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What is more likely to drive cryptocurrencies over the next decade: New technology or a crisis?
“War is the father of all things.”
As Bitcoin’s parabolic trend run continues, the crowd cheers. The path is clear to $24,000 they cry, congratulating themselves as their expectations grow. All markets, including cryptocurrencies, exhibit the tell-tale signs left behind on the tape, like so many betting slips adorning the aftermath of the Grand National.
Only with cryptocurrencies, it is not paper floating in the breeze but prices recorded in a ledger. The price data, when viewed historically using a chart, shows that no matter if it’s Bitcoin, the Euro, Ethereum, or Ripple, publicly traded instruments move through time in one of only three ways.
And the least stable of all is the parabolic trend.
When demand is greater than supply prices rise as sellers offer their holdings for sale at higher prices. New buyers must compete with each other to get their orders filled, and this behaviour causes them to outbid each other, absorbing all the inventory available.
The greater the imbalance, the faster prices move through time.
Imagine a square. Now imagine a 45-degree angle moving across the square from the lower left to the upper right. The 45-degree line represents a stable trend. Up one, over one. When trending normally, prices move up then counter trend down printing lows higher than previous highs.
But, when demand overwhelms supply price does not follow the 45-degree line; instead, it follows a path that’s travelling at a faster velocity, up two, over one, or faster.
If you’ve ever played with bricks or playing cards, building a tower higher and higher, you’ll know that as the structure goes higher, the greater the need for stability at the base.
When parabolic prices go vertical, if the base the structure is built on is faulty, then expect the tower to fall.
Parabolic moves don’t last long. And typically when they end, prices will do one of two things, either moving sideways waiting for the trend line to normalise back to near the 45-degree angle or aggressively sell off back down to the 45-degree line.
Note that the 45-degree line is not a Gann angle, rather its a way of explaining the residue left behind after the race has ended.
As Bitcoin moves higher, ask yourself who is doing the new buying at parabolic highs? Is it the 5%, the most consistent group of speculators and investors, or the 95% majority, who want in at any price, reacting to next stop moon bullish articles?
The point is, Bitcoin could go to the moon, but, on the way, there will be high probability low-risk areas of entry, and there will be low probability high-risk areas of entry. The 5% enter at the former.
If cryptocurrencies are to trade back to December 2017 prices, what is going to drive the new demand?
Is it more likely to be new experimental bolt-on tech understandable to a small number of tech specialists, or could the driver be more traditional?
According to the OECD, corporate debt is $13 trillion — double the $6 trillion held by corporations in 2008.
In January 2018, the International Monetary Fund, the IMF, reported the global debt-to-GDP ratio is 318%, and it’s not just government debt — corporate debt is at near record highs too, accounting for 92% of GDP.
Since 2008, government debt has risen by 75%, household debt is 30% higher, and finance sector debt is up from 2008 levels too.
What’s has debt got to do with cryptocurrencies?
The news dished out to the masses is a mechanism of distraction — nothing more — especially so when it relates to financial markets. It’s a sleight of hand, typically running articles on the stock market, focusing on the levels of the Dow Jones Industrials, cheering when the Dow makes new all-time highs.
The 95%, influenced by magazine articles, either buy or stay away rarely contemplating the short side of the market.
The problem is the articles are rarely correct — like the classic death of equities headline in 1979 — written just after a major low in equities and just before the beginning of the largest bull market ever.
Most people invest through ETFs, mutual funds, and retirement plans, with some investing their own capital in their personal brokerage accounts.
The majority who buy shares analyse the sales and net profit figures to calculate future earnings potential. It is no secret that US stock markets made all-time highs in April 2019, but few take the time to peel back the veneer of top-line earnings figures and dig a little deeper.
Since the 2008 financial crisis, companies have used the environment of cheap debt, brought about by rising bond prices, to buy back their shares.
When a company buys back its shares it reduces the number of shares in the float and this, in turn, amplifies the earnings figures, which are used to provide valuations, which are used to attract investors, and around the positive feedback loop we go.
How many shares have companies been buying?
The stock market rally of the last decade looks and feels real, but the amount of shares repurchased by corporations is the hidden driver behind stock market price levels. Between 2008 and 2012, companies bought back around $200 billion of stock, but in 2013 they doubled their buyback activities. Last year US corporations bought back just under $800 billion of stock.
Money flows into the stock market were helped by making the main competitor for money inflows, the global bond market, unattractive to investors. With quantitive easing, demand for bonds was absorbed driving bond prices higher and returns, the bond yields, lower.
In their search for yield, investment professionals were forced into the stock market. When combined with corporations having access to cheap money via lower yields and professional money being driven into stocks due to the unattractiveness of the bond market, the stock market soared.
Yes, the stock market made new all-time highs in 2019, but at what cost?
While on the surface stock prices are higher, the total underlying profits of the companies that make up the indexes have not increased.
What has increased are the multiples, yes, the earnings per share have increased because the number of shares in existence has gone down, but the total amount of money generated by these companies has not gone up.
This is financial engineering par excellence. It’s a mirage. It means that the economy hasn’t got more valuable, and it means that stock prices have been engineered higher by printing more money and creating new debt.
The problem is it is not sustainable. In the short term, by buying back their own stock, companies can provide extremely high levels of return in the forms of dividends and share buybacks.
On the 24th April 2019, Microsoft made a new all-time high of $131.37. What’s behind the move? The majority look at the headline number of sales, profit margin, and net income concentrating their analysis efforts only on the income statement, but the minority, the 5%, look at the cash flow statement and balance sheet.
While the investment mantra for the masses is sales and income, the 5% look at a companies cash flow statement. The main difference between the income and cash flow should be depreciation, and the analysis of the cash flow statement is used as a quick and effective simple check of the numbers presented. It’s on the cash flow statement where you find the amount of money a company is paying investors to hold their stock.
This year, Microsoft are paying back $13.5 billion in dividends and $17.2 billion in common stock repurchases, that’s $30.7 billion back to shareholders. But here’s the thing. If you look on the income statement, Microsoft made around $79.9 billion in gross profit, and this means that this year Microsoft will be paying back 38.4% of its gross profits to investors.
One thing to check is how Microsoft is able to pay out such a large percentage of their gross profit. This information is found on the balance sheet looking at total liabilities and long term debt.
And it’s here the 5% find their answer. Microsoft has increased its debt substantially since 2014, increasing its total long term liabilities by 218%. Currently, Microsoft’s debt is higher than its shareholder’s equity.
In other words, Microsoft is now a debt-leveraged company.
Microsoft is an example of a great company going into debt to buy back its shares. But many other companies are not a moat-owning business like Microsoft who are buying back their shares too.
Share buybacks are the main driver behind Microsoft’s new high share price. The point? The information spoon fed to investors in stocks and other assets like cryptocurrencies is often little more than a distraction. The 95% look only at the surface. The 5% dig a little deeper.
On the surface, everything looks good with the stock market at near all-time highs, but underlying the all-time highs are record amounts of corporate debt.
The mainstream news tells the 95% that banks are better capitalised than they were in 2008 and that banks are much more resilient against external panics and shocks. While that is true, the rest of the corporate United States is more highly geared and leveraged than ever before.
Instead of businesses putting capital to work to increase value for their shareholders they are buying back shares, at ever increasing prices.
In 2019, the world is drowning in debt. The headline news is that mortgage debt is lower than in 2008, but every other sector has much higher levels of debt — auto loans and student loans are at record highs, and now the stock market has rallied, individual investors are coming back in taking positions near record highs — not with their own cash but with margin or borrowed funds.
In previous articles, podcasts, and videos, we’ve talked about using the price cycle and the hype cycle as tools to help guesstimate the most likely location of cryptocurrencies within the cycle.
The availability of credit also moves in cycles. While the price cycle gives clues to the expected price action, and the hype cycle provides feedback on the behaviour pattern demographic, the credit cycle allows some insight into the availability of funds.
Like the price and hype cycles, the credit cycle is not suitable as a short term timing tool; instead, the credit cycle can show periods where new buying funds will be in short supply.
There have been massive increases in government debt, pushing economies forward, and at the same time, offsetting levels of corporate taxation, which is allowing economies to grind ahead — in the short term. But in the longer term, rising stock prices, share buybacks, and increasing levels of debt are not sustainable.
The economy has had a shot in the arm from the fiscal stimulus of low borrowing costs and the lowering of corporate taxes, but it has been engineered. Yes, the stock market looks healthy, but all is not what it seems.
You might be thinking so what, and you might be wondering what all this has to do with cryptocurrencies?
While most are familiar with the stock market and the concept of private stock ownership, very few understand the real source of power in the 21st century — the bond market.
Of all of our achievements, three inventions make up the world we recognise today: Banking, the bond market, and the stock market.
During the Italian Renaissance, in the 14th and 15th century, the city-states of Florence, Piza, and Sienna were at war. Rather than fight the battles using their own citizens, the city-states paid for outside contractors to fight the wars for them. The only question was — how did the city-states raise the money to pay for their contract armies?
There was a limit to the amount of money available to bankroll an army so it could annex land from a neighbouring state, and, because these local wars were expensive and risky, states like Florence were in constant economic crisis. The expenditure of paying contractors to fight was twice as much as the state was collecting in tax revenue from its citizens.
Something urgently needed to be done. How could a city-state raise money to pay for a contract army when the cost was twice as much as it could raise from taxation?
If you look at Florentine city ledgers of account between 1301 and 1330, you’ll find the answer. Debt.
In less than thirty years, the amount of debt recorded in Florentine ledgers rose from 50,000 florins to 5,000,000 million.
Where did the money come from? As well as taxing citizens, Florentines were required to pay an enforced loan — they were obliged to lend money to their own government.
From now on, instead of raising money in direct taxation, governments could issue IOUs, which, unlike a tax, paid interest back to the citizens who lent the money.
What made these loans different, was, as well as receiving interest, citizens could sell their loans to other citizens because the loans were treated as liquid assets. If you needed to raise money quickly, you could sell your loan to someone else. Another citizen would then receive your interest, but the government would keep the money.
This simple idea changed the way money worked forever.
The Florentines had invented the bond market, and these enforced loans were the first ever government bonds.
Florence in the 14th century financed wars and protected its citizens by turning them into its biggest investors.
The art, the patronage, the culture and enlightenment of the Renaissance came second. Before high creative thinking, came high creative finance.
It changed the world forever.
Florentine government bonds looked like the solution to the problem of raising money forever, the city-states discovered there was a limit to the number of bonds you could issue.
As the city states waged war, using bonds to fund the conflicts, it raised the money from its citizens, but as more bonds were issued, the lower the market face value of the bonds.
The city-states of the Italian Renaissance encountered a problem — supply and demand.
By the early 16th century, the city of Venice had a debt crisis because of a period of military weakness. As the danger to the Venetian state increased, the more investors demanded to be paid to hold the bonds. The key investment advantage with bonds is that interest is paid on the face value of the bond, which is not necessarily the price you pay to own the asset.
If the state is at war, the risk to the state increases, and as the risk increases the likelihood of the state surviving to pay you back decreases. As the risk of payback decreases, the tradable value of the bond decreases too, pushing the payable yield on the bond up.
Because of a crisis, the Venetian bonds were trading at less than 10% of their face value, and this meant that the yield on the face value of the bond, given you paid only 10% of the face value, is much higher at around 50%.
The key to understanding bonds is this: The market sets the price you pay for a bond. Bonds are the price you pay for risk; hence, the term risk markets as another name for the bond market.
As the risk of holding a bond goes up, so does the yield as the price of the bond falls because of the increased risk. If the state has to pay a higher rate on newly issued bonds, then this cost is transferred to all the other borrowers. This is how the bond market and bond prices influence interest rates.
Like the Italian states of the early 14th century, the 21st-century global economy has a problem. Thanks in part to the 20th-century invention of the central bank and fixed fractional banking, and the decoupling of currencies from a gold standard, allowing the unlimited creation of money out of nothing, the world is now swimming in debt.
And again, you might be wondering what has trillions of dollars of debt go to do with cryptocurrencies?
The invention of the bond market changed finance forever. Today, the bond market dwarves the stock market in size and is the mechanism that sets global interest rates for everyone.
In Wall Street — Money Never Sleeps, Gordon Gekko lectured the audience on the perils of WMDs. Weapons of (financial) mass destruction. Calling the audience, whose average age was in their late twenties to early thirties, the NINJA generation — No income, no job, and no assets.
As the generation that created the multi-trillion dollar debt mountain beings to retire, who is left to pay back the debt? How can you pay down $22 trillion of national debt? Today, with more debt than ever, the younger generation is going to have to figure out a way out of this crisis.
Last week the speakers at the Blockchain event met in New York City, discussing amongst the usual debates on DEX, decentralised exchanges and the scaling of Bitcoin with the Lightning Network, the future potential of STOs, securitised token offerings, stable coins, and DeFi — decentralised finance.
At Blockchain week, many presentations on the potential drivers of the cryptocurrency markets were given. One target market is the video game industry where around 60% of gamers have proved that a market exists for the buying and selling of virtual assets, like a custom outfit for your game avatar, yours for only $500. The video skin industry is a multi-billion dollar per year market, it’s niche, but it shows there is a market willing to pay for virtual assets.
Traditionally wealth has been maintained, passed down through centuries, using the big three asset classes of gold, land, and art.
In previous articles we’ve discussed the hype cycle, and, if December 2018 was the bottom of the cryptocurrency market, the bottom of the trough of disillusionment, what is going to drive the cryptocurrency market or blockchain market up the slope of enlightenment over the next decade?
Is it more likely to be a niche product for a growing niche industry, or is it more likely it will be like the invention of banking, the bond market, and the stock market, a totally new paradigm that will change, like the Florentine bonds of the 14th century, the world of finance forever.
What if the use of physical money is ended, replaced instead with a blockchain driven digital currency, allowing governments to track with near 100% efficiency the flow of money in the economy — and the collection of income via taxation — allowing for more accurate control of inflation replacing the animal driven emotions of profit and loss in the bond markets with AI-driven systems.
One way to reduce the amount of global debt is through inflation. In the Wonderwall series, we talked about how the United States and China import and export inflation and deflation. Perhaps the Trump trade war is about generating inflation inside the US economy, causing higher prices for goods which will be passed onto the US consumer. As bond yields in Germany are negative in some parts of the curve, high levels of debt will not be reduced by inflation but magnified instead.
With debt levels at record highs, the likelihood of a massive shakeup of the financial system increases. Companies like Microsoft have expressed interest in using blockchains, as a mechanism to improve user identity and security. In other words, to improve control and security over their user base.
Among the sponsors of the May 2019 Blockchain event are IBM, Microsoft, and Amazon. Big money is moving in.
As the stock market hit all-time highs in April 2019, fuelled by cheap debt, caused by high bond prices as money flow searches for yield, consumers own higher levels of debt than ever before, and the likelihood of a six sigma event increases.
Out of a future crisis, will blockchain technology emerge like banking, bonds, and stocks, as the fourth great invention of finance?