The Problem With 'Undervalued' Cryptocurrencies And Emerging Markets

by: Ivan Martchev

Voltaire famously said that “paper money eventually returns to its intrinsic value – zero.”

His words serve as an inspiration for many precious metals enthusiasts, but if Voltaire were alive today, he very well might modify that statement to cryptocurrencies “eventually returning to their intrinsic value - zero.” The same could be said for the Argentine peso, the Turkish lira, and other currencies that have turned into confetti in the 21st century, which is only 18 years old.

First, let's look at bitcoin.

I don't have a problem with blockchain as a technology, which I admit is revolutionary; but I do have a problem with bitcoin, as I believe it is an electronic line of code that is unnecessary in the blockchain process. It was designed with the idea of creating a global bubble. This bubble has now popped, and it is deflating before our very eyes.


Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

There have been stories in the press that huge sell-offs have happened before, but the bitcoin bubble has still managed to reflate. The most notable such bitcoin sell-off and recovery came in early 2014 around the failure of the largest bitcoin exchange in the world at the time, the Mt. Gox exchange, after it was decimated by hackers. The reason why I think this bubble will be impossible to reflate is that regulators have finally figured out how big traders spoof the bid-ask spreads in order to manipulate crypto prices.

The Justice Department has jumped in with a criminal investigation, and the CFTC is furious at the CME for not having put in place agreements in order to properly settle its futures contracts, as the exchanges whose prices the CME relies on for settlement values refuse to share the data! (See June 8, 2018, MarketWatch, “U.S. regulators demand trading data from bitcoin exchanges in manipulation probe.”)

Still, I am grateful that the CME launched bitcoin futures contracts, even though it is glaringly obvious that it did so prematurely, because that created a two-way market. Although I think these contracts have a very high chance of being discontinued as trading volumes decline and the bitcoin price keeps going lower, the CME futures contracts popped the bitcoin bubble even before the regulators jumped in.

As any fund manager worth his salt will tell you, no market price is real unless you can short the asset. Before the listing of bitcoin futures, we had a global mania that was a one-way street. I believe bitcoin is the first truly global mania because of the rise of the Internet. Previously, bubbles were geographically segregated, such as the Tulip Bulb mania, the South Sea bubble, the 1929 Wall Street crash, and many others.

There is nothing evil about short-selling. If an asset price is overvalued, based on a thorough analysis of the situation, then an investor can short it. If a thorough analysis calls for the price to appreciate, which is typically due to rising profits and/or rising cash flows, then the investor should buy. There are numerous devils in the details of shorting and/or buying stocks, bonds, commodities, and (crypto)currencies, but if properly done, this analysis is what rational investing is all about.

At the time of this writing, bitcoin has a “market cap” of $123 billion, according to As I have mentioned previously, I think the term “bitcoin market cap” is absurd, as there are no sales and earnings to discount into the future. A market in bubble mode is not a discount mechanism but a runaway train just marking time until it goes off the tracks. That means $123 billion is invested on the way to zero, which is where I think bitcoin is going.

Some Currencies are Under Severe Stress in 2018

It has not been a good year for the Brazilian real, Turkish lira, Argentine peso, Mexican peso, or South African rand. On September 13, 2017, Bloomberg ran a story on how the Turkish lira was among the most undervalued among emerging market currencies based on “z-scores,” which is a model that measures standard deviations away from 10-year averages. Although the Bloomberg story was published nine months ago, all Fed QT operations were already announced at the time of its publication, and the rampant emerging markets dollar borrowing had been well-known (to those who pay attention).


Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I would like to point out to the z-score model creators that the term “undervalued emerging markets currency” has been a spectacular oxymoron under certain conditions, which I believe we have at present. The currency does not have to fail in order for the oxymoronic relationship to hold true, but it can get so badly clobbered and not come back that it is not worth catching the falling knife before the bottom is in. This is due to the negative feedback loops, where a weak currency creates higher inflation and the central bank feels obligated to hike interest rates to stop the flight of capital and there is a domino effect on the banking system where banks stop lending activities. This sequence of events, which is a little different in various financial crises, can create a bad recession in the economy whose currency is in a free fall.


Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Let’s use Turkey as an example, where both inflation and interbank lending rates are on a severe uptick right now, while the central bank is hiking interest rates. This type of domino effect can be arrested before it becomes irreversible - the Russians famously stopped a rout in the ruble in 2016 - but for that, a nation needs high foreign exchange reserves and a current account that is close to balancing, as well as a proactive central bank. The Russians had all of the above, but the Turks face problems in all these categories.


Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Relative to the size of the Turkish economy, which is nearly $900 billion in annual GDP, the value of its forex reserves is not enough to stem the slide, given the high current account deficit and the need for external financing. The negative feedback loop of rising interest rates, rising inflation, and a falling Turkish lira seems to be ongoing at this very moment.


Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Because I do not believe that the Federal Reserve is done with its quantitative tightening operations, I think we have the potential for a much bigger dollar spike than the one we have at present, due to the rampant emerging market dollar borrowing that we have witnessed over the past 10 years. (Dollar borrowing is equal to dollar shorting, as the borrowed dollars are sold to use as the borrowers please.) When rising U.S. interest rates catalyze the repayment of those loans, they cause a dollar short-squeeze.

As things stand right now, such a spike in the exchange value of the dollar would make all emerging markets’ currency issues deteriorate significantly from present levels through the end of 2018.

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