QCP Macro Deep-Dive Series: Fiat & Crypto (16 Aug 2021) Part 1
50 years ago, on Sunday 15 August 1971, Nixon took the US off Gold convertibility. This was arguably the single most important economic shift in modern economic history, the first step in a complete shift to a Fiat-based monetary world.
With this shift, money supply became unencumbered. Central banks could now expand their monetary base without fear of claims on their reserves. Without the Gold-backed limit on money supply, the floodgates were opened.
Since then, there has been an unprecedented rise in central bank printing. Money supply has grown in a parabolic fashion and has seen an even more exponential rise in the wake of Covid (Chart 1). Central banks have treated this as a free pass to print whatever they need to keep the economy juiced up (Chart 1 — M2 from $710 billion to $20.4 trillion in 50 years).
In the Fiat-based world, the core weapon of the central banks is their currency. More specifically, the devaluation of currency (through monetary policy tools like interest rates or Quantitative Easing) gives the country an edge in global trade, effectively benefitting from the economic growth in other countries. Also, the management of inflation expectations through money supply ensures the increasing demand required for economic growth.
This major shift by the US soon led to a global free-floating exchange rate regime which in turn led to a global currency war that is being fought to this day. No country was going to give the US a free ride devaluing unilaterally and stealing growth at their expense.
The result was a Fiat “race to the bottom” where global central banks embarked on a decades-long tit-for-tat devaluation of their own currencies, driving global money supply through the roof (Chart 2–12 major countries M2 at US$100 trillion).
Because these currency devaluations happened across the board, one might be tempted to believe that Fiat cash has held its value. After all £1 bought $2.40 in 1971, not too different from the $1.40 today. To see the impact of the shift, we need to look at a ‘neutral’ asset. Gold for example.
The results are damning for Fiat cash — Against Gold, the USD has lost 98%, the GBP 99% and the JPY 93% since 1971 (Chart 3).
And it’s not just Gold that grossly outperformed cash. Almost all other major asset classes have seen significant price appreciation against cash. If for no other reason, just because of the fact that asset values are typically measured against (or denominated in) currency which constantly loses value by design!
This means that asset prices are largely a function of the currency, which is itself a function of central bank action.
A good example is seen in the Nikkei Index denominated in JPY (white line) vs. USD (blue line) vs. Gold (orange line) from 1971 to now (Chart 4). Against Gold, Nikkei has had practically zero price appreciation. Against Fiat cash, it only experienced price appreciation from 2012 after the Bank of Japan embarked on Abenomics, a monetary expansion policy that effectively devalued the currency and boosted inflation expectations.
And with the USD being the de facto global reserve currency, we can actually see how the price movements of all assets are strongly tied to the Federal Reserve’s money printing (of course with varying sensitivities due to factors particular to each asset). [Chart 5 — Yellow line (US money supply), Orange line (Global liquidity proxy), Purple line (Bonds), Blue line (Gold), White line (S&P 500) all normalised to USD Index (DXY)].
So we know that, in the long-term:
1. Asset prices are largely a function of currency value and central bank action
2. Central banks are caught in an intractable spiral of currency devaluation and money printing to sustain economic growth
Our natural conclusion is that:
1. Cash is trash in the long-term
2. Successful investing is essentially about picking the optimal store of value (against cash) at any particular point in time
3. Owning crypto is a no-brainer as it remains an underowned asset class globally (i.e. crypto will be the biggest beneficiary of continued central bank printing)
At this point you might ask about those who say that “Cash is king”? They might be right but only in the short-to-medium term.
The huge amounts of money printing has led to severe asset price inflation from all the liquidity and leverage in the system. Because of this, deleveraging cycles and liquidity shocks, like what we saw on the onset of Covid in 2020, are bound to happen from time to time.
Current asset prices reflect the expectation of constant liquidity flowing into the system in this new monetary equilibrium. Any hint of tightening from the Fed and the potential withdrawal of this liquidity would result in a downward repricing of financial assets. This is the reason for our focus on Fed action in market broadcasts.
What does the Fiat system have to do with crypto? The answer is a lot!
One good example of too much liquidity chasing too few “assets” are NFT PFPs (profile pics) changing hands for millions of dollars, and collection market caps in the billions. Also, the exponential move higher across crypto assets in the first half of 2021 from a market flush with liquidity as well as the hard crash on the back of potential Fed tapering when inflation numbers were deemed unsustainably high.
In part 2 of this Deep-Dive series we’ll be exploring the long-run inflationary dynamics of BTC & now ETH after EIP-1559 & into ETH 2.0, and how that stacks up against that of Fiat.
