Cryptocurrency: The Next Hedge Against Recession
By Block Society
As a preface, it’s important to mention that the US and the global economy is robust and has very strong momentum due to technological advancement and global free trade where present. This piece is not an exercise meant to scare investors. It is merely pointing out the deep cracks within the economy that are becoming visible to the naked eye. Long term, we are bullish on our outlook for the national and global economies.
Setting the scene
For years Austrians and other libertarian economists have been warning about the coming financial crisis. Just as Ron Paul predicted the crisis of ‘08, these economists have been saying things like ”Indeed, it’s hard to imagine how our clueless central bankers could have done anything more to crush those very ingredients – two-way trade, risk premiums, meaningful carry trade costs and short-seller skepticism – that keep financial markets disciplined, balanced and sustainable.” – David Stockman Porter Stansberry of Stansberry research, one of the largest investment research firms in the world, recently released a podcast titled “The Biggest Bubble in World History”. Even the mainstream pundits are starting to shake in their convictions that this economy is the strongest economy ever.
The extraordinary claims made by these free market economists and financial experts must come with extraordinary evidence to be taken seriously… unfortunately they do. Evidence of the coming collapse is beginning to pile up. Historically low artificial interest rates set by the Federal Reserve will be the key focus of this piece. However, other drivers toward the financial cliff are mounting – the Post-‘08 bailouts, the exploding debt within most major sectors of the economy, the statistical rarity of 10+ year time frame that we have seen for this recovery, the inverting yield curves, and the trade wars are just a few.
This economic downturn, like all before it, will send investors into hedging positions. They will flee from the typical products and go into safer or less correlated asset classes. Cryptocurrency is the newest asset class. Born out of the ’08 financial crisis, it may become one of the new hedging assets, as it is much more efficient and antithetical to the current financial system.
Often, Austrian School libertarians say that artificially low interest rates are going to wreck the dollar. What exactly does that mean? Well, interest rates determine the future cost of money. Interest rates set by the Federal Reserve are the cost of overnight money lent to commercial banks on the loans they receive from their Regional Federal Reserve lending facility. Think about it like this: If you are purchasing a home and taking a loan from a bank, if you take a loan at 0% interest, you are getting a free loan. You only pay the bank back on what you borrowed, no more (and in nominal terms, no less). The loan is “free money”. If instead, you take a loan for 10% APR, you will owe the money you were lent plus all of the interest. At a 10% rate, over the lifetime of your 30 year loan, you would pay $300k instead of the $100k you would pay for a 0% interest loan.
This concept is similar to commercial banks and the central bank. The Federal Reserve lends money to commercial banks so that they can go out and loan money to consumers. The Federal Reserve, though, does not have any competition. They set the federal funds rate which means that they have a de facto monopoly on inter bank lending. Worse yet, this monopoly is granted by the federal government, meaning that it will not go away until the federal government gets rid of it. This lack of competition has allowed the Federal Reserve to drive down interbank interest rates, particularly the federal funds rate to less than 1% for the 8 years from 2009 to 2017. As you can see on the graph below this artificially low interest rate for this length of time is historically unprecedented. We have never seen such cheap money for such a long time.
Let’s step back for a moment and talk about price signal theory. Prices signal to consumers when to buy a product or when to sell a product. In terms of BTC, if the price of one BTC drops to $3000 in the coming month, most savvy investors in the industry would be excited, and they would begin to purchase up BTC wherever they could. BTC would be seen as cheap. If the price rose to $100k, the story would be inverse. Most savvy investors would say that it is overvalued at the current time and they would sell. These prices of BTC signal to investors that the value is higher or lower than the current price, or it is right where is should be. These investors naturally build a price floor and a ceiling into the price of the asset. These floor and ceiling prices are set by the competitors in a highly liquid market. This is a healthy way prices form, as a process of discovery rather than dictate.
Sometimes, when it seems necessary to protect a certain group to the government, they offer companies or organizations artificial price floors or ceilings. For example, the minimum wage law is a price floor. The minimum wage disallows any worker from offering their services at a price lower than the minimum wage, even if the value they offer is less than minimum wage. This causes inefficiencies in the market. Cheap labor becomes more scarce, the price of products rise, and unemployment rises (especially among the ultra-poor) to name just a few effects. The way the Federal Funds rate is set is through a price ceiling. The Federal Reserve tries to keep the price of future money between banks at a certain level. The Federal Reserve does not mandate the price, but it uses the issuance and take back of treasury debt to influence the Federal Funds Rate to a target price. The inefficiencies here include a decline in savings, an expansion of debt based consumption and investment. This leads to poor choices when accounting for debt, and defaults on that debt begin to mount. The malinvestment that causes these defaults eventually leads to widespread falling prices across asset classes. A recession ensues.
Crypto, the Safe Haven
Often what happens in recessions is multiple asset classes begin to weaken, resulting in large selloffs as investors seek to find the market prices of the assets. The money that was in those asset classes moves to asset classes that are seen as hedges. For example, during the ’08 crisis, real estate and equities got pummeled, while commodities like gold and oil posted record-breaking figures. Commodities, as is normal in recessions, were used to hedge against falling prices in the equities and real estate markets.
For this coming recession, in addition to commodities there is a new asset class, one that is often likened to commodities and hard currency – cryptocurrency. This asset class’s supply is very difficult to manipulate due to its lack of centralization. Cryptocurrencies vary in levels of centralization, but one thing they all have in common is the impetus of the blockchain which drives toward decentralization. Blockchain technology is by its very nature a decentralizing force. The lack of centralization ensures a large mitigation in price manipulation and control by single entities. Couple this with sound economics and currency like properties, we have a perfect hedge against the system that is beginning to fail us. Lenders could not become impelled to act in a certain way because of some ultimate lender who has power over the supply of cryptocurrency. This is not the way that most cryptocurrencies are designed.
In addition to all of this, the efficiency factor of cryptocurrencies and blockchain tech are completely disruptive to the traditional world of finance. Trade and transaction settlement can now become virtually instant. Banks no longer need to be in between every transaction as trusted third parties. Instead, miners and stakers bring the cost of trust as close to 0 as possible through commoditization.
Cryptocurrency is the perfect candidate to be a major hedge in the next recession. If it does become a hedge, get ready for large swaths of value to flood into the market. Pushing up prices throughout the next recession.