Thought you knew what an asset is? Unprecedented times are fostering unconventional ideas about the very essence of our financial existence, including what is characterized as an asset.
For all intents and purposes, Tony Chung led a privileged life. Chauffeured to school in his own Daimler, his afternoons were spent whiling his time away at the Singapore Cricket Club.
Throughout the 1930s, Chung’s father ran a prosperous business, supplying the British troops that were garrisoned in the island fortress of Singapore with the creature comforts of home, Chung senior had made his family fabulously wealthy in the process.
But even before the ink had dried on the documents of surrender, as the British, who were thought to be undefeatable, ceded control over Singapore to the invading Japanese, Chung knew that the idyllic life of his past was effectively over.
As the Japanese took over Singapore, almost overnight, the cost of even the most basic items skyrocketed.
Once treasured British pounds were now worthless pieces of paper, no more useful in Singapore than throughout occupied Malaya.
And before the invading Japanese could issue their own currency, cigarettes and sweet potatoes became the de facto items to facilitate a simplified barter trade.
Chung, having had nothing more than an interrupted secondary school education had to take to trading in cigarettes to keep the family fed.
And as Chung soon learned, what qualifies as an asset is more often than not a function of circumstance as opposed to any intrinsic value.
New Year, New Assets
Which is why persistently low interest rates are fueling a new ideology in the corridors of power that have the potential to redefine what “value” even means in our epoch.
Wall Street bulls rallying around sky-high stock valuations and Washington politicians embracing ever-increasing deficits to prop up the economy may be ideological opposites, but the justification for their beliefs share a common root — near-zero interest rates.
A prolonged period of virtually free money, where it costs almost nothing to borrow, has made stocks more valuable and debt more supportable.
The rally in everything from Bitcoin to big tech are all manifestations of what some on Wall Street have termed the “TINA” trade — There Is No Alternative.
When bank deposits pay nothing and government bonds pay next to nothing, investors will grasp at almost anything to eke out a return.
And while such an approach is not wrong directionally, because the value of an asset is its future income discounted to the present using interest rates plus a “risk premium” — the extra return you expect for owning something riskier than a government bond — it also makes it harder to discern what an asset even is anymore.
Got a Problem? Just Blame it on Low Interest Rates
Low rates have been used to justify the outperformance of big growth companies like Apple, Amazon and even Tesla, for whom the bulk of profits lie far in the future.
But increasingly, even the most cockeyed optimist must have a lot of confidence about how the next few years will play out to justify Apple’s current value.
And for Tesla, that confidence needs to stretch into the decades.
For Bitcoin? Perhaps well beyond.
But fueling Bitcoin’s persistent refusal to fall to zero has also been the zero-rate logic that has fueled the “everything rally.”
Over the course of the pandemic (which for now shows no signs of abating), the U.S. Congress has borrowed roughly US$3.4 trillion, and the Biden administration is looking to increase that by another US$1.9 trillion more.
Roughly one quarter of American GDP, this burst of borrowing is larger than since the Second World War.
Put It On My Tab
But if U.S. President Biden and his Treasury Secretary are to be believed, a further burst of borrowing is not only justifiable, it’s financially prudent given that interest rates are at their historical low.
According to Biden and friends, the additional debt won’t increase interest expenses any more than what they were before the pandemic — or to put it another way, America is up to its eyeballs in debt anyway, what’s another couple of trillion dollars between friends?
And if that sounds familiar, that’s because that was precisely what John Law wrote about the French economy right before the world’s first stock market bubble was inflated, exploded disastrously and created the conditions that led to the French revolution.
Writing in the 18th century, John Law, a Scottish economist and convicted murderer wrote,
“I maintain, that an absolute prince who knows how to govern can extend his credit further and find needed funds at a lower interest rate than a prince who is limited in his authority.”
“In credit as in military and legislative authorities, supreme power must reside in only one person.”
And while Biden is limited in his authority, with the Democrats in charge of every branch of government, sufficient groupthink could potentially unfetter their ability and appetite to borrow.
The problem isn’t so much those in Washington who believe that the United States can borrow more, it probably can — but it’s those who hold the view that America can borrow completely limitlessly that are cause for concern.
Magic Money
Because those lawmakers who essentially believe that America’s ability to borrow is limitless argue that the U.S. can always print more dollars to pay off that fresh debt — the very definition of “magic money.”
Bolstering their argument, these politicians who believe in “magic money” point to the fact that over the past decade, interest rates have fallen despite a rise in borrowing.
The problem with this logic is that it assumes interest rates are independent of the level of debt.
In reality (where the rest of us live), there is some not-so-fictitious level of borrowing that will inevitably push up inflation and interest rates.
Just because no one knows what that level is doesn’t mean it doesn’t exist — it just means that it’ll be a heck of surprise when we discover it.
And the more Washington spends as if there is no limit to its borrowing, the sooner it’s likely to hit that limit.
Last year, former U.S. Federal Reserve official William Dudley wrote that inflation is likely to be a genuine risk, precisely because nobody seems to think that it is.
Conflating the looming crisis is the fact that how much debt the U.S. can carry isn’t just dependent on interest rates, but on GDP as well.
Think of it in terms of someone borrowing money from a bank.
As long as your bank knows that you have a job and can keep making repayments on your loan, they won’t foreclose on it.
Similarly, as long as the United States keeps on producing, it can keep on borrowing, and spending.
But even before the pandemic, U.S. GDP growth had been slowing.
Mired in not one, but two economic disasters in the span of just 12 years, GDP growth trends were heading down, just as debt was trending upwards.
However much fiscal headroom the U.S. still has, has certainly been reduced — consider that federal debt has risen from just 35% of GDP in 2007, to well over 100% today.
And that’s why there are a growing chorus of high profile investors and individuals who are increasingly placing their bets on Bitcoin and cryptocurrencies as the last remaining keeper of score.
Given that Bitcoin (and most other cryptocurrencies) are deflationary by design, there is a growing sentiment not just in Wall Street, but around the world, that if the U.S. isn’t interested in maintaining the value of its currency, perhaps it may be time to start taking out dollar hedges.
And Bitcoin appears particularly attractive because it fits both the speculative narrative — that as the Fed prints more dollars, these dollars will flow into asset inflation — as well as the inflationary hedge narrative — because there will only ever be a fixed amount of Bitcoins, their ability to act as a store of value is superior to dollars.
While Bitcoin has long been derided as having no intrinsic value, at the rate that the U.S. is printing dollars, it’s just a matter of time before the same accusation can be hurled at the greenback.
And in a world where magic thinking is leading to magic money, perhaps it makes sense that more investors are looking at magic assets.
