The Relationship Between US Government Debt and Bitcoin, Explained

The kind of inflation outbreak that might prove bitcoin’s power as a hedge asset isn’t coming in the near term, according to some economists. 

“Right now, low interest rates tell us there’s no evidence that we’re borrowing too much money,” Stanford economist Erik Brynjolfsson said. “Separately, but related, inflation is also very low. The Fed has set a target of about 2% for inflation, and it’s consistently been missing that target on the low side. We don’t see any evidence that inflation is taking off.” 

In fact, future economic growth could be in danger if the U.S. doesn’t embrace new stimulus, former Treasury Secretary Larry Summers told CoinDesk. He says the potential for inflation isn’t as concerning as the potential for economic growth coming to a halt. 

“I think the greater risks are still on the side of secular stagnation and low interest rates,” Summers said. “There may be some temporary sense of heat in the economy because of all the stimulus that’s been provided in the last year.”

Bitcoiners are closely watching inflation indicators such as the U.S. Treasury yield curve steepening in early January, which shows that investors expect economic growth that will require the Federal Reserve to raise rates to control inflation. The five-year breakeven rate, which represents how the bond market foresees long-term inflation, has been above 2% since the beginning of the year.

These indicators point to future rising inflation, but “we’re not seeing it yet,” Brynjolfsson said.

“It’s possible, even likely, that government policy over the coming year will change that and start bringing interest rates back up,” Brynjolfsson said. “The Fed may monetize some of that [debt] by printing money.” 

Right now, the markets are screaming for more debt.

“Supply and demand dictate that when there are more savers than borrowers, then [real] interest rates are going to fall to zero or even negative,” Brynjolfsson said, commenting on a discussion paper by Summers and Harvard economist Jason Furman. “The markets are willing to buy government assets and if the government were to issue more debt it would be snapped up very quickly.”

Savings have increased significantly during the pandemic while the supply of investment capital has decreased, Summers said. As a result, real interest rates on servicing government debt are negative and likely to remain that way in the near term, which means that the government would make money off of borrowing more. (The real interest rate is the interest rate when inflation is taken into account.)

With little room for central banks to lower rates and a clear runway to borrow more, many advanced economies are turning to fiscal policy to stave off the continuing crisis.

“If you look around the world, there’s a shortage of demand in lots of large advanced-economy countries … [that] began this crisis at deeply negative interest rates and have had little policy space with interest rates,” U.S. Federal Reserve Chair Jerome Powell said during an event hosted by Princeton University last Thursday. “That all is going to hang around for a while.”

When vaccines create a world that can spend freely again, that may still not produce the high inflation that bitcoiners would be looking for as an affirmation of BTC’s “inflation hedge” thesis.

“As the pandemic recedes and we see a potentially strong wave of spending as people return to their normal lives and begin consuming various services, there could be quite exuberant spending and we could see some upward pressure on prices,” Powell said. “The real question is how large is that effect going to be and will it be persistent? Because clearly a one-time increase in prices that isn’t very large is very unlikely to produce persistently high inflation.”  

In the near term, bitcoin will still profit from a low interest rate environment even if inflation doesn’t skyrocket. The less money investors can make on bond yields, the more money they might instead put into potentially higher-returning assets like bitcoin, Summers said.

“It’s a fairly straightforward argument,” Summers said. “When the amount you can earn on bonds goes down, people put less of their money into bonds and more of their money into other assets and that increases the value of those assets.”

Brynjolfsson added: “The demand for assets like U.S. Treasurys, gold and bitcoin has dramatically exceeded the supply, driving up prices. Specifically, in the case of Treasurys the markets are saying that they would like the government to borrow more, that there aren’t enough secure assets for what people want to do.”



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US Treasury Department Proposes New KYC Requirements for Cryptocurrency Transactions

US crypto users seeking to transfer their assets from a cryptocurrency exchange to their own personal wallets will have to comply with a new KYC requirements under a regulation proposed by the Treasury Department. - 2020-12-19T153455.954.jpg

In an effort to address anonymous transfers of digital assets by bad actors, the US Treasury Department has launched a plan to require some crypto users to offer information about their identities. The new plan targets private accounts that allow the holder of a unique digital key to store crypto assets and transact with others directly without going through a financial institution. Such accounts are known as unhosted or self-hosted wallets – a form of software (thumb drive) on a user’s cellphone or computer. The wallets are not held on a bank or a registered exchange.

In the new proposed regulation, the Treasury Department requires banks and money service businesses such as popular crypto trading platforms like Gemini, Coinbase to verify the identities of self-hosted or unhosted wallet holders for any digital asset transaction that exceed $3,000.

Banks and crypto trading platforms would have to report any crypto transaction exceeding   $10,000 to the Financial Crime Enforcement Network (FinCEN) within 15 days.

Investors Embracing Digital Gold

This week for the first time, Bitcoin price has climbed to $20,000, before quickly surging to $23,000 yesterday. These are the latest in a series of significant milestones that have seen the price of the cryptocurrency rose by almost 400% since March. The current rally is impressive as investors looking to get higher returns have been moving to embrace the leading cryptocurrency this year in the wake of the COVID-19 pandemic.

Bitcoin’s recent embrace by institutional investors including PayPal has made people more confident about the cryptocurrency. Major institutional investors including billionaire Paul Tudor Jones, Square Inc., MicroStrategy, and others have been adding the crypto into the portfolios. The current rally validates longtime crypto bulls but also raises the question of whether this will end in tears. While the era of $20,000 might be temporary, the crypto asset is, more than ever before, here to stay.   

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Bitcoin (BTC) $ 27,760.44 1.71%
Ethereum (ETH) $ 1,648.01 0.19%
Litecoin (LTC) $ 64.33 1.57%
Bitcoin Cash (BCH) $ 231.89 0.88%