Michael Saylor has generated a fair bit of buzz this year through his decision of switching from traditional options such as US Treasuries to Bitcoin as far as the reserves of his company (MicroStrategy) are concerned. He is not alone, with more and more corporations at the very least considering strategies involving partial re-allocations.
Why Is This Happening?
When it comes to mega-trends, especially those in their relatively early stages, it is vital to take a step back and come to terms with the underlying reasons which made them possible. More specifically, in our case, it makes sense to ask ourselves what would compel companies to embrace a change as bold as transitioning from status quo assets such as bonds to digital alternatives, in Michael Saylor’s case bitcoin?
It is ultimately all in the realm of game theory, with it being both wise and necessary to put ourselves in the position of someone who is running a company that happens to be sitting on significant reserves which are currently in the form of either cash or cash equivalents such as short-term government debt (for example US Treasuries).
Needless to say, a wise CEO does not want to stand by idly as the purchasing power of those reserves dwindles. And in light of the fact that all over the world, central banks are going all-in as far as monetary stimulus is concerned and governments are on their way to going all-in when it comes to the (more inflationary!) fiscal stimulus dimension, it should come as no surprise that market participants who just so happen to be “savers” in one way or another (for example, by sitting on cash and cash equivalents) feel that they are collateral damage. And, unfortunately, they are.
How Did This Happen?
As a quasi-axiomatic statement, there is simply too much debt in the system, with Japan arguably representing the canary in the coal mine and the European Union as well as the United States following suit, especially in the aftermath of the Great Recession. The consequences of this are perhaps best articulated by economist Richard Koo, with his “balance sheet recession” argument. More specifically, Koo points out that in Japan and later on other countries, individuals and businesses alike found themselves in extreme situations, for example realizing that their debt exceeded the value of their assets.
The responsible approach for any rational economic actor, he asserts, is answering one simple question: is there enough money coming in?
If the answer is negative, solutions which revolve around filing for bankruptcy tend to be the only options. If however there is still money coming in, any responsible player essentially has no choice but to succumb to the following rationale: for better or worse, asset values probably won’t go below zero and as such, the only reasonable play represents gradually trying to pay down debt, until once again debt levels stop exceeding asset values.
Unfortunately for the economy, both options are highly deflationary in a world where debt is money. To put it differently, in a world where a borrowed dollar has the same purchasing power as a dollar saved across generations, a world which needs continuous debt-fueled monetary expansion to survive. To be blunt, it would be impossible by design for all debt to simply be paid back because there is more debt in the system than there is cash to re-pay it.
As such, it should come as no surprise that debt destruction is literally the last thing authorities want and that they will do everything in their power to ensure that their ultimate nightmare does not materialize: the proverbial system collapsing during their watch.
What Has Been Done?
In a nutshell, the post-Great-Recession world in monetary policy terms can best be described as a desperate attempt to spur inflation (in terms of CPI), with everything this encompasses: people spending more, borrowers borrowing and lenders lending. In a world where debt is money, while it is true that central banks have their share of powers (creating roughly 7% of what constitutes money today), it is commercial banks that currently hold the keys to the inflation machine at this point, accounting for the bulk of money creation.
And while central banks have been working harder and harder, commercial banks… well, haven’t. Borrowers either. Why? Simply because both parties are doing the responsible thing: cutting back on spending and debt acquisition due to the debt overhang issue so as to get things back on track in terms of sustainability.
There is just one problem: a Paradox of Thrift situation that ensues. In practical terms, doing the responsible thing makes perfect sense at an individual/granular level. But when everyone does it, the system as it was designed crumbles due to ending up in an uncontrollable deflationary spiral. When company A cuts down on spending, this leads to revenue reduction for Company B, a let’s say Company A customer. Less revenue for Company B leads to it cutting back as well and things continue in this manner indefinitely.
Can We Afford to Stop Spending and Borrowing?
Simply put, no. And for this reasons, central banks and governments are doing everything in their power to re-ignite spending. Central banks have essentially been as aggressive as their legal framework allows by expanding the monetary base and bringing interest rates to historically low levels but as we have been able to witness, this has not resulted in consumer price inflation because lenders and borrowers haven’t joined the proverbial party.
What has this resulted in?
Two main dimensions:
- The punishment of savers across the board, from companies that are sitting on significant cash reserves to let’s say baby boomers who were sold on the dream of at least partially living via interest rates on saved capital and have been disappointed… to put it mildly.
- Asset price inflation if you will rather than consumer price inflation, to a wide range of assets skyrocketing due to the fact that among other things, savers oftentimes have no choice but to acquire assets, even at valuations previous generations considered excessively risky.
What Does This Mean for Corporations?
If the status quo persists, then even if we would not have problematic consumer price inflation, asset inflation along with ultra-low returns for “safe” assets would be here to stay. As such, the current asset price inflation trend is likely to continue, even if things do not pick up at the consumer level in terms of inflation.
Central banks and governments might succeed at re-igniting inflation, for example through a legal paradigm shift for central banks (such as measures with respect to re-thinking the Federal Reserve Act in a way that give the Fed the power to also spend rather than merely lend) or if governments step in through increased fiscal stimulus (something that has already been set in motion, especially in a post-pandemic world). In this case, individuals and businesses alike would have even more in the way of incentives to move away from cash and cash equivalents.
While other scenarios are possible, the two above represent the most likely outcomes and as can be seen, this makes it clear that the average person as well as business essentially has no choice but to keep getting rid of cash and acquiring digital assets.
Why Digital Assets, Especially for Corporations?
At the end of the day, it’s all a matter of simple logic to understand the two main driving forces:
- In a world where market participants are essentially forced to acquire assets, valuations end up becoming less and less attractive for “traditional” assets, leading various players to more “exotic” options such as digital assets, anything from domain names to cryptocurrencies.
- For corporations, acquiring certain digital assets (especially domain names) can also end up being a wise business rather than strictly investment decision. A domain name can be used to launch a marketing campaign, an online store that generates a considerably better return compared to its brick and mortar counterpart... could go on and on
...think of it as a combination between the investment and utility perspectives, in a world where savers are punished and asset acquisition is encouraged.
Fad or Long-Term Mega-Trend?
As this article hopefully made clear, we are firmly in the latter camp. The only scenario which could result in major disruption when it comes to digital assets would have to be related to governments and central banks completely changing course: increasing interest rates, allowing large businesses to collapse and even risking the implosion of the financial system as a result to the derivative-fueled time bomb that exists.
Politically speaking, while not completely impossible, we have valid arguments to believe that this scenario is highly unlikely for the simple reason that it would result in political suicide. Once again venturing into game theory perspectives, political decision-makers are unlikely to gamble their careers away by risking a systemic collapse under their watch.
As such, in light of the fact that there are significant incentives when it comes to status quo preservation and even increased aggressiveness, digital asset acquisition at the corporate level can be considered a mega-trend which is most likely here to stay.