Monday, January 31, 2022

Why Bank Negara and EPF should buy Bitcoin

 

Malaysia is currently reeling from the revelation of Genting Hong Kong’s bankruptcy. News of the bankruptcy is rousing the ire of many because the company was given an unsecured loan of RM2.5 billion by Maybank, RHB and CIMB – three of Malaysia’s biggest banks. The kicker is, the Employees Provident Fund (EPF) – Malaysian employees’ retirement fund – is one of the largest shareholders of these three banks at 14%, 43% and 16.5% respectively.

If the stock prices of these banks take a hit – as they are likely to, as an incident of this magnitude will rattle investor confidence – the EPF, which millions of Malaysians depend on for their livelihood post-retirement, will invariably receive a sizable haircut.

Sure, we can say that the banks should have done better due diligence or that they shouldn’t have given out unsecured loans, but the crux of the matter is, there is always counter-party risk when a fund as important as the EPF invests in banks, as these banks can and do provide loans to some businesses that end up failing.

But the EPF can’t afford to default. Too many people’s livelihoods are at stake. So, it’s imperative that it invests in an asset which has a high upside but minimal to no counter-party risk.

What if such an asset exists? And what if I told you that if Bank Negara Malaysia (BNM) were to put this asset on its balance sheet, it could both grow the treasury and move away from holding billions of dollars’ worth of inflating fiat currency?

Let’s look at how this can be done.

In my previous columns on inflation (columns 1234, and 5), I noted how rampant money printing was today. This devalues our currency, reduces our purchasing power and transfers our wealth to the rich.

The antidote to this plague of easy money – money that can be created at will by a monopolistic organisation (the central bank) at the behest of the government – is to switch to a hard money standard.

Hard money is money whose supply is capped and can’t be manipulated by the powers that be – or anyone for that matter. For millennia, gold served as hard money. Many ancient civilisations – from the Egyptians, the Chinese, the Indians and the Romans lusted over it, hogged it, went to war for it and draped their kings and deities with it.

Much more recently, and even when government-issued money was first devised, it was still tied to the gold reserves of the country. A nation couldn’t issue paper money unless these were backed one to one to their gold reserves. They were on the gold standard.

Even today, where national currencies have been cleaved away from the gold standard, and where governments are free to print money wantonly and inflate its value away, central banks still keep large gold reserves.

This is due to some of gold’s characteristics: It is scarce as it is difficult to extract, does not decay, rot or rust, can’t be counterfeited, and is aesthetically pleasing.

These characteristics make gold inherently valuable as money, not just valuable by government decree (aka enforced by men with guns), as fiat currencies are.

However, it’s not perfect.

There’s a reason people moved away from gold as money. It’s heavy to carry around, is not easily divisible and can easily be stolen. Imagine having to pay for a roti canai and a teh halia with gold. You’d have to pay using what are essentially flakes of gold, carry a heavy pouch full of gold coins and would have to live in perpetual fear of being mugged at knifepoint.

Paper money fixed this as it was easy to carry around and was a lot more divisible. More recently, credit cards and apps such as GrabPay and Touch’nGo e-wallet have largely solved the problem of having funds stolen as transactions can be done electronically.

However, this switch to both paper and digital currency still comes with huge counter-party risk. For example, since the ringgit is issued by BNM, and unbacked by anything, it can decide to print more money, making each unit of it less valuable over time and robbing us of our future purchasing power – something that has been happening for decades.

But now technology offers an alternative – something that seems far superior. An alternative that can function as hard money, is easy and cheap to transact with, and is an asset that will appreciate in value over time.

This alternative is bitcoin.

Bitcoin, in a nutshell, is a decentralised digital currency whose transactions are verified cryptographically and recorded in a public, distributed ledger called a blockchain. If this sounds like gobbledygook, watch this explainer video to get a better understanding of it.

Most importantly, there will only ever be 21 million bitcoins in the world as its supply is hard-capped, making it the only institutional-grade asset where supply is unreactive to demand.

For instance, if the demand for gold shoots up, gold miners will mine more gold, increasing its supply, and eventually bringing down its price. Similarly, if the stock price of a company shoots up due to high demand, they can perform a stock split, increasing the units of stock, thereby lowering the price.

But no matter how high the demand for bitcoin is, there will never be more than 21 million bitcoins in the world (almost 19 million of which have already been mined). This makes it the ultimate scarce asset.

Also, since the bitcoin network uses the SHA-256 encryption algorithm, it is, for all intents and purposes, unhackable. In addition, transactions can be sent online at any time, they settle in minutes and they only cost a few cents. And since it doesn’t have a leader or employees, isn’t tied to a corporation and doesn’t have a single point of failure, it can’t be controlled or subverted by bad actors. It has no counter-party risk.

Bitcoin’s many attractive attributes have not gone unnoticed, with demand for it skyrocketing, and bringing its price along for the ride. The chart below shows its performance for the past 10 years, where it has gone from being worth almost nothing in 2008, when it was first invented to now being worth around RM160,000 per Bitcoin.

In short, bitcoin is a new, robust, digital-native hard money; an asset which has outperformed all traditional assets since its inception; and is a way to opt out of the unjust, inflation-infested world of traditional finance – all rolled into one. It is the asymmetric bet of our lifetime.

Bitcoin’s history of incredible price appreciation, coupled with its characteristics that I have detailed above, should encourage institutions and corporations to consider buying and holding bitcoin in their balance sheets if they want to stay relevant and profitable.

Many, in fact, realise this. In 2021, El Salvador became the first nation in the world to approve bitcoin as legal tender and put it on its balance sheet. It seems quite apt that El Salvador translates to “The Saviour”.

Many other countries such as Paraguay, Panama and Tonga have signalled that they might be making similar moves in the near future. Just a few days ago, a Bill was tabled in the US state of Arizona to make bitcoin legal tender.

In addition, below is a non-exhaustive list of pension funds, insurance providers and high profile publicly-traded companies that have put bitcoin (the pure form or its derivatives) on their balance sheet:

  1. CalPERS, California’s $441 billion public pension fund;
  2. Altshuler Shaham, an Israeli pension company;
  3. Houston Firefighters’ Relief and Retirement Fund;
  4. Fairfax County (Virginia, US) Police Officers Retirement System;
  5. Mass Mutual, a multibillion dollar insurance company;
  6. Tesla, the trillion-dollar electric carmaker; and
  7. Morgan Stanley, a multibillion dollar investment bank;

In fact, Fidelity Investments, one of the largest asset managers in the world found that a whopping 36% – more than a third – of all institutional investors across the US and Europe own bitcoin and other digital assets.

Fidelity also made an incredibly astute observation in a recent report: “…there is very high stakes game theory at play here, whereby if bitcoin adoption increases, the countries that secure some bitcoin today will be better off competitively than their peers. Therefore, even if other countries do not believe in the investment thesis or adoption of bitcoin, they will be forced to acquire some as a form of insurance. In other words, a small cost can be paid today as a hedge compared to a potentially much larger cost years in the future. We therefore wouldn’t be surprised to see other sovereign nation states acquire bitcoin in 2022 and perhaps even see a central bank make an acquisition.”

Is BNM game enough to be the central bank that does this?

And I think the EPF should seriously consider holding this asset, especially since some pension funds already trust and hold bitcoin. The longer these institutions hold out, the higher the price they’ll have to pay to eventually acquire bitcoin and, hence, the smaller the returns.

And Malaysia badly needs to acquire hard assets. The table below is pulled from Bank Negara’s website:

BNM’s biggest holding by a large margin is in foreign currency, which I would assume is mostly denominated in US dollars (USD). However, as we’ve seen, the USD is being inflated away, with most other currencies faring even worse.

And gold, an actual hard asset, accounts for less than 2% of BNM’s reserves, which is worrying.

But even gold has pretty much stayed stagnant for the past 10 years. That’s because there’s a new player in town – a new player that’s been eating its (gold’s) lunch; a new player that holds promise of becoming one of the, if not the, primary treasury reserve assets for the world’s central banks and corporations in the next few decades.

In fact, our former prime minister Dr Mahathir Mohamad had something strangely prophetic to say in an interview in 2005: “As you know, what we have up to now, is not what we had at Bretton Woods. At Bretton Woods, the decision was to fix exchange rates, to value the dollar according to a certain quantity of gold. An ounce of gold would be worth I think US$38 or something. Under Nixon, they went off the gold standard, and from then on, the US currency has had no backing. And now, because it owes the world more than US$7 trillion, it is a nation in debt. It is a nation that has, actually, no money, and exists on the basis of loans from other countries, and the acceptance of the US dollar as a trading currency. So we need to sit down and discuss these things in order to resolve and formulate a new international exchange regime that is more stable. Probably, based on gold again; but it may be some other formulation.”

This “some other formulation” could very well be bitcoin. So, it may be prudent for BNM and EPF to get some just in case, or they could risk getting left behind in a world that’s increasingly adopting a bitcoin standard.

If they are afraid to stretch the risk and want to be cautious given the current unpredictability of the price of bitcoin, they can buy both gold and bitcoin. But they shouldn’t ignore bitcoin.

To sum it up then: The problem is largely inflationary fiat currency and the solution is something deflationary – like gold or bitcoin, preferably the latter for reasons stated above; or both. - FMT

The writer can be contacted at kathirgugan@protonmail.com.

The views expressed are those of the writer and do not necessarily reflect those of MMKtT.

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