Dollar Inflation & Bitcoin’s Buffer

The dollar’s depreciation is at risk of sparking off inflation and the primary beneficiary of that would be gold and Bitcoin.

When Paxton Cayne first moved into his 19th century brownstone on Jefferson Avenue in New York’s Bronx borough, he had a job at one of the top banks in Manhattan and wore sharp Brooks Brothers suits to work.

Every morning, as was his routine, Cayne would grab a bagel and a black coffee with no sugar, from a bodega at the corner of Franklin Avenue and Hancock Street, before catching a subway into lower Manhattan.

In the evening, Cayne would stop by that same bodega to pick up some groceries before heading home for the evening.

And over time, he got to know the owners of the bodega when one day, Cayne forgot to bring his wallet to work, the owner of the bodega suggested that he just run a tab at the bodega.

From the owner’s perspective, it would induce Cayne to spend more, and from Cayne’s view, it’d save him the hassle of always having to make sure he had enough cash to shop there.

And so it went for the better part of a decade, Cayne would run a tab at the Bodega and pay at the end of every month — an arrangement that ran smoothly until the 2008 financial crisis hit.

Before Cayne knew it, he was out of a job and barely able to make rent from his meager savings.

The owner of the Bodega soon noticed that Cayne was no longer coming in dressed in his Brooks Brothers suits and looking increasingly disheveled, but somehow, Cayne still made regular payments on his tab.

But when Cayne started to run bigger tabs, and delaying payments on those tabs, the bodega owner started to worry and curbed his credit before cutting it off altogether when Cayne stopped paying completely.

At which point Cayne broke down and explained that he had exhausted all his savings.

The bodega owner, who wasn’t spared from the financial crisis either, was sympathetic, but unmoved,

“Look, until you can prove your ability to make good on your tab again, I can’t offer you any more credit.”

And that’s increasingly how things are looking for the dollar.

Doubting The Dollar

More than ever before in recorded history, the world is starting to have serious reservations over the widely accepted presumption of American exceptionalism.

Largely out of frustration, in the 1960s, then French Finance Minister Valery Giscard d’Estaling railed against the dollar’s “exorbitant privilege” which allowed America to draw freely on the rest of the world to support its over-extended standard of living.

Yet for almost 60 years, the world did nothing about it and the collapse of the Soviet Union and America’s victory over communism solidified the dollar’s dominance in carbonite.

That may be set to change.

Already stressed by the coronavirus pandemic, American living standards, long the envy of the rest of the world, are coming under increased stress at a time when American exceptionalism is no longer a guarantee.

Under normal circumstances, currencies reflect the equilibrium between domestic economic fundamentals and foreign perceptions of a nation’s strength or weakness.

And dollar supremacy, long taken for granted by Washington, has been under pressure long before the coronavirus pandemic started with the first sneeze.

Domestic Disturbance

A profound shortfall in domestic U.S. savings was glaringly apparent well before the coronavirus pandemic.

As recently as January this year, a poll from Bankrate revealed that almost 60% of Americans wouldn’t be able to handle a US$1,000 emergency, such as a medical bill.

And by the end of the first quarter of 2020, net national saving, which includes depreciation-adjusted savings of households, businesses and the government sector, fell to just 1.4% of national income — the lowest reading since late 2011, and just 20% of the average of 7% from 1960 to 2005.

Granted the coronavirus pandemic and the lockdowns that ensued, forced most America households and businesses to draw on their already meager savings.

But the pandemic has only papered over an American tendency to want to invest and grow instead of save, with the U.S. taking advantage of the dollar’s role as the world’s reserve currency and drawing heavily on surplus savings from abroad to fund Cadillacs and candy floss.

American profligacy however has not come without a price.

In order to attract foreign capital, the U.S. has run a currant account deficit — a broad measure of trade because it includes investment — every year since 1982.

And if you’re wondering why 1982, just Google who was in the White House at the time — none other than Ronald Reagan with his trademark Reaganomics.

Regardless of one’s views towards Reagan, his economic policies created the go-go 80s and an era of unprecedented avarice — it also marked the tripling of the national debt in the eight years that Reagan occupied the White House, and ultimately reversed the post-World War 2 trend of shrinking the national debt as a percentage of GDP.

The coronavirus pandemic and the ensuing economic crisis has merely stretched the tension between saving and the current account to breaking point.

According to the bipartisan Congressional Budget Office, the U.S. federal budget deficit is likely to soar to a peacetime record of 17.9% of GDP in 2020, before (fingers crossed) receding to 9.8% in 2021.

But that doesn’t mean that America would have paid down it’s debts — no, it just means that America would have borrowed less in 2021 as opposed to 2020.

To be sure, the coronavirus pandemic has made Americans more thrifty, but the spending by Washington has far outstripped any frugality hard wrought by households.

While a significant portion of the fiscal support emanating from Washington has been saved by fear-driven and now unemployed American workers, monthly data from the U.S. Treasury Department shows that crisis-related expansion of the federal deficit has far outpaced the fear-driven surge in personal saving.

In April, the deficit was 5.7 times the shortfall in savings in the first quarter of 2020 or over 50% larger than the April increment in personal savings.

Americans are saving more, but Washington is spending even more than households can save.

To understand just how deep the savings deficit is, consider that during the financial crisis, domestic saving was a net negative for the first time on record, averaging -1.8% of national income from the third quarter of 2008 to the second quarter of 2010.

This time round, most analysts estimate the domestic savings rate could plunge by as much as -5% to -10%, with serious implications on the dollar.

How Safe is Your Dollar?

For now at least, the dollar appears to be strong, benefiting from typical safe haven demand, which has long been the case during periods of crisis.

During the financial crisis, many who had panned the dollar were stunned when it emerged from that economic quagmire stronger than ever.

In the first quarter of 2020, despite America racking up more coronavirus cases and deaths than any other country, the dollar was up almost 7%, against a broad cross-section of U.S. trading partners and a full third above its July 2011 low, according to data from the Bank of International Settlements (a clearing bank for central banks).

But remember, the strength of a currency consists of two components — domestic economic fundamentals and foreign perception.

And it is the latter that has been particularly problematic over the course of the Trump administration.

Trade protectionism, withdrawal from international institutions and the cornerstones of a global world order, such as the Paris Agreement on Climate, the Trans-Pacific Partnership, the World Health Organization and traditional Atlantic alliances, including the withdrawal of troops from Germany, have all created doubt over America’s continued commitment to the global world order that it helped build and currently leads.

Domestically, gross mismanagement in the federal response to the coronavirus pandemic and wrenching social unrest as a result of institutionalized racism, coupled with the poor response in the wake of those protests are all stark visual reminders of America’s sharply diminished global leadership.

Graphic scenes of law enforcement officials armed to the teeth, firing tear gas and rubber bullets into unarmed crowds of protesters seeking social justice, look more the response of a totalitarian dictatorship, than a beacon of democracy, and undermine Washington’s ability to criticize China’s heavy handedness in Hong Kong.

The worst thing an ideological rival could say is not “I hate you,” but that “you and I, we are not so different after all, are we?”

As the economic crisis caused by the coronavirus starts to finally stabilize, the dollar could easily test its 2011 lows, weakened by as much as 35% in broad trade-weighted, inflation adjusted terms.

And while it is unlikely that the dollar will collapse (empires typically fall well before their currencies fall out of favor, and America is not yet on the brink of collapse), the dollar’s decline will have three key implications.

First, the decline of the dollar will be inflationary, which is why some investors are betting on and hedging against the dollar, using a variety of tools, including gold and Bitcoin.

Second, inflation in conjunction with what could be a weak economic recovery could spur stagflation — a worse case scenario where tepid growth mashes up with rising inflation that will wreak havoc on financial markets and cause untold levels of economic hardship that America hasn’t faced in decade.

Under such circumstances, stocks will suffer, but alternative assets which could act as a potential store of value, including Bitcoin, may thrive.

Finally, a weaker dollar will result in a sharply widening trade deficit.

A weaker dollar coupled with protectionist policies will only hurt Americans, diverting trade between the U.S. to other higher cost producers and acting effectively as a tax on America’s beleaguered consumers, as well as stoking the flames of inflation.

That could have a downward spiral effect on the American economy — because as costs increase, inflation rises, Americans will be forced to spend less, leading to less economic flow — the very lifeblood of the American and indeed, the global economy.

Understandably, winning elections in the U.S. is less about logic than it is about rhetoric.

And championing Chimerica — that chimera of American consumption coupled with Chinese production — does not make for a clarion call on one’s bully pulpit, nor does it pander to one’s nationalist base.

But that would be a mistake.

America and China both need each other — one to consume and the other to produce.

Washington’s poorly timed (but politically expedient) desire to decouple from China may make for a good sound byte, but in essence undermines one of the biggest buyers of America’s bonds.

Who then will step forward with the wherewithal to fund America’s profligacy?

And what pound of flesh (namely interest rates) will America’s creditors demand in exchange for their largess?

The problem with privilege is not in the exercising, but in the preservation.

The coronavirus pandemic and Washington’s response to racial turmoil have cast it in a very harsh light.

America’s undermining of global institutions means that eventually countries will question the tax they pay for using the currency of a global hegemon they no longer admire, or respect.

Short of politically palatable alternatives, could Bitcoin become the least objectionable compromise?

Consider that just six months ago, nobody had foreseen the widespread economic destruction that a virus could have on the global economy — anything is possible.

Because “exorbitant privilege” needs to be earned, not taken for granted. The dollar may still be dominant today, but that doesn’t guarantee its indefinite privilege.