Journal of Financial Planning: June 2023
Ivory Johnson, CFP®, ChFC, is the founder of Delancey Wealth Management LLC (www.delanceywealth.com). Mr. Johnson has a B.S. in finance from Penn State University, has been certified by the Digital Asset Council for Financial Professionals, and is a member of the CNBC Financial Advisor Council.
The economic historian Charles P. Kindleberger once remarked that “the propensity to swindle grows parallel with the propensity to speculate during a boom.” How ironic that a man who believed a hegemonic power was needed to maintain a stable international monetary system would foretell the systemic damage dovish central banking policies would ultimately cause.
Bitcoin was first launched in January 2009 by a computer programmer or group of programmers under the pseudonym Satoshi Nakamoto whose white paper1 described it as “a purely peer-to-peer version of electronic cash (that) would allow online payments to be sent directly from one party to another without going through a financial institution.” One of the objectives was to maintain privacy by publicly announcing the transaction without disclosing an identity, the way ticker tapes reveal the time and size of trades. Another goal was to achieve financial sovereignty with no need for a trusted third party or a middleman.
Rumor has it that bitcoin was created in response to the 2008 financial crisis, but it’s worth noting Nakamoto’s comments that “the root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.” He (or she, or they) specifically identified the problem it was attempting to address, namely the loss of one’s purchasing power and a central bank that can create money not backed by anything of value out of thin air.
Bitcoin is to many investors a scam, a fad that will collapse under the intense weight of wannabe innovators’ shortcomings and SWIFT network naivete. These accusations are leveled after years of being told not to fight the Fed with no instructions on how to defend oneself against economic insults masquerading as loose monetary policy. Bitcoin’s detractors may eventually be proven correct, but as Hedgeye Risk Management recently opined to its “Early Look” subscribers, “if they had to mark-to-market, the Fed is like the largest regional bank failure . . . losing money hand over fist with around $8 trillion in low-yielding, fixed-rate securities funding around $8 trillion in high-cost, short-term liabilities.”
Quantitative easing, for what it’s worth, saw the Fed manufacture money to buy bonds from the balance sheets of the banks and give the interest from said bonds to a Treasury that can’t live within its means, only for the banks to lend the Treasury even more money by replacing the bonds they just sold to the Fed with the proceeds of the sale. Suffice it to say that if a private citizen did this, they would be arrested for money laundering. Instead, low interest rates amplified financial asset values and increased the collateral used to borrow money. Now that interest rates have gone up and the Fed has tightened, there is less liquidity to service the most debt ever recorded in human history.
The zero interest rate policy (ZIRP) has likely created several problems we don’t even know exist yet, namely in the form of misallocating capital. Investors hell-bent on earning more yield, on getting more bang for their buck, purchased illiquid investments that might end up giving them the bang without returning their bucks when they actually need them. The name BREIT, which limited redemptions, comes to mind.2 Moreover, the issuance of private debt has become a $1.4 trillion industry3 that has securitized loans that were made to small and midsized companies who are headed into a recession. These obligations are often floating rate loans that have been securitized and sold to investors, 65 percent of whom are pensioners in search of higher yields.
Bitcoin might be quite the swindle, but the Satoshi Nakamoto white paper indicates that it is a response to this level of systemic financial engineering. A cursory analysis of recent price movement suggests that it mirrors the liquidity either created or eliminated by the global central banks. For instance, in response to COVID-19, the Federal Reserve grew the money supply by 40 percent, with the European Union hot on its tail growing its own money supply by 22 percent.4 Fiat currency, in the midst of becoming even more abundant, was being exchanged for something that had a cap in supply because there will only be 21 million bitcoins ever produced.
Given the steepness of the economic slowdown of American households, banks and businesses were given boatloads of money that stoked inflation. The Fed responded by engaging in quantitative tightening that led to a historic decline in the money supply on a rate of change month-over-month basis as defined by M2. The very same dynamic that led to bitcoin’s price appreciation had been turned upside down.
The correlation between global liquidity and bitcoin’s price is consistent with Nakamoto’s endorsement for a currency that cannot be debased. All of this leads one to consider that, in the long run, bitcoin might be everything or can be nothing. The notion that Uncle Sam and his collaborators can accept short-term pain in exchange for long-term stability bears no resemblance to past behavior. It could be anything—a pandemic, a bank run, a plane crash, a market crash, a pension bust, a fiscal collision, the unmarked finally getting marked, or a JGB yield curve control game gone woefully bad—that eggs the central bankers on. One more pivot, a little bit of liquidity, just another taste to get us through the next business cycle.
In fact, it’s already happened. Silicon Valley Bank failed because a ZIRP forced them to go further out on the yield curve with their depositors’ money. Once interest rates increased, their depositors realized they could get more interest by going across the street. This forced the bank to sell assets, and not only did those held-to-maturity (HTM) bonds lose money, but the extent of those losses was made plain (by Twitter) when those assets were marked to the market. The Fed responded by creating a facility to buy the HTM bonds, again with manufactured money, that created the liquidity to make the depositors whole.
The central bank’s inability to stop debasing the currency would be something to behold given the amount of debt that has to be refinanced. The national debt comprises $24 trillion held by the public and $7 trillion of intragovernmental debt that includes the Social Security trust fund that Congress spent and replaced with IOUs. The Treasury and its allergic reaction to fiscal responsibility compounded the problem when it borrowed money on the short end of the curve to pay for the COVID-19 stimulus programs.
According to the Treasury Advisory Borrowing Committee, $7 trillion of the debt held by the public had to be refinanced in fiscal year 2023, which is March 2022 through March 2023. If they had to pay an additional 1.75 percent to refinance these obligations, it would be an additional $120 billion in interest payments5 or 15 percent of the military budget. The Fed also used to send the Treasury its profits, the difference between the interest paid by the bonds on its balance sheet and the low interest rate it paid depositors. That dynamic has been reversed, and along with it the loss of $100 billion in profits.6 that represents four times the NASA budget.
The positive impact deficit spending has on GDP growth wanes over time, the marginal productivity of debt has been raising its eyebrows since the 1950s,7 and the law of diminishing returns can’t seem to stop grinning. None of us can say with 100 percent certainty that the Fed will resort to increasing the money supply or encouraging hyperinflation, but the odds sure ain’t zero. After all, nobody ever shoots Santa Claus and I’m told he has a bag of entitlement benefits loaded up on his sleigh. Bitcoin, by its very design, is a hedge against any of these possibilities.
This is not to say that bitcoin cannot become nothing. The government seized all gold bullion and coins via Executive Order 6102, forcing citizens to sell at well below market rates. Immediately afterwards the government set a new official rate for gold that was much higher as part of the Gold Reserve Act of 1934. The motive is debatable, although FDR reportedly said in a May 7, 1933, fireside chat that “behind government currency we have, in addition to the promise to pay, a reserve of gold and a small reserve of silver, neither of them anything like the total amount of the currency.”
Bitcoin is not a tangible asset, the internet would be difficult to shut down, and there is no leadership or central computer that can be approached to enforce any sort of ban, but the government can close the off ramps and prevent consumers from exchanging bitcoin into fiat currency that can pay for goods and services. Regulations can also limit the adoption rate of bitcoin through the eradication of exchanges and financial products that represent bitcoin via ETFs or similar interests.
A less likely demise of bitcoin would be a Congress that gets its act together, finally pays the piper, and asks the American public to accept sacrifices and third rail politics grasping a tattered white flag. In an effort to thread the needle, Jerome Powell might attempt to maintain the current interest rate and let the lack of liquidity run its course. He could allow the balance sheet to shrink by way of maturity, which is a bear case for bitcoin. Danielle DiMartino Booth of Quill Intelligence makes the case that we could reduce the footprint of a shadow banking system that provides nearly 60 percent of total consumer and business credit8 and moderate the securitization market, which she believes is an inefficient way to price credit and return it to the banking system that must withstand the light of day.
Bloomberg suggests that 20 percent of publicly traded U.S. companies are zombies that lack a sound business model and only exist because they have access to cheap credit.9 Allowing them to fail would create more capacity for the remaining 80 percent who can compete for better priced credit. Worst case scenario, the Fed announces that 2 percent is the new zero, but the days of zero interest rate policy are behind us because it feeds the non-banking sector that adds little value to economic growth. These would be painful concessions, and even if alternative strategies are adopted, they are unlikely to offer immediate relief that’s pleasing to the eye, or the pocketbook.
We are wrestling with something we can’t seem to put our arms around: that bitcoin is the past trying to keep the future at bay. It is a quarter of office-building loans that need to be refinanced in the next year10 at higher rates looking over their shoulder at the lower quality properties hiding in the shadows of illiquid alternative investments. If the concept of bitcoin is hard to fathom, it’s because the circumstance of it being everything is too unimaginable to even consider. For bitcoin to become nothing, however, would likely be a victory for the ages and we should all pray like the biggest sinners in Babylon for it to hit rock bottom.
Endnotes
- Nakamoto, Satoshi. n.d. “Bitcoin: A Peer-to-Peer Electronic Cash System.” Bitcoin. https://bitcoin.org/bitcoin.pdf.
- Bary, Andrew. 2023, March 1. “Blackstone Limits Breit Withdrawals for Fourth Straight Month.” Barron’s. www.barrons.com/articles/blackstone-limits-breit-withdrawals-c88fe6f6.
- Elisei, Chiara. 2022, December 20. “Analysis: Private Debt Markets Face Reality Check as Companies Grapple with Rising Rates, Recession.” Reuters. www.reuters.com/markets/rates-bonds/private-debt-markets-face-reality-check-companies-grapple-with-rising-rates-2022-12-20/.
- Boyle, Ryan James. 2022, July 15. “More Money Supply, More Problems.” Northern Trust. www.northerntrust.com/canada/insights-research/2022/weekly-economic-commentary/more-money-supply-problems.
- Sloan, Allan. 2022, June 27. “Fed Interest Rate Hikes Just Made National Debt a Lot More Expensive.” Washington Post. www.washingtonpost.com/business/2022/06/27/fed-rate-rises-interest-national-debt/.
- Curran, Enda, Jana Randow, and Jonnelle Marte. 2022, October 25. “Fed Is Losing Billions, Wiping Out Profits That Funded Spending.” Bloomberg. www.bloomberg.com/news/articles/2022-10-25/fed-is-losing-billions-wiping-out-profits-that-funded-spending#xj4y7vzkg.
- Federal Reserve Board; Bureau of Economic Analysis.
- Lynch, David J. 2022, December 19. “Financial Risks Grow in Shadowy Corner of Markets, Worrying Washington.” Washington Post. www.washingtonpost.com/business/2022/12/18/shadow-banking-financial-risk/.
- Lee, Lisa. 2022, May 31. “Zombie Firms Face Slow Death in US as Era of Easy Credit Ends.” Bloomberg. www.bloomberg.com/news/articles/2022-05-31/america-s-zombie-firms-face-slow-death-as-easy-credit-era-ends.
- Mullaney, Tim. 2023, April 9. “The Coming Commercial Real Estate Crash That May Never Happen.” CNBC. .