Zürich – The Covid-19 outbreak has precipitated multiple layers of economic shocks to the global financial system. These effects combined with an already precarious economic and political landscape are incalculable at this juncture due to the extreme amounts of uncertainty. However, this is what we do know:
- Global liquidity event with volatility higher than Global Financial Crisis (“GFC”)
- The lock down time and therefore economic recovery is unknown
- Economic activity outside of Healthcare, Online and Food supply chains is grinding to a halt
- Global travel is all but non-existent
- Oil prices are at multi-decade lows – fuelled by Russia leaving OPEC & drop in travel
- No visibility on company future profits
- Covid-19 will pass in due course
The global financial industry is currently experiencing what is known as a liquidity event. This means that investors lose all confidence and pull investments moving as much into cash as possible, resulting in ALL asset prices moving down including other “stores of value” like Gold and Bitcoin. The extreme volatility we are experiencing is born by panic and uncertainty until decisions start being made by governments to quell the situation and offer greater certainty, like offering UNLIMITED quantitative easing.
The effects of a complete lock down on an economy is far reaching. Think of the restaurant owner. Without regular guests, it cannot afford to pay rent, therefore the property owner is unable to make mortgage payments forcing the bank to foreclose on the property.
The bank then has two choices, (1) extend more credit until the crisis is over but would need access to more capital made available by the government through quantitative easing OR (2) repossess the property and sell in the open market. In the current environment, there would be many forced sellers putting huge pressure on property prices. In effect, the lower property prices would only cause greater amounts of pressure on the bank’s balance sheet as asset prices go down and liabilities stay the same which leads to bankruptcy and a larger crisis.
Generally, option 2 is a last resort for governments due to the social impacts. There is a 3rd option but has never been implemented before (discussed below).
The situation is exacerbated by the drying up of the money multiplier effect caused by COVID-19. This tool is a well-known effect that ensures that new money supply is distributed effectively throughout the economy once the government implements quantitative easing.
What is the money multiplier effect?
Let us look at the restaurant business again. For simplicity and this example, Let us assume guests frequenting the restaurant work at the bank, the bank borrows money from the central bank and receives freshly printed money and pays its employees, these employees then pay the restaurant using this income (1st multiplier). The restaurant then pays its waitrons using the same printed cash in tips and salaries (2nd multiplier). Waitrons then leave work to go and pay rent, buy groceries, etc (3rd multiplier), and so on. The same cash makes it way through the system ensuring asset prices and values are maintained by converting into rental incomes, company earnings, etc.
The US government announced this week unlimited amounts of quantitative easing until the crisis is over. The sums of money offered are far greater compared to the GFC. However, on this occasion there are 2 significant economic differences:
- Covid-19 has shutdown the economy at large
- Oil prices are at decade lows compared to peak prices at the GFC
Due to the Covid-19 pandemic and the lock down effects, economies are not operating normally which reduces the economic money multiplier effect (restaurants are closed as per example above). This means that much more money is required through multiple channels to provide relief compared to the GFC. This is highly administrative and unproductive.
Secondly, newly printed money will enter the system without productivity increases, in fact, more likely the opposite will occur. The result? Once the crisis is over countries will face much higher levels of debt without an increase in productivity.
The increased levels of debt will need to be serviced by the economy. However, the increased levels of debt can only be serviced if productivity increases.
In order to increase levels of productivity, governments use either fiscal or monetary tools. Fiscal tools will require more debt to fund the spending. Therefore, governments usually opt for monetary tools that include lowering interest rates and increasing money supply (more debt).
However, interest rates are already at 0%.
Therefore, the only options are:
- Increasing money supply = inflationary
- Negative interest rates
Neither of these options are good for storing value in the Dollar/Euro in the medium to long term.
Inflation means that a dollar tomorrow will buy you less goods and services compared to a dollar today. Negative interest rates mean that 1 dollar at the bank will be worth 0.98 dollars a year later i.e. banks will take from your deposits.
Assuming governments opt for increasing money supply versus negative interest rates, the 20-year low in global oil prices will significantly reduce the impact of increased money supply on inflation or price increases. The oil price is a major driver of the cost of many products in the economy and therefore low oil prices reduces inflation significantly. The result is that governments may need to print much more money for the same inflationary effects and growth in GDP.
Performance of asset classes since announcements of quantitative easing (as of 24 March):
- Equity market: -18.5%
- Bond Market: +40.6%
- Dollar Index: +3.1%
- Bitcoin: +41.6%
There is a 3rd unprecedented option to completely FREEZE the global economy outside of healthcare and food services until the crisis is over. Governments would issue food and other coupons (using the Blockchain) valid until the crisis is over while granting relief on all bond, loan, rental or property agreements. However, this would take a massive global cooperation that has never been witnessed before and given the current US-China relations is highly unlikely.
Therefore, under these circumstances we believe alternative stores of value will be sought-after by global citizens. We suspect in this digital age, digital currency with a fixed supply will offer huge benefits in this regard given the economic environment.
There are other knock-on effects that are positive for the Blockchain and Decentralisation:
- Businesses build decentralised office networks to reduce crisis risks
- Citizens de-risk from single income jobs to multiple or diversify income streams
- Citizens seek out new online opportunities to reduce risk at centralised office spaces
The Covid-19 pandemic has shown the benefits of a centralised government acting in unity to implement the necessary precautionary measures. However, in the private sector, it has shown the weaknesses in today’s economy of centralised private corporations. We expect a shift to occur in the private sector toward greater decentralisation post the crisis.
In conclusion, given the expansive monetary policy that is to be implemented over the coming months, investors will seek out alternatives methods to store value. While Bitcoin will maintain its dominance in market share, Blockchain support services, Crypto Exchanges and other crypto currencies will show leveraged growth as more users enter the environment pushing profitability and number of users further along the J-curve.
Therefore, the entire Blockchain ecosystem will benefit due to the increased appetite for fixed supply crypto currencies and supporting assets. It is still too early to pick the winners, however, a Smart Passive Index approach will ensure more capital is allocated to the winners and a diverse exposure to the market is maintained during this period of expected rapid growth.