This article is sponsored by RBC Dominion Securities.
Stocks, gold and Bitcoin. At first glance, there doesn’t seem to be anything similar between these three incredibly different assets. Bitcoin doesn’t exist anywhere except on the Internet. Gold is a physical commodity. And stocks represent ownership shares in publicly traded corporations. But if you look closely enough, there is a fascinating common link between these seemingly unconnected assets, and it’s a big part of the reason why so many people want to own them.
First, a little background. Between these three assets, Bitcoin has certainly been causing the most ruckus lately. While we might argue about what the future holds for Bitcoin, there’s no denying that it is an elegant and beautiful creation. For one thing, Bitcoin is a truly de-centralized currency. This means that, while every other currency has some sort of central administrator, Bitcoin has none.
When the first Bitcoin was created by Satoshi Nakamoto, he, she or they did the programming and then disappeared, leaving it to run on its own ever since. Nakamoto brilliantly anticipated the incentives and security that would be needed to keep Bitcoin both hack-proof and decentralized. Even if Nakamoto were to suddenly reappear, there’s nothing they could do to change anything about their creation.
Driven in part by Nakamoto’s ingenuity, over the past few years, the price of Bitcoin has soared, creating thousands of overnight millionaires – and leaving many thousands more feeling like they missed the bus. Today, Bitcoin is ranked as the sixth largest currency in the world.
While gold has been around a lot longer than Bitcoin, there are actually a surprising number of similarities between them. Gold, like Bitcoin, involves mining. While mining for Bitcoin is a little different than following a vein of gold half a mile underground, both involve investing huge amounts of time, money, energy and resources with no guarantee of just how much the final product of all that hard work will be worth. Both assets are also very hard to come by. And gold, like Bitcoin, can’t be hacked.
But beneath these superficial similarities, there’s a much deeper link that gold and Bitcoin both share: fear. Ask either the world’s most passionate goldbugs or most fervent Bitcoin boosters what they like most about their assets of choice, and nine times out of ten, one of the first things that will come up is a mutual distrust of fiat currency.
Fiat currency is what most of us think of when we think about money. That $20 bill you exchanged for a beer and a burger? It’s really nothing more than a promise from the federal government to honour that piece of paper (or plastic) as a means of exchange, backed by its ability to tax its citizens. At its most basic level, fiat currency is essentially just an IOU from the government that issued it.
Here’s where the distrust comes in. Most of us watched with varying degrees of angst as governments around the world have been running their currency printing presses in overdrive to pay for program spending. We’ve also all seen or heard stories about debt-laden countries whose governments printed so much currency that their own people stopped believing that it had any value, leading to devastating devaluation, runaway inflation and economic crises.
Gold has traditionally been seen as the perfect hedge against this type of fiat currency risk. Generally speaking, when currencies go down in value, the price of gold goes up. Because of the volatility surrounding it, it remains to be seen whether Bitcoin is also immune to the risks that follow more traditional currencies. But true believers in Bitcoin certainly insist that this is the case.
Which brings us to the last of our three assets: stocks. Stocks have also historically been a great hedge against currency devaluation. When inflation hits, stock markets initially tend to fall as investors adjust to the higher interest rates that inevitably accompany bursts of inflation. But over time, the world’s largest corporations can simply adjust their pricing to compensate for any temporary devaluation.
If a burger at McDonald’s cost you five dollars today, for example, and the fiat currency where you live were to become devalued by 50 per cent, you can bet it won’t be long before that same burger will cost you $10. That flexibility may not be good for consumers, but it’s one of the most important tools that corporations use to protect themselves, their profit margins – and their shareholders.
So while stocks and gold may seem old-school compared to Bitcoin and its fellow cryptocurrencies, all three assets are often bought for a remarkably similar reason: as a long-term hedge against inflation and devaluation. If the general public eventually starts to sour on the value of fiat currencies in the face of overzealous government spending, you may well want to make sure you own something whose value will go in the opposite direction than all those glorified IOU’s we all carry around in our wallets.
This article is supplied by Alan MacDonald, an investment advisor with RBC Dominion Securities Inc. Member–Canadian Investor Protection Fund.