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Fed Admits Cryptocurrencies Threaten US Dollar

Exclusive Research

  • The Federal Reserve has admitted that digital currencies pose a threat to the US dollar’s international standing.
  • The Fed’s own actions are accelerating the adoption of alternatives to the US dollar.
  • Digital currencies and bitcoin, in particular, may be a more imminent threat than the Fed acknowledges.
  • Bitcoin may become the world’s reserve currency.

The Federal Reserve published a revealing research note entitled “The International Role of the US Dollar” on 6 October 2021. The note argues that the US dollar is the world’s dominant currency and that it will continue to serve this role in the foreseeable future. It also reviews the principal challenges facing the dollar’s international status. In the short-term, it argues that there are unlikely to be serious threats, but, in the long-term, it identifies three threats, which are the euro, the Chinese renminbi and digital currencies, both private and public.

The official admission that digital currencies pose a threat to the dollar’s international standing is newsworthy in its own right. A technology popularised in 2009 is now viewed as one of the most significant threats to the world’s most important currency, alongside the European trading bloc and the People’s Republic of China. If this is what Bitcoin has achieved in the past twelve years, what can it achieve in the next twelve?

Dominance

The Fed’s research note argues that the US dollar has been the world’s foremost currency, because of the size, strength, stability and openness of the US economy, as well as the US’s robust legal framework. These same attributes, it argues, will keep the dollar in its leading position going forward. To back this claim, it demonstrates that the US dollar is, by far, the preferred currency in official foreign exchange reserves despite a recent decline. This dominance implies that the dollar is still viewed as the world’s store of value. It goes on to state, unironically, that a “key function of a currency is as a store of value which can be saved and retrieved in the future without a significant loss of purchasing power.”

The Fed’s report further cites research that shows that 50% of the world’s GDP was generated by nations whose currency is anchored to the dollar. China alone is responsible for 20% of the world’s GDP being anchored to the dollar. Anchored currencies are “currencies explicitly pegged to the dollar as well as currencies that move less than 2 percent against the dollar in over 90 percent of months.” They conclude, therefore, that the US dollar is the world’s anchor currency.

The report goes on to discuss how the dollar is the world’s medium of exchange. The US dollar easily dominated global trade and international finance. It accounted for 96% of trade in the Americas, 74% in Asia-Pacific and 79% in the rest of the world. It only lagged in Europe because of the euro. In addition to this, the dollar dominates international banking, as 60% of international liabilities and claims are denominated in dollars. The dollar also accounted for 88% of global foreign exchange transactions in 2019, while the euro accounted for 32%.

Hubris

In its report, the Fed concludes that “absent any large-scale political or economic changes which damage the value of the U.S. dollar as a store of value or medium of exchange and simultaneously bolster the attractiveness of dollar alternatives, the dollar will likely remain the world's dominant international currency for the foreseeable future.” It thus paints a rosy picture for the future of the dollar and conveniently ignores the effects of its own actions.

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Arguably, large-scale economic changes have already taken place and they are driving capital towards dollar alternatives like bitcoin. As we have argued elsewhere, the Fed is directly responsible for the precipitous deterioration of the dollar’s purchasing power. The dollar’s M2 money stock has tripled since 2008. The Fed’s never-ending quantitative easing measures, in combination with the additional multi-trillion dollar spending packages Congress is going to pass, is likely to accelerate the dollar’s demise. These are the root causes of the current inflationary pressures that are proving to be anything but transitory. The Fed claiming that the dollar is a hedge against a “significant loss of purchasing power” is thus either delusional or satirical.

The importance of maintaining the US dollar as the world’s anchor currency, furthermore, explains some of the animus we described elsewhere, with regards to El Salvador making bitcoin legal tender. The risk, as we pointed out, was that if El Salvador’s experiment was successful, it could engender a domino effect of bitcoin adoption. This would directly threaten the US dollar’s global dominance. As the Fed’s reckless monetary policies continue, the more likely it is to incentivise other nations to follow El Salvador’s lead. This shift could be further accelerated by the private sector’s move towards bitcoin adoption, which could be a precursor to central banks following suit.

The question then is, what will the Fed do, in conjunction with other federal agencies, when it realises that bitcoin is a threat to the US dollar’s global monetary hegemony? Will it follow China and try to ban cryptocurrencies? Will it try to kill it with regulation as Ray Dalio said? By the time they wake up to the threat, it will likely be too late and bitcoin will be untameable. It may become the global reserve currency faster than we know it.

Conclusion
The Fed report is important because it recognises the threat that digital currencies pose to the dollar’s global primacy. The Fed conveniently ignores its own role in diminishing the dollar’s global status. This self-delusion may lead bitcoin, in particular, to become a threat to the dollar’s global standing much faster than expected and become the world’s reserve currency.

Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial, tax, legal and other matters.

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