The Coronavirus has proven to be the proverbial straw that broke the global economic and financial system’s back. The virus itself has devastated some of the elderly and those with previous medical conditions and has similarly exposed the fragile financial conditions of economies all around the world and put them in critical condition.
Global financial markets (bond & equity markets) have been on a historic bull run since 2009, with only a few mild perturbations in between. However, this wasn’t on the back of stellar global growth or historically normal financial conditions. Rather, global economic growth has been particularly mild, even with the support of unprecedented Central Bank intervention, designed to induce the perception of wealth creation via highly leveraged economic activity. Previous decades saw stronger growth on the back of less debt in the private and public sector. This past decade has seen mild growth on the back of unprecedented levels of private and public debt.
Traditional valuation metrics for equities, all around the world, like ratios comparing corporate enterprise values to earnings or sales had all been blowing past previously seen highs. Those previous highs were all met with subsequent crashes, i.e. the dotcom bust and the 2008 financial crisis. In many ways, global equities were more expensive for the last few years than their peaks right before the 2008 financial crisis and the dotcom bust.
A worrying amount of corporations all around the world have been unprofitable on a free cash flow basis for some time now. This means they haven’t been able to sustain themselves through their normal business operations, but have instead relied on historically accommodative financing conditions to paper over their lack of operational sustainability. And instead of using this accommodative financing to invest in useful business capital to increase earning potential, operational sustainability, or shore up their balance sheets, many have used the opportunity to buy back their own equity, raising their earnings per share through financial engineering. It’s not a coincidence that many pay packages for C-suite executives are based on maximizing earnings per share. It’s also not surprising that a record amount of CEOs stepped down or retired in late 2019 through early 2020.
Over the past month or so, global equities have corrected to the downside in a historic way, but we’re still at valuation levels equal or just below the peak of valuations during the 2008 financial crisis. If investors thought those valuations were expensive in 2008 on the eve of a recession, then there’s still a lot of potential for more revaluation to the downside for global equities.
Global bonds have also been historically expensive even though the credit quality of governments and corporations has been anything but prime. Certain government bond yields in the Eurozone had even turned negative as early as late 2014 and the amount of this negative yielding debt has only increased since then into the tens of trillions of dollars. About a week ago some of the yields on very short term US government debt had themselves turned negative. If negative yielding debt doesn’t make much sense to you, don’t worry, it shouldn’t.
We also saw an ominous signal in US bond markets in late 2019 with the beginning of a “yield curve inversion”. Normally, longer maturity debt has higher yields than shorter maturity debt. Meaning a 10 year bond usually pays a higher interest rate than a 1 year bond. An inversion of this normal relationship would mean a 10 year bond yields less interest than a 1 year bond. This has historically signaled that interest rates in general will be lowered and the market expects an economic recession.
As a result of supply chain disruptions, the desolation of travel and tourism related industries, stress on health care systems, non-essential business shut-downs, and the breakdown of financial markets, Central Banks have moved extremely aggressively over the last week and a half to shore up the dams of an already fragile and vulnerable financial and economic system.
Central banks have seen unusual and concerning activities in the functioning of systemically important credit markets which have provoked extremely aggressive actions on their part, even outpacing the unprecedented responses by central banks during the last global financial crisis.
Abnormality is the new normal in fiat-land.
A Time-line of Central Bank Actions: The Fed, ECB, & BOJ
Below we are highlighting the actions of the three most important central banks in the world based on the yearly traded volume of their currencies in the global foreign exchange market(Forex). Other central banks are important and have made drastic moves as well but for the time being they are not as influential on global financial markets as these three: The Federal Reserve ( Fed), the European Central Bank (ECB), and the Bank of Japan (BOJ).
(1)The New York Federal Reserve Branch offered to make trillions of dollars available to help the critical “repo” market. The repo market is a market financial institutions use to post collateral (usually US Treasuries) in order to borrow cash from other financial institutions for very short time periods.This interbank lending market is critical plumbing of the financial system. The NY Fed had started to get heavily involved in this market in September 2019 for the first time since the 2008 financial crisis, and in mid-March expanded this involvement quite considerably after more “highly unusual disruptions in Treasury financing” reared their head.
(2) The European Central Bank(ECB) relaxed capital and liquidity regulations for its banking institutions and announced that additional net asset purchases of €120 billion will be added to the already existing asset purchase programs.
(3) The Bank of Japan (BOJ) conducted unscheduled outright purchase of Japanese government bonds (JGBs).The BOJ announced it will continue to conduct additional outright purchases of JGBs as needed, taking into account evolving market conditions.
(4) The Federal Reserve Open Market Committee lowered the target rate for the federal funds rate to 0 to 0.25% citing weak business fixed investment, weak exports, stress in the energy sector, and the effects of the coronavirus on economic activity.
(5) The Fed decided to increase its balance sheet by buying $500 billion of UST and $200 billion of mortgage backed securities in order to “support the smooth functioning of markets for Treasury securities and agency mortgage-backed securities that are central to the flow of credit to households and businesses”. In total this is a $700 billion balance sheet expansion. This is about an ~18% increase in the Federal Reserve’s balance sheet.
(6) The Fed reduced its reserve requirement ratios to zero percent for depository institutions effective March 26th. The elimination of reserve requirements for thousands of depository institutions is designed to support a bank’s ability to continue lending to households and businesses. This means banks don’t have to have any capital backing up new loans. Loans (money) can be created without any reserves. We are entering an era of no reserve banking.
(7) The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank announced a coordinated action to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements created during the 2008 financial crisis.The swap lines serve as an important liquidity backstop to ease stress in global funding markets. The Fed wants to make sure every other Central bank has access to enough dollars to keep their respective financial systems from collapsing.
(8) The BOJ announced it will provide financial markets with more yen via purchases of JGBs, accept corporate bonds as collateral for yen loans, increase its existing purchases for commercial paper and corporate bonds, and actively buy Japanese Exchange Traded Funds (ETFs) and Japanese Real Estate Investment Trusts (REITs).
(9) The Fed established the Commercial Paper Funding Facility (CPFF). Commercial paper markets directly finance a wide range of critical economic activity, supplying credit and funding for auto loans and mortgages as well as liquidity to meet the operational needs of a range of companies. The commercial paper market has been under considerable strain in recent days as businesses and households face greater uncertainty in light of the coronavirus outbreak.
(10) The Fed established a Primary Dealer Credit Facility, or PDCF. The facility will allow primary dealers to support smooth market functioning and facilitate the availability of credit to businesses and households. Credit extended to primary dealers under this facility can be collateralized by a broad range of investment grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities. A primary dealer is a market maker who buys government bonds with the intention of re-selling them to others. Through this action the Fed has included commercial paper, municipal bonds, and even equities as acceptable collateral in an effort to keep the Primary Dealers and their market making activities functioning.
(11) The Fed established the Money Market Mutual Fund Liquidity Facility, or MMLF. The Federal Reserve Bank of Boston will make loans available to eligible financial institutions secured by high-quality assets purchased by the financial institution from money market mutual funds. Money market funds are a common source of financial security for families, businesses, and a range of companies. The MMLF will assist money market funds in meeting demands for redemptions by households and other investors, enhancing overall market functioning and credit provision to the broader economy.
(12) The Federal Reserve Board established U.S. dollar liquidity arrangements (swap lines) with the Reserve Bank of Australia, the Banco Central do Brasil, the Danmarks Nationalbank (Denmark), the Bank of Korea, the Banco de Mexico, the Norges Bank (Norway), the Reserve Bank of New Zealand, the Monetary Authority of Singapore, and the Sveriges Riksbank (Sweden). This a massive expansion of swap lines facilities, like those already established between the Federal Reserve and other central banks.These new facilities will support the provision of up to $60 billion for each Central Bank added. These U.S. dollar liquidity arrangements will be in place for at least six months. However, these temporary measures often fail to be temporary.
(13) The ECB created a €750 billion Pandemic Emergency Purchase Programme (PEPP). These asset purchases will be conducted until the end of 2020 and will include all the asset categories eligible under the existing asset purchase program which include corporate bonds, government bonds, and asset backed securities.
(14)The Fed established the Money Market Mutual Fund Liquidity Facility, or MMLF. The Federal Reserve Bank of Boston will now be able to make loans available to eligible financial institutions secured by certain high-quality assets purchased from single state and other tax-exempt municipal money market mutual funds.
(15) The Federal Open Market Committee (FOMC) will purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support financial market functioning. In addition, the FOMC will include purchases of agency commercial mortgage-backed securities in its agency mortgage-backed security purchases.
(16) Established two facilities to support credit to large employers – the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.
(17) Established a third facility, the Term Asset-Backed Securities Loan Facility (TALF). TALF will enable the issuance of asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets.
(18) Expanded the Money Market Mutual Fund Liquidity Facility (MMLF) to include a wider range of securities, including municipal variable rate demand notes (VRDNs) and bank certificates of deposit.
(19) Expanded the Commercial Paper Funding Facility (CPFF) to include high-quality, tax-exempt commercial paper as eligible securities.
In total, the three most important central banks in the world conducted approximately 19 historically significant monetary operations in only a week and a half just to keep the financial system from breaking.
Stores of Value and Safe Havens
During times of economic and financial unease investors lean on, and tend to pile into, so called stores of value or safe haven assets. These have traditionally been cash, government securities, precious metals, and some stable, dependable equities that offer essential economic functions. These stores of value and safe havens are expected to maintain or even increase in value during economic and financial turmoil. Many of Bitcoin’s strongest narratives have been centered around its potential to be another asset added to the list of stores of value and safe havens during these types of economic and financial conditions.
Although it’s only been a short timeline, many of the assets considered safe havens or stores of value had failed temporarily, besides cash. Many government securities, gold, silver, utility stocks, and Bitcoin had major sell offs during the market turmoil of mid-March. Cash and, in particular, USD, has proven to be king during extreme stress.
However, to meet this globally panicked demand for USD, the Federal Reserve has engaged in unprecedented measures to meet Dollar demand both nationally and globally. The measures taken to meet this demand dilute the existing purchasing power for holders of USD and reduce confidence in the Dollar’s ability to hold purchasing power over the medium to long term.
Many of these assets that have traditionally been considered safe havens or stores of value might prove to be effective over the next few weeks, months, or years, but for a scary week in mid-March 2020, there was almost nowhere to hide. Everything failed.
Bitcoin, during March, has failed to be the safe haven some might have hoped for (for the time being), but it doesn’t mean that it could never serve as one nor does it mean Bitcoin has failed. Far from it.
Bitcoin is designed to solve the double spend problem as well as process the transactions of its users, moving forward as a network every ten minutes. Almost every narrative or possibility sold outside of these functions is not assured by the design of the network. Bitcoin’s design makes very limited, but strong technical assurances — none of which concerns its price or volatility. Predictions of the financial behavior of Bitcoin by its proponents are social possibilities, not technical assurances.
Although its short term failure as a financial safe haven has been disappointing to many, when we look under the hood of the recent sell off we find a lot of evidence that long term holders of Bitcoin still view it as a good store of value going forward.
According to research done by Coinmetrics and Unchainedcapital, approximately 500k BTC moved during the big sell off from March 11th to March 15th. Over 73% of that 500k BTC had moved in the last 6 months, and over 91% were BTC that had moved in the last year! Only 9% of the 500k was BTC that hadn’t moved in over a year. This indicates an overwhelming majority of the sell off was short term, speculative capital in BTC exiting while long term, solvent holders of BTC haven’t flinched.
In addition, the research conducted above is in itself intriguing regardless of the story the data tells. It’s impossible to get this granular picture for any other asset.Information about the holding period of the assets being moved in other markets might as well not exist. The type of research Coinmetrics and Unchainedcapital were able to conduct extremely quickly isn’t possible with bonds, equities, or precious metals in “public” markets. But it can be done with crypto-assets like Bitcoin by anyone with a working internet connection and curiosity.
Transparency is a huge asset in a time of massive uncertainty.
Now that global central banks have flooded markets with an almost unfathomable amount fiat, one shouldn’t be surprised if a small fraction of that liquidity finds its way to alternative assets in an alternative ecosystem. And given the financial size of this alternative, a small fraction of this tsunami of liquidity flowing in can have massive impacts on the valuations of the assets in this alternative financial system.
As the mainstream financial networks continue to decay under the weight of excessive leverage and obsolescent institutions, it’s time to update our financial operating system.
It’s time for plan ₿.