The best way to get a cheap loan is to have collateral backing it. You buy a home, the bank keeps the deeds until you pay the mortgage. A company issues a bond, the bondholders get a claim on all the assets before the shareholders.
You can use all sorts of things as collateral, like real estate, bonds, shares etc. Collateral has issues though. Firstly, is it liquid? So real estate is not great, it takes time to sell, bonds are better. There is another issue, has the lender pledged the collateral to someone else? Very often you don’t know, so lenders get borrowers to sign documents that say their collateral isn’t lent to someone else but you never really know and very often in distressed situations it turns out that collateral has been pledged multiple times.
In the world of digital assets, the multi-pledge problem is solved. For example, once I pledge my bitcoin to someone as collateral, I cannot do so again. Digital assets can be placed in a trust account with both lender and borrower signing with their cryptographic keys, once done the borrower cannot use or pledge the collateral elsewhere without the lender agreeing.
How about liquidity though? In the case of bitcoin, traded volumes now exceed $10 billion daily, it is highly liquid, that liquidity exceeds turnover on the London Stock Exchange and is growing all the time. The only thing holding bitcoin back as collateral is its volatility and that is something only time will fix. Even so, bitcoin is now being used as collateral for loans in private lending and it’s only a matter of time before this goes mainstream. As you would expect, the best money in the world happens to be the best collateral too.
The Cantillon effect
Richard Cantillon was an Irish-French economist who first suggested that a monetary expansion would greatly benefit those who first receive the money at the cost of those who receive it last. Having worked this out, Cantillion went on to make a fortune in the famous Mississippi Company bubble.
The Cantillon effect plays out still to this day through monetary expansions. To profit you must be as close to the monetary expansion as possible, i.e. be able to get the cheap loans. So for example, if you are a bank you can borrow wholesale at 0.5% but if you want a pay-day loan you will pay over 20%.
There are several notable monetary expansions happening right now, the first is the Federal Reserve’s Repo market operations, the second the Chinese governments Corona interventions ($500 billion in the last two weeks) and finally, the European Central banks “Corporate Sector Purchasing Program”.
The trick to benefit from Cantillon is to get your hands on the cheap money at the source. It’s hard to do but it can be done, as we will see next.
LVMH is 43% owned by Frenchman Bernard Arnault. The company has been fabulously successful and late last year, announced its $16bn acquisition of jeweller Tiffany.
Last week, to finance the acquisition LVMH issued a large corporate bond including €7.5 billion, with maturities range from 2 -11 years. The cost? 0.05%. So to be clear, not 5%, not 0.5% but 5 one hundredth’s of one percentage point. That’s an interest cost of €3.75m per year for a company that makes over €10 billion per year, the interest cost on the new loan will barely alter the roundings.
Guess who participated in every tranche of buying? The European Central Bank. Through their Corporate Sector Purchasing Program they bought into every single maturity of LVMH debt. This was confirmed by Christine Lagarde after questioning by some members of the European Parliament. These renegade politicians probably thought the net transfer of wealth to Europe’s richest man was a bit wiffy.
This is the Cantillon effect. It is the best example I have seen. A company can borrow, with the help of a central bank who through their own buying force the interest rate down. In this case the cost of borrowing became almost zero. The net cost of this is spread across all holders of EUR, in particular though, savers.
I can only salute Bernard Arnault. Like Richard Cantillon, he has seen the opportunity and taken it. If politicians and bankers are willing to finance your operations via what is an effective tax on the population, then you take the money and don’t ask questions and you go on a crazed buying spree, just like he has.
That the stock market rises relentlessly is not a surprise in this environment. Remember, as interest rates approach zero, the rational price for stocks is infinity. Fiat money has lost its meaning, it no longer properly functions as a relative price guide or resource allocation tool, but it doesn’t mean you can’t profit. Either get close to the monetary spigot and get the free money or buy something scarce because money and bonds no longer fit that description.
What is the interest rate?
As if to emphasise the point about interest rates, I received this letter this week from my friendly UK financial services provider. The bank in question is known as ‘Smile’, a branch of the Co-operative Bank in the UK, a listed company.
They had written to advise me of the newly updated overdraft rate for both arranged and unarranged overdrafts on my “Smilemore” account. That rate is 35.9%. This is not some loan shark, not some mafioso operation. A major UK high street lender is writing to retail clients in the UK telling them when they borrow, they should “smile more” and pay 35.9%, a mere 720 times what Bernard has to pay.
The price of money is totally distorted, again this is the Cantillon effect. If I have urgent need on money in the UK it will cost me 35.9%, how is that different to Bernard of LVMH? He urgently needs money too because he has committed to pay €14 billion for Tiffany, he has to pay them or they will sue him.
Banks of course find it incredibly hard to make money in this environment. Central bank action forcing low interest rates, squeeze their margins on formal lending and so they make up for it in other areas, like charging their smiling clients egregious fees. That’s Cantillon in a nutshell.
I would contrast this with bitcoin, the bitcoin borrowing rate is high. For lenders the interest rate is about 8.5% and if you wish to borrow the rate is around 14%, services are all available at blockfi. Looking at interest rates across time, this is far more reasonable, there is a real price to real money and in bitcoin’s case it accurately reflects what many would consider a more appropriate discount rate than 0.05%. The difference in the price of fiat money and bitcoin money speaks volumes.
Seeking help for the USD
“Maintaining the U.S. dollar as the world reserve currency is vital for the national security community. It enables the U.S. to impose and enforce sanctions on entities that violate treaties or international law – results are essential to counter-proliferation and counter-terrorism activities. Sanctions are imposed when countries or their citizens develop or expand weapons programs that are considered dangerous to the international community. Having U.S. dollar transactions settle through the U.S. gives law enforcement jurisdiction to investigate, charge, and convict criminals of financial crimes such as money laundering, fraud, and terrorist financing. Since the U.S. dollar holds value through time, it is the safest currency in which to conduct international business transactions. This gives the U.S. global economic dominance. If the U.S. dollar loses its status, these national security advantages disappear, leaving the U.S. vulnerable. This project could allow the national security community to prepare for and defeat scenarios that could prevent this economic crisis.”
For bitcoin the question will be this – can you become a global reserve currency if you don’t have any aircraft carriers and an arsenal of nuclear bombs? I would posit that encryption is more powerful than any physical weapon and that every government tried to keep encryption under wraps for so long is the proof. My application for the job will read “you can’t bomb decentralised software”. I will report back on whether I am successful.