Crypto Market Commentary
6 April 2020
Doc's Daily Commentary
The 1 April ReadySetLive session with Doc and Mav is listed below.
Mind Of Mav
What Caused The Crisis & How Do We Fix It? Part 1
Here in the US, there are quite a few reasons to be a pessimistic investor:
? Almost 10 million people in the US have filed for unemployment insurance in the last two weeks. Many won’t have jobs to return to, even with the best possible projections
? US GDP growth is poised to fall by an unfathomable 34% in 2Q20 (Q/Q, annualized), with the steepest drop expected in April
? S&P 500 earnings are forecasted to fall to $110/share in 2020 with 2Q 20 EPS estimated to be down 123%. Goldman Sacs now forecasts a 25% decline in S&P 500 dividends
? Supply chains are intertwined in this world such that even the “recovery” in China is struggling to see gains in even the most secured & advantageous sectors.
? The US High Yield credit market is poised to potentially have to absorb an additional $555bn in Investment Grade downgrades as a huge swath of BBB-rated companies are re-evaluated in the Coronacrisis. One of the most concerning aspects of the current market crisis is this chart below. Almost half of the investment-grade corporate debt is BBB-rated and just one step over the non-investment grade. Once BBB-rated corporate bonds start losing their investment-grade status, liquidity will dry up for these guys.
? Something I don’t see anyone discussing the possibility of: we will likely have social distancing, if not total lockdowns, until we have a vaccine. The risk of remission is already playing out, and countries like China are going back to lockdown.
Even still, and surprisingly, there are reasons to be optimistic too.
? Monetary stimulus has been swift, targeted, and appears to be almost unlimited. Take what you will from that, and certainly here in crypto-land it seems like sacrilege to laud anything to do with monetary and fiscal policy that promotes such blatant currency inflation . . . but, cryptocurrency doesn’t benefit in the aggregate if society completely ceases to function. Like everything, we need a balance, and right now we need society to get back on track and semi-functional before we discuss how new technologies, like cryptocurrency, take over in the long term and help to correct systemic issues.
? Fiscal stimulus is now in place to support individuals who are losing their jobs, incentivize companies to keep people employed, and provide a financial backstop to corporates. Again, we can express our disgust, but normal people are hurting right now. They need something to fall back upon before we can pick them up.
? Asia has begun a nascent recovery, providing a lens for US investors on how things may look once the impact of virus mitigation efforts begins to wane. This is obviously tempered by remissions, as we saw with China.
? Medical companies around the remain focused on developing vaccines and treatments for the virus. That sense of urgency and common good is what creates miracles of science and industry. Like WWII, the very best and worst of humanity is on display right now. Just like that war, we’re going to see humanity come together and catalyze a brighter vision of the future.
So, on that topic, let’s spend this week talking about the future.
Or, more specifically, how we get there. After all, how do we fix a global economic crisis?
Last week we talked about how to resolve the pandemic. As we discussed, there is much that has to happen right now to get in front of the worst pandemic we’ve seen.
But, people need to eat. So, let’s take this economic crisis thing one step at a time.
In the immediate term, there’s a lot of fires to put out.
As markets are down, businesses are closing, and unemployment is rising, everyone looks to leaders to provide economic guidance on how to weather this turmoil.
Everyone wants to know: What gets an economy back on track?
After all, there is so much to consider. Every economic downturn is similar but always very different at the same time. What worked last time may not work this time. It’s hard to know where to start.
Unfortunately, there isn’t a magic bullet.
Leaders are going to have to ask some serious questions about tradeoffs which will need to be made amidst the chaos of these tumultuous times.
The first big decision is what to do with those interest rates.
After all, they’re the first line of defense, right?
Well, an important thing to know about interest rates (or cash rate) is that they are set by Central Banks and then passed along to average consumers by regular banks.
The Government of a nation, and even the head of state, don’t really get a say in the decision-making process of the Central Bank because they are technically an independent entity. This is why you see Trump express his displeasure of economic conditions by directing calling out Jerome Powell, head of the Federal Reserve, rather than just, you know, doing something about it.
Most Central Banks try to work with their local governments to achieve two main things: stable inflation and economic growth — in that order.
This is why economic downturns are bad in the eyes of the Central Bank. It normally leads to people spending less money, and when people save more of their income that means that there is less money exchanging hands out there in the economy.
When that happens, it means businesses will make less money. When businesses make less money, that means that they won’t be able to employ as many people. When less people are employed, it means there are less people won’t be able to go out and spend money.
This vicious cycle continues and this is really, really bad. We’re seeing the beginnings of this today.
So, how do we put an end to this?
Well, businesses will normally react to this lack of demand with large price drops. They will put their stock on sale or offer discounted airfares, perhaps lower the price of their services, but regardless, the net result will be that the general price level of things is lower.
This result, where the price of goods is falling, is called deflation.
We might be used to that term regarding cryptocurrency, but what should be clear is that deflation is horrifying to a Central Bank. Remember, they care about stable inflation far more than they actually care about economic growth.
Why is that? Shouldn’t they care about economic growth more than the currency itself?
Not if you’re a Central Bank.
Central Banks exist, if for no other reason, to look after the wellbeing of their currency — not necessarily the whole economy. But, as those two are intrinsically linked, we see Central Banks react to deflation by lowering interest rates.
Lower interest rates mean that people can access credit more easily and banks are more willing to lend more money.
Ah! Of course! The cure to coronavirus was more money all along!
Lowered interest rates also have the effect of getting more money out into the system as people can borrow money at cheaper rates. They use that cheap money to buy things like cars, phones, or houses.
You’ll also see more businesses willing to offer 0-interest loans that break up a big purchase into smaller ones. A smaller price, broken up into multiple payments, is always going to be more attractive to a consumer. Such a pricing model is made possible thanks to a cheap interest rate backing it up.
The intended effect is for businesses to stop lowering their prices, which is causing deflation, and instead get consumers to purchase more thanks to the lower interest rate making it more attractive.
A side-effect, which I often see painted as bad, is that inflation rates punish people who keep their money locked away in a bank. Thanks to inflation, they’re losing value on those savings to the tune of 3-4% per year.
But, in the eyes of the Central Bank, that’s the system working as designed. People will be less inclined to hoard their savings and instead put that money to work stimulating the economy.
So, of course, the moment we saw things start to head south, the Fed quickly acted with interest rate cuts that seemed extremely rash at the time. Never before had we seen such a large cut made without waiting for their meeting to announce it.
Even with that, even when consumer banks also drop their rates following the Central Bank, we still have to hope that consumers notice the difference in interest rates and their payments.
In that, we see the biggest flaw with even drastic measures like massive rate cuts done quick: it exposes how slow Monetary Policy is to take effect, and oftentimes by the time it does, the measures were far too late.
This is why we’ve been critical of how Central Banks around the world have been acting in the last two years, essentially trying to float the world economy along on increasingly thin measures and rates, which has left us extremely vulnerable for a sudden and drastic downturn like this one.
So, the Monetary Policy that Central Banks employ has hardly slowed the crisis.
Tomorrow, we’ll talk about how Governments employ Fiscal Policy in response to a downturn.
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