How long will the US Dollar reign supreme?

[Originally posted on May 23, 2023]

(Any views expressed in the below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.)

There has been a lot of chatter recently about de-dollarization and weakness in the financial system. We wanted to share some zoomed-out thoughts on what history can teach us about changing Financial Systems, and how you can best position for the future. (Hint: Buy Bitcoin).

Shelf Life of Global Reserve Currencies

The Financial System as we know it has really only been around 500 years — which in the wide arc of humanity, isn’t really that long. Aside from using computers instead of quills, our system today resembles pretty closely the financial systems of 16th century Europe. One country, or empire, amassed enough economic and military power to set the rules, and set themselves up as the Global Reserve Currency, giving them access to print money and run up large debts. As shown in the graph below, the players changed, but the game largely remains the same.

Ray Dalio has spoken and written prolifically about how countries and currencies rise, and inevitably fall. The idea being that if we understand the past, we can better navigate the future. Dalio has identified several factors that contribute to the fall of Global Reserve Currencies. We’ll highlight a few below:

Large Debts

From households to corporations to the US Government we’re more in debt than we ever have been. We’re seeing this play out in real time as the US Government is about to hit their debt ceiling (again). Which, all political charades aside,will result in a higher debt ceiling. Large debts lead to large interest payments which inevitably lead to…

Printing Money

When the choice is to default on the debt or print money, governments always print more money. The above chart shows the relationship between the Fed Balance Sheet and Debt Payments with a ~3 year lag. In other words, the money printing follows almost exactly the cost of the interest payments that are coming due over the upcoming three years.

Think the Fed are reducing their balance sheet? Think again. They have no choice but to keep printing, otherwise they can’t make interest payments and eventually default on their debt. All this money printing eventually leads to inflation and monetary debasement. Countries that were fine holding US Debt don’t want to be paid back with printed, weakened dollars, so they stop buying US Debt. Which then leads to…

Loss of Reserve Currency

Historically, other central banks have been some of the largest holders of US Debt, but that is changing rapidly. The above chart shows how China has drastically reduced their US Treasury holdings over the last year. Similarly, The Bank of Japan reduced their holdings by 13% this year.

We also see this shift happening when we look at central banks ditching the dollar to increase their gold reserves. Q3 saw the biggest increase in central bank gold demand and we anticipate this to continue.

How Long Will the US Dollar Reign Continue?

Does all of this mean that the US or the US Dollar is on the brink of collapse? That is a little extreme, but it’s certainly worth getting outside of our Normalcy Bias from time to time to think about what the future might bring.

Is even a small system change impactful? When would such a drastic change happen? What should I do about it?

Balaji Srinivasan, former a16z partner and Coinbase CTO, furthers this thought exercise by arguing that Bitcoin and the Internet Financial System (aka crypto and DeFi) will be an inflection point that could cause the future financial system to start taking a different shape from the European systems of the past:

De-dollarization is decentralization. That is, rather than a *single* replacement reserve currency, we’re entering a multipolar world with several networks that compete with both each other and the dollar for different functions.

1) Store of value → Bitcoin, gold, precious metals

2) Medium of exchange → CNY, INR, USD, local currencies

3) Financial system → Crypto, China, India, FinTech, local economies

Basically, if you think of the dollar as a network where the ‘System Admins’ are Fed and Treasury, key pieces of that network are getting unbundled. And this is no longer a purely market-driven phenomenon. States are now de-dollarizing for national security purposes. They don’t want the Fed to have a remote kill switch for their economy. And why would they? It’s not democratic for the Fed to control another country’s economy. Other states want to be sovereign and want to rely on their own local currency, if they can.

How hard is it really today to stand up an international payments network or digital currency, with both consumer and enterprise functionality? Way easier than it was in 2008.

Indeed, it’s already underway. How much transaction volume already occurs on networks where the Fed isn’t the ‘System Admin’? Think about Bitcoin, Ethereum, India’s UPI, China’s WeChat + digital yuan, and smaller networks like Brazil’s PagSeguro and Southeast Asia’s GrabPay, just to name a few. You don’t have to “like” any of these to acknowledge some have 100M to 1B users already.

They aren’t the good guys, but Russia gives one answer. They seemingly managed to transition away many functions from the dollar to the yuan in one year, in the middle of a war, without completely wrecking their economy. So this shows that de-dollarization can happen very fast if a state decides to do it. Even countries that don’t like Russia know that a playbook exists.

Exiting the system

With de-dollarization chatter on the rise, impending money printing, and bank failures leading to almost 50% of Americans who think their money isn’t safe in US banks, it’s natural for investors to start thinking about how to structure their portfolios.

As we’ve discussed, the whole financial world is highly correlated with the money printing of the Fed, and with SVB we’ve seen how quickly contagion can spread through the financial system. So, really we’re looking for assets that can:

1) outcompete the monetary debasement and

2) allow the investor to retain control over one’s assets without relying on intermediaries.

One way to think of this is identifying assets that are Inside vs Outside the system:

Inside Assets

• $AAPL Stock
• Gold ETFs
• Grayscale’s GBTC

Outside Assets

• Self custodied Bitcoin/Crypto
• Real Estate
• Physical Gold

While tech stocks have done a decent job of outperforming the money printing, you don’t actually own the stock, and as we saw during the Gamestop debacle, are subject to many intermediaries. Gold ETFs and GBTC give you exposure to hard assets, but are subject to restrictions within the system.

In terms of Outside Assets, gold has been around for millenia and is where investors immediately turn to in times of uncertainty, so it’s no surprise to see Gold topping the chart of what assets investors would buy on a US Default.

It is quite remarkable however, to see Bitcoin third on that list. Remarkable in the rapidity of its ascendance. From the last major financial crisis where Bitcoin rose from the ashes to now steadily capturing market share as an exit from the dependency on state currencies.

Bitcoin, and the Crypto Market broadly, has outperformed the high level of money printing more than any other asset class. And this outperformance against the central bank balance sheet has come despite several drawdowns greater than 75%.

Even if a change in regime from the US Dollar might not be imminent or as extreme (though some argue it is), the debasement of the dollar in any amount can be impactful. So, whether all this happens within the next 90 days or the next 90 years, we believe that the USD will devalue over time and the current financial system will continue to undergo changes.

So, with the data on large debt, money printing, and a declining reserve currency, does a portfolio restructure better hedge your viewpoints on the future of the existing system?

In addition to traditional Outside Assets like gold, exposure to Bitcoin, and other crypto assets, is becoming a must in every portfolio, now more than ever.

Here’s a handy framework to help you think about how you’d like to position yourself for the future. Which statement resonates with you?

And before you plot yourself on this matrix, here’s a sobering quote from Ray Dalio that might influence your position:

Ironically, the closer most people are to the blowup…the riskier the situation is, but the safer people tend to feel. That is because they have held the debt and enjoyed the rewards of doing so. The longer it has been since the last blowup, the more people’s memories of it have faded — even as the risks of holding the debt rise and the rewards for holding it decline.

If Bitcoin and Crypto really are a part of the financial system life raft, then it’s probably worth being early rather than late. At 8DC we’re already on board the life raft and we continue to recommend to LPs and others that hedging against the system with Outside Assets is a smart thing to do.

We’re fans of tried and true safe haven assets like precious metals and real estate. Obviously, we’re even bigger fans of Crypto. Exposure to Bitcoin and Crypto is becoming more and more obvious as well, whether you hold it yourself, or with experts like 8DC where we self-custody using institutional best practices.

At 8DC we continue to live and breathe crypto and the changes that are incoming. As you go through this thought exercise and decide you want more exposure to Crypto Assets, we’re here to help you manage it.