. Will the world be still fighting the virus in 3 years? https://www.ft.com/content/3f6c31fb-c59c-4aa0-88fd-275a880dad1a
  2. After the inactivity of the EU to help, Italians feel abandoned by the block and note that they got more help from China, Russia and Cuba. https://www.cer.eu/insights/trouble-eu-brewing-coronavirus-hit-italy
  3. Rise of Google, Facebook, Amazon, Microsoft: https://www.theguardian.com/commentisfree/2019/dec/25/2010s-tech-giants-google-amazon-facebook-regulators  
  4. Stock buybacks account for most of the stock price increase: https://markets.businessinsider.com/news/stocks/stock-market-share-buyback-programs-fading-gone-years-coronavirus-bernstein-2020-4-1029068723  
  5. https://www.businessinsider.nl/ma-largest-deals-world-2019-2019-3?international=true&r=US, https://www.businessinsider.nl/5-biggest-mega-mergers-of-2019-according-to-mergermarket-2019-10?international=true&r=US  
  6. Many globally known brands like Netflix, Uber or the infamous WeWork operate with loss or make very little profit compared to their raised capital: https://www.thedrum.com/opinion/2019/11/26/wework-shows-real-profit-still-matters-more-growthhttps://www.spglobal.com/ratings/en/research/articles/200219-fast-starters-will-netflix-tesla-uber-and-wework-keep-pace-11350587  
  7.  Global debt record in 2019: https://www.axios.com/global-debt-increase-q1-2019-92ef0a63-b86e-471d-84c8-588a719f3fc2.html  
  8.  Brent Johnson’s Milkshake theory of the dollar: https://www.realvision.com/shows/the-expert-view/videos/brent-johnsons-dollar-milkshake-theory  
  9. Economic contagion cannot be stopped with social distancing.
  10.  https://www.vox.com/2014/6/20/18079946/fed-vs-crisis, Chinese response: increase credit: https://cathayrev.com/2018/09/10/chinas-response-to-the-2008-global-financial-crisis-and-its-legacy/  
  11. and at some markets they are such a big part of the buy side that some participants said they could halt the market as the FED is the only buyer for now. https://www.zerohedge.com/economics/if-getting-us-6-trillion-more-debt-doesnt-matter-then-why-not-350-trillion  
  12.  One example could be Amtrak which has not produced profit in the last 50 years and currently got a 1 billion bail out, https://www.wsj.com/articles/hit-by-coronavirus-amtrak-banks-on-billion-dollar-bailout-to-stay-afloat-11584979346  
  13. Emergency rate cut: https://www.reuters.com/article/us-health-coronavirus-china-cenbank/china-unexpectedly-cuts-reverse-repo-rate-by-most-in-five-years-to-support-virus-hit-economy-idUSKBN21H0EM, Money printed: https://www.focus-economics.com/countries/china/news/money/new-yuan-loans-disappoint-in-february-while-m2-growths-jumps-to-two-0  
Luc Correia Cabrito