Ray Dalio's recent post on economic cycles and the coming paradigm shift is very well written. His usual capability of putting into simple terms complex concepts (if you are interested in understanding how the economic machine works have a look at his video here), coupled with his knowledge of economic and monetary history are very rare even among the most accomplished and successful macro investors.
Even rarer — unfortunately — among policymakers, central bankers, and politicians. Personally, when Dalio speaks, I always listen carefully and — more often than not — I agree. But not this time, at least not entirely. Even Dalio's flawless macro-analysis misses something. And it is something big, something very important. Possibly the biggest paradigm shift since the early ´90s and the internet.
Dalio's View of the Current Economic Cycle and the Coming Paradigm Shift
You can read Dalio's full post here or here, but I will try to summarize his conclusions to facilitate our discussion. In short, the last decade (since the 2007–2008 crisis) has been characterized by “easy money/credit” i.e. central banks quantitative easing policies and zero interest rates have inflated asset prices which have greatly benefited investors owning assets such as bonds, stocks, and real estate.
Growth was slow, and inflation remained low. Equities rallied consistently,
driven by continued falling discount rates (e.g., from central bank
stimulus), high profit margins (in part from automation keeping wage
growth down), and, more recently, from tax cuts
Now, this is the status quo. Dalio proceeds then to highlight what the incoming paradigm shift will be:
Central banks “easy money/credit” policies are unsustainable and sooner or later they will have no ammunition left to support the economy (or rather the financial markets, if you do not believe the “trickle-down” BS economics)
Right now, approximately 13 trillion dollars’ worth of investors’ money is held in zero or below-zero interest-rate-earning debt. That means that these investments are worthless for producing income
US Liabilities (like Medicare and Social Security) are becoming due and
cannot be met if not with (i) higher taxes or (ii) bigger deficits which will be monetized. If I may add something, the situation is even worse in the EU, in the sense that here the option will be — differently from the US — either do not honor the liabilities (i.e cut pension entitlements as they did in Greece) or increase taxes, since monetizing debt seems not an option with the current political standoff between the northern block and the rest of EU countries and the position of the BCE. That is one of the reasons why I add, the EU is inevitably going to face the collapse of the Euro. But that is another story.
cannot be met if not with (i) higher taxes or (ii) bigger deficits which will be monetized. If I may add something, the situation is even worse in the EU, in the sense that here the option will be — differently from the US — either do not honor the liabilities (i.e cut pension entitlements as they did in Greece) or increase taxes, since monetizing debt seems not an option with the current political standoff between the northern block and the rest of EU countries and the position of the BCE. That is one of the reasons why I add, the EU is inevitably going to face the collapse of the Euro. But that is another story.
So given this scenario Dalio asks:Which investments will perform well in a reflationary environment accompanied by large liabilities coming due and with significant internal conflict between capitalists and socialists, as well as external conflicts. It is also a good time to ask what will be the next-best currency or
storehold of wealth to have when most reserve currency central bankers
want to devalue their currencies in a fiat currency system.
And his answer is GOLD. Now his post stops there and in a follow-up post he will explain why gold is a good portfolio diversifier in this case.
What Dalio Misses
So what is wrong with Dalio's analysis? Nothing really. It is flawless. Except for one thing: he looks only backward, to monetary history and not even one bit forward into the future. To be fair with him, at the moment of my writing, he has not yet published the second part of his post in which the role of gold will be analyzed and maybe, just maybe, he will also consider the role that cryptocurrencies, born out of disrupting software technologies, can have in the future in a modern investment portfolio.
Crypto Assets Are Still Not Understood Well Enough
To be clear this is not about taking up “ideological” positions, this is not about being crypto or a gold “fundamentalist”; it is about making a rational evaluation of what can be the role of cryptocurrencies — in addition to that of gold — in the difficult times to come.
Since gold's role remains indisputable (at least in the short term and I will explain below why this may change in the future) and it will be the subject of Dalio's follow up post, let me make here the case for crypto.
First of all a caveat: the fact that most of the famous investors, mainstream economic commentators and economists speak generally in negative terms of the crypto sector does not necessarily mean that they have an “agenda” to fulfill or an interest to defend — tough some certainly do — but it is more likely a sign of a lack of competence and very superficial
knowledge of the crypto sector. I cannot really blame them.
knowledge of the crypto sector. I cannot really blame them.
Complexities
The first problem is that there is a very high barrier to entry in this
sector which makes it very difficult to grasp, especially at the very beginning. It is a challenging sector where new complex technologies
meet finance, monetary theory, economy, and the law.
sector which makes it very difficult to grasp, especially at the very beginning. It is a challenging sector where new complex technologies
meet finance, monetary theory, economy, and the law.
If you approach it strictly from your professional background — which is normal — you only see that little part of which you have direct knowledge; but if you do not make an effort to understand all the other interdisciplinary implications you will necessarily have a restricted, incomplete and inaccurate view of the sector. Fortunately (or unfortunately) only a few people can invest the necessary amount of time to acquire such interdisciplinary expertise and get — at least the basics — to enjoy a 360° view of what the crypto sector really is and can offer.
The second problem is that here very complex technologies play a pivotal
role. And technological innovation is very subtle. At the very beginning it is understood by very few only within restricted circles of tech proficient people before it becomes of mass adoption and, until then, it is very difficult to predict what kind of changes such innovations can bring into people's lives and businesses.
role. And technological innovation is very subtle. At the very beginning it is understood by very few only within restricted circles of tech proficient people before it becomes of mass adoption and, until then, it is very difficult to predict what kind of changes such innovations can bring into people's lives and businesses.
It is not by chance that even very well known tech people — the likes of
Robert Metcalfe, Steve Chen or even Steve Ballmer — famously failed to
predict how the technology they knew very well would evolve.
Robert Metcalfe, Steve Chen or even Steve Ballmer — famously failed to
predict how the technology they knew very well would evolve.
1995: “I predict the Internet will soon go spectacularly supernova and in 1996 catastrophically collapse.” — Robert Metcalfe, founder of 3Com.
2005: “There’s just not that many videos I want to watch.” — Steve Chen, CTO, and co-founder of YouTube expressing concerns about his company’s long term viability.
2007: “There’s no chance that the iPhone is going to get any significant market share.” — Steve Ballmer, Microsoft CEO.
Imagine then how proficiently the likes of Buffett, Mnuchin or Roubini — just to name a few of the most “admired” contrarians — can be trusted to
discuss such topics.
discuss such topics.
Another problem is that, if the technology is really disrupting and affects established powerful lobbies and interest groups (like crypto is), it is fought tooth and nail until it is either defeated or it defeats its opponents.
The Next True Radical Paradigm Shift: Crypto
To understand where the crypto sector is going it is necessary to grasp its historical evolution.
The Bitcoin blockchain protocol invention enabled for the first time in
history the trustless and decentralized creation and transferability of a global monetary value which is cryptographically secured and thermodynamically guaranteed — educate yourself here. Then the Ethereum protocol went a step forward by enabling programmers to write codes onto the blockchain to control and transfer values and the so-called smart-contracts were born.
history the trustless and decentralized creation and transferability of a global monetary value which is cryptographically secured and thermodynamically guaranteed — educate yourself here. Then the Ethereum protocol went a step forward by enabling programmers to write codes onto the blockchain to control and transfer values and the so-called smart-contracts were born.
Assets can be now digitalized into tokens and trustlessly transferred peer to peer. A system of incentives can be created to encourage fair play within a community and remunerate participants with economic values which are trustlessly pre-programmed and assigned, crypto-economics is born.
ICOs peaked and then Security Token offers started.
Decentralized crypto exchanges — where traders can exchange tokens and
cryptocurrencies directly peer to peer without the need of a broker —
are coming.
Decentralized crypto exchanges — where traders can exchange tokens and
cryptocurrencies directly peer to peer without the need of a broker —
are coming.
This is what's happened so far. See, it is like an avalanche. And because
protocols, apps and technological layers are built upon each other this
innovation avalanche is unstoppable.
protocols, apps and technological layers are built upon each other this
innovation avalanche is unstoppable.
What more this will bring?
One of the most interesting posts I have recently read on the subject was authored by Kyle Samani of Multicoin Capital, The Crypto Mega Theses.
He points out to 3 areas where crypto will bring more disruptive innovation: decentralized finance networks, Web3 decentralized networks, and digital gold as a store of value.
Decentralized Finance
Again more technological complexities which render a fair evaluation of the sector hard to make for anyone and especially for those who are not the full time involved on those topics.
Take decentralized finance for instance. Protocols are being built on top of other applications. They do not provide a service to customers, they are not visible from the outside. Only programmers understand what is going on and how they perform functions and enable new applications to function.
Multicoin Capital's article does a great job for the struggling non-tech professional like myself to explain that, so I will not repeat, but the important point they make is that
the magnitude of this breakthrough cannot be overstated. For the first time, financial markets can be global, permissionless, and for many kinds of derivative contracts, free of counterparty risk. This was impossible until recently.
This is happening now. They expect this mega trend to compound over the next decade. As a sign — only in the last 18 months — the amount of capital locked in decentralized finance smart contracts has grown from $0 to over $400M.
Web3 Networks
What about Web3 then? We all know the problems of centralized Web2 networks and the abuses of consumers' data by such companies (Facebook docet). But the future will be Web3 networks i.e. decentralized networks where the data is owned by its legitimate owner, the consumer. Such networks are built on top of public decentralized blockchains and will use necessarily crypto-tokens for a frictionless functioning.
Note that this change will not be driven by consumers but by entrepreneurs who will choose to build their networks in this new way for a simple matter of trust. They have learned the hard way that they cannot trust centralized networks, therefore they will go independently the alternative route.
Consumers will always passively opt for what brings them more utility and when decentralized networks will be better developed they will start to switch from centralized to decentralized networks. It will take some time but it will happen. This will create a new wave of business value creation which will generally benefit the sector and the market capitalization of the largest cryptocurrencies.
Digital Gold
Finally let me elaborate on Kyle Samani's thesis for digital gold, as he calls it.
If one agrees with Dalio that physical gold should have an important part in an investor portfolio, especially in the coming times, I would argue that bitcoin — as a sort of digital gold for the lack of a better word — should also have a part in that portfolio. The two can coexist, for — even if with many similarities — they are different and can also help hedging one another weaknesses.
I have put together the following tables to facilitate a rational comparison of both physical gold and bitcoin (click + on the zoom of your browser to read clearly the tables).
Table 1 comparison Gold-Bitcoin — Click below for the hyperlinks since they are disabled on the tables: See here Gold Lease Rate explained — even gives a yield on gold paid in gold — also bitcoin generates interest rate when borrowed
Table 2 comparison Gold-Bitcoin — Click below for the hyperlinks since they are disabled on the tables: Goldmoney — The Bitcoin network’s total hash rate reached a peak of 79 tera hashes per second (TH/s) on July 20, 2019
Table 3 comparison Gold-Bitcoin — Click below for the hyperlinks since they are disabled on the tables: has already proposed solutions here — The annual mine production — the above ground cumulated stock is estimated at approx 176.000 — In this sense its scarcity can be questioned
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From the above comparison, it is clear that gold and bitcoin have indeed
many similarities. Where gold is superior is in its proven historical
track record of acting as an inflation hedge and an SOV. Bitcoin is
clearly little proved in comparison.
many similarities. Where gold is superior is in its proven historical
track record of acting as an inflation hedge and an SOV. Bitcoin is
clearly little proved in comparison.
Now, however, gold will face new hard tests against an entirely new set of conditions and parameters. Why? Simply because Bitcoin (the protocol) has introduced new criteria against which gold's historical role as an SOV should now be measured.
Let me clarify.
Since the Bitcoin genesis, there has been a massive and radical paradigm shift in how the issues of trust, money, store of value and transfers of economic values will be dealt with in the future. There has never been before such a radical shift enabled by a new and disrupting technology.
This is the whole point.
If I may try to make a comparison, it is like the impact that the internet
— as a vehicle for exchanging information — had on traditional media,
newspapers, and magazines. Their role today is undoubtedly not the same
it was back in the '90s and who could have predicted such dramatic
changes back then?
— as a vehicle for exchanging information — had on traditional media,
newspapers, and magazines. Their role today is undoubtedly not the same
it was back in the '90s and who could have predicted such dramatic
changes back then?
Similarly gold — as an SOV — has never before been impacted so heavily by the invention of an artificial alternative SOV which scarcity is algorithmically induced and which has so many revolutionary features such as being censorship-resistant, resilient, portable, transferable, cryptographically secure and without counterparty risk. All those features make bitcoin a very strong competitor to gold's role as an SOV, if not superior in some instances.
And since this is the first time that this happens, the mandatory question to answer is: what if investors slowly become aware of that and start migrating towards a crypto-based digital version of gold? What will be the need for the huge hoarding of gold? Is there a place, in a smart investor's portfolio, for some bitcoins next to the traditional physical gold bars? If so then, which portion of one's portfolio should be allocated to the crypto sector? 1%, 3% maybe 5%?
Conclusions
Any intelligent investor should find the answer to the above questions. And because the most rational and likely answer is that bitcoin will impact in a number of ways the future of gold as an SOV, then investment strategies need to be modified accordingly and crypto investments must become a part of the portfolio of any rational smart investor.
Certainly not yet to replace it, but rather to be a hedge against gold's weaknesses. And vice-versa.
Furthermore, if you subscribe — like I do — to Kyle Samani's investment thesis which provides a very rational ground in favor of the growth of decentralized finance networks and decentralized web3 networks as well as to digital gold as a future SOV, then the investment case for crypto is even more compelling.
Finally, if institutional investors, family offices, HNWI, and UHNWI start
allocating even only 1% of their portfolios to the crypto sector what
will be the impact on the price of bitcoin? This is exactly the trend
that I have described in this recent article.
allocating even only 1% of their portfolios to the crypto sector what
will be the impact on the price of bitcoin? This is exactly the trend
that I have described in this recent article.
At this very moment, all the above technology-driven changes are taking
place and this is producing a dramatic, massive and radical paradigm
shift that will impact our future lives and the way we do transact
economic values.
place and this is producing a dramatic, massive and radical paradigm
shift that will impact our future lives and the way we do transact
economic values.
Smart and highly skilled investors like Ray Dalio should not miss that,
cannot miss that. I'd love to read a post of him commenting on the above
topics.
cannot miss that. I'd love to read a post of him commenting on the above
topics.
PS: The following past articles can be useful to understand more about
bitcoin and how it relates to issues such as gold, money, currency, and
store of value.
bitcoin and how it relates to issues such as gold, money, currency, and
store of value.
- Will Bitcoin vindicate Hayek? May 2018
- Why we should not listen to Warren Buffett May 2018
- Bitcoin a scary chameleon March 2018
- What if…bitcoin is not a bubble December 2017
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© www.bianconiandrea.com — 2019
Originally published at https://medium.com on July 25, 2019.