Coronavirus has caused by the time of writing 310’000 infections and 13’000 deaths.
In parallel, the stock markets have crashed worldwide, here is the S&P Index since the financial crisis from 2007/2008:
In parallel, the Bitcoin price has crashed as well. This might sound un-expected because Bitcoin has been classified as a safe haven.
This article analyses, what’s behind the Bitcoin price crash and what will happen as next:
- We analyze the current status of the stock markets and the monetary environment
- We analyze what happens as next with the stock markets
- We analyze Bitcoin Price and
- What will happen as next
So, we look at the WHY? And we look at WHAT’s NEXT?
Analysis of current stock markets and monetary environment
The stock markets have been waiting for a crash for several years. There have been some incidents on the markets, but the central banks have absorbed them with their standard tool – create more base-money and patch with the newly created base-money the places, where the markets start to blow off.
The repo crisis, which started in September last year and culminated in December last year, showed that the central banks are fully committed to removing any irregularity from the markets by using their standard tool.
So, central bankers’ understanding of the networked financial markets is much better than it was the case during the Lehman crisis in 2007/2008. Central bankers were prepared for everything except a black swan of the Coronavirus.
The declaration of the worldwide pandemic by WHO, the lockdowns and the fear of people became the black swan event. Of course, the central bankers responded with their usual toolset (create more base-money), but they were not prepared for the scale of this event.
However, the big difference from this crisis versus the Lehman 2007/2008 crisis is the following – Lehman crisis was a monetary crisis, which could be fixed with freshly created base-money and fiscal stimulus from the biggest economies.
Our current event is not a monetary crisis, it’s a shock on the supply lines – the internetworked economy cannot deliver if just-in-time delivered parts are not available. And because of the supply shock, we get the demand shock on the economy, which leads to the deflationary environment.
As the demand is declining, then the revenues of the companies will start to decline too. This leads to the decline in their earnings, which will then lead to the decline of their stock price. That’s the logical reasoning of the current stock market crash. The decline of the anticipated revenues is the primary effect.
The quantitative easing (the creation of the new base-money by the central banks) has created in the last 10 years an army of the zombie companies. These companies are not able to cover their capital costs in the normal interest rate environment, their operational revenues are too small for this. These companies can exist now only in the current very low-interest-rate environment. If their interest rates would grow or if their revenues would decline, then they will end up in the bankruptcy.
The interest rate for the corporate credit will start to grow – because the banks are aware of the situation of the zombie companies, so the banks just start to charge more interest (higher risk premium). We will get a situation, where banks will start to give less credit to the economy, which results in the continuous defaults and bankruptcies of the zombie companies.
What’s next with the stock markets?
Federal Reserve has announced 2.206 trillion USD base-money creation, which is in total 59% of Federal Reserve’s balance sheet till now. ECB has announced 0.75 trillion EUR base-money creation. They call it a “package” or “liquidity injection”, but in reality, it is new base-money creation.
In total, ca 40 central banks have reduced their base interest rates or have launched their next base-money creation programs. This will be pushed into the economy through the banks, however, as the balance sheets of the banks will deteriorate, then we doubt that banks will be helpful in pushing this newly created base-money into the real economy.
In parallel, the biggest OECD countries have launched the fiscal stimulus programs in the size of 5% – 15% of the GDP. This will be in the form of direct supports to some industries (airlines) – we think this is a very bad idea. The government should rather nationalize the airlines and later privatize them. Or this will be in the form of guarantees for the borrowers. However, we do not know how long the lock down’s will last and neither we do know how fast the economy can be re-started.
We think these initial programs of central banks base-money creation and fiscal stimulus programs will fail. The base-money creation will not be enough to motivate the banks to create new credit-money via lending, which will result in the credit crunch, which will trigger defaults and bankruptcies. The fiscal stimulus programs will only prolong the existence of zombie companies, but doesn’t solve their key problem – they will fail as soon the interest rates on the corporate credit start to increase (which happens now)
The failure of the support packages means the secondary effects of the failing zombie companies will start and these effects will create holes in the banks’ balance sheets. This will further reduce the banks’ capability to lend. This means the banks will push less credit into the economy, which means real interest rates for the zombie companies are going even higher, which will bring more zombie companies down. This will result in a vicious circle until the economy will be cleaned from the unproductive zombie companies.
Defaulting zombi companies will be the secondary effect of the current crash.
In parallel, the unemployment will grow and the salaries will decline, which will result in reduced demand, which results in fewer revenues for the producers, which reduces the profits of the producers, which will reduce their stock price.
We think the stock markets will continue the fall because the secondary effects of failing zombies will take over the primary effect of supply chain shock and declining revenues.
It is possible that the central banks and governments will understand these secondary effects and will respond with even bigger stimulus packages. Maybe they can stop the decline, but this will be on huge costs of the additional base-money created and on the cost of additional state deficits, which translate into the increasing interest rates, which will then again cause the zombies to fail.
The failing zombies will default on their loans and banks have to write off these loans. If these write-offs are too big, then the banks will need to be recapitalized (either with base-money creation or with the new government debts). This will reduce the credit in the economy, which translates into the credit-crunch, which translates into additional zombie companies failing. The failure of the zombie companies will be a healthy outcome for the economy: However, this will include as well as failing banks, which will trigger massive base-money creation by the central banks.
How far will the stock market crash?
Let’s look at the chart above – it contains the Fibonacci retracement levels.
The current S&P 500 down movement continues can continue till the 0.618 retracement level, which would be ca 1’700 USD or it will continue till 0.786 retracement level, which would be ca 1’250 USD.
The current S&P 500 level at the moment of writing is 2’300 USD. So, there will be quite some way to go.
Analysis of the Bitcoin price
The unprecedented base-money creation by the central banks should logically speak lead to the increase of the Bitcoin price. So, the key question here is – why did the Bitcoin price dropped so massively?
The answer to this is in our overleveraged monetary systems. We have quite an amount of hedge funds, which are using highly leveraged trades – the low-interest-rate environment creates a perfect environment for the over-leveraged trades – practically you take a loan and you leverage your long position. Everything works well, till the markets are moving up – hedge funds are generating nice profits. And as all the market players know the “Fed Put” (i.e. Fed starts printing money as soon the markets will crash) then this was considered a low-risk trade.
However, the opposite happened – the “Fed Put” did not work, the market’s crashed and the overleveraged positions were below the water. When this happens, then cash needs to be added into the leveraged positions for avoiding the liquidation (and losing everything). To get cash everything will be sold – gold, treasuries, and Bitcoin. That’s what happened.
This was the reason for the Bitcoin price crash.
Something similar happened in the 2007/2008 Lehman crisis with the gold price – although it was widely anticipated that the central banks will create a massive amount of new base-money, which would mean growing gold price, the gold price was sinking. The reason was the same – the hedge funds with overleveraged positions had to liquidate any assets for avoiding their trading positions liquidation.
However, when the S&P 500 reached his bottom, and when it became clear how much new base-money was created, then the gold price had quite some increase.
We have here multiple forces in play:
- We forecasted before that the S&P 500 continues to move down to 1’700 level or 1’250 USD level. This would cause the next round of the “any asset liquidation” to get cash and to fill the holes in the trading positions. This would drag Bitcoin price down again
- From the other side, it becomes clear about which un-precedented joint effort of base-money creation we are speaking – this would translate into the additional demand for Bitcoin, which will drive the Bitcoin price up
- The initial fiscal stimulus packages and base money creation packages will probably fail because of the secondary effect of failing zombi companies. This will result in the bank failures (the zombie company’s defaults result in huge holes in the banks’ balance sheets). The banks will be re-capitalized (of course with the newly created base-money), however as these amounts will be huge, then this will result in the even bigger base-money creation, which results in an even bigger Bitcoin price increase.
There are multiple scenarios for how this crisis will play through the economy. However, all paths will result in the:
- Massive base-money creation (which pushes Bitcoin price up)
- Massive fiscal stimulus, which creates more government debt, which brings the interest rates up, which will cause the banks to fail (which pushes Bitcoin price up)
The Bitcoin price decline, which is triggered by the S&P 500 downward movement will stop at some point – that’s when the S&P 500 will reach his bottom. After that, we have the effects of the already announced base-money creation, which will drive the Bitcoin price up.
After that, we will have the upcoming base-money creation, which will be triggered by bank failures. This secondary effect base-money creation will be more than the initial response base-money creation, which will drive the Bitcoin price more up.
The bank failures can bring with him the collapse of the traditional financial system. We can anticipate that bank failures will result in the flight to crypto, where everyone can control his own financial assets without the middlemen (without the existing banking system). This will add additional price pressure to the Bitcoin price.
Nowadays we have several discussions about what are the key use cases of crypto. Some speak about the payment use cases, we in the SmartCredit.io speak about the credit use case, and some speak about the gaming use cases. But in this scenario here the key use case will be the alternate financial system, independent from the current financial system, with the ability to control your own assets.
If we look at this context here, then the Bitcoin crash of the last 10 days will be just a blip on the radar screen. However, this crash will be important, because it will be the enabler for the emergence of the well prepared alternate financial system.