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Making bank, breaking banks


Is the financial machine broken?

It would be impossible to look at any crypto news without looking at the broader economy and what is driving the smaller cogs in the machine.

Globally, interest rates are at all-time lows, bond yields are tiny in most countries and negative in others. If you thought that paying an account keeping fee of $10/mth for allowing the banks to hold your money was ridiculous, then you are not going to like negative-yield bonds. Imagine depositing $100 000 and when you go to get it back the following year, it is only $99k. Then you look around and realise that prices of goods and services have gone up, so you have lost capital as well as purchasing power. Ouch! It seems crazy but that is the reality in several countries.

At the same time as bond yields and cash interest rates are heading lower, stock markets are heading to new highs. That may sound good, until you realise that the economies and underlying earnings of most companies are at record lows.

People who are buying stocks in companies with very low earnings are speculating (read: gambling) that the stock price will increase, even when the fundamental analysis shows no reason why it would go up. Recently, people have bought Hertz, even though the firm had announced bankruptcy. For those who are unaware, when a company goes bankrupt, it often pays back its debts at just pennies in the dollar, and investors most likely receive zero. These are crazy times indeed.

Where is the smart money heading?

There are still some undervalued stocks, and the companies which have been doing it tough (but not filed for bankruptcy) may recover well. Whilst the silly money goes into speculative stock with low earnings, hoping to quickly sell it before it goes down, some of the wiser investors are playing a longer game.

Corporate debt may pay a higher rate than government bonds, compensating investors for their higher risk. This may be likened to lending money to someone for consumer spending (eg. A credit card, which may attract 10%+ interest) versus lending money to someone for a house (a mortgage may be 3% interest).

If the person cannot pay back the loan, you as the lender may be able to seize the underlying asset. In the case of the credit card, it may have been used to buy food, or furniture, so you could expect to get back nothing, or only a small percentage of what was paid. In the case of a house, even in a bad market, you could likely receive at least 50-70% of your money back. It is still bad, but not as bad as the alternative.

Those investing into government bonds with a negative rate, may think that having 95% of your money is better than losing potentially 20% or more in an alternative investment.

When cash is no longer king

Some experienced investors are hoarding cash, waiting for the big opportunity to jump in and buy good stocks at discount prices. This is a strategy which has worked in the past, and those who “bought the dips” after the 1987 crash or after 9/11 may have enjoyed some good profits for taking a risk and buying cheap. Warren Buffett may be the king of opportunistic investing; he is currently sitting on an enormous stockpile of cash and biding his time.

Although media pundits may frequently say “we are in unprecedented times”, there are others who draw comparisons between 2020 and the Great Depression, or the 1918 Spanish Flu. In some of these past scenarios, stock market investors may have lost up to 90% of their money, and others bought stock at large discounts. A smaller subset of investors bought into scarce commodities and did very well.

During the Great Depression, gold prices almost tripled between 1929-1933. When the USA went off the gold standard in 1971, gold prices tripled again. After the 9/11 2001 crash, gold prices quadrupled. After the GFC1 in 2008, gold prices also tripled. Yes, there were pullbacks after each climb, and you would have had to time your purchases perfectly to pull off a 400% gain, but even if you mistimed it and only doubled your money in a couple of years, you could still feel good.

It’s all about the base…

The world monetary system used to be based on gold, but nowadays it is all based on trust. As governments around the world accrue more debt and experience a drop in income (GDP), trust in governments may be at an all-time low.

In recent weeks, it has come to light that some Chinese were just pretending to have gold. So far, 83 tonnes of gilded metal, reportedly worth billions, was discovered to be just gold-plated copper. This revelation obviously caused a shock to the markets.

It is not only the bullion holder who loses money when his cache is revealed to be almost worthless. Investors who backed the bank who lent money to the frauds based on their “gold” holdings have also lost, and investors who borrowed money from the unfortunate bank to create real estate developments will also be disadvantaged.

For millennia, gold has been a global monetary standard, and when its value is debased, tragedy ensues. As some may be aware, the Chinese character for ‘crisis’ is the same as the character for ‘opportunity’. There is always a boom on somewhere…

Enter the crypto

It is rare for gold to be faked, but not unheard of, as with the Chinese story this year. Some insiders claim that some US gold is actually gold-plated tungsten, but this has not been confirmed. Bitcoin has a far shorter history than the precious metal, but is often spoken of as ‘digital gold’.

Bitcoin is a commodity which is, like gold, is in short supply, and holds it value due to its rarity. Unlike gold, however, bitcoin cannot be faked, as there is an immutable blockchain which verifies and records every transaction. If there is a whiff of fraud, the fraudsters can be identified, and the blockchain rolled back and repaired.

There are some of a certain age who will always trust gold and not trust bitcoin, yet the boomers are aging and dying, whilst the next computer-savvy generation is growing. Aside from being “unfakeable”, bitcoin has an advantage in that small amounts can be readily accepted for small purchases, and large transactions can occur in seconds, across borders.

Obviously, major world governments are still run by older bankers, who are more likely to adopt gold as their monetary standard. Yet there are some who speak of national currency backed by bitcoin or another cryptocurrency. The Chinese already use a digital currency to pay government employees, and rumours abound that Germany may soon follow suit, having some of its national currency backed by bitcoin, not gold.