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1/ Some thoughts on how a US fiscal crisis may play out and how crypto does in response. In short, deflation likely a greater risk than hyperinflation. Still positive for crypto longer term though a bearish event for all financial assets, save gold.
2/ In his analysis, @johnarnoldfndtn rightly points out the intractable politics of reigning in the budget. But the conclusion, per Modern Monetary Theory, that the bulging debt eventually leads to rising inflation, is more debatable.
3/ In countries with weak central banks, government pressure to monetize deficits leads to high inflation. (Venezuela) The Fed is not so weak, will target 2% inflation, not easily bow to whims of fiscal policy. In the US, bulging debt probably means a credit crunch.
4/ Credit crunch here means a buyer’s strike on US Treasuries. Yields go up, signaling to the government to get its fiscal house in order. Uncertainty rises, leading to a drop in investment; cost of capital rises for all. In short, a recession results.
5/ We’ve already been through a recession, so we know what that’s like for inflation—it stays low. Here, the problem is worse, because the government has to cut spending/raise taxes, which means weaker demand and deeper recession.
6/ “Debt-deflation” becomes a risk. If growth is so weak and leads to deflation, existing debt becomes more difficult to service. 3% interest rate debt expensive if inflation is 0%, free if 3%. Clearly, Fed will try for QE4, since deflation is anathema.
7/ Worse yet is if Fed can’t ease monetary policy due to USD weakness. However, this didn’t happen with the EU crisis, less likely with reserve currency. BUT if Fed needs high rates to stabilize USD, ouch, because now both fiscal and monetary policies are contractionary.
8/ Whatever the case, US growth is in the pits, the specter of deflation haunts the Fed despite a one-off inflation spike from USD weakness. Clearly the rest of the world suffering because the main global growth engine has stalled. What does this mean for assets?
9/ Clearly, USD should weaken and reserve currency status will be questioned, but unlikely to be as significant as people think, since currencies are a relative concept, and while the USD is going through a crisis, other countries will be badly hurt as well.
10/ Remember, Japan is already overly-indebted and Europe’s debt situation is arguably worse than US’. China is epically over-levered, and a US crisis could precipitate a China crisis if the market wonders how all that debt gets serviced if its biggest customer US is downsizing.
11/ In terms of crypto, the question is whether it is priced like tech or commodity. Take BTC. If it’s still early stages of mainstreaming, it’s still got a lot of early tech risk premium. It’s high risk, so in a de-risking environment, it may be the first to go in portfolios.
12/ If BTC in later stages of mainstreaming, maybe it trades more like a commodity (precious metal), in which case it trades with low or negative correlation, like gold. This is a hopeful scenario – mainstreaming likely longer-term process, fiscal crisis nearer-term.
13/ Difficult to see where to hide in a fiscal crisis. If QE4, clearly the front-end of the yield curve – back end less so, with higher fiscal risk premium. Gold seems to be the only winner. Perhaps EUR and JPY gain against USD. Ouch for equities.
14/ Longer-term, when the dust settles, clearly the diversification away from the USD will continue, leading to a more multi-polar world. BTC clearly benefits but probably still at the margins. Central banks will continue to be fundamentally wary of crypto. (see next)
15/ Gold likely the winner. But for households and institutions and corporates, interest in alternative safe havens will clearly rise. Crypto challenges of volatility, custody, security, governance getting resolved will be the speed limit to further adoption.
16/ Clearly some major uncertainties in the analysis. One: how will Congress respond? A credible fiscal plan doesn't have to be austere ST as long as there is a LT plan. But if entitlements are the problem and tough to tackle, kick-the-can solutions more likely.
17/ Two: how prepared is the banking sector? Much better shape than pre-Lehman, but stress tests are in order to see if asset impairments lead to weakly-capitalized and therefore weakly-functioning banking system. Extra ding to growth and possible bailouts.
18/ Three: who starts the UST buyer’s strike? Since the US has a current account deficit, it is dependent on foreign financing. Foreigners usually the first ones to bail. But many countries trust USD more than their own, so a sell-off may not be so soon or violent. Unclear.
19/ Comments welcome. Complex systemic topic. Kindly asking crypto financial market experts to enhance the discussion. @aridavidpaul @zerohedge @fundstrat @cburniske @TusharJain @_JillRuth @APompliano @ZhuSu @MustStopMurad Others?
