The Breakdown - The Case for $500,000 Bitcoin

Episode Date: August 30, 2020

This week’s episode of Long Reads Sunday is a reading of the latest essay from Tyler and Cameron Winklevoss. The essay looks systematically at the problems of the slate of current store-of-value assets, including the U.S. dollar, oil and gold.  The brothers argue why those assets have, or are starting to have, value in their safe haven function, while bitcoin is on the rise.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by crypto.com, BitStamp, and nexo.io, and produced and distributed by CoinDess. What's going on, guys? It is Sunday, August 30th, and that means this is Long Reads Sunday. Long Read Sunday is the episode where I find a piece that I thought was particularly interesting and read it for you guys. Hopefully it saves you some time. It allows you to listen to some great content while you're on the run or doing work or whatever it is. This week's selection was actually really easy because as soon as I saw Tyler Winklevoss drop the essay, the case for $500,000 Bitcoin, I knew I had to focus there.

Now, going into this, I didn't love their analysis of, of Bitcoin for Dave Portnoy, specifically in the context of asteroid mining. In fact, that was even the subject of a previous Longreed Sunday. However, if you're going to make an argument for half-million dollar Bitcoin, I'm going to listen, so let's see what they had to say. Golden Oil have historically been reliable stores of value. Because they are scarce commodities, they make dependable hedges to the inflation of fiat currencies. As a result, they have commanded price premiums above and beyond the demand for their consumption alone. For the last 75 years, the U.S. dollar has also been a reliable store of value. This is a result of its comparatively

good management by the Federal Reserve and the strength, resilience, and reputation of the U.S. economy. In fact, it is the most widely held fiat currency in the world and recognized as the global reserve currency, denominating and settling the majority of international trade. With that said, we believe that there are fundamental problems with gold oil and the U.S. dollar as stores of value going forward. Below, we will make the case that Bitcoin is ultimately the only long-term protection against inflation. The problem with the U.S. dollar. Economic cycles are notoriously hard to predict, but over a long enough time horizon, they do happen. The Keynesian tools that governments can avail themselves of to soften down cycles are well

understood. Spending money, lowering taxes, and printing money, i.e. cutting rates, quantitative of easing or QE and or adjusting cash reserve ratios for banks are the major levers that governments can pull to counteract an economic contraction. These strategies, however, have diminishing returns, and their ability to stimulate an economy depends upon how novel they are at the time that they are being summoned. Traditional wisdom dictates that during pro-business cycles, a government should run a budget surplus, either by spending frugally, saving prudently or some combination thereof, and print money sparingly. The idea is to have enough dry powder lying around to help jumpstart the economy if and when it starts to go into a tailspin. In practice, however, the U.S. government has been

taking an entirely different tact. Even before COVID-19, and despite the longest bull run in U.S. economic history, the government was spending money like a drunken sailor, cutting taxes like Crazy Eddie, and printing money like a banana republic. What began as a shot in the arm during the credit crisis of 2008 never stopped, despite the U.S. economy being out of the woods for years. And so what started as an acute prescription has morphed into chronic dependence and denial, a.k.a. addiction. The resulting maladaptive behavior is, not surprisingly, very difficult to correct. See Exhibit A. Every time the Fed tries to rain in QE pre-COVID, markets recoiled viscerally and became combative. And if stock market gains are your measure of success, you will choose not to

upset the apple cart, even if it's wildly untethered to reality. You will naturally avoid a painful intervention and rehabilitation and continue to kick the can down the road as long as you can. According to the U.S. National Bureau of Economic Research, the U.S. recession that began in December 2007 ended by July 2009. Nevertheless, Treasury ran a budget deficit every year since, which in aggregate more than doubled Uncle Sam's debt to $22 trillion by the start of 2020. In addition, Treasury's ability to collect money was attenuated in 2017. Congress reduced the corporate tax rate from 35% to 21% by passing the Tax Cut and Jobs Act.

Enter COVID-19. According to the Congressional Budget Office's projections, the U.S. will run a deficit of $3.7 trillion in 2020 and $2.1 trillion in 2021, bringing the grand total to $29 trillion by September 2021. Cut to Ross Perot rolling over in his grave. All of this pre-COVID excess was made possible through a combination of borrowing and printing. From July 2009 up to the pandemic, the line item for mortgage-backed securities on the Fed's balance sheets grew approximately 3x from $545 billion to $1.6 trillion. Similarly, the book entry for Treasuries with a maturity date of greater than five years

grew almost 3x from $315 billion to $872 billion. Together, these assets represented $1.6 trillion printed out of thin air. They also demonstrate just how far the Fed wandered outside of its traditional mandate of promoting maximum employment and stable prices. While a central bank is expected to buy and sell short-term debt, treasury bills or T-bills in the U.S., in order to manage short-term interest rates, when it extends its open market activities to long-term treasuries and other assets, it is operating firmly in the unconventional land of quantitative easing. The increase in long-term treasuries is perhaps the more troubling point. It reveals that one body of the government, the Fed, has purchased

$557 billion of debt from another body of the government, the Treasury, using money it printed. By channeling its inner rumple-sil skin and spinning straw into gold, the Fed bank rolled $557 billion of the Treasury's deficit spending. Well, technically, there are intermediaries between the Treasury issuing these wrong-term treasuries and the Fed purchasing them. The more this debt issuance money printing merry-go-round turns, the more it looks and feels like self-dealing, or what economists would describe as unambiguous debt monetization. When a government finances its operations via the central bank's printing press, as opposed to taxation or bona fide arm's length borrowing. Enter COVID-19 again. After pounding the turbo for more than a decade,

the U.S. government was left with no choice but to pound it again. And practically overnight, the Fed waved its magic wand and increased the supply of U.S. dollars in circulation by $3 trillion. Examining the Fed's balance sheet uncovers that it added $344 billion more mortgage-backed securities and $820 billion more long-term treasuries, i.e. debt monetization, from February 2020 to July 2020. In other words, of the $3 trillion increase, $1.1 trillion was printed. To put this in perspective, the Fed printed two-thirds as much money in the last six months as it did over the prior 11 years.

And that's not all. The Fed is committed to a YOLO whatever it takes, QE posture going forward. On top of this, the House passed the CARES Act, authorizing a $2 trillion stimulus package that includes helicopter money. Yes, Milton Friedman's 1969 parable came to life in 2020, and lawmakers are currently negotiating another stimulus package. At the time of writing, House legislators are gulp trillions of dollars apart. Remember when a billion was a big number?

So what does all of this newly minted money mean? That the specter of inflation or hyperinflation is staring down on us. While inflation, as it is measured, remained under control over the past decade, the prices for luxury goods and assets such as real estate have arguably been inflating for some time. Pre-COVID inflation may have expressed itself this way due to neoliberal policies that favor capital over labor, and because this money hose was extended primarily to credit-worthy parties think Wall Street, not Main Street, causing it to trickle up rather than down. But COVID is a different story. While 2008 efforts were geared towards bailing Wall Street out of its self-created dumpster

fire, the CARES Act is a $2 trillion stimulus package designed to save the broader U.S. economy from a force majeure. It is aimed at Main Street and includes $300 billion of cash payments for individuals, $260 billion in additional unemployment payments, and $350 billion in small business loans. When these checks get cash, they won't be spent on trophy mansions in Bel Air, but instead on core goods such as bread, milk, and razor blades, injecting cash directly into the major arteries of the U.S. economy. Well, it's too early to tell whether these stimulus acts will simply fill a hole of otherwise lost income or have a much larger impact on prices, we are no doubt sailing in uncharted waters. The great monetary inflation is nigh. If you want to dance,

you got to pay the fiddler. The world is drowning in debt, and this was the pre-pandemic consensus. COVID's impact has been so swift and blunt that it can easily distract from the fact that it's actually just another layer on a global debt cake that has been baking for quite some time. And the layers of this cake involve structural problems that don't go away with a vaccine. From 2009 to 2019, the U.S. debt-to-GDP ratio swelled from 83% to 106%. Post-COVID, it's on track to hit 135% by September of this year. To bottom-line this, the U.S. debt-to-GDP ratio will grow more this year than it did over the entire prior decade.

China's debt-to-GDP ratio was 300% entering COVID and has grown to 318% as of Q1-2020. The rest of the world is not faring any better. Taking the COVID goggles off, unfavorable tech-evolvehors. tonic demographic shifts have been well underway in many developed countries for decades. Falling birth rates have inverted population pyramids, which means that shrinking younger generations will increasingly be unable to shoulder the growing debt burdens, e.g. health care, pension, social security, etc., that have been handed down to them by the much larger, much older generations. In Japan, this demographic challenge is best illustrated by the fact that more adult diapers

are sold in a year than baby diapers. Putting the COVID goggles back on, the pandemic is bringing this dance with debt closer to its inevitable finale. And it's severely limited the efficacy of responses available to governments when the next Black Swan lands. The Keynesian standbys of increasing spending and lowering taxes have become threadbare and haggard. We're reaching a point where creating more debt to stimulate the economy, in the context of so much existing debt, won't work. While the third and final lever, cutting rates, is out of bullets because short-term interest rates are already at or below rock bottom. Negative in some instances. Sooner or later, these ballooning debt-to-GDP ratios will begin to strain credibility if they haven't already,

and the fiddler will hold out her hat. At the risk of mixing metaphors, there will be no choice but to face the music. The younger generations will awake to the generational plunder that has been bestowed upon them, and forced to atone for the sins of their mothers and fathers. What's going on, guys? I'm excited to share that one of this month's breakdown sponsors is Crypto.com. Crypto.com offers one of the most cost-efficient ways to purchase crypto out there, as they've just waived the 3.5% credit card fee for all crypto purchases. What's more? With crypto.com's MCO Visa card, you can get up to 10% back on things like food and grocery shopping.

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i.e. a hard default. Two, adopt austerity measures in hope of running a budget surplus. Or three, reduce the value of the debt they owe through inflation, i.e. a soft default. A hard default is highly undesirable as it generally leads to further crisis and calamity, not less. Given the fact that the U.S. dollars is the global reserve currency, a hard default by the U.S. government on any amount of debt would be catastrophic to the global economy. It is therefore hard to imagine any future in which the U.S. government would hard default on any portion of its debt. Austerity measures face their own set of challenges. Implementing them requires a strong political will in an even stronger stomach. The U.S. government has run on a budget surplus only four times in the last 50 years.

When a government actually tightens its belt and chastens its spending, it is often greeted with riots and insurrection. In addition to fomenting social unrest, spending cuts and tax increases tend to shrink GDP, further aggregating jet-to-GDP ratios and making an already bad situation worse. A soft default is the likely strategy for most governments trying to de-leverage, including the U.S. government. And just this morning, Fed Chairman Jerome Powell inasmuch confirm this. In this scheme, a government intentionally devalues its currency in order to erode the real value of the debt that it owes. Lenders get paid the same amount of dollars that they are entitled to, however, because of inflation, such dollars are now worth less in real terms.

Economic studies show that this approach produces less damaging long-term outcomes than are hard default, whereby lenders get paid less dollars than they are entitled to or no dollars at all. When a central bank decides to pursue a soft default strategy, it targets a particular inflation rate and proceeds to print enough money to hit it. Once reached, this target inflation rate reduces the government's debt obligations by the same rate. And while the stated reason for the COVID money printing spree may have been economic stimulus, its input and end result will be the same, arose by another name. Regardless of the rationale, an increase in the money supply relative to the available goods will always lead to a rise in prices, which is to say inflation. How a government

distributes newly minted money is an interesting policy issue that can determine where inflation rears its ugly head. See earlier, our thoughts on trickle up inflation. If the government is the recipient, then the soft default is considered debt monetization or the nationalization of debt. If both depositors and borrowers get it, depositors through higher interest rates and borrowers through lower interest rates, then it's called dual interest rates. If lenders and shareholders get it, then it's quantitative easing. If the people get it, it's helicopter money, and so on. Winners and losers. Regardless of what channel the central bank uses to inject money, into the economy? The winners and losers are the same. Borrowers will be rewarded at the expense

of lenders and depositors. Investors and entrepreneurs will be more able to adapt to rising prices, while those who are tied to fixed cash incomes, e.g. civil servants, social security recipients, pensioners, etc., will share the same fate as lenders and depositors. Ultimately, inflation damages trust and will make it harder and more expensive for a government to borrow the next time around. Depending on how long or short memories are, this trust could take generations to rebuild. And while COVID-19 has hurled us farther down the path towards a soft default, the greater culprit is the U.S. government's permanent and unapologetic policy shift towards a debt monetization model to finance its operations. Central banks have seen this coming for some time and have been bracing themselves.

If there was ever a time to hedge against systematic fiat currency risk, that time has come. The problem with oil. Oil is no longer a reliable store of value. Supply. Technological advancements in fracking have dramatic. increase the supply of oil and have called into question the Hubert Peak Theory and other peak oil theories. It turns out there is much more oil underground than anyone ever thought. Demand. In addition to oil becoming more plentiful, there are global forces at play reducing its global demand,

such as the push for renewable energy and the political pressure in many countries to reduce carbon footprints. Storage. Oil's physical nature combined with its large industrial applications makes it uniquely vulnerable to sudden and severe negative demand shocks. When demand dries up, oil that would have otherwise been consumed must be stored. This is normally not a problem unless a demand shock is so steep and abrupt that its resulting supply glut overwhelms the available storage infrastructure. Because storage is so inelastic, such a scenario can lead to a gnarly game of musical chairs. And that's exactly what happened on April 20th, a month into the U.S. pandemic lockdown. Demand for oil dropped so precipitously that oil hoarders suddenly found themselves scrambling for storage

depots. When storage ran out, those still holding barrels had no choice but to pay people to take their oil, causing the price of oil to go negative. Yes, really, the West Texas intermediate oil benchmark closed at negative 37 and 63 cents. The problem with gold. Currently, gold is a reliable store of value in classic inflation hedge. Supply. The supply of gold is actually unknown. While gold remains scarce or precious on planet Earth, the same cannot be said with respect to our galaxy. Scientists believe that asteroids contain a plethora of metals including gold and have compiled a database of over 600,000 asteroids in their compositions. Commercial asteroid mining may sound like science fiction, but the space gold rush has begun.

NASA's mission to explore the metal asteroid psyche will commence in 2022, and, in an effort to incentivize space entrepreneurship, the U.S. government has already enacted legislation that allows asteroid mining companies to own whatever they mine from asteroids or otherwise obtain in space. And since 2016, the UN's Committee on the Peaceful Use of Outer Space has included space resources as Agenda Item 15 on its legal subcommittee. If technological advancements progress over the coming decades to allow for practical and reliable access to near-Earth asteroids, it could lead to a massive positive supply shock in the market for gold. Elon Musk already plans to put humans on Mars, including himself, and recently won the contract to launch the aforementioned NASA's

Psyche mission. Since 1997, NASA has successfully landed four rovers on Mars. It seems entirely plausible that Elon Musk, the founder of a private aerospace company, SpaceX, and a tunnel construction company, the boring company, will be able to put a machine on an asteroid, drill a hole, and retrieve extractions back to Earth within his lifetime. Even a semi-credible effort that foreshadows this long-term inevitability will crater the price of gold. Portability. It's hard to move gold in the middle of a pandemic. It's hard to move gold during a war. It's hard to move gold if there's a change in government attitude towards your property rights. It's hard to move gold, period. If you've ever seen Die Hard with a vengeance, you know it can take dump trucks to

move gold. The answer. We've laid out the problems with the US dollar, gold, and oil. Now let's talk about the solution. But first, let's establish a few general ideas and some perspective on money. Money is a technology. It was first invented thousands of years ago to solve for the limitations of barter, namely what economists refer to as a coincidence of wants dilemma. Like any technology, money can always be improved upon and iterated on. Humans have been involving money since its Inception. Crypto is just the latest iteration. Money has been many things over the years, including but not limited to shells, beads, metal, paper backed by metal, paper not backed by metal, and much more. Ultimately, money is whatever we all agree it is. Bitcoin is the world's first

internet native money, which is to say money purpose built for the internet. It works the same way that your email works, which is not the case for all other forms of money. Cryptocurrencies like Bitcoin are networks, not companies, and should be valued using Metcalf's law. Methods used to value companies such as discounted cash flow models simply won't work. Even drawing stock market bubble analogies is comparing apples and oranges. Now back to the solution. While gold's the classic inflation hedge, there are compelling reasons why Bitcoin is poised to take its mantle. Supply. Bitcoin is not just a scarce commodity. It's the only known commodity in the universe that has a deterministic and fixed supply. As a result, Bitcoin is not subject to any of the potential positive supply

shocks that gold or any commodity for that matter may face in the future. Beyond, superior supply attributes, Bitcoin possesses all of the other characteristics that make gold valuable and actually performs better on a side-by-side comparison. As it turns out, Bitcoin is better at being gold than gold, and not just incrementally, but by an order of magnitude or 10x better. It is widely held belief in technology circles that when a product is 10x better than its closest substitute, it will escape its competitions. We believe Bitcoin has achieved this. Portability. For example, Bitcoin works like your email, which means it's borderless and never sleep, Any amount can be sent anywhere in the world over the internet 24-7-365.

This makes it not just very portable, but also censorship-resistant. It's not hard to move Bitcoin in the middle of a pandemic, a war, or a change of government. It's easy to move Bitcoin full stop. Breakthrough. How was this all made possible? Prior to the invention of Bitcoin, the idea of a decentralized network of money in which unrelated computers around the world could reliably reach agreement with each other was thought to be entirely theoretical.

How could strangers agree on who owns what and ensure that people, people don't spend more than they have when there is a clear incentive to try and cheat the system. In computer science, this problem of agreement is known as the Byzantine General's problem. In the context of money, it is referred to as the double spending problem. When Satoshi Nakamoto, Bitcoin's pseudo-anonymous creator, published a Bitcoin white paper in 2009, he, she, or they presented the world's first ever solution to this intractable agreement problem. Behold the Bitcoin mining algorithm. As described, it ensures that a network of computers that don't know each other will, in fact,

reach agreement with each other in a reliable manner, and that this agreement or consensus, what today we call a blockchain, would be immutable and verifiable. Historically, such agreement had to be entrusted to a central party or ended up concentrating towards one. For the first time in the history of the world, this is no longer the case. The magnitude in this breakthrough cannot be overstated. It is easily as significant as the invention of the internet itself. Network effects. With respect to other cryptos, Bitcoin has a significant first mover advantage. Not only only because it's the first crypto as we know it, but because it was the first one with gold-like

store of value properties. As such, it enjoys tremendous network effects, not dissimilar to those experienced by social networks like Facebook and Twitter, due to its vibrant community of users, developers, miners, exchanges, custodians, etc. Nothing demonstrates this better than the fact that Bitcoin is an open-source project that can be copied or forked by anyone in the world at any moment. And yet despite being forked many times over the years, it remains the dominant crypto, store value, or otherwise, both in terms of market capitalization and liquidity. This race is Bitcoins to lose. To the moon. Inflation is coming. Money stored in a bank will get run over. Money invested in assets like real estate or the stock market will keep pace. Money stored in

gold or Bitcoin will outrun the scourge. And money stored in Bitcoin will run the fastest, overtaking gold. It's true that gold has a multi-millennial head start and a strong foundation of trust. As a result, it may be the right short-to-medium-term choice for risk-adverse types. After all, Bitcoin is still young and therefore carries both significant technology risks as well as political risk in certain jurisdictions. Nonetheless, we believe that Bitcoin will continue to cannibalize gold and that this story will play out dramatically over the next decade. The rate of technological adoption is growing exponentially. Software is eating the world and gold is on the menu. Bitcoin has already made significant ground on gold, going from white paper to over 200 billion in

market capitalization in under a decade. Today, the market capitalization of above-ground gold is conservatively $9 trillion. If we are right about using a gold framework to value Bitcoin, and Bitcoin continues on this path, then the bull's scenario for Bitcoin is that it is undervalued by a multiple of 45. Said differently, the price of Bitcoin could appreciate 45x from where it is today, which means that we could see a price of $500,000 U.S. dollars per Bitcoin. All of this does not factor in the possibility of Bitcoin displacing some portion of the $11.7 trillion of fiat foreign exchange reserves held by governments. Foreshadowing this, at least one publicly traded U.S. corporation has begun holding Bitcoin as a Treasury Reserve asset. If central banks

start to diversify their foreign fiat holdings even partially into Bitcoin, say 10%, then 45x gets revised upward towards 55x or $600,000 USD per Bitcoin and so forth. We hope you found this helpful and informative. We certainly enjoyed thinking about these topics and sharing our thoughts. Onward and Upward, Cameron and Tyler.