Outside of being a significant public health crisis, Covid-19 exposed some of the long-term problems associated with fiat currencies and seemingly unlimited monetary stimulus. The recovery from the global financial crisis came and went, yet the economic reliance on central bank support never ceased. As global debt reaches record high levels and ever more fiat is printed, investors are increasingly turning to verifiably scarce assets to hedge against the worst-case scenario.
Fiscal And Monetary Stimulus
Governments and central banks responded to Covid-19 with unprecedented amounts of fiscal and monetary stimulus. Japan, for example, launched a fiscal stimulus package of 45% of GDP. Most developed countries ended up with fiscal support of around 20% of GDP while developing economies were closer to 10% due to high interest rates and little financial room for manoeuvre.
The ExodusPoint Partners International Fund returned 0.36% for May, bringing its year-to-date return to 3.31% in a year that's been particularly challenging for most hedge funds, pushing many into the red. Macroeconomic factors continued to weigh on the market, resulting in significant intra-month volatility for May, although risk assets generally ended the month flat. Macro Read More
The U.S. government spent more than $6.5 trillion in its 2020 fiscal year, which ended on September 30. Spending increased by 47% or $2 trillion while the revenue side was slightly lower than a year ago. These dynamics led to the addition of $3.1 trillion to the national debt. With a new stimulus package being negotiated, as well as remaining funds that have been authorized but not spent, the national debt will only go up.
Zero Interest Rates And Asset Purchases
On the monetary side, rates are close to zero in most advanced economies, negative-yielding debt is at or near an all-time high, and central banks continue to purchase assets. The European Central Bank, for example, recently increased the size of its bond-buying program by 500 billion euros. The program is now at 1.8 trillion euros, bringing total monetary stimulus in 2020 to over 3 trillion. The ECB has also extended the end date for the program from June 2021 to March 2022 and committed to providing further liquidity until the Covid-19 pandemic is over.
Across the Atlantic, the Federal Reserve balance sheet expanded from roughly $3.7 trillion to nearly $7.4 trillion, as it purchased a wide range of assets and provided loans to the financial system. The Fed is committed to continue buying $25-$30 billion per week of Treasuries and mortgage-backed securities. As the government passes the $900 billion coronavirus relief package, with more to follow, the Fed will likely further increase its purchases of the Treasuries to facilitate low rate borrowing for the Treasury Department. According to the CME Economics Unit, the Fed's balance sheet could expand to between $8.5 trillion and $10 trillion over the next 12 months.
This concept of the Fed printing money to finance fiscal deficits of the government is known as debt monetization and is part of the modern monetary theory (MMT). MMT has gained substantial support since the beginning of Covid-19 and argues that the high level of debt, relative to GDP, should not constrain government's spending. MMT proponents suggest that the Fed can always print more money to pay off the obligations of the government. However, experience shows that sustained deficit monetization tends to, over time, lead to inflation.
A Shift To Scarce Assets
With the backdrop of massive stimulus spending and MMT gaining traction, investors are increasingly shifting their attention to scarce, non-inflationary assets.
Uranium, for example, is a relatively scarce asset with limited supply. Opening a mine requires significant capital, and it takes 10 to 15 years for that mine to become fully operational. Discoveries of uranium deposits are also rare. However, uranium is used for industrial purposes and therefore, its price depends on supply and demand fundamentals.
Gold, on the other hand, has been used to store and preserve wealth for centuries. Investors also use gold to hedge their portfolios against inflationary dynamics as well as macroeconomic and political risks. Its store of value appeal comes from restricted supply and low inflation. Between 2016 and 2019, for instance, gold's inflation averaged 1.2% per year. Reserves are also limited, with only 57,000 metric tons yet to be mined, according to the United States Geological Survey. This year, gold is up around 23% as investors look to protect their portfolios.
Bitcoin is another scarce asset. It's up more than 200% over one year and has gained some acceptance as the digital gold of the 21st century. Unlike gold, however, Bitcoin's scarcity is mathematical, not physical, and publicly verifiable. Only 21 million Bitcoins will ever be mined, and close to 90% of them have been mined to date. Inflation of the Bitcoin network is currently 1.8% and is programmed to be cut in half every four years. This will continue until 2140 when all 21 million Bitcoin are mined and the inflation, or new issuance, reaches 0. It's worth pointing out that Bitcoin's supply is hard-coded and therefore not dependent on external variables, like demand or price.
The Problems With Fiat Currencies
For entrepreneur, investor, and political strategist, Joel Zamel, commodities like Bitcoin, gold, and uranium, are attractive investments given their supply limitations. Zamel notes that the Federal Reserve’s policy of buying all bonds, along with record-setting debt levels have pushed the demand for Bitcoin to record highs. Since fiat currency is effectively in unlimited supply it is, in theory, subject to unlimited inflation (see Zimbabwe). As investors begin to come to terms with the debasement of fiat currency along with low interest rates and fiscal stimulus, assets in scarce supply become interesting options in a pivot away from the “money printing” economy. Zamel, whose companies consult to governments and maintain an international advisory team of former senior government officials, suggests debt monetization in recent years will remain unchanged - including during the COVID-19 crisis.
Some investors argue that Bitcoin's 21 million cap can be changed. While it's possible, it's also highly unlikely. The supply cap is what gives Bitcoin value, particularly in the world of unlimited monetary expansion. Any change to the protocol requires broad consensus from various network participants. Lifting the 21 million supply cap would be financially detrimental for most of them, which would make it impossible to reach an agreement on such a change.
As governments and central banks pursue continued monetary expansion, scarce assets with verifiably limited supply and low inflation are gaining traction with investors. Gold and Bitcoin both fit this narrative. While gold will continue to benefit from the flight to safety trade, Bitcoin is a higher conviction bet on the failure of fiat currencies. In the words of Stanley Druckenmiller, "if the gold bet works, the bitcoin bet will probably work better."