Bitcoin continues to follow its own narrative, and the broader cryptocurrency space along with it.

(We note with amusement that, at the time of this writing, Bitcoin continues to press against all-time highs in the $60,000 area, even as tech stocks turn red and the broader market finds itself gripped by a new market structure event — the fallout from which is not over yet.)

Bitcoin’s increasing ability to ignore market-moving headlines of the bearish variety comes not because crypto-oriented investors are out to lunch, or otherwise not paying attention.

It comes because crypto assets are in the knee of the curve with respect to broad-based adoption, as they transform the buttoned-down global finance space from the inside out. That positioning translates to a rising tide of demand that overpowers other considerations.

The “knee of the curve” — also sometimes known as the “elbow of the curve” — is a mathematical term referring to the point where an accelerating parabolic curve starts to go vertical.

Or if you picture the shape of a hockey stick, standing upright with its forward tip resting on the ice, the knee of the curve would be the point at which the functional part of the stick, which is meant to meet the puck, connects with the handle of the stick, which goes up at a near-vertical angle.

“Knee of the curve” as a term was popularized a ways back in relation to the prolific inventor, scientist, and futurist Ray Kurzweil, and his predictions relating to the coming Singularity.

For those who believe in Kurzweil’s theory (we are skeptical), there will come a point where the exponential gains born of compounded computing power will unleash not just artificial intelligence, but some form of silicon-based hyper-intelligence or super-intelligence.

After this happens, according to Kurzweil’s view, humanity as a species will more or less merge with machines and effectively become immortal.

We’re not holding our breath on that one, though the Singularity is supposed to be near (as declared in the title of Kurzweil’s most popular book). The knee of the curve for super-intelligence is still far away, in our view, and may not show up in this century — if it even arrives at all.

In contrast to that, the knee of the curve for crypto asset adoption is already present, right here and right now. It is grabbing headlines and staring us in the face.

Consider the following announcement via Business Wire:

Visa Becomes First Major Payments Network to Settle Transactions in USD Coin (USDC)

Visa (NYSE: V) today announced a major industry first in bridging the worlds of digital and traditional fiat currencies: the use of USD Coin (USDC), a stablecoin backed by the U.S. dollar, to settle a transaction with Visa over Ethereum—one of the most actively used open-source blockchains…

Visa has spent the last year establishing a pathway for digital currency settlement within Visa’s existing treasury infrastructure, a platform that moves billions of dollars each day across thousands of institutions in more than 200 markets and 160 currencies.

Visa — one of the largest payment processors in the world — is opening up an eight-lane superhighway for fast, seamless, fiat-to-crypto transactions and vice versa.

What’s more, when one big player does it, they all have to do it. Mastercard, which has embraced its own suite of cryptocurrency initiatives, will surely follow Visa with some form of stablecoin transaction enablement.

Then, too, the credit card payment giants are doing this, in part, because they are terrified of Silicon Valley challengers like PayPal and Square taking their market share via crypto asset payment rails.

The traditional banks are looking on, too, and feeling a mix of intense pressure and existential dread. If a crypto asset payment revolution takes hold without them, traditional banks risk going the way of buggy whip manufacturers in the aftermath of Henry Ford’s assembly line.

Here is another headline that recently caught our eye, via Bitcoin.com:

The Fed Plans to Unveil Digital Dollar Prototypes in July

The U.S. Federal Reserve has been actively working on a central bank digital currency (CBDC). At least two prototypes of a digital dollar are near completion, developed by officials at the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology (MIT). They plan to unveil their research as soon as July, said James Cunha, who leads the project for the Boston Fed…

Even the Federal Reserve — along with many other global central banks — understands that the crypto asset revolution is something to join rather than fight.

The arrival of central bank digital currencies will not pose a threat to Bitcoin, meanwhile, because Bitcoin is digital gold, and CBDCs will be fiat currency in digital form.

The supply of Bitcoin will remain forever capped, whereas the supply of digital dollars will remain open-ended; as such, it will make more sense than ever, in a digital-dollar world, to use BTC as a store of value — and a means of protecting savings — while switching to digital dollars for the purpose of paying taxes, or otherwise conducting transactions that require the use of a digital fiat asset.

Meanwhile, the reason Visa has chosen to settle transactions in USD Coin (a popular dollar-backed stablecoin) is because dollar-denominated stablecoins are essentially normal dollars wrapped in code, allowing them to migrate onto the blockchain. 

Imagine the traditional fiat banking system and the newly developing crypto system as separate entities that are not compatible at first glance. What is needed is a bridge, or perhaps a super-highway, between the two systems: A way to go instantly and seamlessly from fiat to crypto and back again.

This is what Visa, and other payment processing giants, will potentially provide by way of stablecoin transaction mechanisms.

Dollar-denominated stablecoins are tradable on most crypto exchanges; that, in turn, means the vast majority of crypto assets will be two steps away from payment in any form of end currency.

First you swap the crypto asset for USD stablecoin, a process that is instant; second, you use the USD stablecoin to complete whatever transaction is at hand. That’s it.

Americans who travel abroad have long been used to the instant fungibility and universal fiat access provided by credit cards. If an American uses their Visa or Mastercard to pay for lunch at a cafe in Europe, a currency transaction will take place instantly and seamlessly behind the scenes, and will likely be executed at the most favorable exchange rate available (the bank’s own bulk exchange rate). 

With Visa offering stablecoin conversion, we are reaching the point where crypto assets achieve the same level of fungibility and instant swapability at the point of payment for a transaction.

That, in turn, means consumers will be able to hold their savings in whatever form of base asset they want — be it fiat or crypto — and then swap a portion of assets into whatever transaction currency is required instantaneously, at the touch of a smartphone screen or swipe of a card, with no effort, while knowing the payment rails facilitator is giving them the best exchange rate in the moment.

This transition to widespread crypto asset accessibility — which is happening so fast it should make your head spin — is the “knee of the curve” we are talking about in terms of the crypto asset revolution transforming the global finance system from the inside out.

Two or three years back, when the crypto space was still dominated by wild-eyed libertarian notions of blowing up the system or taking it head on, we explained patiently and thoroughly why the crypto revolution would go a different way: It was always bound to be more of a Trojan Horse-type deal than a direct head-on assault, working within the functional parameters of the system to introduce radical change gradually at first, and then suddenly.

At this point, the crypto Trojan Horse has penetrated the fiat castle walls; the revolution is here, and accelerating, and close to changing everything. 

On Feb. 26 — less than a month ago — we explained why risk levels were elevated for a “Market Structure” related meltdown event. A few weeks on, the danger has only grown.

As we said in the piece:

A market structure event is major price dislocation — like a meltdown or a flash crash — that happens for reasons unrelated to investor sentiment or a long-term fundamental outlook.

Market structure is a reference to the way investors are positioned: Who is long, who is short, how much leverage they have, and so on.

The phenomenon of “portfolio contagion” is notably a market structure issue: If leveraged hedge funds take a large hit to a certain area of their portfolios, for example, they often have to liquidate positions in unrelated areas of the portfolio to reduce exposure across the board.

In this manner, a sell-off can be contagious in that the selling jumps from one area of the portfolio to another; the linking factor is the structure of what the hedge funds are holding.

If you are curious what a market structure event looks like, here’s a fresh example. Check out the below chart of ViacomCBS (VIAC), which was one of the year’s best-performing names prior to last week.

Wall Street was shocked on Friday as a single hedge fund, Archegos Capital Management, had more than $20 billion worth of positions liquidated by its brokers as a result of unmet margin calls. 

This fund was seriously leveraged, according to sources who spoke with Bloomberg.

Archegos was estimated to have $5 billion to $10 billion worth of assets under management, but anywhere from $4 to $9 worth of leverage for every $1 of capital. That made the fund’s total equity exposure as much as $50 billion against a base of $5 billion to $10 billion.

At four-to-one leverage, a 20% move can wipe you out. And at nine-to-one leverage, a 10% move can wipe you out.

It appears that ViacomCBS (VIAC) and Discovery Inc. (DISCA) — two media stocks that had run up hugely year-to-date — were having a bad week, with selling pressure leading to double-digit declines.

The double-digit declines then triggered a margin call for Archegos, which appears to have been leveraged up to its eyeballs in VIAC, DISCA, and a handful of other names.

When a whale-sized hedge fund goes into forced liquidation, the prime brokers who handle the fund’s accounts will execute “block trades” — the buying or selling of large blocks of stock — to close out the impacted positions as soon as possible, to avoid the danger of the account going negative and leaving the prime broker with losses on its books.

On Friday March 23, Goldman Sachs, Morgan Stanley, and others executed tens of billions in block trades — Goldman did $6.6 billion alone prior to the market open — to liquidate the fund’s holdings.

The forced liquidation led to valuation wipe-outs significantly in excess of the block trade size. On Friday alone, an estimated $35 billion worth of market cap evaporated, mostly concentrated in Chinese technology companies and media conglomerate stocks.

Market structure events are typically not one-off occurrences. They are more like a bag of popcorn in the microwave. First you hear a single, solitary pop. Then you hear another… and then another on a shorter time delay… until finally a crescendo as hundreds of kernels pop at once.

The reason this happens is because, particularly at the tail end of a bull market period, hedge funds tend to be jam-packed into the same types of positions.

At the same time, leverage levels tend to be their highest at a market peak, and the overall leverage ratio for U.S.-based long-short hedge funds was recently still above 200%, according to Morgan Stanley data.

So, what happens is, you have a significant number of market players who are “long and wrong” in the same names at the same time — and they are not just wrong in a modest way, they are wrong while significantly leveraged.

As a result of this crowded positioning, a correction-level decline (10% or more) in a popular industry group can wind up triggering a margin call for a particular large fund — and the pain of the forced liquidation that ensues transmits losses to other portfolios with the same or comparable exposures.

And if market forces were already conspiring against the overextended, overvalued group of stocks these funds were long — like, say, rising 10-year and 30-year yields putting direct pressure on wildly overvalued technology stocks, even as China’s stock market melts down (it is already happening there) and a rising tide of new supply in the form of SPAC issuance and IPOs continues to flood the market — that tends to make the selling pressure worse, as a critical mass of funds ponder heading for the exits before their own margin calls hit.  

The market danger here remains severe — for technology stocks in particular, if not the market overall.

In our view, last week’s forced selling in names like VIAC and DISCA marked the start of a rolling liquidation phase — one of the earliest kernels in the bag of popcorn to pop — and we might now be entering a period like the ones that followed March 2000 and March 2007, where the real pain was just getting started.

One of the world’s largest container ships, greater in length than the height of the Eiffel Tower, is stuck in a narrow canal. It is stuck because the ship ran aground on the sides of the canal.

High winds blew the ship off course, causing it to drift sideways until its ends were firmly lodged in the sides of the canal. As a result of this, the canal waterway has been blocked.

The blockage means that, until the ship is dug out — a process which could take days or even weeks — other ships cannot pass through.

That problem, in turn, has created a kind of traffic jam for seaborne global trade. Because ships can’t get through, the cargo of the ships can’t get to ports.

This seaborne traffic jam is so bad, it is costing the world an estimated $9.6 billion per day in lost trade revenues, which translates to $400 million per hour. All because a single ship got stuck. The canal in question is the Suez Canal, a man-made waterway in Egypt.

The Suez Canal connects the Mediterranean Sea with the Gulf of Suez on the Red Sea, and serves as a kind of transport shortcut for goods flowing from Europe and Russia to Africa or Asia.

When the Suez Canal is closed or blocked, the alternative route for shipping goods from, say, Italy to China or vice versa requires sailing all the way around the southern tip of the African continent.

Having to loop around Africa is a wildly expensive journey in comparison to the Suez shortcut — which is why the Suez Canal was commissioned in the 1850s. It required an estimated 1.5 million workers, mostly digging by hand, over the course of ten-plus years to complete.

The Suez Canal has long been considered a major “choke point” for international trade flows. In 2020, nearly 19,000 ships passed through, carrying 12% of global trade volume and 10% of oil volume.

As a result of this importance, geopolitical wargame scenarios have long included impact estimates of what might happen if the Suez Canal were sabotaged or otherwise shut down. But in the various scenarios that have been gamed out, we doubt any of them included Mother Nature playing a prank via blowing a ship sideways with high winds. 

As a result of the blockage, transport rates are skyrocketing. The Africa route takes longer and uses a lot more fuel, which simultaneously reduces the availability of ships and increases the price of the journey.

Importers and exporters are thus now scrambling for alternatives to seaborne routes, which means looking at shipments over land (by truck or train) and shipments by air. But those routes are more expensive, too — compared to the bulk rate of giant container ships — and now demand is spiking.

“You’re starting to get some people in panic mode,” logistics executive Michael Piza told Bloomberg this week. “We’ll really feel the full impact here in the next seven to 10 days.”

Many assume the impact of the Suez Canal blockage will be inflationary. We’re not so sure. On an overall basis, it could actually have a net deflationary impact on the global recovery. If so, that would make the U.S. recovery stand out even more.

To understand why price spikes in the midst of a global trade jam-up can be deflationary, consider the fact that higher prices can act like a tax.

When the price of gasoline and groceries shoots up, for example, those costs take a larger share of the money in consumer wallets. If consumers have no choice but to pay more for necessities, they will then have less discretionary income to spend in other areas.

The same calculus applies to businesses. If a business can pass on the cost of higher transport costs, it will. But if the business can’t pass on the costs — or if revenue is simply lost because shipments were weeks late — that makes revenues and profits go down.

Liquidity is a key variable in determining whether a price spike is inflationary or not. If liquidity is plentiful and there is plenty of spending cash available, businesses can raise their prices and borrow more from capital markets, while consumers can simply decide to pay more. 

But if liquidity is constrained, higher prices can lead to belt-tightening as a ripple effect. When that happens, businesses see profits go down as costs go up, and consumers purchase less.

Unfortunately, too, a new currency crisis is unfolding in Turkey even as the Suez Canal jam-up plays out (we’ll explain more of what’s going on there next week).

This is an important factor because currency meltdowns in emerging markets have a tendency to be contagious; a severe episode of liquidity withdrawal in Turkey is already showing signs of contagion, with liquidity withdrawal and tightening conditions in other E.M. countries.

The behavior of the crude oil price could be useful in getting a sense of how the Suez Canal impacts play out. On news of the Suez Canal blockage, crude oil prices initially shot higher by 6% (a very large single-day move for crude). But the very next day, crude gave back most of that gain.

Our sense of the Suez Canal impact, on balance, is that it is just more fuel for the fire in terms of the strong-dollar environment we are seeing — and it is also bad news for tech stocks.

Why is this the case? Remember the connection between liquidity and inflationary impacts.

The one country that is still awash in liquidity right now is the United States. This means that, if prices go up at the margins because of the Suez incident, U.S. consumers will have little trouble paying.

It also means that inflation at the margins will not stop the U.S. growth boom now unfolding, because there is plenty of cash on hand to absorb initial headwinds.

A consumer price index reading of, say, 3% won’t stop U.S. consumers from spending, given they are more cash-flush today than at any time in decades. We’ll have to get a fair bit higher (as will 10-year and 30-year yields) before the growth party slows down.

That, in turn, means near-term inflation pressures are likely to increase in the United States, which translates to more downward pressure on treasury bonds and upward momentum for long-term interest rates. And the more that the 10-year and 30-year yield rise, the more that speculative tech stocks get hammered.

Then, too, because the Suez Canal impact is deflationary for the rest of the world (ROW) — their consumers don’t have the liquidity to pay up, which means spiking prices act like a belt-tightener — the transmission effects of rising U.S. long-end rates will hit ROW all the harder, creating a sell-off in emerging-market assets (this is already happening), which further translates to selling in the tech space.

All of this then loops around to an uber-bullish environment for the U.S. dollar because — even more so than before — other countries are seeing their growth outlooks weaken, and their debt loads looking increasingly problematic, as the U.S. continues to embrace vaccine-powered and consumer-spending-fueled growth, further increasing the relative attractiveness of the USD.

There are other views of what’s happening in terms of macro impacts — we are partial to ours, of course — but what really matters is the price action, which is the best substitute we have for an overall market verdict.

And right now the price action is telling us our strong-dollar views are dead on, and that differentials favoring the U.S. over ROW are only getting stronger — with the Suez jam-up adding to that dynamic.

In early December 2020, TradeSmith Decoder turned aggressively bullish on energy stocks. We bought a sizable basket of fossil-fuel-related energy names at that time — eight in all — anticipating a recovery-fueled share price surge as a result of resurgent oil demand.

That overall basket did quite well, providing multiple instances of either triple-digit gains or close to triple-digit gains, in the space of less than three months.

But we recently took partial profits across the board on that energy basket, and significantly tightened our risk points on the holdings that are left, as such that if prices decline by a modest amount, we’ll be out.

We aren’t turning flat-out bearish on energy stocks at this time, but we’ve definitely shifted to neutral. And if our profit-protective risk points are hit, thus closing out a nice trade, that will be fine.

Our initial energy stocks call was more sentiment-based than supply-and-demand based, meaning, we anticipated investors getting excited about oil stocks as part of the vaccine-powered recovery narrative, with positive emotions getting ahead of the actual demand picture.

We also thought a rebounding crude oil price would give energy stocks a tailwind. In that particular area, the Saudis helped us out twice.

First, the Saudis helped with a unilateral crude oil production cut of a million barrels per day in the first week of January; that news, taken by markets as a total surprise, caused the oil price to surge, and energy stocks along with it.

Then, in the first week of March, the Saudis said they would extend the duration of the production cut when the market had anticipated it was coming to an end. That news (another surprise) caused the oil price to jump yet again, and energy stocks to surge yet again.

That was all well and good in terms of driving the bullish energy stocks. But here is the problem moving forward: The Saudis appear to be underestimating the resilience of U.S. shale producers — for the second time in less than a decade.

In 2014, the West Texas Intermediate crude oil price was above $100 per barrel. At that time, the Saudis decided to wage an “oil war” to try and kill off U.S. shale producers.

During that time, the Saudis telegraphed a willingness to flood the market with excess oil supply, in the hopes that a plummeting oil price would bankrupt the U.S. shale industry and scare off new investment.

As a result of their oil war efforts, the crude oil price did in fact plummet, going from $110 per barrel to less than $30 per barrel in the space of two years.

But the Saudis miscalculated, because the U.S. shale industry didn’t go bankrupt, and shale investment didn’t dry up. Over the next few years, shale production grew so much that the U.S. at one point overtook Saudi Arabia’s spot as the world’s largest oil exporter.

Here in 2021, the Saudis aren’t trying to knock down the oil price with a supply glut. Instead, they are trying to prop the oil price up, and encourage higher oil prices, by keeping supply off the market.

But the mistake the Saudis are making, in our view, is assuming that the U.S. shale industry won’t rebound from the pandemic — the same way it did from the oil war seven years ago.

After the OPEC+ Meeting of March 4, 2021, Saudi prince Abdulaziz bin Salman openly mocked the U.S. shale industry, smugly telling reporters that “Drill, baby, drill is gone forever.”

What the prince meant was that he expected no new ramp-up of U.S. shale output — which is why it was safe to implement production cuts. It would make no sense to try and prop up the oil price with production cuts if U.S. shale producers had the ability to come back strong; the shale producers would just add supply to the market and take market share.

And this is where we run into a problem for oil and energy stocks: If the crude oil price stays above $60 per barrel, it is, in fact, likely to bring back new shale production, which could then glut the market with more supply than it needs.

When we made our bullish energy stocks call in December 2020, West Texas Crude was around $45 per barrel. At the $60 level that is a 33% price increase; at the $65 level it is a 45% price increase.

More importantly, a sustained outlook for $60 and above seems to be the threshold where U.S. shale producers — and oil majors like Exxon — can justify investments in new production.

One way to tell whether a production rebound is happening is to monitor the “horizontal rig count” — a measure of how many rigs the shale patch has in operation.

As the oil price declines to unprofitable levels, the horizontal rig count falls as production shuts down; if the rig count starts to climb again, that is a sign production is bouncing back. With the oil price retaking $60 per barrel in mid-February, that is just what we are seeing, in a kind of repeat trajectory of what happened after the oil price bottomed out in 2016.

This means that, above the $60 threshold, “drill, baby, drill” could prove to be alive and well. That is the level where U.S. oil output is likely to climb if sustained, filling in any gap created by Saudi cuts.

This more or less explains why oil prices saw a large-scale drop last week.

A new five-year forecast report from the International Energy Agency (IEA) showed that any short-run constraint on the oil supply is more artificial than real, meaning, demand is not yet strong enough to justify a rising oil price, which means higher oil prices here and now are born of the Saudis and OPEC+ keeping supply off the market.

This puts the crude oil outlook in a kind of no man’s land.

Below $60 per barrel, the U.S. shale taps are off, which means supply can be artificially restricted if the Saudis and OPEC+ maintain discipline. But if the oil price goes above $60 for a sustained period of time, as the Saudis want, spare production capacity from the shale patch and various oil majors should kick in. 

If we combine this implied supply ceiling (above a certain price, new supply challenges the market) with the observation that the reflation-and-recovery narrative was looking a bit overheated, and then add in the challenge of a rising U.S. dollar hurting commodity prices, it looks like the bullish energy stocks narrative may have played itself out for the time being.

Although, with that said, the crude oil outlook (and thus the energy stock outlook) does have one wild-card factor: The potential for supply-shock disruptions in the Middle East, where a sudden cut-off of oil flow could drive an oil price spike.

We saw a preview of the supply-shock factor this week with oil’s sharp rebound on news of the Suez Canal incident — which, if you haven’t heard about it, amounted to a parallel parking job gone badly wrong, but with a container ship longer than the Eiffel Tower rather than a car — and a resulting $400 million-per-hour traffic jam that disrupted global trade.

We’ll have more on the Suez jam-up tomorrow, if we don’t wind up bumping that topic to next week because technology stocks are crashing. (Look out below!)

A general tone of conflict with China is escalating now — not just in respect to China versus the United States, but China versus Western allies as a group (with the United States at the forefront).

This is ominous news for Western companies with significant business exposure to China (like Apple and Tesla). It is ominous news for countries with significant supply chain exposure to China (there are far too many to list). Plus, it is bad news for emerging markets (which are not an attractive buy at this time).

The conflict is escalating, in part, because the United States wants it to. Given the current state of things, the United States has a strong incentive to pick a fight with China now.

There is an element of “no time like the present,” meaning, it appears better to act now rather than later; but there are also powerful economic reasons for the United States to pick a fight with China right now, that we shall explain. 

The short version in terms of economic incentives is this: If a new trade war breaks out in short order, or a significant slowdown of international trade occurs, that development would likely disproportionately help the U.S. economy, while hurting China’s economy at the same time.  

The West, meanwhile, is rapidly approaching a kind of critical moment with China. On various fronts, China has been pushing hard to serve its own geopolitical interests, and has been doing so for years.

In all manner of areas, from technology to client-state relationships to ideological influence — call it the “digital authoritarian state” model versus the Western democracy model — China has been advancing a position, like pushing pieces forward on a chess board, that the West sees as adversarial.

In some ways this is “the Thucydides Trap” writ large. The Thucydides Trap is a shorthand description for what happens when a rising great power challenges an existing great power; most of the time, though not always, the ultimate result is war.

To avoid war, and resolve the situation peacefully, in such a way that the existing great power and the rising great power co-exist, is to avoid war and thus avoid the Thucydides Trap. To wage all-out war is to fall into the trap, as has happened so many times in the past.

But avoiding the Thucydides Trap is not just a matter of the existing great power and the rising great power being reasonable with each other, as we are starting to see now.

If a clash of worldviews and geopolitical interests turns into a clash of civilizations, some type of conflict resolution becomes inevitable. At that point, the question is whether the conflict is resolved with words and negotiations or violence and brute force.

We would argue that, from the perspective of the United States — and perhaps other allies in the West, too — this confrontation with China is coming whether anybody wants it or not.

The inevitability of confrontation creates an element of striking while the iron is hot, so to speak: If you have to confront an adversary who is growing stronger, better to do it sooner, rather than waiting for their power to grow.

Then, too, at the current point in time, the United States is in a much, much stronger position than China.

There is a popular narrative that says China won the pandemic because their economy bounced back faster in 2020; that China is stronger economically and politically than the United States; and that China is “winning” while the United States is on the back foot.

That narrative — that says China is beating the United States — is completely and utterly wrong.

The United States still holds huge, almost overwhelming macroeconomic advantages over China; the United States is far better positioned than China for what is going to happen over the next decade or two; and China’s projection of having won the pandemic is mostly a mirage, perpetuated by those who have ideological incentive to believe the United States is weaker than it actually is.

What we have noted, so far, is that the West has incentive to confront China sooner rather than later; that the United States has significant incentive to push back against China; that a trade war or slowdown in trade would disproportionately help the U.S., and hurt China, simultaneously; and that the overall position of the U.S. is far better than China, to the point where China “winning” is a mirage.

To understand why China is far weaker than it appears — and the United States is far stronger — we can start with the below chart, via the World Bank, showing China’s consumption as a percent of GDP over the past six decades (1960-2019).

Domestic consumption is also known as personal consumption or household spending. It represents the appetite for goods and services from consumers — individual citizens and their families — as opposed to government spending or business spending.

China’s greatest challenge is to increase its overall level of domestic spending. This means getting Chinese households to consume more — and buy more stuff — which in turn would make China’s domestic economy stronger and less reliant on exports.

In most Western countries, the level of domestic spending is significantly higher than it is in China; in the United States, domestic consumption has hovered around 70% of GDP for nearly 20 years.

A higher level of domestic consumption creates an advantage in economic and geopolitical terms. The more that an economy is powered by local spending, the less dependent it is on exports to sustain it.

In 2019, China’s economy was 56% more reliant on exports (as a percentage of GDP) than the United States. That means China is significantly more exposed to trade-war risk than the United States.

If international trade channels shut down, it will have a greater impact on China than America, because China relies more on shipping stuff abroad, whereas America’s economy is more powered by spending that goes on at home.

But that is only part of the story explaining why America is in a better situation than China.

Because China’s level of domestic consumption is low, China has to create economic growth through aggressive capital expenditure and supply-side business investment.

In plain English, this means that, if China wants its economy to grow at a certain rate, and households aren’t spending enough, the government has to build bridges, subway stations, “ghost cities,” highways to nowhere, and so on, in order to create jobs and economic growth.

At the same time, because China’s households don’t spend enough, China has to stimulate its economy with “supply-side” measures, meaning, it has to pump money into businesses to try and get them to ship more exports, build more factories, and so on.

Spending lots of money on infrastructure and business development may sound good, but it is possible to have way too much of a good thing. In order to create economic growth — the Chinese government is terrified of what would happen if a recession ever occurred — China has been pumping huge sums into infrastructure and state-directed business development for decades on end.

In fact, as a result of China’s aggressive spending on infrastructure — building all those ghost cities and highways to nowhere — China’s internal debt ratios are approaching catastrophic levels.

According to the International Institute of Finance (IIF), China’s domestic debt — not including foreign debt — rose to 335% of GDP in 2020. That is more than triple the debt-to-GDP ratio of the United States as of year-end 2020.

In addition to being far more leveraged than the United States — and not just by a little, but rather a huge margin — we can also say China’s economy is dangerously imbalanced.

The Chinese government is addicted to “supply-side” economic growth boosters — stuff like building infrastructure, expanding business capacity, and so on — while extremely weak on “demand-side” measures, which comes from boosting domestic spending (households supporting the economy locally).

One might ask, why doesn’t China just find a way to increase its level of household spending? Why don’t they just start building up their domestic economy, instead of relying so much on exports and non-productive infrastructure projects?

The answer there is because, first, China’s economy is already so maxed out on debt (note the 330% debt-to-GDP estimate) that the Chinese government is extremely worried; and second, because China has become addicted to supply-side spending at the regional and local level.

The Chinese government is not just a handful of bureaucrats in Beijing running everything; it has dozens of layers, filtering all the way down to regional and local entities — the equivalent of governors, mayors, local councils, and so on.

At the same time, the structure China has created is like a vast plumbing network that is incredibly hard to fix or change. The whole system is built to fund more infrastructure and more business investment, with regional and local officials taking a cut of the action; it has been this way for decades.

That is why China can’t just turn off the spending on the supply side; the existing structure won’t change that easily. Nor can China start spending on the household side to increase consumer demand.

The reason China has been talking about debt discipline lately is not out of fiscal prudence (though that is the image they like to project), but rather out of hidden panic at how bad the unproductive spending has gotten behind the scenes. 

In the United States, the picture is very different. Domestic consumption in the U.S. already hovers around 70% of GDP, which means local consumption powers the economy. Then, too, the United States is in the opposite position to China when it comes to infrastructure.

Whereas China has been overspending on infrastructure for years now — think ghost cities and bridges to nowhere — the United States has a number of productive infrastructure projects it can invest in (because U.S. infrastructure has been neglected, rather than overbuilt).

What this means is that, in a real trade war, or a sustained slowdown of international trade, China would be extremely vulnerable — far more so than most pundits realize.

China’s debt levels are terrifyingly high; its domestic spending levels are painfully low relative to rich industrial nations; and the situation is not easily fixed because Chinese government officials, at many levels below Beijing, are addicted to the non-productive supply-side projects that line their pockets.

Then, too, the picture gets worse for China when one considers inflation vulnerabilities. China has to import agricultural products to feed itself, whereas the United States is an agricultural superpower that produces more food than it can internally consume. China also has to import oil and gas, whereas the United States is an energy superpower thanks to the shale revolution.

The agricultural and energy angles mean that, were food or energy prices to rise sharply (a real possibility in the coming years), China’s economy would be exposed to painful inflation with no way around it — you can’t not have food or not have oil — whereas the U.S. would be significantly insulated via internal production of food and energy.

Then, too, another factor looms that favors a confrontational attitude from the United States.

The heavy fiscal stimulus being deployed by the United States is going to power an aggressive economic recovery; the more that the stimulus funds are spent domestically, the more powerful that the economic recovery will be. That gives the United States an incentive to restrict or discourage imports.

In economics, there is a concept known as “marginal propensity to consume,” or MPC for short. MPC is a measure of how much someone will spend on consumption if they come across new funds.

As a general rule of thumb, the MPC for a wealthy person is zero, because they already have enough cash to buy whatever they want. As such, if you give money to a wealthy person, they will likely invest it.

The MPC for lower-income individuals, on the other hand, tends to be very high. The greater the gap between what a family needs and what a family can afford, the higher the likelihood that family will spend with new funds that are coming in. This means buying the “stuff” that powers daily life: Diapers, peanut butter, a new air conditioner, school clothes, and so on.

So, the United States is going to experience blockbuster growth in 2021, in part, because lower-income individuals are going to do catch-up spending in huge amounts, even as middle-income and wealthy individuals spend aggressively in an embrace of normal life and all the things they missed in 2020.

But to the degree that American households spend money on imports — buying “stuff” that is produced abroad — that is the rough equivalent of the $1.9 trillion stimulus leaking out at the edges, helping to power the recoveries of other countries versus staying within the United States

And to the degree American households are encouraged to spend more money locally — meaning, to the degree they consume more goods and services produced domestically — the more that the impact of the stimulus will stay within the U.S. economy, strengthening in a feedback loop of local business profits and increased local employment.

The geopolitical implication here is that, if the United States were to start a trade war with China tomorrow, it might actually help the U.S. on balance — or at minimum would hurt far less — because spending that was directed toward imports would go toward local products instead.

And to the extent the U.S. further embraces “demand-side” spending — meaning, the government is sending money to consumers, which increases consumer demand — the U.S. has increased incentive to reduce international trade flows, to the extent that consumers spend more locally versus spending on imports.

China, again, is in the exact opposite position. The Chinese government is far more leveraged than the U.S. government — almost to the point of crossing over the edge — and China cannot rely on local domestic spending to power its economy. As such, were China to lose its export channels, it would seriously hurt.

Nor can China really afford to attack the United States economically by, say, dumping treasury bonds for example. That is because, were China to take actions that substantially weakened the dollar, those same actions could trigger an inflationary spike in food and energy prices — which could be potentially disastrous for China, a forced net importer of both.

When you put the whole picture together, the United States is in a very dominant position relative to China — and even has a natural incentive to push for confrontation, because a reduced flow of imports would only make the U.S. domestic economy expand faster. 

This may explain why, on Monday, March 22, the United States joined with Canada and the United Kingdom to announce new sanctions on China in relation to human rights violations. You can read the U.S. Department of State press release here. 

Our overall view is that the time has come for the West to start confronting China in a serious way, and that, at the same time, the United States has an economically dominant edge over China and is well aware of it.

For these reasons, we can expect U.S. pushback on China to increase — which means we can also expect general tensions to ratchet higher. That, in turn, has negative implications for U.S. businesses with exposure to retaliatory measures from China, and broader negative implications for emerging markets in the world.

To sum up with a poker metaphor: The U.S. has the strongest hand and the biggest chip stack at the geopolitical poker table right now; China likes to act as if its hand is strong, but China is actually bluffing. The U.S. knows this, and things are about to get intense.

Tesla’s share price — which closed 24% off its highs yesterday — saw a nice little bounce (though still down 24%) after ARK Investment management released its latest Tesla price targets for 2025.

The targets are not just unrealistic, they are laugh-out-loud unrealistic, almost to the point of being nonsensical. They offer three levels:

• “Bear case”: TSLA reaches $1,500 by 2025 (123% gain from the March 22 close).

• “Expected value”: TSLA reaches $3,000 by 2025 (348% gain from March 22 close).

• “Bull case”: TSLA reaches $4,000 by 2025 (497% gain from March 22 close).

For Tesla to fulfill the ARK bull case, it would need to have a greater than $3 trillion market cap in four years. The “expected value” case is a slightly lower hurdle, suggesting a market cap above $2 trillion.

Tesla, as of this writing, still doesn’t turn a profit by making cars. Its profitability to date comes from selling regulatory credits.

Meanwhile, the market cap of Volkswagen — either the No. 1 or No. 2 automaker in the world by volume, routinely competing with Toyota — is less than $200 billion as of this writing.

Here is another way to look at it: The total market cap for the 10 largest automakers in the world by valuation, excluding Tesla, comes to about $915 billion.

So, ARK expects Tesla — which had less than 1% of global auto volume in 2020 — to be worth more than double the total present value of the top 10 automakers in the world by 2025 — as an “expected value” case — and more than triple the top 10 as a bull case.

Again, this is not just outlandish — it is nonsensical.

In the past, we have joked that, in order to justify its loopy Tesla bullishness, ARK was factoring in the prospect of self-driving cars on Mars.

It turns out our joke was merely half a joke. The ARK price targets for 2025 are based on the assumption Tesla will dominate the self-driving taxi business — which, of course, does not exist yet — along with assumed production volumes of 5 million to 10 million vehicles per year.

Meanwhile, in the real world, Tesla delivered fewer than half a million cars in 2020, which means ARK is assuming a Tesla production ramp-up of somewhere between 900% and 1,900% — while somehow maintaining profit margins that justify a valuation 10 to 15 times higher than Toyota’s or Volkswagen’s  (automakers who can already produce 10 million cars a year) — and further assuming Tesla will beat all other competitors to self-driving dominance, while pioneering a business model that doesn’t exist yet (the self-driving taxi business), in the face of self-driving challenges far more thorny than expected not just for Tesla, but the entire industry. (At the rate we are going, it could be 2030 before self-driving cars are well and truly a thing.)

Meanwhile, in the real world, it remains possible to fool Tesla’s self-driving software with a piece of black electrical tape applied to a road sign.

Pranksters demonstrated this by using a piece of tape to modify a sign that said SPEED LIMIT 35 MPH in such a way that Tesla’s cameras interpreted the “3” as an “8,” causing the vehicle to auto-accelerate to 85 mph in a 35-mph zone.

Elon Musk’s response to the above news on Twitter — we kid you not — was to reply with two laughing-face emojis: No text, and no sign of concern — just the two emojis.

Adding to the sense of “can this actually be real,” the wildly inappropriate Twitter response from Tesla’s CEO — or, Technoking, according to the recent SEC filing — came in the immediate aftermath of an incident in Lansing, Michigan, now being investigated by the National Highway Traffic Safety Administration (NHTSA), where a Tesla drove into a parked police car.

Here is the reporting from WLNS.com, the website of a local news station:

Michigan State Police said a Tesla on autopilot drove into a Lansing area trooper’s patrol car.

It happened around 1:10 on Wednesday morning as the trooper was investigating a car vs. deer traffic crash on I-96 near Waverly Rd. in Eaton County.

MSP said while investigating that crash with their emergency lights on, a Tesla on autopilot drove into the patrol car…

Laughing emojis indeed: This whole thing is nuts, and reminiscent of a zany comedy sketch. For those old enough to remember it, one can almost hear the “Benny Hill” theme playing in the background.

Then we remember there are true-believer investors with the bulk of their life savings wagered on Tesla, and we don’t know whether to laugh or cry (or both).

But, if you do have any money in Tesla, we urge you to erect a “volatility wall” now. ARK might need to act zany and irrational, but you don’t. Go here to start protecting your TSLA shares — and any other stocks that ARK might get their hands on.

In our view, the ARK price target is a form of rationalized insanity based on the fact that ARK is trapped.

You see, the entire ARK business model depends on the assumption that the sky-high valuations of stocks they own — not just Tesla but many others — will stay sky-high for the duration.

Not only that, in order to keep the game going, the valuations of these companies cannot just hang out around the moon; in order for ARK to keep delivering outsized returns in its ETF vehicles, those valuations have to soar well past the moon, far out into the solar system, and wind up on Mars.

As an investment shop, ARK has zero incentive to be rational.

Being rational would mean admitting that the entire speculative tech landscape got pumped up by trillions of dollars in emergency stimulus amid a “lower for longer” interest rate backdrop, via one-off pandemic conditions that will not be repeated.

Being rational would further require admitting, openly and honestly, that many of ARK’s favored names (including Tesla) could see their share prices fall dramatically from their peaks, by as much as 50 to 70% or even more.

Even the mighty Amazon saw a drawdown of roughly 95% between December 1999 and October 2001 — this is just the way of things.

But ARK does not have the option of being rational, you see, because acknowledging rationality would effectively be the same as telling their investor base to sell, which would potentially accelerate a tech valuation collapse driven by a powerful economic recovery (real growth crowding out speculative fever) and rising long-term yields destroying the “lower for longer” case.

In a strange way, then, the ARK price targets for Tesla are completely rational — but rational relative to the situation ARK is in, not the trajectory of Tesla’s share price over the next few years.

ARK has no business incentive to be logical with respect to Tesla’s prospects, and very strong incentive to perpetuate a fantasy on the hope that things miraculously work out; and so that is what they do.

One of the reasons we pound the table on this subject is not to dunk on ARK or make hay from their folly, but because we don’t like to see ordinary investors getting hurt.

Our strong hunch is that, when all is said and done, investors in the ARK family of ETFs will have collectively lost a larger sum than they gained, in terms of total absolute dollar amounts; a result like this is possible, or perhaps even likely, because the vast majority of billions flowed in at the end, when the valuations were highest and the timing was worst. 

As for why the Technoking of Tesla (Musk, per his own anointed title) is posting laughing emojis in response to existential business risks, we’ve got no answer for that one — other than the possibility he is starting to crack under stress. 

Relations between the United States and China are on a downward slope, and tensions are on an upward slope. This has been true for a while now, enough so to fuel talk of a “new Cold War” between the U.S. and China, alternately known as “Cold War 2.0.”

The original Cold War played out between the United States and the Soviet Union, beginning shortly after the end of World War II and lasting until the Soviet Union’s collapse in 1991.

It was called the “Cold War” in part to distinguish an absence of hot war, meaning, tensions were high but no missiles were fired (with a handful of extremely close calls).

In some ways, though, Cold War 2.0 is a bad description of the U.S.-China relationship. In the original Cold War, the U.S. and the Soviet Union were true rivals who shunned the notion of doing official business with each other; the U.S.-China situation is not like that at all.

Instead the U.S. and China are intertwined in many ways, with finance and commerce links that would be incredibly painful to sever. For instance, China relies on American demand to help power its export-driven economy, and some of the most valuable American companies in the world (e.g., Apple and Tesla) have a substantial share of revenues, profits, and future growth prospects tied to China. 

This makes the U.S.-China relationship more like a bad marriage than a Cold War.

It’s a relationship that once had better days, but has increasingly gone sour; it has a significant amount of shared commerce and property interests in common; there are multiple third-party relationships to consider (e.g., countries being asked to pick a side, America’s or China’s); and unless things get catastrophically bad, a full divorce is probably not in the cards.

A common characteristic of a bad marriage is the tendency to hide one’s true feelings. For the sake of keeping the peace — or avoiding a downward spiral — both parties keep their real opinions hidden.

Keeping real opinions hidden is also standard operating procedure for foreign diplomacy.

As a general rule, the skilled diplomat does not speak bluntly on controversial issues. Instead, he or she maintains a careful protocol of civility and decorum, while delicately addressing the controversies behind closed doors.

That is the way it typically goes. At a certain point, though, a bad marriage can deteriorate to the point where confrontation is inevitable. Once that point is reached, it is mainly a matter of how the confrontation is handled — with results that can range from civil and productive to ugly and disastrous.

The U.S. and China are now in the blunt confrontation stage of their relationship. The last shreds of formal civility and tip-toeing around hard issues are gone. Now it is about blunt talk, harsh words, and the question of whether U.S.-China conflicts will be resolved with dialogue or violence.

The change was on display at a high-stakes, two-day diplomacy meeting between the U.S. and China in Alaska last week. It was the first official contact between China and the Biden administration — and the Biden administration chose to play hardball.

Antony Blinken, the U.S. Secretary of State, began the talks with harsh criticisms of China’s actions in relation to human rights violations in Xinjiang, authoritarian actions in Hong Kong, and saber-rattling toward Taiwan.

“Each of these actions threatens the rules-based order that maintains global stability,” Blinken said. “The alternative to a rules-based order in which might makes right and winners take all,” Blinken added. “That would be a far more violent and unstable world.”

Under normal circumstances, that kind of blunt talk would be unheard of from a foreign diplomat — let alone from the U.S. Secretary of State. But the U.S.-China relationship is not in a normal place.

Yang Jiechi, the top diplomat on China’s side and a right-hand man of President Xi, responded with equal force. Whereas the schedule allowed for two minutes of opening remarks on each side, Yang spoke for roughly 16 minutes.

Yang accused the U.S. of having a “cold war mentality,” questioned the health of American democracy, and more or less accused the U.S. of being a bloody-minded imperialist power. “We do not believe in invading, through the use of force or to topple other regimes… or to massacre the people of other countries,” he said.

In diplomatic talks, it is standard procedure for members of the press to listen to the opening remarks, and then leave the room before the high-level discussions begin.

But this time, in a further display of norm-shattering, U.S. Secretary of State Blinken asked reporters to stay in the room after Yang Jiechi’s 16-minute speech, so that the media could note the U.S. rebuttal to China’s response.

The whole thing was quite remarkable — in some ways like a marriage counseling session where both parties are encouraged to let it all out, ripping into each other as they do so.

Two days prior to the talks, the Biden administration had placed sanctions on 24 officials in China and Hong Kong, relating to China’s decision to strip Hong Kong of its autonomy with a new election law.

The harsh tone that kicked off the Alaska talks was part and parcel of that sanctions decision; it is very clear the days of friendly discussion are gone.

The Biden administration has likely calculated that, at some point, an effort has to be made to forcefully push back against China — and there is no time like the present.

To that end, the U.S. is simultaneously seeking to rebuild alliances within “the Quad” — a four-way partnership between the U.S., Japan, India, and Australia — as a means of countering China.

The state of the U.S.-China relationship is high stakes for investors, too, because of the direct impact it can have on global markets generally and various companies specifically.

Tesla, for example, looks quite vulnerable to retaliatory Chinese actions — with two extra helpings of risk because first, so much of Tesla’s growth story is predicated on China-based sales; and second, because China has a natural incentive to ambush Tesla anyway, once it has gotten what it wanted (a transfer of knowledge and competitive know-how to its home-grown EV industry).

We’ll dig more into the growing Tesla risks later this week; for now, the main takeaway from the Alaska talks is that the U.S.-China relationship is entering a stage one could consider the opposite of boring: No matter what happens, there are going to be more fireworks.

And because the U.S.-China relationship is so intertwined — like a bad marriage on a global scale, touching countless aspects of commerce, technology, finance, geopolitics, and more — there will almost certainly be some volatile and surprising outcomes ahead. 

Wild and weird developments continue to unfold in the electric vehicle (EV) space.

For instance, Elon Musk gave himself a new official title this week: “Technoking of Tesla.” Zach Kirkhorn, the Chief Financial Officer of Tesla, was also given a new title: “Master of Coin.”

It sounds like a joke, but it isn’t. Or rather, Musk’s actions might be a joke — played on his own shareholders — but the titles were actually filed with the Securities and Exchange Commission (SEC).

Lenient Tesla shareholders might say: “Oh, that’s just Elon being Elon.”

And yet, surely, some shareholders will be feeling less lenient with Tesla shares down 26% from the January peak (as of the March 18 close). With another bad day or two, all of the gains from S&P 500 inclusion could be wiped out; if TSLA continues to decline, the antics will become less and less funny.

And here is where things get strange: While Tesla’s shares are cratering in full-on bear-market mode, the shares of old-school automaker Volkswagen rocketed higher this week, in part thanks to new optimism surrounding Volkswagen’s plans to challenge Tesla.

In fact, the Volkswagen AG share price (VWAGY on the pink sheets) moved so far, so fast this week, the Volkswagen chart looks like an echo of the GameStop short squeeze — or perhaps the original Volkswagen short squeeze of 2008.

Nor is it just Volkswagen feeling the love. The share prices of Ford and General Motors have roared higher in recent days, seemingly on optimism regarding their ambitious EV plans.

It is hard to make sense of this.

• At first, Tesla was supposed to be the dominant EV juggernaut whose technology, and profit margins, would dominate all other players.

• Then room was made at the top for dozens of EV-related companies, on the assumption that not just Tesla, but multiple new players — like NIO, Xpeng, Nikola, and so on — would own tomorrow’s EV market and crush the old guard.

• And now, with Tesla and the other EV upstarts tumbling, bets have shifted back to the old guard, who will supposedly — we’re not sure what, exactly — conquer new heights of profit with their EV efforts somehow.

It doesn’t make sense because it was never supposed to make sense.

The original inflating of the EV bubble was not based on some rational accounting of the EV market as a competitive space — it was just a wall of money rushing in for a payday. With the original EV thesis fraying at the edges, that money is now rushing hither and yon; the only thing to make sense of is a tendency for manic behavior.

In many ways, the efficient market hypothesis (EMH) is pure nonsense, in the sense that EMH assumes an overlay of rationality that never existed.

In trying to rationally justify a price level, Wall Street analysts often do the same thing. They will start with, say, the empirical observation that Tesla has a $609 billion market cap, and then try to reverse engineer a rational, forward-outlook-based case for why that market cap exists.

Sometimes there really is a rational case; but at other times it is just the wall of money, or, in Wall Street parlance, “flows.” Flows don’t have to be rational; flows are just flows.

This is why investors can appear to embrace wild contradictions, like, say, giving Tesla a valuation that implies it will crush the old-school automakers — and then ramping the valuations of the old-school automakers simultaneously, on the theory they will be serious EV contenders.

Quant-based money manager Rob Arnott, along with Lillian Wu and Bradford Cornell, released an intriguing research paper this month that explains how the thinking process works. It is titled “Big Market Delusion: Electric Vehicles,” and you can read it here. Here are the key points:

• The “big market delusion” is when all firms in an evolving industry rise together, although as competitors, ultimately some will win and some will lose.

• The electric vehicle industry, with its astronomical growth in market cap over the 12 months ending Jan. 31, 2021, is a prime example of a big market delusion.

• In the highly competitive and capital-intensive auto industry, the January 2021 valuations of electric vehicle manufacturers are simply not sustainable over the long term.

The paper goes on to underscore that “the hallmark of a big market delusion is when all the firms in an evolving industry rise together even though they are often direct competitors.”

It seems the opposite of rational, and the opposite of efficient, to bet that a whole crop of entrants can win a zero-sum game. In sports-betting terms, it would be like pricing every football team as a lock to win the Super Bowl. That isn’t how competition works; it doesn’t compute.

And yet, in theory, there is a justification for the “everyone’s a winner” approach. We can call it the venture capital model.

When a venture capital firm makes 10 investments, the expectation is that most of those investments will fail or otherwise lose money, but the gains from one or two out of 10 will cover all the losses.

The venture capital game is about spreading one’s bets across a new technology space, on the theory that you can’t be sure who will become the dominant player. So you make multiple wagers, and expect to lose on most of them, and then hope to turn a profit, on balance, through the outlier winners that rise above the fray.

In their zeal for defending the efficient market hypothesis, some economists have latched on to the venture capital model — or some version of it — to argue that markets are still efficient even in the presence of big market delusions.

If you bought all the EV names as an equal-weighted basket, this argument goes, and then made money on balance 10 years later from the one or two winners, that is enough to argue for market efficiency.

And yet, when venture capitalists do their thing, an important part of the methodology is awareness that 90% of the investment portfolio (if not 95%) could wind up as a tax write-off.

The venture capitalist who spreads their bets is not only cognizant of the need for a huge win to justify the strategy, but knows that most of the investments will fall somewhere between unprofitable and a complete loss.

Do investors in the EV space have that willingness to accept, in advance, the likelihood that 90% or more of the space could be wiped out? We doubt it.

In a funny way, the whole EV journey makes perfect sense to us — and doesn’t seem strange or puzzling — because it is just human behavior writ large. Trying to understand the rationality of market pricing is just the wrong lens, because sometimes there isn’t any; it is more about understanding the hardwired irrational tendencies of human behavior, which in many respects are predictable and timeless.

In the TradeSmith Daily for Oct. 12, 2020, we wrote:

If you haven’t bought Bitcoin for the first time yet, the odds are good that you will. The question is whether you will do it sooner — and be glad that you did — or do it later and wish you had acted much earlier.

Bitcoin as priced in U.S. dollars (BTC/USD) closed at $11,563 the day those words were broadcast. As we write today on March 18, 2021 — just over five months later — the Bitcoin price has more than quadrupled.

The speed of the move has been a pleasant surprise. The direction and magnitude, however, were no surprise at all. As we explained in 2019, Bitcoin has a historic one-time journey to make on the road to becoming a global store of value, and that journey is far from over.

The way to think about it, in our view, relates to the stabilization point for Bitcoin’s “store of value market share” relative to gold; were Bitcoin to attain 50% market share, for example, the value of all the Bitcoin in the world versus that of all the above-ground gold in the world would be equal.

Were Bitcoin to have 33% market share, in contrast, the ratio of Bitcoin’s total value versus gold’s would be 1-to-2; at 25% market share versus gold, it would be 1-to-3.

Either way, the present-day, above-ground gold supply is worth roughly $11 trillion. Such implies that, wherever the ratio ends up, Bitcoin has miles to go before it sleeps (in the sense of reaching a low-volatility price plateau). 

In 2019, we explained in detail to TradeSmith Decoder readers how Bitcoin would cross an “institutional bridge,” with a cycle of adoption and investment allocation from the world’s largest money managers and asset allocators driving a cycle of higher Bitcoin prices through the laws of supply and demand.

In recent months, the flow of institutional adoption news — Bitcoin being embraced by this institution or that — has felt almost constant, with headlines every week if not every trading day. The trend continued this week, with CNBC breaking the following news on March 17:

Morgan Stanley is the first big U.S. bank to offer its wealth management clients access to Bitcoin funds, CNBC has learned exclusively.

The investment bank, a giant in wealth management with $4 trillion in client assets, told its financial advisors Wednesday in an internal memo that it is launching access to three funds that enable ownership of Bitcoin, according to people with direct knowledge of the matter.

The move, a significant step for the acceptance of Bitcoin as an asset class, was made by Morgan Stanley after clients demanded exposure to the cryptocurrency…

To quote Bruce Willis in the 1980s action movie, Die Hard: “Welcome to the party, pal!”

For many investors, the “digital store of value” concept is hard to wrap one’s head around. But they are starting to get it, in part by expanding their repertoire of mental models — the mental picture of what constitutes a store of value, what its critical functions are, and so on.

When a concept is so new or different it feels hard to grasp, it can help to relate that concept to something more familiar. On May 5, 2020 — when BTC/USD was below $9,000 — we said the following:

Before Bitcoin, only gold had served as a reliable and immutable store of value for the entire world. Bitcoin has taken that use case and gone digital with it.

In our view, that level of value-add to the world — acting as a store of value that is truly digital, truly trustable, and accessible to everyone — is potentially worth more than all of the FANG stocks put together. We also suspect that, in due time, the world will figure this out.

In the name of mental model expansion, we can play around with the FANG concept by imagining Bitcoin as a FANG-like entity — a technology juggernaut like one of the “big four:” Apple, Amazon, Google, and Facebook.

At present moment, the market capitalization of Apple, Amazon, Google, and Facebook added together amounts to slightly less than $5.9 trillion.

For Bitcoin to be worth more than all those put together, it would need a market cap in the $6 trillion range — or about 500% appreciation from current levels. Given that physical gold’s market cap is currently about $11 trillion, a BTC/USD market cap of $6 trillion does not feel like a stretch; in fact, it feels conservative.

But the point is not to pick a level or a dollar-based target, because all of these numbers will move around. It is more to get a sense of magnitude, and to compare the potential trajectory of BTC/USD to more of a known entity that investors are familiar with — the valuation of the tech juggernauts, in juxtaposition to the services they provide.

As a hypothetical FANG, Bitcoin does not have a physical, tangible presence. But neither does Google, unless one counts, say, thermostats and home speakers, which are less than a rounding error in total revenue terms. (The same goes for all of the physical devices Google makes, in comparison to digital search advertising.)

One can then ask: Since all the FANG juggernauts make money, what monetizable service does Bitcoin provide? The answer there, as one might guess, is “digital store of value:” It is useful having the ability to hold one’s savings in a commodity (Bitcoin is treated as a commodity by U.S. regulators) with maximum scarcity, maximum ease of transport, and global reach.

And in terms of universality, it is hard to get more universal than the global store of value case. Not everyone needs web search or social media or e-commerce — but anyone with savings, from the largest conglomerate to the lone saver, can benefit from having a place to store those savings, easily and simply, in a manner that protects against fiat currency depreciation.

What about the profits, though? All of the tech juggernauts are money makers, and Bitcoin seems to have no return-on-revenue stream. Except this isn’t exactly true: Bitcoin provides a stream of cash flows for BTC miners, who keep the network running by mining new coins and verifying transactions.

Then, too, investors in BTC see capital appreciation in the same manner as, say, the holders of a tech stock that pays no dividends; the increasing value-add is built into price appreciation as a supply-and-demand function.

What about the innovation factor, and all of the brilliant engineers and coders who work for the tech juggernauts? On this front one could argue Bitcoin is even more FANG-like than the juggernauts: The Bitcoin ecosystem is a kind of decentralized collective, maintained and upgraded at the margins by some of the smartest people in the world.

If one had to tally the number of brilliant coders working on innovative Bitcoin use-case extension projects at any given time — including all of the private entities and institutions building payment rails for BTC, and on-off ramps for usage of BTC in various ways — the collective coding power of the Bitcoin ecosystem might even exceed the big four already (think tens of thousands of brilliant individuals, all working on BTC-related projects that benefit the Bitcoin ecosystem as a whole, at any given minute of any given day).

One reason investors may feel intuitively comfortable with the FANG juggernauts, but not with Bitcoin, is because the dominant sphere of, say, Google or Facebook has the feel of a tangible thing. Even though these entities are virtual, they have servers and people and services and network effects, and a level of power, built up in a kind of flywheel, that cannot be replaced or replicated.

Trying to build another Google or Amazon or Apple or Facebook, in a world where the original already exists — and wields its competitive advantages with full force, while continuing to innovate as fast as it can — would likely not just be hard, but almost impossible.

In that respect, Bitcoin is the same. The inherent dominance of Bitcoin is not just about the decade-plus ledger history (although that matters quite a bit) or the global reach and branding (which matters a lot, too); it is also about the living, breathing nature of the Bitcoin ecosystem, and all the ways BTC is rapidly evolving at the margins in terms of accessibility and use-case applications.

Trying to replicate Bitcoin’s inherent advantages — and most critically the physical tangibility of the Bitcoin ecosystem — strikes as just as hard, if not even harder, than attempting to rebuild a tech juggernaut from scratch, while fighting the mighty incumbent who continues to improve as fast it can.

On Feb. 17, we said America is Winning the Vaccine Race. A month later that assessment has proven spot-on. While the United States administers more than 2 million shots per day, nearing 3 million, Europe is descending into a new COVID-19 nightmare.

The situation looks dire in Europe, with a “third wave” of COVID now sweeping the continent. Italy has entered a third national lockdown. Poland — the EU’s fifth-largest nation by population — is considering a new lockdown as COVID cases spike by 74%. And in France, per the French minister of health, “Every 12 minutes night and day, a Parisian is admitted to an intensive care bed.”

At the same time, administration of the AstraZeneca vaccine — which the EU wagered heavily on, largely due to its lower cost versus the Pfizer and Moderna vaccines — was suspended in multiple EU countries for fear of blood clot side effects, either slowing the rollout or grinding it to a halt in some places.

Europe’s mishandling of the vaccine rollout started as a bungle, and it now threatens to become a catastrophe. To get things back on track, EU authorities are pondering extreme measures.

Ursula von der Leyen, the head of the European Commission, believes the EU must consider “emergency controls on vaccine production and distribution,” per the Financial Times. “We are in the crisis of the century,” von der Leyen said, adding that “I am not ruling out anything for now.”

The EU is planning an emergency vaccine summit next week, in which the heads of state or government for all 27 EU members will meet. Depending on what gets decided, it is possible the EU may restrict vaccine exports, or even force vaccine production facilities on local soil to tear up their existing contracts.

If moves like these are made, they would be jarring violations of free-market principle and international trade law, justified on the basis of a war footing — comparable to how factories were commandeered for state-mandated production during World War II. 

Europe’s vaccine problems began with an overly bureaucratic negotiation process, a short-sighted overreliance on the AstraZeneca vaccine for the sake of lower costs, and a pile-up of production and distribution delays.

All of those issues were then intensified by blood clot fears relating to the AstraZeneca vaccine. At least 16 EU member nations — including France, Germany, Italy, Spain, and Sweden — chose to slow or suspend the AstraZeneca rollout based on 30 cases of blood disorders out of 5 million recipients of the AstraZeneca vaccine.

The head of the European Medicines Agency (EMA) has said the EMA believes the AstraZeneca rollout should go forward, with the benefits outweighing the risks. Boris Johnson, the Prime Minister of the U.K., also publicly announced he would soon be taking an AstraZeneca vaccine himself, in a move to help restore public confidence in the vaccine. 

And yet, even if the suspensions are completely lifted, the damage may have been done in terms of vaccine hesitancy and a public loss of faith in the AstraZeneca vaccine. In desperate straits as the third wave of COVID worsens, the EU is reportedly considering Russia’s Sputnik vaccine as an alternative.

The question before was how much Europe’s recovery would lag the U.S. recovery. The new question is whether Europe will experience a recovery at all — or slip into a new downturn or recession instead.

In the EU, the last round of mutually agreed pandemic relief was a hard-fought battle between the “frugal five” EU members — Germany, Austria, Denmark, the Netherlands, and Sweden — and the countries in dire need of fiscal help, like Italy and Spain.

Europe’s next round of fiscal stimulus (pandemic relief) could put an even larger strain on the budget. And yet, the “frugal five” EU members may not fight as hard against it this time, because they will need it, too. 

Alternatively, if the austerity mindset wins out, and Europe tries to make it through a new COVID-related downturn with no help, EU economic output could shrink painfully.

If the austerity scenario happens, Italy and Spain will once again wonder aloud why they should stay in the EU in the first place, the logic being: “If you won’t help us in a real crisis, when will you help us at all?”

Either way, in our view, the differentials between the United States and Europe already favored the dollar relative to the euro. Now, as Europe’s COVID teeters on the edge of catastrophe, those same dynamics dramatically favor the dollar.

In our view, the EU will likely be forced to issue hundreds of billions of euros’ worth of new fiscal relief to battle economic COVID fallout — or alternatively face centrifugal political forces (cries of anger from Italy and Spain) that threaten to tear the EU apart.

Either scenario, juxtaposed against a vigorous U.S. recovery and world-beating vaccine rollout, points to a far lower exchange rate for EUR/USD.