What?s In Your Loan?


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By Keith Weiner

Opposing Monetary Directions

?Real estate is the future of the monetary system,? declares a real estate bug.

Does this make any sense? We would ask him this.

?OK how will houses be borrowed and lent??

?Look at this housing bond,? he says, pointing to a bond denominated in dollars, with principal and interest paid in dollars.

?What do you mean ?housing? bond?,? we ask, ?it?s a bond denominated in dollars!?

?Yes, but housing is the collateral.?

OK, so it?s not a housing bond. It?s a dollar bond used to finance the purchase of houses. These are not the same thing at all, the way chalk and cheese are not the same thing, despite both being single-syllable words beginning with the letters ?ch?.

El Salvador?s Bitcoin Gamble

A few weeks back, we looked at the investor?s side of the lending equation. We described the difference between speculating on an asset?s price vs. lending money to a productive enterprise who pays part of its production to the investor in the form of interest.

Now, let?s look at the borrower?s side. The country of El Salvador just announced that it will issue ?bitcoin backed bonds.? On Twitter, it is common to see many calling them ?bitcoin bonds,? like an attempt to blur the distinction between chalk and cheese.

It is telling what El Salvador plans to do with the billion dollars?yes, let?s be clear, this is a dollar-denominated bond?that it plans to borrow. Half of the proceeds will be used to buy bitcoin, and the other half will fund government subsidies to create a new city powered by a volcano (you can?t make this stuff up).

The magic is that bitcoin is projected?by one of the promoters?to hit $1,000,000. This is about 15 times its current price. This price rise is treated as a given. At this price, the country will sell some of its bitcoin to repay investors. So, this scheme is just a way to leverage bitcoin as a free money?i.e.

dollars?machine. They are borrowing dollars to fund a speculation on an asset. And they are mixing this in with borrowing to spend on infrastructure, such as a volcano power plant and a new circular city promised to be like Alexandria, and the new financial capital of the world.

It gets better. A key part of the scheme is to corner the market for bitcoin. Or, in the words of the promoters, ?bitcoin would be taken off the market for several years.? So, they not only speculate on the price of bitcoin, but openly tout that they will drive the price of bitcoin up and profit from this rise.

Contradictions and Flaws

We will leave aside the two obvious flaws. One, the price will rise as a result of their buying. In other words, they will pay more for their bitcoin. And two, the price will drop as a result of their selling in five years. This is a problem that all large investors have to think about.

The deeper problem (assuming that this will work at all) is revealed in the fact that a poor little country could drive the price up so much. If bitcoin is to be money?and not just a chip for betting to make dollar gains?this is a bug, not a feature. One should want stability, not big opportunities to make big amounts of money. For example, even during times when India is buying a lot of gold, the price does not necessarily go up. And India buys a lot more gold than El Salvador could ever hope to buy of bitcoin.

El Salvador?s scheme is to borrow dollars to use bitcoin as a means to make more dollars. Those dollars will (they hope) be forked over by savers who will buy from them at a million bucks. Presumably, these new speculators will buy at a million bucks because they hope to sell at two million. Or ten million.

The yield on the billion dollars of this bond, will be paid in dollars. This is assuming that it is paid at all (Moody?s recently downgraded the country to caa1, which means the issuer is in poor standing and there is a very high credit risk). We would assume that the only way the country will repay this bond is if bitcoin does indeed skyrocket. This raises the question, if one wants to bet on bitcoin going up 15X, why would one bet on a high-risk credit to earn 6.5%?

Backward Models and Speculation

Moving on from El Salvador, there is another case which is also described as ?bitcoin lending.? In this case, borrowers put up their bitcoin as collateral, to borrow dollars. Those borrowed dollars can be used for anything?even buying more bitcoin. This is not borrowing to finance production. And it is not borrowing bitcoin, but dollars.

More importantly, it has the whole borrowing model backwards. If you needed $1 million to build a factory, and you already had $1.5 million, then why would you borrow $1 million at all? Most entrepreneurs don?t have the money, which is why they are seeking a loan. But in this case, those with a larger amount can borrow a smaller amount (loan to value on these loans can be as low as 25%). This is just another way to speculate, just another way to leverage up speculative assets.

We are not saying don?t speculate, or don?t borrow to speculate (if you understand all the risks). We are saying that this is not the future of our monetary system. Speculation is a process of conversion of one party?s capital into another?s income, to be consumed. By definition, and by its nature, this process is not sustainable. Capital is precious, and once it?s gone it is gone. It does not ?recover?. It can be re-accumulated only by the slow process of saving, of consuming less than one produces.

A Better Monetary System

This is why we say that gold is better money than bitcoin. Bitcoin may be better at skyrocketing (also crashing). But gold is more stable. Gold can be used to finance productive enterprises (indeed Monetary Metals is doing so).

We need a monetary system that works, which means it can finance the production of food, cars, mobile phones, and even houses. We need a stable interest rate, and stable asset prices. Only gold provides these features.

? 2021 Monetary Metals