Is It Time to Pay More Attention to Bitcoin and Other Crypto-Currencies?
- The sanctions placed on Russia are extraordinary in that central banks are used as a weapon, freezing Russian state assets and Russian Oligarch assets that are held in Western Countries. This is a first, and could have several important repercussions.
- This action could well be another step in the decline of the U.S. Dollar as the primary reserve currency for the world as Russia begins to transact oil and other commodity sales in other currencies, especially the Chinese Yuan.
- Any reduction in the use of the U.S. dollar as the primary reserve currency reduces the use of the dollar in international transactions and reduces the ability of the U.S. to project its power globally via sanctions.
- By extension, as some countries push to ‘de-dollarize’, it begins to legitimize the use of crypto currencies as reserve assets that are beyond the reach of sanctions.
What Is a Reserve Currency?
A reserve currency is any currency or precious metal that is held in large quantities by governments (central banks). Reserve currencies are the most stable currencies, issued by stable governments and are used to make large international transactions, which minimizes currency translation risks.
In order to function as a reserve currency, it must:
- Have adequate liquidity (there must be enough around) to facilitate efficient international transactions.
- Be freely and easily exchanged for other currencies, which means that capital needs to be able to freely flow in and out of the reserve currency country.
- Be held by many monetary authorities and held in consequential amounts.
The dollar was first recognized as the primary reserve currency in the Bretton Woods Agreement of 1944. Its clout in world trade grew rapidly from that point, as shown in the graphic below and the dollar remains the primary currency of choice for large international transactions, like oil and other commodities. Having reserve currency status imparts certain power to the U.S. and is the reason that economic sanctions can be effective.
The rise of other economies, like China, and the use of sanctions against other central banks, specifically Russia, raises questions in other countries about the advisability of having the preponderance of reserves in dollars. In short, what is to stop the U.S. from sanctioning others? Russia’s economy is quickly feeling the pain of those sanctions, but it is also providing ample incentive for Russia and China to transact in Rubles, or Yuan in place of the dollar. If that trend were to expand, it could enable a decline in the ability of the U.S. to project power globally via sanctions, and implicitly forcing the U.S. to rely more on military might.
Is the Dollar Threatened?
Our fiscal irresponsibility is a long-term threat to the dollar as that ultimately undermines the stability of the dollar, if not addressed, but that does not appear imminent. Nonetheless, the dollar is often described as ‘the cleanest dirty shirt in the laundry’ because the dollar’s status has slowly been eroded since its peak in the early 1970’s. But, if the power of the dollar is to decline, the power of some alternative must also rise and no other currency appears ready to replace the dollar. The Euro is handicapped by the lack of a political union. In the U.S., all Treasury debt is the same, but in Europe, German government debt is a far cry from Italian government debt, despite both being priced in Euros. As a result, the Euro is fundamentally handicapped in any effort to become the primary reserve currency.
There is also persistent speculation that the Chinese Yuan is positioned to replace the dollar, but to be a reserve currency, the free flow of capital must be allowed over borders to facilitate large transactions. China is not in a position to accommodate that because if capital flows were free, there would likely be a massive flow of capital out of the country as the Chinese elite seek to limit their dependence on the CCP. The Yuan has some attraction as a reserve currency, but without a mechanism to allow free capital flows, that is simply impossible.
One thing that appears to be better positioned to potentially act as a reserve currency are crypto currencies, such as Bitcoin and Ethereum. For countries that desire a disconnection from the dollarized Western world, crypto currencies could be an option. Certainly, Russia would have been better served having some reserves in ‘unsanctionable’ Bitcoin as opposed to dollars and crypto currencies now have a market cap of roughly $2 trillion, so liquidity is improving.
Our primary concern regarding cryptos is, and has been, government regulation. All governments rely on the ability to control the money. Without that, there effectively is no government. As such, there is a natural tension between crypto currencies and government. If cryptos become a threat to the official currency, there is a very real risk of the crypto being banned by government. However, the Ukraine conflict brings up a situation where governments of some of the largest and most powerful countries on earth could embrace crypto currencies and that would be a giant leap in the legitimatization of crypto currencies. After a long pregnancy, maybe the birth of a new ‘independent’ reserve currency is finally being born.
The fact is crypto currencies are finally offering individuals and investors freedom from their own government’s currency. This has not been lost on the governments, and they are seeking to pursue controls around their use, and even initiating their own digital money. Chris Giancarlo lays out this conflict in his book, “Crypto-Dad: The Fight for the Future of Money”. This represents the first true “unrestricted currency” choice for individuals, and it has set up a conflict with some citizens and their governments as to who is in control. It will be interesting to watch how this plays out over the next several years.
What We’re Reading
Why the Federal Reserve raises interest rates to combat inflation
Inflation: Top consumer issue, top policy challenge
Forecasters see growing chance of a recession as Fed hikes rates this year
Fertilizer Prices Surge as Ukraine War Cuts Supply, Leaving Farmers Shocked
Yemen’s Houthis claim attack on Aramco facility
It’s the beginning of the end of globalization
Semiconductors are like oil — making more in U.S. can avoid global crises
How Cryptocurrency Is Helping Ukraine
Reasons to Wait Until 70 to Start Taking Your Social Security Benefits
Palumbo Wealth Management (PWM) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where PWM and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.palumbowm.com
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.Bitcoin, Central Banks, China, Cryptocurrency, Currency, Debt, Dollar, Economic Sanctions, Euro, Federal Reserve, Reserve Currency, Rubles, Russia, US, Yuan
Articles, General News, Weekly Commentary