The Breakdown - The Great Monetary Inflation: Paul Tudor Jones' Complete Case For Bitcoin

Episode Date: May 12, 2020

Jones' letter lays out his bitcoin and macro thesis.  Last week, investing legend Paul Tudor Jones rocked the world of crypto and traditional markets with his full throated entrance into the bitcoin market via his latest letter to Tudor BVI investors.  While the headlines (and the quick price bump on the back of FOMO buying) were great, the story is even more interesting than the soundbyte.  In this episode, NLW breaks down Paul Tudor Jones complete case for bitcoin, looking at:    The context and previous attitudes towards bitcoin of both authors of the letter The “Great Monetary Inflation” thesis driving a focus on stores of value How money supply growth compared to real economic output growth hasn’t been this out of sync since inflationary periods in the 1970s and 1980s The “Inflation Race” - a list of 8 potential inflation hedges The four categories by which a store of value can be judged: purchasing power, trustworthiness, liquidity, portability A ranked look at bitcoin, gold, fiat, and financial assets in the context of those four categories. 

Paul, do you see this, though, in relation, and I'm thinking about tech stocks now, because one of the things we have seen over the past two months is just the move towards virtual. Anything that can be done virtually has had great success, whether it be Zoom or any of the big tech companies in the Valley, because we're all able to do that virtually. Is that the way you see Bitcoin and separately, do you own gold? I was going to ask at the same time. I have assets in gold also. I think gold can go substantially higher. And yes, the digitization of the world clearly benefits Bitcoin. I mean, we wouldn't even be talking about Bitcoin if we weren't seeing First Cousins like Venmo and a variety of other ways.

My children don't even carry cash. They barely even know what cash is. So we're clearly digitizing the global economies. You've seen some countries do it explicitly like India. You're seeing other countries on the way to do it like China. So we're getting in an increasingly digitized world, and Bitcoin will be that much more accessible by that universe of people that could own it as a store of value. When you think about every bull market, every single bull market,

has one common threat, an ever-expanding universe of people who own it. So there's probably the estimates are between 55 and 70 million people own Bitcoin. we really, if you're buying Bitcoin, your bet is that number is going to go to 120 million or to 200 million. And it's kind of hard when you look around and you see that the world's becoming increasingly digitized, not to think that the preponderance evidence at this point in time doesn't point in that direction. Welcome back to the breakdown and everyday analysis breaking down the most important stories in Bitcoin, crypto, and beyond. This episode is sponsored by ArisX.com, the Stellar Development Foundation, and grayscale digital large-cap fund. The Breakdown is produced and distributed by CoinDesk. Here's your host, NLW.

Welcome back to The Breakdown. It is Monday, May 11th, and yes, it is halving day. Excitment abounds. There are about a trillion different having live streams. CoinDesk's consensus distribute is happening for the next 24 hours for their first part of, and then throughout the week. I'll be hosting a session tonight at 6 p.m. and then again tomorrow, I'll be doing a live breakdown at 8 a.m. Eastern time. All in all, there is a ton going on,

and it really caps a pretty incredible week last week. Now, obviously, last week was defined in some ways by Paul Tudor Jones, the famous hedge funder talking about his Bitcoin thesis. And what you heard in the clip at the beginning of this episode was him on CNN this morning talking a little bit bit more about it. But I think that one thing that Twitter does poorly is actually help you understand the story behind the headline. It's good at the headlines, it's bad at the stories. And Paul Tudor Jones getting involved in Bitcoin is not just a whim and it's certainly not

reducible to a quick Twitter soundbite. Now, the investment letter that he released last week to his investors to help them understand why he was authorizing his 22 billion. billion dollar fund to potentially allocate low single digits into Bitcoin came out. So we got to see the entire letter. So what I want to do for today's episode is actually bring you into that letter, help you understand the motivation, help you understand how he came to this conclusion, both in terms of the larger environment that mandates it, and specifically what is interesting or what is challenging about Bitcoin itself as an asset. So we're basically breaking down the Paul Tudor Jones complete case for Bitcoin.

All right, let's actually start with who wrote this letter, because Paul Tudor Jones, in fact, had a co-author, Lorenzo Georgiani, and I think it's really relevant to understand what his background is as well. At the end of last week, Adam Pokernickey, who is a partner at a registered investment advisor for Bitcoin, dug into this specific question and actually went to Lorenzo's LinkedIn profile to figure out what his background was. It says prior to joining Tudor Investments in 2013, Lorenzo held several senior positions at the International Monetary Fund in Washington, D.C., between 1996 and 2013, where he took a leadership role in the IMF's efforts to revamp the international financial architecture and resolve financial crises. He has been directly involved in managing financial crises in Asia, Argentina, Turkey, and the Eurozone. Lorenzo has published academic research and refereed journals and authored numerous IMF reports on the international financial architecture, including the role of IMF. lending, global capital flows, sovereign debt restructuring, and bank rescue operations.

He also authored several IMF country reports. The point here is that this is someone who is deep inside the establishment of the global monetary order, right? This is not an outsider by any stretch of the imagination. That's part one. That's one of the co-authors. What about Paul Tudor Jones himself? Well, those of you who hadn't heard of him before probably have gotten the gist of the details now. Legendary Wall Street trader worth more than five billion, seventh on Forbes list of top hedge funders right behind people like Ray Dalio, got famous for predicting the 1987 crash. And importantly, here's how he describes himself vis-a-vis Bitcoin. He says, truth in advertising, I am not a hard money nor a crypto nut. I'm not a millennial

investing in cryptocurrency, which is very popular in that generation, but a baby boomer who wants to capture the opportunity set while protecting my capital in ever-changing environments. One way to do that is to make sure I am invested in the instruments that respond first to the massive increase in global money. And given that Bitcoin has positive returns over the most recent timeframes, a deeper dive into it was warranted. I did have some experience with it back in 2017, having a tiny amount in my personal account for fun. Amazingly, I doubled my money and got out near the top when it was apparent to any market technician we were blowing off. It is amazing how well one can trade when there is no leverage, no performance pressure, and no greed to intrude upon rational reflection. When it doesn't count, we are all geniuses. Basically, he is saying that he is not someone who's

coming into this as a Bitcoin enthusiast. He's dabbled on a personal level, but never really considered it from his portfolio standpoint. But, and this is a key line from his letter, he says, quite often how the markets respond will be at odds with your priors. He's basically saying, you've got to throw aside what you think you know to watch what actually happens with the markets. So let's get into his argument and what brought him back two and a half years later after his first dabbled into Bitcoin. To understand Jones' Bitcoin thesis, you have to understand his assessment of the global macro environment. Now, this letter was called the Great Monetary Inflation, and the first paragraph reads as such. COVID-19 is a one-of-a-kind virus that has triggered a one-of-a-kind policy response globally.

The depth and magnitude of the economic drop-off took modern monetary theory, or the direct monetization of massive fiscal spending, from the theoretical to practice without any debate. It has happened globally with such speed that even a market veteran like myself was left speechless. Just since February, a global total of 3.9 trillion, 6.6% of global GDP, has been magically created through quantitative easing. We are witnessing the great monetary inflation, an unprecedented expansion of every form of money unlike anything the developed world has ever seen. The long and the short of it for Jones is that there is this moment of a real potential crisis where we get back to inflation. So what's the setup for this? Well, first it has to do with debt.

As he points out, the CBO, the Congressional Budgeting Office is projecting that U.S. government debt ratio to reach above the World War II peak. He says that it's not inconceivable that economy-wide debt ratio will increase by 50% of GDP over the next year and a half. And importantly, he points out that, quote, central banks are on the hook to help fund this debt increase and then goes to explain how that looks in practice. The Fed's balance sheet has grown 60% since the end of February and is on track to double by the end of the year. And importantly, this isn't just the Fed, this isn't just the U.S. The Bank of Canada has tripled its balance sheet. The Reserve Bank of Australia has increased its balance sheet by 43%. What does this look like in terms of the monetary supply? Well, M2, which is basically

all the cash and liquid money plus savings deposits and other slightly less liquid but still available monies, has increased 18.5% since a year ago and is likely to get to between 20 and 40% by the end of year. A key question maybe is how does this relate to history, right? How far away from the norm is this? Well, during the great financial crisis, M2 never grew by more than 10% a year. So that's one data point. Another data point has to do with the relationship between M2 and the growth in real outputs, right? It's not just about the growth in the money supply. It's about how the growth in the money supply compares to growth in real economic output of the economy in general. Milton Friedman, and this is a quote that Jones puts in his letter, said, inflation is always and everywhere a monetary

phenomenon that arises from a more rapid expansion in the quantity of money than in total output. So the point is that there's a disparity, there's a gap between how much money supply is growing compared to how much the output of the economy is growing. Well, the only periods where M2 growth exceeded real output growth over a five-year period by the same or a faster pace as now were the late 1940s on the tail end of the Depression at the end of World War II and the inflationary periods of the 70s and 80s. So that's the historical context. Now importantly, when it comes to these inflation predictions, Jones doesn't think that it's going to happen right away. He thinks that we're going to see asset price reflation much more quickly,

which we're already seeing, right? This is the supposed V-shaped recovery that we've seen or heard talk of. But there's a second piece of this which has to do with consumer demand. And there is a demand shortfall right now, which he believes is preventing goods and services from inflating in the short term and actually expects that to continue for some period of time. His question and his most important question in some ways is, quote, whether the large monetary overhang in the recovery phase will eventually stoke consumer price inflation. What this comes down to for him is will the Fed have the political willpower to do what it takes to avoid that inflation, which would be to massively increase interest rates to incentivize savings and disincentivize spending. And he believes that it just seems unlikely based on where we are

now. He said, when the time for liftoff finally occurs, any hiking is likely to be delayed and unambitious. Furthermore, the risk of a complicit, i.e. politically appointed, central bank chairman cannot be easily dismissed, given that central bank independence is no longer a sacred cow. This is a really important part. And for people who watch the relationship between the Fed and the Treasury, which are supposed to be highly independent of one another, that has been one of the most concerning signs of this crisis is just how fully the Treasury has sort of absorbed the Fed into its sphere of influence. If you go back and listen to my episode with Danielle DiMartino Booth, that's a big part that she talks about. She talks about how it's gone from corrupt to broken, and that's basically

what she's talking about. On top of all of this, he also worries that there could be other reasons for inflation that have to do with basically geopolitical changes. He says, there may come a tipping point when a breakdown in global supply chain spills over to goods prices, undoing two decades of disinflation attributable to globalization. All in all, let's summarize this. You have a situation now where the Fed is printing a huge amount of money. The money supply is increasing much faster than the total output of the economy itself. This compares to other inflationary periods in history. It seems unlikely that the Fed will have the political ability to actually raise interest rates in a way and at a level that could in fact stop inflation.

And hanging over all of this is the potential that the geopolitical landscape shifts in such a way that there's a different type of inflationary force. This all totaled up is why he called this letter, the Great Monetary Inflation, and why his investment strategy is focused on how to deal with this, what to buy in this context. So that's the section that we'll shift our attention to next. what do you buy inside the great monetary inflation? So let's introduce the contenders of assets that you might want to buy during the great monetary inflation.

This section was called Seeking Refuge from the GMI in the paper in the letter. He rank ordered a list of inflation hedges, or rather his firm, rank ordered a list of inflation hedges called the inflation race. So here's what those lists look like. At one was gold, and the way that they framed it was a 25. year store of value. At two was the yield curve. Historically a great defense against stagflation or a central bank intent on inflating. For our purposes, we use long two-year notes and short 30-year bonds. Number three, NASDAQ 100. The events of the last decade have showed that quantitative easing

can rapidly leak into equity markets. Number four, Bitcoin. And they say there's a lengthy discussion of this below, which will be our next section. Number five, U.S. cyclicals long, over U.S. short, a pure goods inflation play historically. Number six, AUD JPI, long commodity exporter and short commodity importer. Number seven, tips treasury inflation protected securities, index to CPI to protect against inflation. Number eight, GSCI, the Goldman Sachs Commodity Index, a basket of 24 commodities that reflects underlying global economic growth. And number nine, JPM emerging market currency index. Historically, when global growth is high and inflationary pressures are building, emergent market currencies have done quite well. So what the firm did then with this inflation

race was put all these things on a table and look at their performance comparatively over the last week, the last month, the last three months, and the last year. And Bitcoin is at number four for actual productive outputs, which basically is what got him to think about this more. So this is the setup to why they actually thought about Bitcoin, why they put Bitcoin into the fray as a contender. This is where he starts to say, or he comes back to this idea that he's not a hard money nut or a crypto nut. But, and this is as he put it, the GMI caused me to revisit Bitcoin as an investable asset for the first time in two and a half years. It falls into the category of a store of value and has the added bonus of being semi-transactional in nature. The average Bitcoin transaction takes

around 60 minutes to complete, which makes it, quote, near money. It must compete with other stores of values such as financial assets, gold and fiat currency, and less liquid ones such as art, precious stones and land. The question facing every investor is, what will the winner be in 10 years' time? Support for this podcast and this message come from Eris X. With ArisX, you can trade spot and regulated futures on cryptocurrencies through a licensed, U.S.-based exchange. ArisX believes in fair access for all. Sign up to date. take advantage of zero fees and learn more at erisX.com slash consensus. This episode is also sponsored by the Stellar Foundation.

The Stellar Network connects your business to the global financial infrastructure, whether you're looking to power a payment application or issue digital assets like stable coins or digital dollars. Stellar is easy to learn and fast to implement. Start your journey today at Stellar.org slash coin desk. Our final sponsor is Grayscale Digital Large Cap Fund. In times like these, diversification is key. Consider grayscale digital large cap fund.

fund, ticker symbol GDLC. It's the only publicly treated investment product that offers diversified exposure to large-cap digital currencies, all from your brokerage account. For more information, visit grayscale.co slash coin desk. That's g-r-a-y-scale.co slash coin desk. Bitcoin is a store of value that is semi-transactional in nature. Well, what does he mean when he says store of value? He calls it anything that holds its purchasing power in the future. It is completely a function of people's perception of its worth. Well, what about Bitcoin in the context of other crypto assets, right? He says in the context of stores of value, the newest entrant is Bitcoin, which seems to have emerged from the Crypto War of 2017 as the clear winner with a market cap 10x

that of its closest competitor. All tracking so far. Bitcoin is clearly at the very head of the cryptocurrency industry and has a number of features that make it particularly interesting in the context of this particular question that he has as it relates to the great monetary inflation. They looked then at what makes for a good store of value and graded them on four characteristics. The four characteristics were purchasing power, trustworthiness, liquidity, and portability. Now, they gave each of these a different weighting. So purchasing power and trustworthiness were each given 30% of the weighting of a score of 100, while liquidity and portability were both given a 20% score.

So they basically are saying purchasing power and trustworthiness are even more important characteristics for a store of value than are liquidity and portability. Importantly, they removed real estate art, precious stones, and things like that because the liquidity and portability makes them just sort of not even on the chart. And because of that, they focused just for the sake of this discussion on financial assets. So in the final accounting with all the grading done, the financial assets got a subjective score of 71, gold got a subjective score of 62, Fiat Cash got a subjective score of 54, and Bitcoin got a subjective score of 43. And again, this is grading assets by their ability to store value.

However, and this is important, to quote Jones, what was surprising to me was not that Bitcoin came in last, but that it scored as high as it did. We'll come back to that in just a minute. Let's look into how they actually graded in these different categories. Purchasing power, trustworthiness, liquidity, and portability. On the purchasing power front, he said that many on his team focused on financial assets. So basically they were looking for carry. They were looking for yield as a way to beat inflation. Jones was less focused on that or had more skepticism there and pointed to the 1970s

inflation during which most financial assets yield couldn't keep up with inflation. Instead, for Jones, what he was interested in was, quote, the scarcity premium. He said, I also made the case for owning Bitcoin, the quintessence of scarcity premium. It is literally the only large tradable asset in the world that has a known fixed maximum supply. By its design, the total quantity of Bitcoins, including those not yet mined, cannot exceed 21 million. Approximately 18.5 million Bitcoins have already been mined, leaving about 10% remaining. On May 12th, Bitcoin's mining reward, the pace at which the supply of Bitcoin is increased, will for the third time be halved, falling from 12.5 to 6.25 Bitcoins per block of transactions

added to the blockchain. Future halvings will likewise occur approximately every four years consistent with Bitcoin's design, thus continuing to slow the rate of supply increase and causing some to estimate that the last available Bitcoin will not be mined for another 100-plus years. This brilliant feature of Bitcoin was designed by the anonymous, of Bitcoin to protect its integrity by making it increasingly near and dear, a concept alien to the current thinking of central banks and governments. That one paragraph describes the argument for Bitcoin in the face of unlimited money printing better than any amount of our best tweets ever could, which is why I wanted to read you the whole thing. So again, in the context of this

grading assets by their ability to store value for purchasing power, many on his team were focused on getting yield from financial assets, but Jones was really interested in the scarcity premium of Bitcoin. What about trustworthiness? Well, in that, you'll probably not be surprised. Bitcoin scored the lowest simply because it's the youngest, especially in the face of something like gold, which has been around for 2,500 years. With liquidity, it actually is a really strong area for Bitcoin. In the letter, he says, Bitcoin is the only store of value that actually trades 24-7 in the entire world. This is something we've talked a lot about before, how Bitcoin is the only free market. Well, as he's pointing out, it's the only one of these assets that really trades 24-7

across the entire planet, no matter where you are. The market doesn't close. Lastly, there's the question of portability. And I really like the way that he described this. It's something that you'll have heard a lot from me here. Joan says, finally, there is portability. Like liquidity, it is not an issue until it is. Imagine a geographic upheaval, whether it be caused by war, an epidemic, or change in government

that becomes hostile to holders of wealth. A great store of value can be seamlessly moved from one jurisdiction to another with little or no transaction costs. Cash is obviously good for that. Gold is okay but clunky, but of course, nothing beats Bitcoin, which can be stored on a smartphone, among other options. So on both the liquidity and the portability front, Bitcoin is doing really well. So that's kind of a flavor of the overall exercise that they did. And as I said, Bitcoin came in fourth.

But the key conclusion for him had to do less with where on the list of assets it fit, but more it's price relative to those other assets. So he basically comes to the conclusion that Bitcoin is currently mispriced. He says, again, what was surprising to me was not that Bitcoin came in last, but that it scored as high as it did. Bitcoin had an overall score nearly 60% of that of financial assets, but has a market cap that is 1,200th of that. It scores 66% of gold as a store of value, but has a market cap that is 160th of gold's outstanding value. Something appears wrong here, and my guess is it is the price of Bitcoin.

Now, all it takes for a smart investor to want to hedge into an asset is to believe that it is fundamentally mispriced in such a way. But there's another part of his argument, one kind of last almost presented as a throwaway piece, but really reinforced on the CNBC interview this morning, where he believes that it's much more commonplace or it's likely to become much more commonplace to have access to Bitcoin going forward. So what he says about this is, quote, the most compelling argument for owning Bitcoin is the coming digitization of currency everywhere, accelerated by COVID-19.

Bull markets are built on an ever-expanding universe of biose. Central to the price of Bitcoin is how many more or less owners of Bitcoin there will be beyond the 60 million who currently own it. The probable introduction of Facebook's Libra, whose value will be pegged to the US dollar and will not be a store of value in that sense, as well as China's DeSep, also tied to the yuan, will make virtual digital wallets a commonplace tool for the world. It will make the understanding utility and ease of ownership of Bitcoin a much more commonplace option than it is today. So this is really interesting because he's parroting basically arguments that many in the crypto space have made that Libra and China's DeSep and other central bank digital currencies

effectively create an onboarding mechanism for new users to get comfortable with digital wallets. That might lead more easily to some different type of asset like Bitcoin. So by way of wrapping it up, let's take his words themselves and to the key point. He says, owning Bitcoin is a great way to defend oneself against the GMI, given the current fact set. As Satoshi Nakamoto, the anonymous creator of Bitcoin, stated in an online forum around the time he launched Bitcoin, quote, the root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. I am not an advocate of Bitcoin ownership in isolation,

but do recognize its potential in a period when we have the most unorthodox economic policies in modern history. So we need to adapt our investment strategy. We have updated the Tudor BVI offering memoranda to disclose that we may trade Bitcoin futures for Tudor BVI. At the end of the day, the best profit maximizing strategy is to own the fastest horse. Just own the best performer and not get wed to an intellectual sigh that might leave you weeping in the performance dust because you thought you were smarter than the market. If I am forced to forecast, my bet is it will be Bitcoin. So like I said at the intro to this, the reason to do this full breakdown is that on Twitter we can capture the headlines and some of the excitement, but we don't capture

the full logic. And as you can tell, a huge amount of thinking went into this, right? This whole methodology for looking at stores of value, these rank orderings of the different stores of value or assets on their ability to store value. These are really important parts of this argument, especially if you want to go turn around and use the Paul Tudor Jones case for Bitcoin when you're talking to your friends, to your family, to people you want to co-invest with, whatever it is. You've got to understand the actual logic going into this beyond the headlines. Hopefully this was helpful. Like I said last week, and I'll say it again, I think this is a massively significant moment.

And, you know, it's not without complications. I'm sure that over the coming weeks we'll talk about what it means to have institutions actually coming into Bitcoin, what the risks might be. Many have pointed out that they're not talking about getting exposure to Bitcoin the underlying asset, but to making bets on futures, which is a very different process. So it's not an unreservedly good thing, just as any institutionalization is not an unreservedly good thing, but it is a significant signal to the market. So hopefully you understand that signal and where it came from a little bit better today than you did. As always, guys, thank you for listening. I appreciate it. And until tomorrow,

be safe and take care of each other.