Why Bitcoin could become the next world reserve asset - Part 1: Why the dollar could lose reserve currency status
In 1944, the Bretton Woods agreement officially established the US dollar as the world reserve currency, a distinction it has retained to this day. However, I believe this era is nearing its end and within twenty years we will see Bitcoin take over as the world reserve asset.
While I’m definitely not the first to make this claim and the concept of Bitcoin displacing the dollar has definitely gained momentum over the last 12 months, this still seems to be a controversial opinion. In truth, I have been wrestling with this idea from the moment I first got interested in Bitcoin back in 2013. In reading Sitoshi’s white paper, it’s hard not to allow the thought “what if Bitcoin replaced the dollar” from entering your mind. But I’ll admit I didn’t think that was actually a realistic possibility back then. As Bitcoin went through multiple market cycles and rebounded stronger than ever each time, that voice in the back of my head kept getting louder and louder. Even as little as three years ago, I thought there was a very small possibility that Bitcoin could become the world reserve asset. The more I learned about the dollar, our weaponization of it and the world’s increasing opposition to it, the more I began to believe this was more likely than I originally thought. The work that Saifedean Ammous, Lyn Alden, Erik Townsend, Tyler Jenks, Nic Carter, Nik Bhatia, Anthony Pompliano, Jason Williams and many more have done has influenced and evolved my thinking on this topic over the last several years. By the end of 2019, I thought the odds were 50/50 that Bitcoin could overtake the dollar at some point in the future. Then 2020 happened. The US government printed trillions of dollars, the Chinese government launched the digital yen and now I believe this is not a question of if, but when.
This is my attempt to finally articulate the argument that first crept into my mind so many years ago. The first part of this series will attempt to explain why the dollar is on the verge of losing its status as the world reserve currency. The second part will cover some of the most likely candidates other than Bitcoin that could replace the dollar and attempt to explain why none of these options are likely to succeed. In part three, I will explain how and why I believe Bitcoin will emerge as the next global reserve currency.
In order to understand why the dollar is on the verge of losing its status as the world reserve currency, we first must understand why all previous world reserve currencies eventually failed.
All fiat reserve currencies eventually fail
I was born in 1985 so my whole life, all I’ve known is the current dollar system. Moreover, because the dollar went off the gold standard in 1971, all I’ve ever known is a fiat monetary system in which the supply of the currency is determined by a small number of people. The concept of sound money wasn’t something I had ever even heard of, let alone learned about, until I started to understand Bitcoin. For most of my life, I had simply accepted that money comes from the government and that inflation is a natural phenomenon because that’s all I had known.
That is until I started learning about the history of money. What I quickly realized was that the last 50 years is actually not the norm, it’s the exception. For most of human civilization, the currency of the time has either been a scarce, durable asset or backed by said scarce, durable asset. Some of the earliest forms of currency were barley and seashells, both of which were limited in quantity at that time. The first metallic coins originated in China and were made from bronze and copper which were hard to mine given the technology and tools available. Silver coins, which were scarcer than bronze or copper, rose in prominence for a time but eventually the world shifted to gold.
Why gold? Well first of all, it’s one of the rarest metals on the planet, so it has inherent relative scarcity compared to other metals. More importantly, it’s difficult to produce more. Mining gold is labor intensive and costly, so the supply cannot be easily inflated. Gold is also extremely durable and capable of being fashioned into smaller, uniform units such as coins. These characteristics, most notably its scarcity, gives its users confidence that it will retain its value and that everyone else will accept it as currency.
Eventually, governments decided to issue paper that was redeemable for gold in order to make the portability of currency easier. This innovation, pioneered in China in the 800s, led to increased economic activity as it made buying and selling that much easier. However, it also opened the door for the introduction of fiat currency.
Fiat is a government-issued currency that is not backed by an asset that is scarce such as gold. Without a tie to scarcity, central banks are free to print as much currency as they like. Most modern paper currencies, including the U.S. dollar, are fiat currencies.
But here is the thing: every time a world reserve currency has departed from sound money principles, aka off the gold standard, it has led to unchecked money printing, currency devaluation and ultimately results in the currency losing its value. Every. Single. Time.
Since 1450, there have been six world reserve currencies including the dollar. Each global reserve currency has lasted somewhere between 80–130 years. As of writing this, the dollar has been the world reserve currency for 77 years. Let’s examine each of the preceding five global reserve assets.
- Portugal — From 1450 to 1530, the Portuguese Real was the dominant currency as Portugal grew into a global trading empire thanks to advances in navigational technology that allowed them to reach new markets in Africa, Asia, and eventually America after it was discovered. The Real was a silver coin of relative uniform weight and as such was inherently scarce. However, the Portuguese succession crisis resulted in Spain conquering Portugal and merging the two kingdoms to create the Iberian Union.
- Spain — Following the conquest of Portugal, the Spanish Real took over as the dominant currency. Originally, the currency was made of pure silver much like the Portuguese Real. However, in order to finance the Thirty Years’ War, King Phillip II of Spain started to debase the currency by adding other, less expensive alloys to each coin thus diluting the amount of silver. More coins flooded the market and contained less silver per coin. The value of the Real eventually plummeted and the Dutch defeated the Spanish to gain their independence.
- Netherlands — the rise of the Dutch East India Company established trading posts around the world and at one point half of Europe’s imports and exports were facilitated by Dutch merchants. This led to the Guilder becoming the dominant currency of the world during the 17th century. The Guilder was originally a return to sound money as each coin was made from pure silver. However, Britain’s Navigation Act which excluded the Dutch from lucrative trading routes in the Caribbean led to the first of four Anglo-Dutch wars. Unable to produce more silver to finance the wars, the Guider too was diluted, and the currency was debased. The eventual saturation of the spice market, the costly Anglo-Dutch wars, and the economic troubles from a devalued currency destroyed the Dutch East India Company and the Guilder as a global currency.
- France — After the fall of the Dutch empire, the French rose to prominence in Europe under the Sun King, Louis the 14th. The Franc, originally a silver coin, was eventually replaced by paper bonds called Assignats to finance France’s involvement in the American Revolution and the extravagant spending of the monarchs. This devaluation eventually led to a financial crisis that sparked the 1789 French Revolution and saw the rise of Napoleon Bonaparte. In 1800, Banque de France was created and commissioned to produce a new national currency. What emerged was the first modern gold coin with a uniform weight. Economically, this sound money was a great success and even though Napoleon would fall shortly thereafter, succeeding governments adopted many of the characteristics of the gold Franc including the weight standard.
- Britain — Britain’s victory at the Battle of Waterloo marked the end of France’s world dominance and ushered in the Industrial Revolution. During this time the Pound Sterling became the global reserve currency which has its roots in sound money. The reason it’s called “the pound” is that the original currency was a unit of account equivalent to one pound of silver. The currency eventually shifted to gold coins but was still based on weight. Bank notes issued by the Bank of England were fully backed by gold thus establishing what we now call “The Gold Standard.” But history has a way of repeating itself and Britain was no different. In order to finance World War I, the gold standard was suspended and treasury notes became legal tender. Prior to WWI, the UK had the world’s strongest economy but after the war the country was in serious debt. By the end of World War II, the British empire was pretty much bankrupt.
Before we move onto the dollar, you might be wondering to yourself; isn’t the Pound still used today? You would be correct. At 326 years old, the modern Pound is the oldest currency still used today and by that standard could be considered the most successful currency ever created. Just one small problem, the value of the pound has declined by 99.5% over its lifetime. So arguably the most successful currency of all time is worth a fraction of a percent of what it once was due, in large part, to moving off the gold standard.
As we can see, each global reserve currency started out with sound money principles. Inevitably, economic pressures such as a lot of monarchy spending or a navigation act or financing wars or a financial crisis or a global pandemic create incentives to look at the short term benefits of loose monetary policy. In every case, this shift led to the debasement of the currency and the weakening of that country’s economy. In time, the economically (and militarily) stronger power replaced the existing currency with its own, which was a reversion back to sound money. The cycle would then play itself out and 80–100 years later and a new global reserve currency would emerge once again.
The trap of fiat
In 1944, the Bretton Woods agreement was negotiated and signed by 44 countries following the end of World War II. This agreement became the foundation on which the next 80 years of world economic, geo-political, and international diplomacy would be based on. The ramifications from that agreement are still being felt today including the rise of the dollar as the world reserve currency.
Under the Bretton Woods System, all other currencies were pegged to the dollar and at that time, the dollar was fully backed by gold. This was possible in part due to the fact that the US spent years stockpiling gold. The Gold Reserve Act of 1934 increased the price the Treasury paid for gold from $20.67 per ounce to $35 per ounce, which led to a large number of people globally selling their gold to the US government because of the higher price. All the imported gold, as well as any gold from US mining, went straight to the Treasury which led to US gold reserves more than doubling from 71 tons in 1933 to 151 tons in 1940. America had accumulated two thirds of the world’s gold reserve at the very time when all of Europe’s paper money had been debased in an effort to fund the war. With the rest of the world in shambles, the US emerged from WWII as the de facto economic superpower built on a stockpile of sound money. For a time, the world had returned to operating on a gold standard. However, as we have seen with previous regimes, history has this funny way of repeating itself.
The economic cost of the Vietnam War combined with the fact that the US did not have enough gold to cover the volume of dollars circulating throughout the world led President Nixon to announce in 1971 that the United States would no longer convert dollars to gold at a fixed value, thus completely abandoning the gold standard. The move at the time was said to be temporary but 50 years later, the US dollar, like all other major currencies today, is still pure fiat. Admittedly, the move away from the gold standard has not been without its benefits. It has allowed The Fed to adjust interest rates and increase the money supply in order to stimulate the economy when needed which one can reasonably argue can and has been beneficial to an economy when used in moderation. The problem is, as we have seen time and again throughout history, “black swan” events make it too tempting to abandon moderation in favor of short-term relief.
Enter 2008 and 2020.
The 2008 financial crisis forced The Fed to enact the largest financial stimulus package up to that time. While the initial TARP bailout was a “mere” $700 billion, numerous reports have shown the US government committed a total of $7.77 trillion to rescue the financial system. Twelve years later, a second black swan event occurred in the form COVID-19 and shut down the global economy. Having seen the “success” of the 2008 bailout, the US government reopened the money printing playbook and injected $9 trillion into the US economy in 2020 and the Senate recently passed an additional $1.9 trillion of stimulus. Money printer go burr indeed.
Before I go on, I do want to make something clear. This is not a judgement or criticism of the decisions made in 2008 and 2020. Experts far smarter than me argue the bailout had to be done in 2008. Today, people desperately need financial support as a result of the COVID pandemic. The purpose of this post is neither to praise nor condemn the actions that were taken in the past. What I am interested in however, is the long-term ramifications of those decisions regardless of they were well intended or not.
Even before 2008 and 2020, the value of the dollar has been eroding since 1971. It’s only been 50 years since the dollar went off the gold standard and since then it’s lost 80% of its purchasing power. And that was before the record levels of money printing that have occurred over the last several months.
The problem, at least in part, lies in the fact that the monetary policy is controlled by a central body (in our case The Fed) that is in charge of supporting the economy, not protecting the currency. Without the limitation of sound money, these central bodies are incentivized to use tools such as low interest rates and Quantative Easing to stimulate an economy at the cost of devaluing the currency. “Without ties to the circulating supply of a stable asset, the US has been able to print dollars indiscriminately.”
The decision to go off the gold standard has many more ramifications beyond purchasing power. There is a great website called WTF Happened in 1971? that has a collection of economic and social graphs highlighting various impacts of the decision to go off the gold standard. It’s worth spending some time browsing through the site.
We have seen this story before with Spain, the Netherlands, France, and Britain. The currency starts off backed by sound money, morphs into fiat to react to black swan events, and eventually collapses. The dollar is on the same path as all of its predecessors so why would we expect a different outcome this time around?
The backlash to the weaponization of the US dollar
Believe it or not, there is a more important trend than the debasing of the currency that is increasing the likelihood that the dollar will lose reserve status. As I went into depth in a previous post, the US has tremendous economic and diplomatic power throughout the world because a vast majority of the world’s transactions are settled in dollars regardless of whether a US entity is involved in that transaction. Any wire transfer that involves US dollars, which is 88% of them worldwide, eventually must be cleared by a US bank, which the US government can mandate to freeze if it so chooses. This is how the US imposes economic sanctions on other countries.
And the US has used this power. A lot. So much so that this weaponization of the dollar has sparked numerous countries to seek alternatives. Russia has been the most vocal on this topic, putting forth a “de-dollarization” campaign, saying that the “US has shown a consistent pattern of abusing its control over the dollar and that as a matter of self-defense, all governments around the world should stop using dollars to settle international transactions.” China has publicly proposed replacing the US dollar as the international reserve currency with a basket of global currencies controlled by the IMF.
But it’s not just America’s enemies that are growing frustrated. In 2019, the Governor of the Bank of England, Mark Carney, gave a speech to other central bankers specifically calling out the disproportionate amount of power the dollar gives to the US. Longtime ally Germany has called for the creation of a new payment system independent of the US. The European Union is beta testing an alternative settlement system that is independent from US influence and allows it to bypass any sanctions imposed by the US. Even our allies have grown tired of the US’s stranglehold on the world reserve currency.
And it’s no longer just rhetoric. Argentina and Paraguay used Bitcoin to settle an international export deal. Iran is actively using Bitcoin to get around US sanctions. North Korea is doing the same. Venezuela’s president Nicolas Maduro publicly stated the country is using Bitcoin in both domestic and global trade, as part of efforts to neutralize crippling U.S. economic sanctions. Russia is stockpiling gold reserves and China is currently testing its own central bank digital currency which it hopes will one day replace the dollar.
The reality is that the rest of the world, enemy and ally alike, has expressed concerns about the power the US has because of the role of the dollar and is actively exploring alternatives.
Today the dollar is still the dominant currency used throughout the world. However, if the dollar were to become less used as the settlement currency for world trade, which we are already starting to see happen, the demand for dollars is likely to decrease. Should demand fall far enough, and countries coalesce around another settlement system, that currency could very well emerge as the new world reserve asset.
There is another, more direct problem with the demand of dollars decreasing. Today, the demand for dollars throughout the world is so high that the US can print trillions and not experience increased inflation. This is simple supply and demand. Even if supply rises, so long as demand matches that supply, the price does not fall. However, if the demand does not rise with supply, or even worse begins to fall, then price falls dramatically. Thus, if another settlement system emerges, the printing of dollars the fed is currently doing will likely have a much greater inflationary impact. Should that inflation rise too fast or too high, confidence in the dollar will erode and demand would continue to fall creating a downward spiral.
Having controlled the world reserve currency for so long has been an incredibly valuable tool for maintaining US power and influence throughout the world. But beneficial as it’s been for us, it’s been equally problematic for many countries throughout the world, which has caused other nations to search for alternatives to the dollar. Ironically, what has been such a source of strength for the dollar might also be the biggest contributor to its downfall.
The Triffin Dilemma
My argument in this post started with the Bretton Woods System and how so many of today’s macroeconomic and political trends can be traced back to that agreement. Back in 1959, a Yale professor named Robert Triffin sat in front of the Joint Economic Committee and predicated that the Bretton Woods system was doomed to fail. The argument he made has become known as The Triffin Dilemma.
Triffin had recognized the conflict of interest that arises between domestic and international objectives for the country whose native currency acts as the global reserve currency. He correctly pointed out that “the country whose currency foreign nations wish to hold, must be willing to supply the world with an extra supply of its currency to fulfill world demand for these foreign exchange reserves, thus leading to a trade deficit.” This leads to tension between a country’s national and global monetary policy as its forced to balance its own interests with the responsibility to make monetary decisions that impact other countries.
The tension arises because a reserve currency issuer is forced to buy more imports than exports (otherwise known as trade deficits) in order to supply the world with the extra reserve currency needed for international trade settlement. This makes it difficult for domestic industries to remain competitive in the world market because goods at home become more expensive. At the same time, demand for that country’s sovereign bonds allows the reserve currency issuer to borrow money very cheaply and incentivizes the government to spend beyond its means without any short-term consequences. Thus, becoming a world reserve currency presents a paradox for the issuing country as cheap sources of capital and positive trade balances can’t happen at the same time.
In his 1960 book, Gold and the Dollar Crisis: The Future of Convertibility, Triffin also predicted that pumping dollars into the world economy would make it increasingly difficult to stick to the gold standard. Turns out Triffin’s predictions were spot on because the US broke the original agreement in 1971 when it went off the gold standard. As a result of the dollar’s role as the reserve currency, the United States has been running the world’s largest trade deficit since 1975. As of January 2021, the US trade deficit has grown to $68.2 billion.
As Lyn Alden pointed out, “When most other countries run trade deficits, they eventually have a big enough currency devaluation so that their exports become more competitive and importing becomes more expensive, which usually prevents multi-decade extremes from building up. However, being the reserve currency of the world creates persistent international demand for the dollar and means the US trade deficit never is allowed to correct and balance itself out. The trade deficit is held open persistently by the structure of the global monetary system, which creates a permanent imbalance, and is the flaw that eventually, after a long enough timeline, brings the system down.”
So how does this all play out for the US dollar? In his book, Beyond Blockchain, Erik Townsend gives an easy-to-understand description of the steps that play out over the course of 80–100 years for a reserve currency and the dollar specifically. Below is an excerpt taken directly from his book:
“How do you choose the reserve currency to start with? You pick the currency that is the strongest credit. At the end of World War II, most of the world lay in ruin [and the US had been stockpiling gold], there was no question that the US dollar was the strongest credit on earth.
What is the consequence of becoming the global reserve currency? The issuing government gets what is effectively a license to borrow and spend beyond its means without immediate adverse consequences. The reserve-issuing government can get away with decades of reckless deficit spending without suffering the usual penalty of skyrocketing cost of borrowing.
What is the result of reserve issuer having this license to be reckless? It takes many decades to play out, but governments generally cannot resist taking advantage of this license, so they borrow and spend as if deficits truly don’t matter at all, and they keep doing so until eventually, they reach the point where they’re no longer the best credit and they’re so over-indebted that their currency is no longer suitable to continue as the global reserve currency.
What happens then? The rest of the world figures out how to replace the reserve currency with something else more suitable.”
With this context, I think it’s interesting to note that not only is the US’s trade deficit the largest it’s ever been, so too is government debt. As of January 2021, US government debt reached a new all-time high of $27.8T.
Furthermore, the US has gone from being the world’s largest creditor nation to the world’s largest debtor nation.
The dollar has followed the first three stages of Townsend’s steps and as for the fourth and final stage, I highlighted earlier in this post how many other countries are already actively looking for alternatives. At this point, it’s just a matter of time until the dollar lose its status as the world reserve currency. The interesting question then becomes, what replaces it?