To most retail investors, the financial markets today might seem to be operating on a Business-as-usual basis. After all, stocks are trading close to their all-time highs which makes up for some lack luster performance in the bond market. But all things considered, this situation doesn’t seem to be that much different than any other robust recovery cycle for stocks. All of that is true, but there is actually some heavy drama going on behind the scenes and in lesser owned asset classes like commodities, inflation hedges and Crypto Currencies. For today’s update, I’m not going to talk specifically about Crypto as much as what is implied by investors’ newfound obsession with the digital stuff, as well as investor implications.
6 Trillion Reasons to Worry About the US Dollar
President Biden rolled out his $6 Trillion budget last week with an $8.2 Trillion spending increase through the year 2031. It won’t pass as is but let’s assume that we’re talking about a very large number in the way of Federal Spending and associated higher tax rates for any with assets or higher incomes. These are the Democrats stepping directly into the footprints of the Republicans who, over the course of the the last 4 years, are equally committed to untethered spending (stimulus) and seem to be comfortable with federal debt approaching 300% of GDP.
It actually makes me a little nauseous to write those words. Why?
Because history is a great teacher and there have been times in the past, in various countries, where currency risk associated with this type of spending have not ended well. The hallmark of all such cycles was of course inflation which we’re now seeing in full color. Inflation usually starts with a shocking move higher, as we’re seeing now, until the economy just stops in its tracks and goes into a deep recession. We expect all the above to occur in the next 3-5 years. Thus far, inflation has been a welcome addition to our current economic recovery giving companies a little pricing power for the first time in decades. But as we move through time, inflation finds it’s way into the cost of goods, labor costs and resource scarcity chewing into profits and earnings as it goes. This is beginning to happen now.
Historically speaking, when any government, releases themselves of any form of budget and effectively floods the country with unearned cash and debt, you eventually create an environment where the world no longer has confidence in the underlying currency (and bond markets) of the offending sovereign nation. This is called currency or monetary debasement. It’s something that has happened in the past but only in very desperate times, in desperate places and desperate situations. Think Argentina, Germany post WWI, Zimbabwe. The United States of America is not a desperate nation, but we’re acting like one now. For years and years, the US Dollar has been the world’s reserve currency of choice. Over 80% of all transactions globally use the US dollar. Here’s a snap of the Trade Weighted US Dollar index.
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When Trump took office in January of 2017, the index was much higher at 88. It’s now trading around 77 and showing no signs of bottoming at the old lows of 2018. What we are seeing in graphic form is currency debasement of the US Dollar. If the current level doesn’t hold, the next level of support is almost 25% lower close to financial crisis lows of 2008.
What’s the point? Investors would be very wise to watch the US Dollar right here and right now. Why? Well, it really comes down to our ability to continue spending and paying interest on our bonds as a country. Remember that old saying “US Treasury Bonds are backed by the full faith and credit of the US Government” which has the authority to print money and tax citizens at its discretion.
What happens if the world loses confidence in the full faith and credit of the US Government?
Crickets…blink…blink
This is where we’re heading; Towards a long-lasting loss of confidence in the US dollar and the full faith and credit of the US Government’s ability to repay its debt? I do not see any form of austerity in our future, just currency debasement and inflation. Consequently, we shouldn’t be surprised that foreign nations are no longer buying US Treasuries, in fact they are net sellers. The only entity buying US Treasury bonds now is the US government. It’s sort of scary to be both the lender and the investor in your own product.
Wrapping it up, we are creating some self-inflicted wounds by debasing our own currency and driving investors away from our main source of distribution – the Treasury Bond market.
Enter Crypto Currencies.
For as much as you might hear that crypto currencies represent a new and improved secure, digital payment system, you have to know that the existence of crypto currencies today is mostly about the loss of confidence in the full faith and credit of the US Government and that little piece of paper called the US Dollar. It’s actually described as digital gold, and as we know, gold has served as an effective value proxy for the US dollar for many decades. In fact, Crypto currencies and gold are becoming substitutes for each other to a degree. In a minute, I’ll tell you why we like gold over crypto for the next several years.
Investors have become obsessed with Crypto currencies of all kinds (Proof of Work to Proof of Stake). The early adopters bought crypto as a Store of Wealth against what we are seeing today in our own currency debasement. They weren’t wrong and we all saw the likes of Bitcoin rise to nearly $60,000/ coin. Unfortunately, others have joined the movement late, chasing returns into an asset class that they couldn’t define. They bought it because others before them made a quick buck, pure and simple.
In the last month Crypto Currencies were decimated losing nearly 50% in just a few sessions and settling on a loss of -35% for the month of May alone. You can bet that these “investors” are asking themselves some hard questions about the legitimacy of the story behind the “store of wealth”. What store of wealth losses 50% in a few days? Gold by comparison has 1/10 of the natural volatility of the crypto universe. Gold has experienced corrections of 11-21% even during long and enduring bull market runs. But that’s a lot different than the 50-70% losses we’ve seen in Bitcoin in just the last 4 years.
If you think about the big picture, you have to understand how much force, power and pressure exists in supporting the value and utility of the US dollar. The US government is far more likely to highly regulate crypto currencies, make them illegal tender for transactions, or tax them to death, than they are willing to give up control of the world’s reserve currency and the role of the central banks. It’s going to be a pretty easy argument for them when hackers of oil pipelines are demanding ransom in the form of Bitcoin. Last year, $350M worth of Bitcoin was paid to hackers in total. Why would our government ever embrace a means of payment that serves cyber terrorists? If anything, I would expect our own government to launch its own highly regulated and highly controlled crypto currency.
I’m sure I’ll get blasted for this statement.
Crypto will never replace the US dollar, but the US dollar’s role as the world’s reserve currency will be less dominant over time.
But crypto (together with gold) is likely to continue its path forward as a sentiment or confidence indicator relative to the value of the US dollar and our government’s monetary and fiscal policies.
Crypto will never replace the US dollar, but the US dollar’s role as the world’s reserve currency will be less dominant over time.
Investor Implications
Let’s talk about using Gold versus Crypto as a hedge against currency debasement. To anyone under 40 years, you might look at gold bullion or owning gold mining stocks as something “boomers” do. Crypto is so…. Digital and techy. Gold is for old people. In either case, you can’t really buy groceries with Crypto or gold. However, there are some very interesting developments in the fundamentals behind gold miners specifically that makes them much more attractive than crypto as a hedge. Consider this; Gold miners now have positive free cash flow that is higher than the technology sector!
Here are a couple charts courtesy of Crescat Capital, the macro gurus on all things gold.
On a pure performance basis looking back to January 1st of 2018, Gold miners (GDX) have a total return of 78% while crypto assets in aggregate (GBTC) have gained 33% through yesterday. Gold miners now have very high free cash flow and are intrinsically a value investment with a century of history serving as an excellent hedge against the US dollar. Crypto has no cash flow and no history. We’re going to stick with Gold and gold miners over crypto… and I’m not a baby boomer for the record.
Other investor implications. We are likely on the cusp of a new wave of relative returns favoring international investments which benefit when the US dollar falls in value. China specifically, is intentionally driving the value of the Yuan higher on their way toward global economic dominance. China now represents 20% of global GDP up from 10% at the turn of the century. The US by comparison represents 28% of global GDP down from 35% at the turn of the century. The trends are in place for China to become the world’s dominant economic force over the US. Our pride as a nation has a hard time with that fact and I expect friction along the way between our countries. But without pride and ego, we might remain open to investments in Asia. Let’s leave it at that.
I hope I have answered the many questions surrounding the role of Crypto currency in this update. As I tell my class of students; Understand what you own and why you own it today. I hope all of my crypto friends out there have good answers to those questions.
Happy Summer!
Sam Jones
