Understanding this Rally in Bitcoin

It has been an interesting start to the year. Bitcoin started 2023 in a hole. It had been driven down to $16,000 well off its peak of almost $70,000 in November 2021. To a large extent, it deserved that low valuation. 2022 had been a rough year for cryptocurrencies in general. The Terra Luna debacle, followed by the collapse of Three Arrows Capital and then the FTX bankruptcy hammered the crypto space into the ground. The sentiment was so negative that the only way out was up.

The macro landscape was also a headwind. The Federal Reserve was hiking interest rates and removing liquidity from the system. As a risk asset, Bitcoin is driven by liquidity and cannot perform in an environment where the cost of money is going up. Jerome Powell of the Fed made it clear that it was his mission to follow in the footsteps of Paul Volcker and deliver a death blow to inflation and this scared the shit out of Bitcoin bulls. As the new year entered, a bunch of things changed.

China's decision to double down on its COVID policy was greeted by violent protests on the street. This forced Xi Jinping to back off and he also backed off from the tech sector. This brought Chinese players back into the Bitcoin market. This was also the cue for other Asian investors to come in, and a handful of hedge funds. It didn't take much to get prices up because they were so depressed and the mood was so negative. Then we got the real acceleration which was the collapse of Silvergate and then Silicon Valley Bank, and concerns about the US banking system, and the flight to Bitcoin as a way of getting out of a system that could potentially implode. The third factor that drove Bitcoin higher is the holy war that the US government has declared on crypto. Democratic senators like Elizabeth Warren are leading a campaign against the asset and this is outraging the crypto community because it is causing the inconsistent application of rules. Signature Bank was closed down while Republic Bank was not for the simple reason that the former works with crypto businesses. Bitcoin was created in revolt against a corrupt and unfair system, and this really is the Bitcoin community roaring back.

But there is a darker side to all these events with people calling for the collapse of the US financial system which will lead to unprecedented money printing, hyperinflation as we saw in the Weimar Republic in Germany in the 1930s, a collapse in the United States dollar and Bitcoin trading up to $1 million by the middle of the year. This narrative is not coming from a lunatic fringe of Bitcoin nuts - it is coming from Balaji Srinivasan, and he is putting money behind his mouth. Balaji, a man who wields considerable influence in the tech and crypto worlds, made a jaw-dropping bet: $2 million that bitcoin would skyrocket from the mid-$20,000 range to $1 million per coin within 90 days.

Balaji has a resume that could be a model for the tech and crypto industries. He’s an angel investor, tech founder, and bestselling author of The Network State (in which he argues that technology will usher in the end of the nation-state era). His experience spans from being the CTO of Coinbase and a general partner at venture firm Andreessen Horowitz, to confounding several companies that were later acquired. Srinivasan is hailed as a polymath, with degrees in electrical and chemical engineering from Stanford University.

Let's take a closer look at the underlying thesis of a collapse in the US financial system specifically and a general decline in United States hegemony. The next chunk of the blog is borrowed from Ray Dalio, who has written extensively on the changing of the world order, and believes we are witnessing a changing of the guard with power being shifted from the US to China. It has to be said that his view is nowhere near as extreme as Balaji’s, and Dalio is no fan of Bitcoin, so let's jump in.

Dalio opens by saying people are good at anticipating events that have happened in their lifetimes. If you lived through the stock market crashes of the Dot.com bubble (2000), the great financial recession (2008), and COVID (2020), you are better equipped to identify the next crash. Although no two crashes are the same, you know how they feel and you have some of the tools to weather the storm. But what happens when faced with events you have never experienced? Dalio suggests the following: go back in history to see if this event happened before you were alive.

One such event that some have mentioned to describe the current turmoil is the changing of the world order. We know over time that empires rise and fall. We had the Roman, Spanish, Portuguese, Russian, Dutch, and British empires. Then after the Second World War, the United States appointed themselves as rulers of a new rules-based order (although they had been playing this role for numerous decades prior). The reason we mentioned the Second World War is that this reinforced the United States at the top of the pile. They were the only country to come out of the war stronger than they entered it. China, Russia, and Germany were the biggest losers in terms of physical casualties losing almost 50 million lives of which half were civilians, The United States lost a couple of hundred soldiers and almost no civilians to speak of, with the exception of the bombing of Pearl Harbour, the US did not see much war action. They had also used their dominant financial position in the world to finance the war.

Their biggest debtor was the United Kingdom, which only finished repaying the debt in 2010. This debt was denominated in gold as per an agreement at Bretton Woods in 1944 where it was agreed that all currencies would be pegged to the US dollar which in turn would be backed by gold. Within 25 years, however, the United States ran out of money. By backing the dollar to gold, they were saying that anyone who held dollar bills could at any time present those dollars to the United States government and receive physical gold of the same value.

By 1971, the US had issued more dollars than they had in gold which means their liabilities exceeded their assets - in other words, the United States was technically insolvent. Another way to look at this was that the US was spending more than it was earning. The holders of the dollar bills got wind of this imbalance and rushed to exchange their greenbacks for gold, and with this, the stockpile of gold in the United States started to drastically decline. On Sunday evening, August 15th 1971, President Richard Nixon announced to the world that the United States would temporarily move off the gold standard. By the way, there is nothing more permanent than a government temporary fix!

Effectively what Nixon was doing was announcing they would no longer honor their obligation to exchange dollars for gold. They were breaking their promise, although Nixon did not uze those exact words. Nixon said that the United States was by far the most powerful economy in the world, and it was, therefore, necessary to defend the dollar against evil speculators who wanted to undermine the strength of the dollar. In a speech that would have made Trump proud, Nixon convinced the world that the US was the victim when in fact they were reneging on their financial promises. This was the end of money as we know it. By moving the dollar, the world reserve currency, off of gold, Nixon was untethering the global financial system, and all hell would break loose. In that single speech, money was no longer backed by the world's most valuable tangible asset (gold), but it was backed by the full faith and credit of the governments issuing that money. This was a completely new belief system that had to be adopted. From 1971 onwards, you needed to place your trust in governments - a fallible, corrupt, and weak institution that only looks after its own best interest. That is scary shit!

The United States could now legally print as much money as it wanted. Given that the United States dollar was the world's global currency, the government could now effectively print gold. How did the stock market react? It was euphoric - it gained 25 percent. There was a party on Wall Street as traders anticipated a flood of money into the economy. This printing of money, without an associated increase in productivity, has the same results all the time. Instead of this new money being allocated to productive areas of the economy, it finds its way into assets like shares (stocks), bonds, real estate, and commodities. That means that whenever there is a crisis as we saw in 2008 with the collapse of Lehman Brothers and in 2020 with the COVID pandemic, you want to buy shares in the stock market because governments print money and most of this money finds its way into this market. The stock market tends to double in the years after these money printing exercises. So let's now talk about world orders. We have seen many over the past 2000 years - Chinese, Roman, Ottoman, Spanish, Portuguese, Dutch, British and American have been the most prominent. If you study each of them, you will notice they have certain commonalities. They tend to be established after a period of conflict (normally a war) and are led by strong revolutionary leaders that are able to inspire and rally the nation. These leaders are able to unite the nation through their strong narrative and establish strong institutions that can ensure that strong governance is maintained for many generations.

They are the victors of the conflict, and because everyone is tired of fighting, no one goes out of their way to contest that leadership. This means we enter into a period of peace, stability, and harmony. The empire can now focus on education, innovation, and technology. This is done through schools, universities, and at the home, and includes the inculcation of values like civility, honesty, and hard work. That provides a healthy respect for rules and laws. There is order within society and corruption is low, and there is unification behind a common purpose that enables the empire to work well together. The empire evolves from producing basic products to more technologically advanced products. The Dutch, for example, invented ships that were able to travel long distances to transport wealth and with that global trade was born. They also invented capitalism as we know it today which helped to finance these voyages. They enriched themselves by being open to the most advanced thinking in the world. They become more productive and more competitive, and with this, they increased their share of global trade

The empire becomes more competitive and more prosperous. Borrowing levels increase and new ventures attract new capital. Output increases and so too do trade levels. As the empire's international reach increases, so too do they need to protect their international trade routes. They are also increasingly paranoid about their dominant position and invest in protecting themselves through military spending. Their currency dominates global trade and becomes a global reserve currency which now facilitates global borrowing. This is a huge advantage - everyone around the world wants to invest in the empire’s currency which means the empire is able to borrow almost limitless amounts of money - the world is literally throwing money at the empire.

The empire also needs to develop its capital markets so the nation can borrow, so entrepreneurs have access to funding and investors are able to participate in their increased prosperity. The Dutch created the first listed company - the Dutch East India Company. Amsterdam became the world's financial capital during the Dutch Empire, London during the rule of the British Empire, New York now, and China is quickly developing its financial centers. The capitalists work with the government and the military to ensure that the financial interests of the empire are promoted and preserved. The Dutch East India Company was granted a trade monopoly by the government and had its own officially sanctioned military to go out into the global markets to make and take wealth.

The empire is now at the top of its power and this is where the decline starts. The empire is rich and a little arrogant. Wages have increased which means their products become more expensive. Smaller less prosperous countries see an opportunity to take trade away from the empire, by copying their products and producing them at a lower cost. For example, British shipbuilders were prepared to work for less than Dutch shipbuilders at the height of the Dutch empire. The British, therefore, hired Dutch designers to come over and build ships with cheaper British workers which allowed the British to rise and the Dutch to decline. Also, as people get richer they tend to work less and pursue leisure and the finer things in life, and at the extreme, they become decadent. Values also start to change - the kids who inherit wealth are less battle-hardened than their parents who had to work for their money. They become soft and entitled, and this makes them more vulnerable to external challenges. As people get more accustomed to the good times, they also start to believe the good times will continue and therefore borrow to fund their lives of comfort and luxury.

We start to see an unequal distribution of wealth - money gets concentrated in the hands of a few elites and the inequality increases. This creates financial bubbles that eventually burst and open the door to money printing, and increased internal conflict between the rich and the poor, as resentments grow. At first, this is not problematic as long as the less fortunate still have access to debt and are able to fund a decent lifestyle. This, however, is not good for the underlying wealth of the country as it becomes less productive and its currency starts to weaken over the longer term. The costs of maintaining and defending the empire now exceed the revenues that it is earning and the decline starts to accelerate as the empire becomes unprofitable. The British empire grew to such an extent that the cost of maintaining its hegemony became untenable. To date, the US has spent approximately $8 trillion on foreign wars and their consequences since September 11, 2001, and trillions more on other operations and for supporting military bases in 70 countries, and it is still not spending enough to defend its international interest around China, which poses as its single biggest threat at the moment.

The debt of the empire continues to grow, and the irony is that the empire increases its borrowing from poorer countries that have higher savings rates. This is one of the early signs of a wealth and power shift. This began in the United States back in the 1980s when it started borrowing money from the Chinese at a time when US per capita GDP was 40 times higher than that of China. The Chinese were eager to save in dollars because the dollar was the global reserve currency. Similarly, the British borrowed from its much poorer colonies. When the borrowers start to notice how the strength of the empire is waning, they become less inclined to continue financing the empire and the decline accelerates.

The empire, under this massive debt burden, is faced with new challenges. It can either default on its obligations, or it can print new money - almost always it chooses the latter option because it is the path of least resistance. That devalues the currency and raises inflation. Internal economic, value, and political strife cause greater polarization. This results in political extremism and populism of the left or right. Those on the left seek to redistribute the wealth while those on the right seek to maintain the wealth in the hands of the rich. At this time, the tax on the rich increases, and they move their wealth to countries, assets, and currencies in which they feel safer. These outflows reduce the empire's tax revenues. When the flight of wealth becomes bad enough, they outlaw it, and those seeking to get out start to panic. These stressful times tend to undermine productivity, which shrinks the economic pie and causes more conflict. Populist leaders emerge from both sides and pledge to restore equilibrium, and that is when democracy is most challenged because it fails to control the anarchy. This sometimes bubbles over into revolution or civil war. This weakens the empire's power internally and also makes it vulnerable to external threats from emerging powers, especially if the emerging power has built up a comparable military. The empire can either attack or retreat. If they attack and lose, that is the end. If they retreat, they retain their hegemony but the rising power senses weakness and vulnerability.

We can now go back to Balaji’s crazy prediction. Dalio says that in the fall of an empire, the decline is gradual at first and then accelerates. The tension between the US and China is increasing. Before Trump was elected, the tension was passive-aggressive. Trump did a great job (as he always does) to move this tension out of the shadows into the card hard light of day, as he embarked on a campaign of saber rattling which manifested in a full-on trade war. Trump’s administration labels China a currency manipulator accusing it of keeping its yuan artificially weak so as to keep its exports competitive. COVID hits and finger-pointing starts. A Chinese Foreign Ministry spokesperson claims without evidence that the U.S. military brought the virus to China, while President Trump makes repeated references to the “Chinese virus,” which he says spread because of failures by the Chinese government. In the middle of July, the United States ordered China to close its consulate in Houston, Texas, alleging that it was a hub of espionage and intellectual property theft. China condemns the order and retaliates by closing the U.S. consulate in Chengdu. In the same week, Washington indicts two Chinese hackers for allegedly stealing coronavirus vaccine research and sanctions eleven Chinese companies for their reported role in human rights abuses in Xinjiang. Meanwhile, Chinese Foreign Minister Wang Yi blames the United States for tensions.

At the end of the Trump presidency, he attempts to cement his legacy of being tough on China during his final weeks in office. Director of National Intelligence John Ratcliffe calls China “the greatest threat to America today,” while the Commerce Department adds dozens of Chinese companies, including the country’s biggest chipmaker, Semiconductor Manufacturing International Corporation (SMIC), to its trade blacklist. The State Department tightens visa rules for the around ninety million members of the Chinese Communist Party. It also sanctions more Chinese officials, including fourteen members of China’s legislative body, over abuses in Hong Kong, Xinjiang, and elsewhere. Additionally, the White House bans U.S. investments in Chinese companies it says have ties to the People’s Liberation Army. Chinese officials vow retaliation against these and other actions the Trump administration takes.

Biden and Xi conducted their first formal meeting (held virtually) since Biden took office lasting more than three hours. Similar to the meeting in Alaska, the leaders voice issues of long-standing disagreement, with Biden raising concerns about Beijing’s human rights abuses and Xi saying that U.S. support for Taiwan is like “playing with fire.” There are no major breakthroughs nor a concluding joint statement, though Biden says they establish “guardrails” to avoid conflict, and experts say it is a positive step that the meeting even takes place.

Russia then invades Ukraine. China refuses to condemn Russian President Vladimir Putin for the war and the resulting humanitarian crisis. Biden tells Xi that there will be consequences if he proves material support to Russia in the war. After the US imposes sanctions on Russia, Xi criticizes them and says they will only add to the suffering. In August 2022, the US did something to really piss the Chinese off - after months of Chinese officials warned the United States against boosting ties with Taiwan, U.S. House Speaker Nancy Pelosi visits Taipei in a trip she says is to demonstrate U.S. support for the island. The trip leads Beijing to suspend U.S.-China climate talks, cut off some high-level military communication channels, and sanction Pelosi. The Chinese military conducts live-fire drills that effectively encircle the island and are much bigger than exercises conducted during the last Taiwan Strait Crisis in 1996. It also launches ballistic missiles over the island, some of which land in Japan’s exclusive economic zone, and Chinese aircraft cross the median line between mainland China and Taiwan.

In February 2023, President Biden ordered the U.S. Air Force to shoot down a Chinese-operated balloon off the southeastern U.S. coast after security officials said it was spying on sensitive military sites. China calls the balloon a civilian weather-monitoring craft that accidentally veered into U.S. airspace. China’s foreign ministry condemns the downing as “a serious violation of international practice” and vows retaliation. The incident causes the Biden administration to cancel a trip by U.S. Secretary of State Antony Blinken to Beijing, raising fresh concerns over a worsening of U.S.-China relations are already strained by U.S. support for Taiwan and trade frictions.

In summary, we may be closer to a change in world order than many would like to think. Many of the markers that Ray Dalio highlighted are playing out in plain sight. The United States has never been more divided. There is fragility in the US financial system. Silicon Valley Bank may require $2 trillion of new money from the Fed. Add to that the demise of Credit Suisse, one of the world's oldest banks centered in the nexus of the world's banking system, and the recipe was there for people to seek an exit from the U.S. dollar. At this time of extreme fragility, you would expect the US administration to come out with guns blazing to calm the markets. Nothing could be further from the truth. In March 2023, Biden released his “Economic Report of the President,” which stated: “[S]sovereign money does not have a fundamental or intrinsic value.” That’s a hell of an admission. In other words, the U.S. dollar is based on confidence, and when confidence starts to ebb, as we’ve seen in previous crises, this can quickly turn into a flood. In a press conference in late March, Fed Chair Jerome Powell suggested the merger between UBS and Credit Suisse had seemed to have gone down well with the markets, but ominously qualified his statement by adding “so far.” When people like Powell, who are supposed to exude confidence and not mince words, express uncertainty about the current banking turmoil, it’s reasonable to suggest that savvy investors also see the danger and seek safe havens.

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