While the price of Bitcoin may be well off its all-time-high, macroeconomic shifts and a strengthening dollar may provide fertile ground for its long-term growth.
When people think about Bitcoin they typically measure its price in relation to the dollar. For instance, when someone says Bitcoin “crossed 20k” they usually don’t mean for that to be in euros or the Japanese yen
And that’s because for better or worse, the dollar remains the world’s reference and reserve currency, setting the price of the commodities that make life possible, from gold to oil, wheat to copper, and everything in between.
It’s therefore no surprise that Bitcoin, and other cryptocurrencies which are increasingly being measured in dollar terms, take reference from the greenback as well.
But it wasn’t always like this.
The Bitcoin Standard
In the early days of crypto’s development, many new tokens measured their price with reference Ether and Bitcoin, as opposed to dollar-based stablecoins like Tether or USDC.
In fact, dollar-based stablecoins didn’t see much use in the heady days of initial coin offerings or ICOs, but rather investors were more keen on how much more Ether or Bitcoin they could make with each successive token issuance.
But taking a reference price against an asset that is just as volatile as that being measured made it very difficult for early crypto investors to tell if they were up or down in dollar terms.
And while measures of tokens against the dollar weren’t as important when crypto was a relatively niche investment class(arguably it still is), it became more significant when larger numbers of investors started taking notice of cryptocurrencies.
So an initial coin offering could have risen against say Ether, but it could have been down against the dollar and so over time, more and more tokens took to just measuring themselves up against the dollar for simplicity, which is what led to the growing popularity of stablecoins.
Around the time, cryptocurrency derivatives exploded in popularity, because if investors could make some money on an ICO, derivatives could help them make even more (or so the belief went) and almost all of these derivatives were priced in dollar terms, with the remainder priced in Bitcoin.
But it’s not as if there aren’t other fiat currency pairs against the major cryptocurrencies like Bitcoin and Ether, they were just not as liquid or widely traded and their derivatives were limited and that may be a good thing.
Liquidity for the Goose & the Gander
Because what’s been happening to the yen and the euro of late should provide even more food for thought when trying to peg an asset against anything outside of the dollar.
The Japanese and European economies are caught in a quandary — both Japan and Europe are heavily reliant on foreign imports of resources, especially oil and natural gas, which are denominated in dollars.
But soaring inflation in the U.S. has forced the Federal Reserve to tighten monetary policy and raise interest rates, which has strengthened the dollar and allowed U.S. Treasury yields to soar.
Japan and Europe’s monetary policies however, have barely budged relative to America’s.
The Bank of Japan (BoJ) is keeping interest rates at their status quo and while the European Central Bank (ECB) has hiked rates by 50 basis points for the first time in over a decade, it may struggle to go further.
Much of the reluctance to tighten monetary conditions by the BoJ and the ECB has to with their export-oriented economies.
Under normal economic conditions, Japan and the eurozone are happy to have a weak yen or euro because it would allow their export industries to gain market share as their goods would be cheaper.
But post-pandemic demand and the sanction of Russian imports of food and fuel by Japan and Europe, are hammering Europeans and Japanese with inflation, something that has hitherto been a stranger to them.
To be sure, Japan and Europe could have chosen to continue dealing with Russia, but likely chose not to in order not to anger their ally the United States.
Compounding the economic situation in Europe and Japan, both the ECB and the BoJ are are putting a cap on their sovereign debt yields by printing massive amounts of money to buy up their own bonds, which is what is leading to a massive surge in their money supply and a precipitous slide in their currencies against the dollar.
At some stage, Japan and Europe will need help, especially if traders continue to bet on a declining euro and yen and this is where Washington comes in.
Uncle Sam to the Rescue Again
In 2002, at a speech before the National Economic Club, then-U.S. Federal Reserve Chairman Ben Bernanke shared some interesting capabilities of the central bank,
The Fed can inject money into the economy in still other ways.
For example, the Fed has the authority to buy foreign government debt, as well as domestic government debt.
Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of U.S. government debt.
I need to tread carefully here. Because the economy is a complex and interconnected system, Fed purchases of the liabilities of foreign governments have the potential to affect a number of financial markets, including the market for foreign exchange.
But Bernanke also noted some jurisdictional limitations of the Fed and added,
While ostensibly Biden’s political theater would appear to be on behalf of Americans, it’s really to ease the burden suffered by Japan and Europe, which are buckling under soaring energy costs.
The U.S. has already tried to do as much as it can to liquefy natural gas and ship it to Europe, especially Germany, but that country which had long grown reliant on Russian supply simply doesn’t have the offloading and storage facilities to deal with the liquified product and will take time to develop those capabilities.
On the Ropes & Russia
There’s only so much that Japan and Europe can suffer before their people revolt and the situation becomes untenable, forcing their respective governments to either try and rush a speedy end to the Russian invasion of Ukraine, or restart trading with Russia.
There are already signs that eurozone governments are trying to encourage some form of negotiated settlement between Ukraine and Russia, especially as the winter months approach and Europeans cry out for natural gas, something which the Biden administration would like to avoid.
And while the ECB has raised its key interest rate by 0.50%, its first increase in 11 years and the largest one since the turn of the century, that only takes the deposit rate to 0%, nowhere close to how far the Fed has gone.
Unlike for Russia, time is rapidly running out for Japan and Europe, with the former sticking doggedly to keeping rates near rock-bottom, even as the latter has already caved with an initial rate hike
Nevertheless, the Fed is capable and stands at the ready at the direction of the U.S. Treasury to do what it takes to shore up the currencies of its allies, including printing dollars to buy yen and euro or even buying the sovereign bonds of Japan and European Union members, parking them in the Exchange Stabilization Fund on its balance sheet.
Such a targeted move wouldn’t necessarily affect the dollar’s value relative to other currencies, but it would weaken the dollar vis-à-vis the yen and euro, allowing Japan and Europe to purchase the commodities that it so badly needs that are denominated in dollars.
The other effect of such a measure by the Fed would be to help reduce Japanese and European government bond yields, without heaping more debt onto the balance sheets of either the BoJ or the ECB.
While Japan, Europe and the U.S. are all experiencing record high inflation, so far, only the Fed has raised rates to any meaningful degree, which is why the yen and euro have slid so quickly and so dramatically against the dollar.
But because global commodities are priced in dollars and America produces practically all of what it needs and then some, the Fed can afford to tighten policy and create a strong dollar.
The U.S. isn’t much of an exporter when it comes to the manufactures that Europe and Japan churn out and while oil prices sting American consumers, Uncle Sam can always pump or drill more if things get too bad, the Environmental Protection Agency be damned.
Japan and Europe on the other hand do not enjoy the luxury of self sufficiency and must rely on imports, which is why U.S. President Joe Biden has been going hat in hand to the Middle East to try and charm the likes of Saudi Arabia’s Crown Prince Mohammed bin Salman to get the oil-rich nation to supply more crude.
The longer the Kremlin is able to drag out its invasion of Ukraine, the greater the pressure on European governments to normalize trade relations with Russia at danger of its people being left to freeze.
As Washington runs out of options to aid its allies (Biden returned from Riyadh with an empty oil can) and winter fast approaches, there are few good options other than to relieve some of the pressure on Japan and Europe by the U.S. Treasury directing the Fed to print dollars and soak up some yen, euro and the sovereign bonds of these two allies.
If the U.S. Treasury were to trigger such a move, it would be highly inflationary and pump more dollars into the global financial system, even as the Fed publicly declares that it is tightening policy (selling or declining to buy fresh Treasuries) to fight inflation.
All of which would be bullish for risk assets denominated in dollars, including cryptocurrencies.