Prominent fund manager and CEO of Janus Capital, Bill Gross, stated in his monthly investment outlook that in the attempt to boost economic growth central banks have turned financial markets into a casino. As central banks are printing money at unprecedented rates and are effectively trying to fight debt with more debt, Gross is comparing their actions to deploying the Martingale strategy in a casino.
Central Banks Apply Martingale Strategy
The Martingale betting strategy is based on doubling up your bet every time you lose on a (near) even odds game. Provided there are no betting limits and that the gambler has unlimited funds, by doubling up every time the gambler loses, the gambler will eventually win back all losses and, thereby, win in the long run. In reality, of course, this system does not work. No gambler has unlimited funds and casinos have implemented maximum bets to combat this strategy.
Gross argues that central banks are doing exactly that, except that they do have an unlimited bankroll as they can keep printing money for free and there is no maximum bet they can place. However, savers and investors are the ones losing out in the current low and in some countries negative yield environment.
Bitcoin could become a Viable Alternative Investment Class
For this reason, Gross believes that savers and investors will inevitably move away from traditional asset classes and move their capital into riskier and largely unchartered investment classes, such as cryptocurrencies. Gross specifically highlights bitcoin as a potential alternative that could come to flourish as central banks keep “playing casino”.
“Bitcoin and privately agreed upon blockchain technologies amongst a small set of global banks, are just a few examples of attempts to stabilize the value of their current assets in future purchasing power terms.”
Gross also mentions gold as a potential asset that could see a strong increase in demand. Furthermore, he believes that “central bankers have fostered a casino like atmosphere where savers/investors are presented with a Hobson’s Choice, or perhaps a more damaging Sophie’s Choice of participating (or not) in markets previously beyond prior imagination,” and thereby cautiously warns investors of the potential risks inherent in entirely new asset classes, such as digital currencies.
Bill Gross is the founder and former CEO of the largest bond investment firm in the world, Pacific Investment Management Company (PIMCO), and has been a heavyweight in the bond markets for several decades. His current company, Janus Capital Group, announced this week a merger with investment management peer Henderson Group, to form a $320 billion asset management partnership.
Bitcoin as a Potential Future ‘Safe Haven’ Asset Class
Bill Gross does have a point citing the cryptocurrency bitcoin as a potential ‘safe haven’ asset class to be, as it cannot be controlled by governments or central banks and can, therefore, not be inflated or deflated at the discretion of centralized institutions. Moreover, as the Bitcoin ecosystem has matured, it has traditionally displayed behaviour similar to that of ‘risk off’ assets, whereby the cryptocurrency makes gains when stocks markets are in the red and when markets display tendencies of risk aversion.
In fact, as highlighted by Pierre Rochard from the Satoshi Nakamoto Institute, Bitcoin has a perfect monetary policy in place, as it is a “rule-based monetary policy was set at its creation and its independence is secured by the distributed nature of the underlying network”. Central banks of nations, on the other hand ,are susceptible to discretionary policy decisions that may not be aligned with the best interests of the economy at large. For example, quantitative easing is criticized for being the ‘largest wealth transfer in history’; even the Bank of England admitted that the policy made the rich even richer back in 2013.
However, due to the fixed total supply of bitcoin and its ongoing creation by miners, there are three monetary phenomena that occur:
- A large part of bitcoins is being held onto in the assumption that they will increase in value
- The market sets bitcoin’s exchange rate and interest rate
- Fractional reserve banking cannot take place
Bitcoin is being Hoarded, setting the Interest Rate
Bitcoin miners and investors have the tendency to hold onto their bitcoin holdings with the assumption that the asset’s value will appreciate as bitcoin adoption by merchants and private users increases. Bitcoin’s historic price development and its price’s strong positive correlation with Internet search volumes have proven this to be the case up to this point in time.
Critics of bitcoin often cite that it will not work as a currency as it does not pay any interest. That is incorrect. Bitcoin’s interest rate is determined between the arbitrage of the expected return of holding bitcoins versus the expected return of lending them out.
If you want to earn interest as a bitcoin holder you can lend your bitcoins out on exchanges for which you charge interest. However, as the expected future increase in exchange rate tends to greatly surpass what any borrower is willing to pay to borrow bitcoins, bitcoin holders will continue to hoard their cryptocurrency holdings until this expectation changes.
Fractional-reserve Banking Cannot Occur for Bitcoin
Fractional-reserve banking refers to banks taking deposits and handing out loans, while only holding a fraction of the deposit liabilities as a reserve. This allows banks to lend out substantially more funds than they actually hold from depositors, which, in turn, increases the money supply in circulation. This is what the current global banking system is based on.
For the cryptocurrency bitcoin, however, this is not possible. The bitcoin protocol enforces full reserves to be held when engaging in bitcoin lending activities. Therefore, no fractional reserve banking can take place and the money supply of bitcoin cannot be artificially inflated.
Bitcoin’s Attractive Features as an Asset Class
Furthermore, bitcoin has a range of superior features to precious metals or fiat currency, as an asset class, but also as a means of making payments.
As an investment asset class, bitcoin trumps precious metals and fiat currencies as it has no storage costs, its transportation is entirely free, its record keeping is automatic and, as its total supply is fixed at 21 million, it is a relatively scarce commodity.
As a payment method, it is superior to precious metals and fiat currency as it is free to use and store, has no transportation costs, is infinitely divisible, cannot be counterfeited and has a very short transaction time, which ensures fast and safe payments.
Whether Bill Gross’ prediction becomes true or not remains to be seen. His reasoning for it, however, is absolutely viable. As central banks are continuing to distort financial markets and investors are being forced into assets that generate zero, or even negative, returns, the cryptocurrency space will soon witness an influx of institutional investors.