Note: This article is a letter written by Anthony Pompliano, the founder of Morgan Creek Digital, to investors during a market turmoil.
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We are witnessing the development of history. There will be many books in the future recording everything that is happening in financial markets now. Every day is as long as a month. Fear and worry dominate most people's emotions. As I wrote earlier this week, like most things in life, all this will pass.
Before we delve into where we are, here's what happened in the last 24 hours or so:
- The biggest news is that President Trump gave a speech last night on COVID-19 (New Crown Virus) and its impact on the economy and health. The key points of the speech are that European transportation to the United States will be suspended in the future; the government is setting up economic relief programs for small businesses and individuals affected by COVID-19; and the IRS may delay the tax filing date of some people.
- The NBA season was suspended indefinitely after a Jazz member was diagnosed with COVID-19.
- The Italian government "orders all stores except grocery and drug stores nationwide until March 25. Public transport, financial and postal services will continue, but crowded restaurants, cafes and bars will be closed. The plant can continue to operate, but Protective measures must be taken. "
- The S & P 500 index fell 7% when it opened this morning, and immediately triggered a fuse mechanism, which suspended trading for 15 minutes.
- The Dow Jones Industrial Average is down about 8.5% this morning.
- Bitcoin's 24-hour drop has exceeded 30%.
- Both crude oil and gold fell to varying degrees.
This is just a small part of many developments. All this can be summarized with a simple framework:
1. The World Health Organization has officially listed COVID-19 as an epidemic. The necessary responses are to increase social distance and stop large gatherings or various forms of economic activity.
2. The virus is stalling economies around the world.
3. As the economy slowed, structural weaknesses in various markets were exposed, including excessive leverage and lack of liquidity.
Unfortunately, we are witnessing a liquidity crisis. The structure of these liquidity problems is well understood, but when they do happen, people feel much worse than expected. The liquidity crisis means that investors are rushing to export at the same time, but there are far more sellers than buyers, and it is actually difficult for investors to realise their assets. It is no exaggeration to say that investors are beginning to drastically reduce the price of assets they are willing to accept in exchange for the cash they are desperately in need of.
That's why you are now seeing a sharp decline in the liquidity market for any asset. In addition, the U.S. Treasury market, the most liquid market in the world, is currently experiencing incredible pain.
(Table 1: Interest rate market volatility is comparable to the financial crisis; Table 2: Bloomberg's US Government Securities Liquidity Index)
These two charts show an explosive growth in volatility and a growing lack of liquidity. If this happens in the most liquid markets, you can imagine how bad the situation will be in the less liquid markets.
This reminds me of assets such as Bitcoin and gold. Historically, these assets have given the impression that they are irrelevant (and traditional markets) and are safe haven assets. But all this will change during the liquidity crisis. In the short term, any asset that can be realised in a liquid market is likely to be sold. Investors are extremely price sensitive. They desperately need cash, and in order to optimize liquidity, they make irrational decisions.
These sellers (and those seeking liquidity) include retail investors, hedge funds, banks, and almost everyone else who has a connection with the financial market. This imbalance between buyers and sellers also explains why the Fed is involved in the repo market (overnight borrowing) and is so large (it recently increased to $ 175 billion). The Fed's statement explains this well:
"According to the instructions of the Federal Open Market Committee, these operations are designed to ensure an adequate supply of foreign exchange reserves and reduce the risk of currency market pressures that may adversely affect policy implementation. It should help support the smooth operation of the financing market. "
If the Fed does not step in, there will be greater liquidity problems. Let us now return to the sell-off of safe-haven assets. Remember, investors' short-term choices are for liquidity. If an asset has a liquid market, the asset will be sold for cash. No asset on this planet is unaffected by this market dynamic.
During the 2008 global financial crisis, the price of gold fell by more than 30%. This is not because gold is a bad store of value, nor is it because it lost its safe-haven status after 5000 years. This is because the gold market is liquid, and what investors need most is liquidity.
Although the price of gold fell by 30% during the six-month liquidity crisis, its price still rose from about $ 650 in 2006 to more than $ 1800 in 2011. why? Because when people worry about US debt defaults, US monetary policy measures are a bad idea, or inflation is rising, they will flock to gold. Simply put, gold has been a hedge and hedging asset throughout the crisis, but in the worst six months it has succumbed to a liquidity crisis.
This is what I believe is happening in Bitcoin. Bitcoin has a liquid market, so many people who hold Bitcoin will exchange it for cash because they need liquidity. In fact, most of them have sold bitcoin last week, which is why the price of bitcoin has plummeted. Those who can't hold or seek liquidity are likely to have taken action, so it's unlikely that we will see continued sell-offs causing prices to fall significantly from current levels.
This does not guarantee that the price of Bitcoin will not fall in a short time, but it does mean that most people who need liquidity may have sold Bitcoin. This brings us to the next stage, how the crisis may affect firm holders and hedge positions.
There is a group of people, most of them individuals, who strongly believe in the concept of sound money. These people took the time to learn bitcoin's technical structure, monetary policy, and potential advantages. They believe that Bitcoin's sound monetary attributes are superior to any other form of currency. No matter how the dollar exchange rate changes, staunch holders will not sell their bitcoins. Their faith cannot be shaken. In fact, they may buy instead of sell when the price of Bitcoin drops sharply. They are now exchanging bitcoins with dollars.
I am one of them, and this morning I switched more fiat currencies to Bitcoin.
Now, the question goes from "Who still owns Bitcoin?" To "What will happen to Bitcoin in the coming months / years?" This is where I'm really excited because Bitcoin is born for this situation of. This is the strongest currency ever seen in the world. It is scarce. Its output is difficult and expensive. Monetary policy is programmatic and transparent. These things are important to any asset, but their importance will increase exponentially as we enter the age that is about to enter.
Although liquidity crises are happening in traditional markets and asset prices have plummeted, the US government will try to save ordinary people when necessary. The legacy system is not based on free market capitalism, but a weakened version that relies on large, centralized institutions and governments to intervene during periods of uncertainty and fear. As we discussed before, there are two tools that central banks and governments can use-interest rate cuts and quantitative easing.
We have seen the Federal Reserve cut interest rates continuously over the past year, including an emergency rate cut of 50 points in the past two weeks. I wouldn't be surprised if interest rates are cut further in the next 6-8 weeks. My guess is that we will see interest rates reach at least 0.25% and most likely 0%. It is also possible that the United States will enter the era of negative interest rates, but they will make every effort to avoid negative interest rates.
Therefore, when interest rates fell sharply, when to take another measure (quantitative easing) became the focus. Over the past few months, the Fed has expanded its balance sheet by about $ 400 billion, but they still say that this is not quantitative easing. Rather than picking words here, it's important to understand that we may not see their next move.
My guess is that by the end of this crisis, we will see quantitative easing totaling at least $ 1 trillion. Any measures below this standard may not be sufficient to produce the expected impact. Think again, billions of dollars are in print.
When governments issue so many currencies, they are injecting liquidity into the system, but they are also reminding people that the US dollar is not a sound currency. They are increasing the risk of high levels of inflation. Many would say that the government is even illegally stealing the bottom 50% of Americans' wealth because they have printed so much money.
Cutting interest rates and quantitative easing are market manipulation. They are trying to save the economy. When they do so, investors have gone through a historic liquidity crisis and then sought sound currency and safe haven assets. During this time, both gold and Bitcoin should perform incredibly well.
But there is another aspect of Bitcoin that is different from gold-the upcoming supply shock (Bitcoin halved in May 2020). Just as Bitcoin is about to become attractive to the US government / central bank with incredible monetary stimulus measures, the supply of this digital asset will be halved. One of the world's scarce assets is about to become scarcer. (This is equivalent to investors seeking gold because of inflation, but half of the world's gold mines are closed at the same time)
I say so much because people need to understand both what is happening in the short term (liquidity crisis) and the structural components that are working in the long term (monetary stimulus and Bitcoin halving) this point is very important.
I have been writing this topic for almost a year. In my mind, there is a 60% -80% chance of it happening. The biggest unknown is how long the bull market for traditional assets can last. The pandemic of COVID-19 has accelerated the demand for monetary stimulus, which will be reduced within 60 days after Bitcoin is halved. I think that while Bitcoin is halved, we will see monetary stimulus, and now this probability is more than 95%.
The price of Bitcoin has fallen in the past few weeks. This is what happened during the liquidity crisis. But to understand what will happen after the crisis-monetary stimulus must be relied on to stabilize traditional markets. This will greatly benefit Bitcoin and gold. Weak hands will be sold during a liquidity crisis, which is simply a transfer of these safe assets to a strong hand-a firm holder.
The market is very volatile. Sometimes it's best to leave your computer and take a deep breath. Other times, it's important to read more about what's going on to make sure you understand what's happening on each timeline.
This time is no exception. Liquidity crises have happened before. They will happen again. In the past, monetary stimulus has pushed investors towards safe assets with strong currency characteristics. There will be many similar situations in the future. If you haven't experienced it before, welcome to the market cycle.
History is repeating itself. Liquidity has dried up. Those who are indifferent to short-term pain can often avoid making bad decisions. I can't believe we have a chance to go through this time. Thankfully, this time we brought a parachute.