From towering debt to bitcoin’s boom, why 2021 is the year of living dangerously

Vaccination is unshackling major developed economies and money is flowing into real economies, sparking overheating and inflation
This may spell the end of the speculative boom in both traditional financial markets and new products like cryptocurrencies and NFTs

Andy Xie

Published: 1:30am, 3 Jun, 2021

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In 2020, four major central banks added US$7.8 trillion in quantitative easing and, according to the Institute for International Finance (IIF), governments of the top 61 major economies expanded debt to 105 per cent of gross domestic product – from 88 per cent in 2019 – an increase of US$12 trillion, in response to the Covid-19 pandemic.

As the Covid-19-constrained economies couldn’t respond to the stimulus, the massive injection of funds largely went into financial markets and sparked a speculative frenzy.

With vaccination unshackling major developed economies, money is flowing into real economies, sparking overheating and inflation, which may prompt some tapering of the Covid-19 stimulus.

Financial markets could face the double whammy of funds being diverted away from speculation to the real economy, combined with diminishing aggregate money supply. It’s clear 2021 is the year of living dangerously.

Governments around the world have made a colossal mistake in their handling of the economic consequences of the pandemic. It has short-circuited normal consumption and production activities. Stimulus couldn’t cure that. Instead, the massive monetary and fiscal stimulus showed up in financial markets.

As vaccination restores normal economic activities, the stimulus that wasn’t needed in the first place will lead to overheating and inflation. The first sign of money flowing out of financial markets is the overheating of the real estate sector. This occurred in China in the second half of 2020.

Now this phenomenon is affecting the US, Britain and many other major economies. Property inflation has a shorter path to consumer price inflation than pure financial inflation. It affects living and production costs.

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Given the combined impact of real estate and commodity price inflation, high-single-digit consumer inflation seems to be baked in for 2021.

The same governments appear ready to add another US$10 trillion in government debt in 2021, which would increase inflationary pressure.

Major central banks are still reluctant to talk about tapering the unnecessary Covid-19 quantitative easing to cool inflation. When markets panic over inflation, which is likely to occur this year, they will be forced to unwind.

Before he lost US$20 billion, he was the best trader you’d never heard of

It would then be too late to avoid a financial crisis. Now is the golden era of financial frauds. When the tide goes out, few will be decently clothed, and the global financial market might resemble a nudist beach.

History shows that financial crises recur because financial institutions are incapable of learning from their mistakes. Greed always gets them. The collapse of Archegos Capital Management, a family office that behaved like a turbocharged hedge fund, casts doubt on how sound big financial institutions really are.

Archegos reportedly lost US$20 billion in a booming market, while the banks that served it lost over US$10 billion. It appears that big banks are flying too close to the sun again.

A man walks past the New York Stock Exchange and the Fearless Girl statue on Wall Street on March 23. Banks associated with the ill-fated Archegos Capital Management are estimated to have lost US$10 billion. Photo: AFP

Financial sector debt has topped 2007 levels globally, increasing by US$4 trillion globally last year alone. It must be leverage provided to speculators by big banks.

Lately, bitcoin’s movements are affecting global stock prices. This shows how important crazy fringe assets have become to the overall financial system, because these assets have become popular. Bitcoin’s market capitalisation has topped US$1 trillion.

Special purpose acquisition company (SPAC) deals, essentially a back-door listing vehicle for dodgy businesses, are closing in on a market cap of US$1 trillion. Tesla, a small and barely profitable car company, almost made it to a market cap of US$1 trillion.

Why bitcoin is best relegated to a footnote in history

The latest trick for creating money out of thin air is non-fungible tokens (NFTs). NFT is basically a fancy word for “unique”. Your smelly socks today are unique.

No other smelly socks, even worn by you, would smell exactly the same. Hence, they are essentially NFTs. If you are famous, and you can make a digital version of them, that could sell for a tidy sum.

NFTs open up a channel for the unlimited creation of financial value, as long as central banks keep pumping in liquidity. This democratisation of creating bubbles anywhere and by anybody is highly destabilising for the financial system.

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You never know how much liquidity someone or something could suck away from main markets for trading in, say, a digital rendition of Cristiano Ronaldo’s smelly socks and football boots.

A trillion here and a trillion there soon add up to real money. As potential demand for money for speculation is unlimited and fast, can central banks keep playing the same game?

World debt, according to the IIF, reached US$281 trillion or 355 per cent of GDP in 2020. It increased from US$142 trillion in 2007, which preceded the 2008 global financial crisis. Low interest rates have made high indebtedness more stable, because it becomes easier to borrow more to pay off old loans.

As the global economy hasn’t grown much, you can be sure that much of the increase is in dodgy stuff, like “stir-frying” stocks, cryptocurrencies and NFTs. The debt is backed by something with value from a trading perspective, but has zero value in terms of fundamentals. When the party winds down, how much debt will be hanging in mid-air?

This year is a turning point one way or another. The inflationary trend is keeping central banks from adding more liquidity, even if they don’t unwind their assets, while the real economy demands more money to keep pace with inflation and more speculative assets compete for liquidity, too. The party is passing midnight, just wait for the big bang.

Andy Xie is an independent economist