Bitcoin And The Dollar System: Quarterly Review

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The calendar quarters come and go. Yet these past three months were probably ones for the record books. 

In this post, I will try to summarise the past quarter from the point of view of bitcoin and macroeconomics. Let's dive straight in!

Case for Bitcoin

In my humble opinion, the last quarter was the first real test for Bitcoin, which it successfully passed. 

In the Freedom Convoy protest, Canadian farmers and truckers demanded the end of coronavirus mandates. This movement drew a lot of sympathy from the international community, and many individuals donated funds to the campaign. The government responded to the latter action by invoking the Emergency Act and ordering financial entities to freeze accounts and assets of individuals who were donating money to the protests.

However, this did not stop people from donating to their cause. People simply turned to bitcoin and raised around $1 million. 

The story of Canadian truckers is an excellent illustration of Bitcoin's primary strength - decentralisation.

There is no centralised point of weakness in the Bitcoin network because it is backed by nodes and miners dispersed worldwide. Without such liability, any authority loses its ability to stop bitcoin-based support, which is the opposite of what the Canadian government did with the two crowdfunding platforms that the support used before they switched to bitcoin.

Furthermore, Bitcoin protects the economic freedoms of anyone willing to defend the movement they deem suitable.

Anthony Pompiliano said in his newsletter: 

Bitcoin is a freedom technology. It is a peaceful protest that arms the average citizen with a censorship-resistant technology that prevents their government from enacting authoritarian measures that encroach on their basic rights.

As some would argue, the Bitcoin community became too focused on the idea of bitcoin as "digital gold".

Shinobi wrote on March 7:

While the narrative of censorship-resistant payments has by no means disappeared, in my opinion[,] it has become slowly eclipsed over the last few years by the mantra of "digital gold" and "digital scarcity.

Although bitcoin withstood the test, the last quarter also exposed some weaknesses in the current Bitcoin infrastructure — it is not perfect. Users have to rely on the centralised exchanges that must comply with the state laws to convert bitcoin into fiat since we live in a fiat-dominated world. But users do have a choice — convenience vs decentralisation. 

As the author of this article argues towards the end, the need to convert bitcoin into fiat will not last forever. As Bitcoin gains adoption and more and more places start accepting payments, the need for bitcoin-to-fiat conversions will subside, if not disappear completely.

In US Dollar We Trust

At the start of March, Zoltan Pozsar from Credit Suisse wrote in a newsletter that the world is witnessing the birth of Bretton Woods III — a monetary order centred around commodity-based money.

Bretton Woods II was built on inside money, and its foundations crumbled a week ago when the G7 seized Russia's FX reserves.

Foreign currency reserves of sovereign nations are mostly US issued debt securities. Short term US government bonds or Treasuries tend to be the preferred option as they are deemed to have a very low risk.

Zoltan also pointed out that the outcome of the new monetary order could be the weakening of the Eurodollar system and the rising of inflation in the western economies.  

As many economic commentators have noted, the G7 actions question the credibility of the US dollar system and the US Treasuries as a saving device.

In his recent interview, Nic Carter agreed that the US and its allies' seizure of the Russian reserves marked the end of the Bretton Wood II era.

Many countries now have ground to re-evaluate their foreign reserves portfolios, especially China, which holds $3.25 trillion in foreign reserves and currencies as of January 2022. 

What stops the US from freezing reserves of other countries that misbehave?

At the end of the day, everything comes down to trust. When it is broken or in question, unnecessary frictions in economic activity arise.

Moreover, trust is crucial for a medium of exchange. As Naill Ferguson, a historian, put it, the critical component of money is trust — trust in the object representing money. In the creditor-debtor relationship, both parties need to trust the medium of exchange used.

Bitcoin -- a decentralised monetary system that is sovereign to anyone, offers us a way to eliminate trust from this equation.

Marty Bent from Bitcoin Magazine wrote on March 8:

In a world where you cannot trust anyone because trust has been eroded, the only viable option is a free and [open-source] distributed software program that anyone can join and validate for themself. Bitcoin has never been more obvious of a solution than it is today.

Although countries could (and probably will) choose to experiment with different dollar alternatives at first, these strategies will fail in the long term, as they require trust to make them work. 

So, what are the potential implications of this broken trust? Countries could diversify their foreign reserve holdings into hard assets, such as gold, commodities or infrastructure. 

Lyn Alden wrote on March 17:

In a world where official reserves can be frozen, some degree of reserve diversification would be rational for most countries to consider.

Actually, China has been decreasing the US Treasury and reinvesting money into infrastructure projects across Asia and Africa. 

Weaker demand for the US bonds makes it more expensive to issue new debt and spend money aggressively, a privilege the US has had so far. It is not that easy to slow the spending machine down. A decrease in foreign appetite for US debt will likely force the US Federal Reserve to step in and use "newly printed" US dollars to stimulate the demand, boosting inflation.

High US debt levels will prevent the Fed from raising interest rates above the inflation rate (I explained why in one of my previous articles). The slow erosion of fiat foreign reserves due to an inflationary environment will only add to an incentive for counties to move their accounts into hard assets. With sovereign reserves representing decades of trade surplus, these countries won't be willing to see these reserves melting away. 

Although it may sound like highly positive news for bitcoin and supporters of the "Bitcoin Standard," this excitement might be premature. 

Bitcoin is not yet big enough to absorb the global shift away from the USD system, as Saifedeam Ammous said in his recently released podcast. And yet, the events of Feb-March 2022 have indeed for better or worse accelerated the process of shifting away from the dollar, he added.

Supply Chain Fragility

The final topic is not unique to the first quarter of 2022, as its roots started growing back in 2020 — and that is supply chain security. However, I do want to touch on it as I think the recent events have only made the fragility of the supply chains more apparent. 

Let's take a quick detour into history. Since around the 1980s, the world has been slowly trading away the resilience of supply chains in return for efficiency. Rather than manufacturing goods close to the end-users, companies shipped their shops thousands of miles away to benefit from lower labour and other input costs. The terms such as "lean manufacturing" or "just-in-time" slowly became household names.

And yet, these practices made the supply chains fragile and vulnerable to any external shocks, such as COVID-19. The authors of a brilliant article — Every Step of the Global Supply Chain Is Going Wrong - All at Once — dive into the COVID-19 impact on shipping routes and two largest ports in California.

Highly complex yet efficient supply chains can function adequately in the "stars-alighted" macroeconomic environment, as Lyn Alden wrote in March 2022.

This problem is not limited to goods the Western countries import from Asia. As this quarter has shown us, the implications are much broader. 

The European energy sector showed how vulnerable it is to events outside our control. European gas and electricity prices rose drastically in the past month.

In his March 2022 memo, Howard Marks wrote that the European dependency on the Russian energy exports — gas and oil — was driven only by pro-climate motivation. At the same time, energy security has not received the necessary consideration.

[Considering] how critical electronics are to US national security, this vulnerability could, at some point, come back to bite the US in the same way that dependence on Russian energy resources has the European Union.

So what can we expect going forward? Researchers at Pimco anticipate that companies will start diversifying their supply chains and reducing dependency on some countries to mitigate supply shocks.

In the long-term, we could see multinational corporations moving some of their operations away from China for domestic reasons: tightening the labour market and moving towards higher value-added manufacturing. 

Besides, government incentives in other Asian countries, such as Japan and Vietnam, will likely facilitate this migration, according to Pimco.

A decade of these things has happened over the past three months. And yet, this quarter made the reasons for Bitcoin’s existence clearer than ever before.