In the previous article, we gave an overview of the emergence of crisis. Next, we will further illustrate how cycles should be dealt with in light of Ray Dalio’s analysis of the economic system, thereby evaluating the value of BTC from a more holistic perspective.
Ray Dalio’s Analysis of the Economic System
In “How the Economic Machine Works“, Ray Dalio simply but profoundly analyzed the operation of the economy from the perspective of Keynesianism.
His analysis is actually an observation of the U.S. national conditions – that is, the Federal Reserve, in essence, regulates the liquidity of the entire economy by altering interest rates.
In his system, the operation of the economy consists of two parts, production and consumption. Production includes goods and services, which scale expansion is relatively difficult, and the market impact is relatively small. Consumption includes currency and credit. Credit expansion is relatively easy because money can be printed, which has a great impact on the market.
Ray Dalio believes that debt due to consumption is an important driver of short-term economic fluctuations.
Since people can borrow to consume more than the output, they have to consume less than their output when repaying their debts. By aggregating everyone’s trades and debts, we can figure out the cycle of the economy as a whole.
From a macroeconomic point of view, the U.S. economic cycle seems to be mainly influenced by the central bank’s monetary policies. However, this is not a reason but merely an outcome. The real reason is society’s excess capacity.
The state can alleviate this problem by increasing the money supply (printing money). Since people’s money on hand will depreciate as the amount of money available in the market increases, they tend to make purchases in order to reduce asset write-downs caused by depreciation. The short-term economic crisis will be “alleviated” as the society’s consumption increases, but what it actually does is merely pushing back the crisis.
01 Keynesian Economic Cycle
Step 1: Central bank lowers interest rates to stimulate the economy and release liquidity. In other words, the Federal Reserve is cutting rates.
Step 2: Banks encourage borrowing by lowering bank loan interest rates accordingly. Hence, more people will make loans to set up factories and companies, thereby driving economic growth.
Step 3: Money supply exceeds social productivity, leading to inflation.
Step 4: If inflation happens during economic growth, the central bank will increase interest rates to curb inflation.
Step 5: Tightening of monetary policy (high-interest rates) will cause money to flow back to banks. Hence, credit will also tighten, and the economy enters into a recession.
After a period of economic recession, the central bank will start to stimulate the economy. This results in the economic cycle going back to the first step.
So, which step are we at now?
In 2017, Ray Dalio believed that U.S. stocks will fall; and in 2016, Soros began to open short positions in the U.S. stock market. These market operations reflected their judgment of the U.S. economy – the economic cycle is not going well. However, the Central Bank having sufficient interest rate adjustment space was pre-requisite in completion of the cycle. Around 1980, the highest interest rate in the history of the Fed was close to 20%. In this case, the macro-control strategy of reducing interest rates would have been effective.
However, since 2009, interest rates in the U.S. have been around 2% for 10 consecutive years, and there is no room for rate cuts to stimulate economic growth. Similarly, Japan and Europe have pursued negative interest rate monetary policies in order to stimulate economic growth. However, not only did it not recover these countries’ economy, instead, they plunged into stagflation.
Since then, the U.S. has entered into a long-term debt cycle, that is, the deleveraging cycle, and the economy is gradually moving towards depression.
02 How to Withstand Economic Depression?
In Ray Dalio’s opinion, the following measures could tackle Depression relatively well:
- Individual, companies and governments reduce expenditures
- Reducing debt through defaults and restructuring
- Redistribute wealth from the rich to the poor
- Central bank increases money supply through quantitative easing
Through a series of measures to stimulate the economy and production, the economy will enter a long recovery period. In the case of U.S. history, the previous Great Depression lasted about ten years, from 1927 to 1937.
Are the measures that Ray Dalio suggests effective? We will discuss this in future articles.
03 Why Does Ray Dalio Go Short on U.S. Stocks?
We need to first understand some of the ways in which the U.S. stock market operates. The S&P 500 (Standard & Poor’s 500 Index) has roughly tripled since 2009. Till date, the U.S. stock market has reached a very high point.
U.S. stocks typically issue dividends to distribute profits to the investors. But in fact, only 25% of these dividends are real profits, that is, the company’s operating earnings. The remaining 75% of the profit comes from stock repurchase. By buying the company’s shares with the company’s money, there are fewer shares on the market, resulting in its stock price rising.
The reason why enterprises have sufficient funds to do shares buyback is because the Central Bank provides zero interest rate for them. Hence, stocks are mainly supported by debt. Jesse Colombo, an American economist, pointed this out in his September 2018 article “Disaster Is Inevitable When America’s Stock Market Bubble Bursts”.
Management salaries of U.S. listed companies are linked to the stock price. Through shares repurchase, the company’s stock price will rise, and the management’s income will increase at the same time. Due to the incentive mechanism, the company’s decision-makers will also be more inclined to carry out stock repurchase to raise price, rather than actually optimizing the efficiency of the enterprise.
That is the real reason why Ray Dalio goes short on U.S. stocks.
Macroeconomic Policies and Bitcoin
01 Properties of the Bitcoin
In such a macro-level cycle, what kind of market is the Bitcoin in?
In our opinion, it actually opens the preface to world-wide venture capital investments, which have the following characteristics:
- Technological Characteristics: Bitcoin, as an internet technology, has the potential to be used.
- Network Effect: Currently, the total number of Bitcoin holders in the world is probably tens of millions, thus, its survival is guaranteed.
- Low Entry Barrier: Traditional financial markets have many restrictions on investing in high-tech companies, such as capital volume and relationships. Comparatively, the Bitcoin market is completely open.
Due to these characteristics, the Bitcoin market is gradually drawing capital attention and its development speed is also getting faster and faster.
02 Reason thatDigital Currency Skyrocketed During 2016-2017
According to Cryptocompare, more than 5 million Bitcoins were traded in RMB, which is equivalent to 3.8 Billion USD, on the first day of 2017. 5 days later, the Bitcoin price in the Chinese market reached RMB 8600 yuan, while the foreign currency price on the same day was only about 7700 yuan. The difference was as high as 1000 yuan.
China’s market signaled a rising trend, which subsequently was spread to the whole world.
Looking back, we will find that this is a financial market driven by hot money.
Studying the source of hot money is the key to studying the boom of Bitcoin.
Speculative Capital Inflows in China in 2015
|National Railway Freight Volume|
|Index||Unit||2015||±% Compared to last year|
|Total Freight Volume||Ten Million Pounds||335801||-11.9|
|National Railway||Ten Million Pounds||271387||-11.6|
|Total Freight Throughput||Hundred Million Kilometres||23754.31||-13.7|
|National Railway||Hundred Million Kilometres||21598.37||-14.0|
2015 Railway Statistical Bulletin
According to the 2015 Railway Statistical Bulletin, China’s railway freight volume fell by 11.9% during the same period. The real economy has fallen sharply, with the investment boom in infrastructure and real estate in 2009 gradually cooled by 2015. During the same period, the government’s monetary easing policy led to a large amount of cash with nowhere to be used.
Since capital is not profitable in the real market, it has to turn to the highly speculative debt market.
This is also an opportunity for China’s P2P lending industry to start rising. According to Wang Dai Zhi Jia’s industry data, by 2019, there were more than 6,000 Internet lending companies in China.
In the meantime, a lot of speculative capital has also turned their attention to Bitcoin. As a result of the domestic hot money, Bitcoin price soared. This further stimulated the entry of funds from Japan and South Korea, which on the contrary, it is the funds from Europe and U.S. that made a late move.
Tightening Monetary Policies in China and the U.S. in 2017
In 2017, China and the United States successively tightened monetary policies to deal with possible systemic financial crises. The Fed adopted the means of interest rate hikes, while China promoted financial deleveraging.
Macroeconomic contraction will lead to the rapid withdrawal of hot money from high-risk markets. Digital currency, as the most risky liquid asset, will definitely be sold first.
Although the Bitcoin market continued to rise until the end of the year, the foreshadowing of the crash has already existed in mid-2017.
03 Our Partial Judgement of Bitcoin
Is Bitcoin a form of digital gold?
Why do people treat Bitcoin as a hedging asset? Currently, Bitcoin is still far from being considered a safe-haven asset, unlike “gold”.
Hedging assets is always a relative concept, the hedging asset will always be one which is more stable. In the digital currency industry, Bitcoin is the most stable, which is why it is a hedging asset. For the real economy, further market feedback is needed to come to a conclusion.
Will Bitcoin be legalized?
As one of the most important powers of a state, no government will give up their minting rights.
The development of human society has always been centralized, not decentralized. Even in the so-called democratic United States, scholars lament that the current federal government is far more powerful than the federal government used to be 100 years ago.
In fact, the recent new round of strike by the Chinese government on digital currency transactions has already begun. Large amounts of Alipay, WeChat and Union Pay accounts that frequently participate in offline digital currency transactions have been banned.
This has led to a gradual shutdown of capital inflow.
Is there any actual value in Bitcoin?
Value exists in illegal places.
Black Market Transactions
In 2013, Silk Road on the Dark Web was well known overnight.
It uses Tor (onion router) to ensure anonymity, and Bitcoin to trade. It mainly deals with drugs, guns and ammunition, counterfeit notes, and other items such as Netflix and Amazon trojan horses, pirated content and fake driving licenses, passports, social security cards, utility bills, credit card bills, automobile insurance records and other forms of identification documents.
In Silk Road’s less than two years of life span, its trading volume reached US$1.2 billion.
Money Laundering on the Dark Web
According to an independent academic study report (Into the Web of Profit) by Bromium, a security company, the annual illegal income of cybercriminals is about $80-200 Billion. This accounts for 8-10% of all illegal income worldwide. The most commonly used money laundering tool is virtual currency. Although many criminals have turned to more secret, anonymous and encrypted currencies, a considerable proportion of them still uses Bitcoin. A $200 billion trade amount is already enough to support a small country’s GDP.
We believe that after the boom of Bitcoin from 2006-2017, the Bitcoin market still has two more years of investment period. The future is full of uncertainty, especially after government intervention in the market.
Bitcoin is a high-risk and high-return equity market for investors. From 2016 till date, although the S&P 500 index has risen by about 1800-2800 (the overall increase being about 40%); in terms of the small cycle of the stock market, it is in the bull market stage. Yet, as the whole macro market enters the long-term debt cycle, the performance of the U.S. stock market actually reflects that it is at the end of the bull market.
However, the Bitcoin market cycle is not entirely consistent with the traditional stock market cycle. This is because, in the traditional financial market, a small amount of money flowing into Bitcoin is enough to drive a large increase in price.
So where did the money come from in this bull market?
In our opinion, there are three possibilities:
- Pyramid Capital: Pursuits short-term speculative profits, and walk away once there is a gain.
- Cryptocurrency Capital: After the hype and bubble burst of smaller non-mainstream cryptocurrencies, people will find a more stable digital currency to hedge with.
- Traditional Capital: Asset allocation. A small amount of capital flowing from the traditional market to the Bitcoin market could drive a great amount of increase in price.
In fact, the more you delve into the market, the more unknown market factors you will discover.
We hope that by sharing some of our recent observations on the market, we can give you a better understanding of the market nature, and we hope to hear more opinions about the market.
We welcome all discussion!