Just Buy Bitcoin
A look at the U.S deficit, the Petrodollar, and Bitcoin as the world reserve asset.
Why Bitcoin
I find myself repeating the same simple mantra repeatedly whenever I speak to someone about investing or finance; it goes something like "just buy bitcoin." Inevitably, and rightfully so, they ask, "why?" This question always elicits a reflexive deep breath and subsequent sigh because I know I am about to hook this person up to a fire hose of information. I also know that they will probably stop listening when I am about 10% of the way through my over-zealous speech.
So, I've concluded that it's best to write out some thoughts on the subject and let people read it at their leisure. Throughout this -hopefully- brief paper I hope to cut through the cacophony of noise and crystalize my thoughts on where our economy is heading, what our government plans to do about it, and how all these things point to acquiring bitcoin. I am writing not only to inform friends and family but for my edification as well.
If you want to master something, teach it.
-Richard Feynman
Weak Foundations
To understand "why bitcoin," we first need to understand the global economy's shaky foundation and the apocryphal narratives swirling around our trade deficit. As we speak, we see something unique happening in global markets that could have massive ramifications for the American hegemony. The dollar seems to be losing its reserve currency status, something it has held since the Bretton Woods agreement in 1944.
A subtle but clear indicator of the empire crumbling is the total treasuries foreigners hold, and net treasuries held by sovereigns have been declining as of late. In the chart below we see that the Federal Reserve is now the largest U.S. debt holder on the planet, not foreigners. We will get to why this is important in a second.
China is not shy about its lack of interest in our debt. In her article "The Fraying of the U.S. Global Reserve Currency System," Lyn Alden pointed out that back in 2013, China broke the mold and stated that it was "No longer in their best interest."
"It is no longer in China's favor to accumulate foreign-exchange reserves," Yi Gang, a deputy governor at the central bank, said in a speech organized by China Economists 50 Forum at Tsinghua University yesterday. The monetary authority will "basically" end normal intervention in the currency market and broaden the yuan's daily trading range, Governor Zhou Xiaochuan wrote in an article in a guidebook explaining reforms outlined last week following a Communist Party meeting. Neither Yi nor Zhou gave a timeframe for any changes.
China is not the only one, according to one Reuters article. (2021).
Foreign investors held $7.053 trillion in U.S. government debt in November, down from $7.068 trillion the previous month.
Japan's holdings, the largest non-U.S. holder of Treasuries, slipped to $1.260 trillion in November from $1.269 trillion in October.
So if capital isn’t flowing into US debt where is it going? Well, as it turns out interest in foreign treasuries has been on the rise for some time. Another Reuters article stated, “Offshore investors increase their holdings of Chinese interbank market bonds by nearly 50% in 2020.” To be fair this still pales in comparison to overall holdings of US debt by foreigners, but it’s a significant shift nonetheless. It makes sense though, doesn’t it? The US is offering 1% for our ten year while China is offering 3% for theirs.
Capital, it would seem, is seeping out of the cracks in the American financial system, and to add insult to injury, Russia now holds more gold than U.S. dollars. Lyn astutely points out something else a bit worrisome.
Six years ago, Russian exports to China were over 98% dollar-based. As of early 2020, it's only 33% dollar-based, 50% euro-based, and 17% with their currencies.
Russian exports to Europe have become increasingly euro-based as well. Six years ago, Russian exports to Europe were 69% dollar-based and 18% euro-based. Now they're 44% dollar-based and 43% euro-based.
This clearly indicates a lack of faith in the dollar as the reserve currency moving forward or at least a hedge against the destruction of credit markets. The U.S. no longer has the percentage of global GDP it once had and thus cannot supply the world with the liquidity it needs to function properly, entropy is increasing, the petrodollar is no longer a viable system and the world sees that.
Petrodollar
Now I think it is appropriate to give a brief explanation of the petrodollar system because it will provide clarity into why everything I just said is important. When the Bretton Woods system started to fray and the U.S. realized there wasn't enough gold to back all the dollars needed for the ever-increasing globalized economy, so they came up with a clever solution that answered the problem while retaining the dollar's supremacy.
Energy is every major nation's largest expense, and you would intuitively think all nations would pay for their oil using their own currency. However, this is simply not the case. The U.S. struck a deal with Saudi Arabia (and other OPEC cartel countries), which stated that you have to pay in U.S. dollars if you wanted to buy oil. In return for the Saudis only accepting USD, the U.S. would lend its military might via the Navy to protect shipping lanes and act as a global enforcer (interesting how China has is focused on building its Navy). Thus the Petrodollar system was born.
Of course, manipulation of free markets always births knock-on effects and bubbles. The effect of pricing oil in USD was that it coerced other nations to price their exports in USD. They needed American cash to pay for their energy. Now everyone needs dollars, and once again, the dollar reigns as king.
Now for the creative part. If you are the Saudi government or any other country, and you have a stack of USD sitting in your bank being eroded by time and inflation, where do you stash your money? The answer has historically been U.S. treasuries. It's ingenious. The U.S. pumps money (via massive trade deficit) into the global economy only to have it flow back onto its shores, where it finances the debt created by said trade deficit.
However, there is a "thermal exhaust port in the death star," a fatal flaw if you will. For this system to work, the U.S. has to run a deficit, a massive one, and what if foreign nations stop buying treasuries? What if countries start transacting with each other in their currencies? The pipeline of money financing our debt gets plugged, and we are left holding the bag.
For the past seven years, China has been using the petrodollar system against the United States. The petrodollar system encourages mercantilist nations to run trade surpluses with the United States and recycle those dollars into buying U.S. Treasuries. However, after a while of doing this, China started taking their dollar surpluses and investing in other foreign assets instead.
We also have another problem, as Lyn points out, the petrodollar system leads to a disproportionate amount of global trade in USD relative to the size of the U.S. economy. In other words, there simply are not enough dollars to go around.
In the aftermath of World War II, the United States represented over 40% of global GDP. By the time the Bretton woods system ended and the petrodollar system began, the United States still represented 35% of global GDP. It has since fallen to only 20-25% of global GDP
So entropy in the current petrodollar system is increasing, and many realize this may not be the solution for the future global economy. We have established that nations are increasingly holding less U.S. treasuries, more gold, and transacting in their currency, thereby silently refusing to finance our deficit and undermining the mechanics of the petrodollar system itself. Lastly, the amount of U.S. dollars in existence is not enough to finance the liquidity our increasingly globalized economy needs. The U.S. cannot support it; no country has a large enough share of global GDP to support it.
Spend, Spend, Spend
As of Q3 2020, we have a total federal debt of 127% of our GDP; historically every country but one that has hit the 130% ratio has had to devalue its currency. The new Biden administration is pushing for another 1.9T dollar stimulus plan. Today (Jan 22, 2021), Biden summarized his executive orders, they included but were not limited too, no more student loan payments until September, no more evictions until 2022, unlimited unemployment, another round of stimulus checks, $15 minimum wage, easier access to food stamps, and government-funded child care. All of this sounds great on the surface, but who is paying for it? Altruism works well to mask true intention. The political parties are two sides of the same coin and will always be plus de noblesse que de sincerité.
Distrust the worthless and lying crowd,
And lay aside thy doubts.- "When from the darkness of Delusion" Russian Poem 1846
It looks as if we have chosen to spend, we have taken the path of inflation. I get it; the only way to manage this debt level without taking austerity measures is to inflate it away. The basic idea being that we can pay the debt back in the future with dollars that are worth less than they are today.
If no one global reserve currency can exist mathematically, what does the future global economy look like? According to Luke Gromen, it looks like the emergence of a regional multi-currency system, with gold taking the throne as the reserve assets from treasuries. If this is the reality we are facing, nations would no longer be forced to hold as many dollars or treasuries; they would also be allowed to buy oil using their own currency. However, if this were to come to fruition and the petrodollar fails, our largest creditors China, Japan, and the EU would cease being creditors.
This lack of buying by foreigners forces the U.S. to fund its federal deficits, meaning either its private sector or increasingly the Federal Reserve itself had to buy Treasuries, and that eventually leads to a dovish shift in U.S. monetary policy, which plays a role in weakening the dollar and starting the cycle anew.
- Lyn Alden
So if this plays out, all nations would be forced to finance their own debt, and again who is left holding the biggest bag? The United States. The E.U. has a surplus, Japan has a surplus, China has a surplus, so they will most likely be fine, although the E.U. has its own set of problems. The U.S. would then stand alone like Atlas, shouldering its mountain of debt.
Listen, here's the thing. If you can't spot the sucker in the first half-hour at the table, then you ARE the sucker.
-Mike McDermot
Lastly, if we look at the TBAC report, the U.S.'s three most significant expenses are Entitlement, Defense, and Treasury Spending. All of these together are 140% of tax receipts. If we implement austerity measures, how long could we go before the federal government went broke? Going bust cannot happen for obvious reasons, the least of which being that America's biggest asset is its military. They cannot afford to let that fail, and they will print money to keep those budgets funded.
Destroy the Dollar or Crush the Economy
We have established that the depth of the U.S. deficit lies congealed at the core of our problems, but our creditors are leaving for better investments. In 2020 the Fed Reserve bought more than 100% of U.S. issuance and according to Gromen, the plan so far in 2021 is for the U.S. government to issue 1.8T more than what the Fed is planning on buying (this could change). If this happens and the Fed tries to reduce printing, we could see a dollar short squeeze scenario very much like the one we saw in March.
Essentially this simply means more demand than supply, equating to a very, very strong dollar. If we have a strong dollar, the money will flow out of treasuries into other investments for a couple of reasons, but the important one is this. When the dollar is too strong, countries with weaker currencies cannot service their dollar-denominated debt; thus they have to sell their treasuries to help with liquidity.
Countries can only buy treasuries in bulk if the dollar is weak. This selling will drive the price of treasuries down and yields up. We need to keep the system flush with cash; we need to make sure that foreigners can keep financing our debt. I know this is all mind-numbingly paradoxical, but this is exactly what happens when you believe you can outsmart the free market.
If yields rise too much, something will systemically break. Of course, the Fed cannot allow this to happen, and it's at this point we would see them step in with yield curve control.
Yield curve control simply means the Fed will buy as many treasuries as needed to keep the yields from going too high (ie. bond prices too low). This requires extreme amounts of money printing. For those of you living under a rock, that's exactly what they did in 2020, and estimates are that 30% of all U.S. dollars in existence were printed last year alone.
A tsunami of U.S. dollars in the global system means a weaker dollar and higher asset prices, ie. asset inflation. If this scenario plays out, we will have successfully broke the dollar's back, allowing nations to buy more treasuries. However, there is a caveat. If the dollar falls too fast, we could see the stock market fail as well, merely out of fear of a collapsing currency. End game, we have now crushed the dollar, the economy, and ultimately the American people.
What is our other option? We could raise rates to defend the dollar. Raising rates quashes inflation, this worked for Volcker in the 70's and 80's. However, times have changed, when Volcker did this, our debt to GDP was around 30%, and Volcker himself said his playbook would not work in today's world for a myriad of other reasons.
So let me explain the crux of this particular quandary, if we raise rates to prevent inflation, people will have to stop borrowing, liquidity will get jammed and the dollar will skyrocket (March 2020), countries will start to default on their debts, they will have to dump treasuries to try and service them. The economy will grind to a halt, the stock market will fall, and this will reflexively reverberate back into the treasury market; at that point, we will try to print our way out. Now you are flooding the system with dollars, but no one is producing anything: the end game, massive stagflation.
Those are our choices, the Fed can stand aside and let interest rates rise until somethings breaks and we are all trading cans of soup for scarce oranges. Or the Fed does whatever the Biden administration wants, which is a form of yield curve control ie. print money so the government can spend it until we are paying for loaves of bread in 1 million dollar notes.
Now in today's cancel culture political climate, do you think it's palatable to not print money? Of course not. This administration does not have a choice if they want to keep their jobs or possibly their heads à la Révolution Française.
Just as an aside, some tax restructuring plays could take place bringing labor back to the States, which could potentially help, but the Biden Administration seems to be far more interested in increasing taxes. I will leave this topic for another blog post.
Bitcoin
It would seem that the mathematical probabilities of one country being the world's reserve currency are increasingly dwindling. No sovereign nation has enough paper to meet the global economy's demands, let alone the GDP to carry out such a Herculean task. As I mentioned, the United States was only able to pull this off post WW2 because we had a disproportionate share of the global GDP.
As more countries develop and the developed countries grow, it will be impossible to have a global reserve currency. We must also ask ourselves, do the benefits of holding the reserve currency status outweighing the liabilities? In other words, do we even want this? Is it in our best interest?
What if the best course of action is to have multiple regional currencies. Each region with one currency made of a basket containing each nation's unique currency. What if each of those regional currencies were backed not by gold as in the past but by bitcoin.
Now I don't want to dive too deeply into why I believe the interestingly anthropomorphic nature of bitcoin is superior to gold; rivers of ink have flooded the internet surrounding this very topic. Just remember why gold became money in the first place, scarcity, divisibility, portability, verifiable, recognizable, etc. We all know bitcoin has these traits and more in spades.
Gold itself has somewhat of a fatal flaw when it comes to being a reserve asset in the current economy, where information and money move at close to the speed of light.
Allow me to explain via story. It was the end of July 1914, a remote Balkan conflict initially thought to be nothing more than a spat was starting to intensify. It would eventually crescendo in the form of WWI. At that time, London was the financial epicenter of the world; every year, London banksters moved around one billion dollars of foreign bonds. The previous year London, Shanghai, and Hong Kong had syndicated a loan of 125 million to China, London had also brought a loan to the Kingdom of Denmark, and the Rothschilds had underwritten a 50 million issue for Brazil. The list goes on and on.
Remember at the time, all this debt being issued by London was backed by gold. The conflict in eastern Europe had started to heat up, and stock exchanges were shuttering; things were getting tense. The banksters realized that the prohibition of gold shipments would cause the entire gold standard to fall apart. With global turmoil going on, shipping gold was next to impossible; it just was not safe. With chaos spreading throughout Europe, merchant banks had no way of sending money abroad to settle their trade deficits. All the paper they issued was virtually worthless, and they now realized they were starring down the barrel bankruptcy.
[Bankers standing in front of a closed London Stock Exchange 1914.]
They could not move their money. Bitcoin handles the portability (transferring money across borders) problem quite nicely. If we were to enter into a time of war, chaos, and distrust, would nations be able to peg their economies to gold? Would we be able to settle debts in gold? Shipping gold has a heavy cost. Quite literally, the weight alone will cost quite a bit to ship, not to mention the security issue of shipping gold to Japan if we are locked in conflict with China. With bitcoin, you could send 1 billion dollars to Tokyo from your apartment in N.Y., and it might cost $6 in fees. On top of that, it might only take 10-30 min to get there.
Now let's talk about the security aspect, no one can stop that payment to Tokyo, no one can hack it or steal it, and you didn't need anyone's permission to send it. That payment is being protected by the most powerful decentralized computer network on the planet. You are trusting in math and logic. When you look at gold through the lens of bitcoin, it is so archaic it's almost laughable. (To be fair, gold has its strengths as well, which I will cover at another time.)
Let us look at a third issue. When we transact, there is always the element of trust involved. How do I know that person on eBay will send me the thing he promised when I pay him. Or an even bigger question, does Fort Knox actually store the amount of gold they profess to store? Not to mention that if I am making a personal transaction in gold, I need an XRF spectrometer to verify the atoms in the gold being handed to me are actually gold and not mixed with other materials.
Sovereign nations also have to think about these things on a much larger scale, for example, is the U.S. credit market going to crumble? Unlike gold, bitcoin is trustless; you can query the blockchain at any moment and know exactly how many Satoshi have moved through time and space. You also know that the blockchain is being audited by a decentralized network every 10 minutes or so, keeping transactions and the bitcoin you hold safe. You do not have to trust an over-leveraged foreign government.
Furthermore, no one will create more than 21 million bitcoin. No country or corporation can inflate away its value. It's beautiful in its simplicity, and sovereign nations can use this tech as a base layer for their newly developed regional currencies discussed above.
So what does this look like mathematically? From the chart shown earlier, we can see that foreign investors hold around 7T in U.S. debt. Let us say conservatively, bitcoin takes 30% of that market cap.
7T*.3= 2.1T
*Bitcoins current MC at a price of 35k with a circulating supply of around 18.5M is around 621B.
2.1T/18.5M= $113,513
Even if Bitcoin took 30% of the treasuries market cap, it should be worth $113k per coin.
Gold's market cap currently sits around 11.7T. If bitcoin matched the gold market cap, with its current supply, that would make one bitcoin worth around 600k. (11.7T/18.5M= 594K)
We could carry this thought experiment further, what if bitcoin took market share from the real estate? Alternatively, even all assets, according to some people's math, all financial assets globally are worth 900T, if bitcoin took 5% of that, we are looking at a 2 million dollar bitcoin.
What if the petrodollar system fails and we price oil in bitcoin? Now we are entering the realm of hyperbitcoinization. This theory has been put forth by bitcoin maximalist all over the internet. It's the theory that bitcoin will act as a black hole eating all financial markets in its path.
I don't know if I'm on board with hyperbitcoinization, but if I were, I would have to ask the question, "does bitcoin have the capacity to handle this calling?" There are only 21 million bitcoin, this is true, and that cannot be changed. However, each coin is made up of 100 million Satoshis. If each Satoshi was worth one dollar, each bitcoin would be worth 100 million USD. At this price, the market cap of bitcoin would be worth 2.1 quadrillion dollars. So yes, bitcoin does have the capacity to absorb a vast sum of the world's wealth.
This is fun to think about, but realistically will despotic governments allow this series of events to happen? I doubt it. I see a world in which bitcoin and sovereigns run a parallel monetary system symbiotic in nature.
Governments have already created CBDC's or central bank digital currencies (google DCEP), and those who have not yet started building are in the process of doing so. These currencies are no different from the current fiat system we have in place now. They will allow governments to manipulate monetary policy and print at will, they will give nations more control over your personal finance and the financial system at large.
Conclusion
Let us recap quickly.
The U.S. government has to run a trade deficit because the petrodollar system requires it.
The U.S. would love to get the trade deficit under control, but the deficit finances our debts.
We need foreigners to keep financing our debt, which they are starting to shy away from for a multitude of reasons.
We might very well have to finance our own debt soon ie. we have to print more money (inflation).
If we raise rates to keep inflation in check, it will crush our economy, which no politician is incentivized to do. But if they keep printing money, they crush the dollar (inflation).
While bitcoin takes over as the primary reserve asset, using regional currencies would be a good thing for everyone. Bitcoin as a reserve asset means minimized trust, and true scarcity, which means bitcoin holds its value across time and space. (This is possible right now via lightning network and the Strike app)
Show me the incentives and I will show you the outcome.
- Charlie Munger
A system like this with bitcoin acting as a base layer would be a win-win. A more decentralized global economy would free up America to get its deficit under control. It would also allow developing countries to grow organically. Bitcoin would act as a reserve asset and arbiter of truth (explained in another post), and finally, it would be good for bitcoiners, as the price would rise exponentially.
Closing
The U.S. does not want to let go of reserve currency status. We are bent on retaining control and weaponizing the global economy. I understand why, there are ramifications to letting go, both seen and unseen. As the American people, we would most certainly feel the pain in the short term, but I think letting free markets reign always works out best long term. The position we are in now is what happens when human nature tells us we are smarter than the market.
I think they will keep rates low. Yellen said as much in her last interview. It seems they plan on letting inflation run until it gets high enough to justify raising rates. The American people will feel it, but they will not understand why their savings and buying power are being eroded. (Obviously, bitcoin fixes this even on a personal level, they cant inflate away your bitcoin.)
They will continue to kick the can down the road as long as possible, and it is possible to kick this can for years or even decades. However, the markets always come to collect, and one of these times the wave will be too big to sidestep. Read up on your Roman history friends.
Last thing I will say because if I don't cut it off here, I could go on for quite some time. Even if nations do not adopt bitcoin as a reserve asset and bitcoin is just an asset for bitcoin maxis, retail speculators, maybe gold bugs, and institutional investors, it will still do very well. Gold and bitcoin both do well in inflationary environments as people and corporations search for a store of value.
Although, we are starting to see more countries mine bitcoin (Iran, Pakistan, Venezuela, China, Russia), and as more large corporations add it to their balance sheet, it only gains credibility. I do not think the scenario I laid out throughout this blog post is out of the realm of possibility. In fact, I think it's very likely, and this leads me back to the first sentence of this article.
Whether you believe in bitcoin or not it doesn't matter, bitcoin is a hedge against the current sovereign debt bubble, its freedom to transact safely and without government interference, it's an incredible store of value, it would work well as a global reserve asset, and it has shown to perform beautifully during inflationary environments. So just buy bitcoin.
_Variant
Twitter: @researchvariant
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