At the core of this dark scenario is the recognition that the edifice is unstable — the debt edifice that sustains demand. The argument has merit. It is not hard to find crevices. Lunch is on sale in Tokyo, where interest rates are artificially low, but you can’t go there to eat it because of Covid travel restrictions. The ECB is performing unnatural bond-buying acts to save the Italians from themselves. Widening spreads on Illinois debt suggest the State needs the ECB’s help. Perhaps Illinois should join the Euro, or issue its own currency — “The Drunken Lincoln”. No wonder Ken went to Miami. But then again, my home state has always been a mess.

In truth, the impending end of the debt supercycle has been continuously forecast for decades. But forecasting this stuff is hard. And the smartest and most persuasive advocates have a habit of writing off overwhelming evidence that they are completely wrong. The dollar is not dead. The dollar strengthened despite Covid stimulus and in the wake of the war. The Western alliance did not fracture. It strengthened.

The bellicose Chinese are in danger of waking up Japan just as Russia has done with Germany and of attacking Taiwan at the expense of catalyzing a pan-Asian NATO. Hua’s ongoing rantings appear to be ghost-written by speechwriters from North Korea. Emperor Xi, just like his pal Czar Putin, is massively overplaying his hand.

America has a healthy chorus of critics, domestic and foreign, who warn us of our impending decay and demise. And we take it seriously. Even when it is ridiculous. Some may remember when the preeminent threat to the United States was considered to be Japan. When American auto workers were smashing Japanese cars with baseball bats. Take a gander at the 1991 classic book, “The Coming War With Japan”. As a side note, my family owned a 1991 Buick Regal, and that car richly deserved a beating.

America tends to be simultaneously dysfunctional and overwhelmingly resilient. And we tend to forget the latter. What does that have to do with Bitcoin? Bitcoin has outperformed the dollar over the last five years, and the dollar has been strong. The bull case on Bitcoin is not tied to the demise of the dollar. The dollar represents the forceful defense of democracy and freedom against emboldened autocracy. Bitcoin adoption may be tied to the survival of democratic states, as crypto at its core is an exercise in economic freedom. Pause to consider that the crypto ecosystem is using dollar stablecoins as its economic backbone. That happened organically. Note that Argentinians have been defending their wealth by purchasing crypto in the form of dollar stablecoins. One of our favorites, the Lightning Network, is incorporating dollar coins into its Bitcoin-powered payment network via the Taro upgrade. And consider that dollar stablecoins are being enshrined in America’s financial system by the advance of non-partisan legislation. As are Bitcoin and Ethereum. Crypto is advancing the globalization of the dollar. Did Satoshi see that coming?

At SkyBridge, we believe Bitcoin is a singular digital asset on a course of adoption as the preeminent non-sovereign alternative to fiat currency, superior to Gold. These views are not tied to the emergence of the Terminator.

What if the stimulus arrived in the form of a digital token worth ten thousand dollars that was subject to a spending expiration date. A ten thousand dollar distribution to your phone tied to a smart-contract caveat enforced by code that it must be spent on merchandise or services at least four times within fourteen days before converting to stable cash. And traceable each step of the way. A hot potato! High-velocity money. Talk about Black Friday! That’s a more direct stimulus route than an asset-inflation wealth effect. We have been dealing with the unintended consequences of those bubbles repeatedly since at least Greenspan. And that technology could be incredibly useful in many other contexts, like providing immediate direct payments to residents in the path of a hurricane, for example.

But altruism is not embedded in deployment of blockchain. It could be intrusive in an unparalleled way. A digital token could be used to mandate that five percent of your existing cash holdings over $20,000 held at banks or brokerages must be spent on certain categories like travel and leisure within thirty days, or the money would expire. Or tied to a rule that paper currency will no longer be valid. That all your wealth must be recorded as tokens on the blockchain - traceable in the electronic universe - and subject to surveillance and control, or a wealth tax. Or a rule that any spending outside the country would be subject to a 30% sales tax. Or that you cannot convert it to another currency or spend it outside the country at all.

China is going down this path. Capital controls are central to the premise of its signature brand of authoritarian, expansionist mercantilism. China has started the process of deploying tracking and control with a digital Yuan student card used to track spending by children. That seems innocuous enough. Except that the Chinese government considers itself the parent of all its citizens. Parents already can supervise spending by giving their child a debit card. So the incremental surveillance is at the government level by virtue of control over the currency. China controls the kids.

And what kind of control would China like to exert over its trading partners? The Ukraine-war weaponization of the US dollar pales in comparison to the power of digital currency reserves among trading partners. Those can be frozen or cancelled at will. They stay on a leash. China or Russia could literally cancel the liquid wealth of any political opponent.

The United States rightfully fears ceding this new monetary super-power to China, so we are actively considering our own central bank digital currency and engaging MIT in the development of the underlying code. This is what Federal Reserve Vice Chair Lael Brainard told Congress this week:

“I don’t think we can take the global status of the dollar for granted,” said Governor Brainard. “And in a world where other jurisdictions move to the issuance of their own digital currencies, it is important to think about whether the United States would continue to have the same kind of dominance without also issuing. It’s possible, but it’s a very important question.”

That prospect gets libertarians all fired up, like Congressman Warren Davidson:

Davidson concluded, “if you turn a central bank digital currency into this creepy surveillance tool and don’t preserve the permissionless characteristics of it, it literally is what China is developing. And we shouldn’t imitate them. We should protect America’s way of life.”

Sure. Let’s not be China. Who disagrees with that? This application of blockchain technology exposes our eternal conflict between self-sovereignty and mutual dependence. President Clinton hit on this balance at the recent Crypto Bahamas conference which we hosted with FTX. And it is not one or the other.

There is a reasonable argument that a regulated, fully-collateralized private-sector blockchain instrument — or instruments — could compete well against Chinese government tokens. US dollar proxies dominate DeFi without any US government participation. And private competition would be dynamic. It would subject the Chinese government to competition from the ongoing well-funded innovation of the private sector. Circle is fighting that rear-guard action in Congress as we speak. But that is not a given. And let’s not forget that the private sector is known to wander off the ranch, and that regulation has been known to wane in the absence of a crisis catalyst. The GFC should be near enough to remind us not to be too pollyannaish about the financial sector. Not to mention the Terra Luna debacle. Poorly managed private sector digital dollars would be the mother of all too-big-to-fails.

But the blockchain horse is out of the barn. Money is changing. Blockchain is changing it. The nature of the participation of the US government may be in question, but ninety countries are considering deployment of central bank digital currencies. The implications of blockchain technology will be explored and exploited by governments for good and bad globally in the coming years. And bad is on the shorter path. Another reason for the US government to be engaged.

The anathema of blockchain facilitating greater government control over money will likely solidify the need for non-sovereign blockchain alternatives. Thus, our continued conviction on Bitcoin. And just as importantly, mandate the preservation of checks and balances on governments associated with vibrant democracy, under assault on every front. A principal obligation of us all.

In the context of this kind of market-wide regime change (from deflation to inflation), a rebound can be powerful.  And often offers a last chance to sell and reposition.  In the context of crypto, we think most of the second and third tier smart contract platforms have lost momentum and will remain irrelevant.  And that our positioning in the top tier names will serve us well as we enter the next phase of the Web3 technology transition.  

Quick Market Thoughts

The market has priced in a 2.75% Fed Funds rate by February 23.  That expectation has taken the air out of myriad asset bubbles - growth stocks, SPAC's, crypto and housing among them.  (Hopefully, oil will be next.)  

The SPX forward earnings multiple is now back to 2019 levels having fallen from frothy 2021 peaks of 22x down to a more comfortable 16x.  That's a material correction.  Keep in mind that the real rate of interest (the 10 year TIP yield) is only 21bps.  It is easy to defend this market multiple if earnings are right.  Of course, estimate revisions may turn negative.  Though one could be heartened by comments by the banks on the enduring health of the US consumer.  

(Yellow line is the forward 12-months earnings multiple. )

Importantly, the market's inflation expectations have receded.  See below for the "10 year breakeven" -- the 10 year Bond yield less the 10 year TIP yield.  It was heading north of 3% at the end of Q1, and that really lit a fire under the Fed and spawned talk of the 1970's.  It has quickly rolled over.  Note that the Fed historically turns skittish when this falls below 2%, as that has been associated with deflationary spirals that eventually require unnatural acts -- like negative interest rates.  As this gauge falls below 2.5% toward 2%, I think the Fed may declare victory.  That also would put a floor on market multiples.  And it is safe to assume that short term positioning in this market is cautious -- potentially subject to a squeeze.

Is this like the tech bubble?  Our Nasdaq sold off for seven straight weeks for the first time since 2001 - the famous burst of the tech bubble.  After the tech bubble, the Nasdaq digested its losses for over a year before putting in a bottom.  Here is what that looked like.   

Remember that bottoms were called time and again during the extended decay before the 70% 2003 rebound.  And nobody called that. 

But this is not like the tech bubble. The tech bubble was fueled by equity capital markets which funded spending on infrastructure by hopelessly money-losing CLEC's and Dot.com's.  This sell-off is the result of normalization of interest rates, and in that regard, it is less driven by vanishing sources of revenue and negative estimate revisions.  So I don't think the comparison is instructive.  I think we could bottom sooner. 

What is most striking to us about this prospect is how fervently it is desired.  This dream seems to resonate. Enthusiasm abounds for the prospect of virtual worlds.  We all seem to be waiting for it, and hoping it meets our hopes. The crypto embodiment of the metaverse manifested in Decentraland remains in the category of distant hope.  Promising?  Sort of.

This is a major challenge for the crypto community.  It is not clear that the federated deployment of capital orchestrated by blockchain (à la Helium) provides any advantage in the design and deployment of the cloud-based AI infrastructure needed to create a natural and engaging virtual environment.  Nor is it likely to produce an authentic technological breakthrough. That may take the tunnel vision and massive horsepower of a centralized behemoth like Meta.  With all of its might.  Or Microsoft. Or Sony. Or a very high quality game studios. It is from those studios that we expect higher quality blockchain-enabled video game content to come to market this year, with the potential to overshadow all of the early entrants to the blockchain game world.

Crypto’s signature contribution to the metaworld is its vibe.  It’s coolness.  The community ethos.  Who wants to be associated with Facebook?  I’ll take my brand equity to crypto-land.  And that is Decentraland’s window of opportunity.  So we will see if they can run fast and break things.  Or even walk briskly. 

What heartens me is the richness of certain experiences in the Decentraland world.  Especially the virtual museums.  Both the structures – the virtual architecture – and the NFT’s – responsive to your presence, and in some cases, priced.  That’s an authentic virtual world interaction with an authentic virtual asset – including of course the museum itself.  We need to see more of those.  And more compelling use cases that could draw users in droves.  Why not sit in the presence of a virtual Kanye or Drake – right in the front row?  Or on the stage?  Or at a post-concert party? Something that could draw millions — not hundreds.

Concerns have been raised that the decentralized organizational structure may be the offsetting cultural liability of crypto, and of Decentraland in particular.  And so it may be. But all that matters is the litmus test of usage, and usage is astonishingly small. Anyone here?

What might bring hoards of users to the virtual world? I can’t predict that.  To find out, I paid a visit in Decentraland to the virtual Astrology Center. I got no clear answer. All I can do now is sit in a Decentraland virtual bar sipping a virtual cocktail, by my virtual self, and wait.

The 1970’s was the stale end of a post-WWII industrial dividend paid to the United States for winning that war unscathed, that ceded to us a dominant share of global manufacturing, populating myriad Midwestern towns with flourishing factories and empowering unionization that fostered the famed middle class. Auto workers, steel workers, coal miners. Good jobs. All of that plus an ongoing spend on defense in the throes of the cold war. Until it became hopelessly anachronistic in the face of global competition. We lamented the ensuing evisceration of our manufacturing base. Not even Reagan’s Morning in America could bring it back to life. Pay a visit to lamentable post-industrial small-town Michigan, Indiana, Illinois, Wisconsin, Ohio. Take a peak in the back of the gas station at the slot machines.

We were entering a globalization era of massive disinflation.  On a tour of manufacturing facilities in Guadalajara in 1999, the plant manager at a large company told me that manufacturing in Mexico cost one-fifth as much as Denver, but that China was even cheaper.  “How cheap is China?” I asked.  “It is one tenth the cost…of Mexico,” he said.  Then came the sucking sound of manufacturing and intellectual property flowing to the mainland.  And massive expansion of an economy that suffocates dissent, traps capital, and deploys debt to subsidize low-return industries. Now more than ever to the service of a militaristic, nationalist agenda of expansion. Lucky us for all the cheap electronics.

But always present during this massive change has been one particular thing. Born into inflation in the 70’s, flourishing in the 80’s during recession, and growing relentlessly into full flower globally without pause has been our dependence on demand financed by debt.  A global record $226 trillion per the IMF.  This debt represents demand.  It is indispensable to demand. This is not news to you:

Whatever inflationary forces may be in place, they drain into a deflationary sewer if for some reason – any reason – our ability to spend is constrained to our limited means.  

We are fascinated by ephemeral disruptions in supply chains that spawn shocking rallies in components and commodities.  But capital formation follows.  Inexorably.  Unbounded.  It is always transitory.  Especially when an expert tells you it is not.  Do not mistake those bottlenecks for structural inflation.  Not that kind.  That does not exist.  On the other hand, the kind in Turkey or Argentina, driven by a currency crisis?  Yep, that happens, and it is likely to recur.

We launched a fiscal and monetary nuclear missile at the Covid crisis — a very good reason. And it spawned a massive asset bubble, as we marveled at the impact of negative real rates on our DCF valuations. And now with the prospect of positive real rates, we are unwinding that. But the real rates are minuscule. The 10-year TIP yield is only 23bps. And the 10-year breakeven (the 10-year Treasury Bond yield less the 10-year TIP yield) already has come down to a 2.6% implied rate of inflation. And wage pressures are associated with fast food restaurants, not heavy industry. Because the structure of this economy not only depends on a punch bowl for an attractive return on investment, it depends on it for demand. Does this look like intractable inflation to you?

The 10-year Breakeven Rolling Over

The further we go down this road, the more ridiculous it becomes to imagine we could ever find our way back.  And that is my preferred fundamental bull case on Bitcoin.  You can get distracted by other issues: power consumption, government hostility, regulatory uncertainty, or the ultimate bogeyman -- illicit trade (because that never happens in dollars).  It is all beside the point.  Fiat currency is a crutch.  In fact, it is a wheelchair.  While the Austrian economists are babbling senselessly in the asylum of fiscal conservatism, they have a stalking horse. 

Bitcoin is scarce.  It is limited.  It is usable, and becoming more usable.  And in an early stage of adoption.  It is becoming indispensable.  And in the rhetorical words of SkyBridge President Brett Messing, ask yourself this:  “Will more people own Bitcoin next year, and the year after, and the year after that?” 

Logarithmic multi-year chart of Bitcoin in dollars.