The Macroeconomic Mirage
The US and global economies are currently in a unique position. As global debt reaches US$281 trillion with no sign of slowing down, the macroeconomic horizon is becoming more uncertain. In 2020, the federal reserve injected over US$3 trillion and a further US$1.9 trillion is expected in early 2021 under the Biden administration.
The act has led to a domino effect resulting in rising inflation across a number of sectors and subsequent moves by many to preserve their wealth. The current Consumer Price Index (CPI) and inflation figures sit well within the predicted range at 1.4% and 1.56% respectively, although a number of individuals suggest that this is not an accurate representation of the current environment, particularly for investors and institutions.
While both of the metrics mentioned above have been used for decades to assess economic circumstances, a key factor is often overlooked – there are variances based on demographics, location, lifestyle preferences, etc. In the current investment climate, many are unaware of the inherent difference between the numbers and the localised and personalised figures that are actually impacting them.
In an interview with Preston Pysh late last year, Michael Saylor detailed the resounding impact that this oversight is having on many of America’s largest corporations. He insists that they are unaware of the severe losses they are incurring, simply by retaining significant exposure to the US dollar via their balance sheets.
Finding an Effective Indicator
Broadly speaking, the expansion of the M2 money supply in the US (25.8% YoY increase in January 2021) has been fueled by stimulus packages aimed at supporting people and businesses through Covid-19 and maintaining fluidity of markets. Despite being partially effective in doing so, adverse effects such as currency devaluation are expected to intensify over the coming years as the rate of expansion continues to grow between 10-15% annually.
Saylor’s insight suggests that treating the M2 money supply as an entity’s cost of capital allows one to apply this as their risk-free required rate of return. In doing so, the harmful impacts of using blanket statistics such as national inflation and CPI to measure portfolio and/or project health are avoided.
How This Works
Assume a company commits US$100 million on its balance sheet to government sovereign debt bonds yielding 1.5% p.a. If the M2 money supply continues to expand over the next ten years at 15% p.a, this risk-free hurdle rate must be exceeded in order to preserve their balance sheet’s value. Assuming no monetary policy changes within those 10 years, a net loss of 13.5% p.a will lead to only US$13.13 million worth of purchasing power by the end of the period. Note that as this example uses sovereign debt, a risk premium is not included. In any other yield instruments, a risk premium spread would need to be taken into account.
If monetary policy was to be put in place to stimulate economic activity during this time, bond yields would drop, further minimising returns. While this would lead to an increase in bond face value, in order to capture it, one must sell them in secondary markets prior to maturation. Even then, the likelihood of matching the coupon value mentioned in the example above would be low.
Why Does This Matter?
The expectation of yielding 15% growth p.a. on USD treasury holdings for the next decade is unattainable without taking on undue risk. Companies need better options to hedge out treasury flows.
In 2008, interest rates on 10-year treasury bonds sat at 5.5% –there was scope to take on lower allocations with additional risk premium in other assets as the bond yield provided a strong risk-free rate. Currently bond coupons are averaging ~1.5%, leaving little wriggle room, and forcing investors to take on more risk in other assets. If the market continues to bid bond prices on speculative upside, essentially shorting volatility, it becomes increasingly likely that bond values will collapse on inflation shocks or an increasingly crowded trade. This is further exacerbated by corporate bailouts and ultra-low interest rates, fueling hibernating “zombie” companies that are siphoning monetary value through debt from the economy and offering little in return.
As companies continue to take on riskier behaviour to remain afloat (bad acquisitions, leveraging up, etc.), the situation could continue to worsen, leading to rapid currency devaluation and widespread liquidations as the cost of capital rises.
How Bitcoin Poses a Solution
In order to avoid such detrimental behaviour, USD denominated investments (that have the goal of preserving wealth) should be observed with skepticism and heightened due diligence. Many have turned focus to alternative investment options such as bitcoin for an easier, more passive approach.
As there continues to be a growing amount of fiat capital chasing bitcoin’s fixed supply, its base value continues to grow. This deflationary characteristic of the asset guards it from asset dilution, ensuring that supply flow remains consistent and intrinsic value holds. Alongside this, its liquidity is deepening – beginning to match commodities and fiat, allowing those that allocate a portion of their treasury to bitcoin to meet short-term needs while holding an asset that has significant potential to increase purchasing power. Holding a Sharpe ratio of 2.62, the asset’s asymmetric return profile far exceeds that of alternative options such as gold (1.66), limiting downside in times of low cash flow with potential for favourable upside. For more information on the factors driving bitcoin’s value as a wealth preserver, Zerocap’s report from the middle of Covid-19 (2020) Bitcoin: This Is the Hedge offers further insight into why there is no comparable asset in today’s market.
As companies and investors continue to realise the outweighed benefits of holding bitcoin on their balance sheet as an alternative to other wealth preserving endeavours, the list of notable investors will grow alongside Tesla, Microstrategy, Square and BlackRock. Through turbulent times, wealth preservation remains the key focus for many. As the global fiat currencies’ value dissipates, there are few reasons not to hold bitcoin and protect purchasing power.