By Professor Tonya M. Evans, Author of Digital Money Demystified
Copyright 2023 Tonya M. Evans. All rights reserved.
Over the course of its ascendance as the global reserve currency, the US dollar (USD) has provided a firm foundation for international commerce and investment. Its stability, rooted in the robust economy and trustworthy institutions of the United States, has allowed it to serve as a benchmark for global trade and a refuge for investors worldwide.
However, recent events, such as the August 1, 2023, US credit rating downgrade by Fitch to AA+ from what had been a sterling AAA rating, have indicated a possible shift in this status quo.
The agency had placed the country’s rating on negative watch in May 2023, citing the debt ceiling fight in Washington.
“The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management,” Fitch said. U.S. stock futures opened lower Tuesday evening after the downgrade. However, financial market advisors have mostly given the “nothing to see here” signal.
They said the same about the stability of the banking sector. But we all remember how that ended up for several regional banks that went into receivership earlier this year, including the failure of Silicon Valley Bank.
The first time the U.S. credit rating was downgraded was on August 5, 2011. The rating agency Standard & Poor’s (S&P) lowered the U.S. long-term sovereign credit rating from AAA to AA+. This was a historic move, as the U.S. had maintained a AAA credit rating from S&P since 1941.
Several reasons and circumstances contributed to the 2011 downgrade:
1. Debt Ceiling Debate: In the summer of 2011, there was intense political wrangling in the U.S. Congress over raising the debt ceiling. The debt ceiling is a cap set by Congress on the amount of debt that the federal government may legally borrow. The political impasse over whether or not to raise it led to concerns about a potential U.S. default on its debt obligations. Although the debt ceiling was eventually raised, the protracted debate highlighted deep political divisions.
2. High Public Debt: S&P expressed concerns about the U.S.’s ability to manage its high levels of public debt. The country’s debt-to-GDP ratio had been growing, and there were doubts about the U.S.’s commitment to implementing measures to address the rising debt levels.
3. Political Factors: The downgrade was not just based on economic calculations. S&P specifically mentioned the ineffectiveness, unpredictability, and partisanship of American policymaking and political institutions, especially as they relate to fiscal policy.
4. Medium-term Budgetary Challenges: S&P was skeptical about the ability of Congress to stabilize the U.S. government’s medium-term debt dynamics, especially given the contentious political environment.
The decision to downgrade U.S. credit came during a period of economic uncertainty, with lingering effects of the 2008 financial crisis, concerns about European debt (particularly the situations in Greece, Italy, and Spain), and global concerns about economic slowdowns.
The S&P’s downgrade, while symbolic, did not lead to immediate financial turmoil or substantially higher borrowing costs for the U.S. government. However, it did introduce doubts about the political system’s ability to effectively manage fiscal and economic challenges, a sentiment that has resurfaced in subsequent debates over U.S. fiscal policy.
What’s Past is Prologue
These events, mainly driven by political strife and a looming debt crisis, put the position of the USD at risk, prompting serious considerations about alternative investment options, most notably, cryptocurrencies like bitcoin.
This prompted me to consider the factors that might contribute to the USD losing its position as the global reserve currency.
Political strife is a significant concern. Increased polarization within the US Congress, coupled with unprecedented levels of public debt, have led to doubts about the stability of the US economy. The most recent indicator of this issue was the credit downgrade by Fitch. Fitch’s decision was mainly driven by the lack of political consensus in addressing the national debt crisis. This inability to reach consensus reflects deep-seated discord within the US political establishment, which in turn translates into financial instability.
The direct economic impact of political instability is one part of the issue. The other part is the decline in trust that such instability engenders among global investors and institutions. As faith in the USD’s reliability diminishes, its desirability as a reserve currency also falls. Trust, a cornerstone of any currency’s strength, is being eroded by these developments.
In addition, the fiscal practices of the US government, particularly the increased use of quantitative easing (QE) (a monetary policy tool used by central banks to stimulate the economy by buying predetermined amounts of government bonds or other financial assets from commercial banks and financial institutions when standard monetary policy becomes ineffective) has led to concerns about long-term inflationary pressure.
If these inflationary fears materialize, the USD’s value could be further compromised.
All these factors point towards a potential reshuffling of the global currency hierarchy deck. In the midst of this change, cryptocurrencies like bitcoin emerge as compelling alternatives.
Bitcoin Was Built for Economic Times Like These
The premise of cryptocurrencies was born out of the 2008 financial crisis, as an alternative to traditional banking systems. bitcoin, the most prominent example, operates on a decentralized network known as blockchain technology, offering potential immunity from politically driven financial decisions.
Bitcoin’s inherent decentralization makes it less susceptible to political influences that may affect traditional currencies. It also operates under a predetermined supply schedule, with a cap set at 21 million bitcoins (19+M of which have already been mined), tending to shielding it from inflationary pressures.
These features position bitcoin as a store of value akin to digital gold. As the USD potentially weakens due to political strife and fiscal mismanagement, bitcoin’s attractiveness strengthens.
Bitcoin, and by extension the crypto economy as it continues to mature, also present a unique opportunity for diversification. Their low correlation with traditional asset classes can provide balance in a portfolio, reducing the risk of substantial losses during periods of economic turbulence or political instability.
Furthermore, bitcoin’s global acceptance is on the rise, as more institutions are adopting it as a viable alternative to traditional currencies. This acceptance translates into increased liquidity, making bitcoin not just a store of value, but also a potential medium of exchange on a global scale.
The inclusion of bitcoin in an investment portfolio also offers considerable growth potential. Since its inception, bitcoin has demonstrated significant growth, often outperforming traditional asset classes. While its price can be volatile, for those prudent and patient investors who are willing to bear the risk, the potential returns can be substantial.
Risk v. Reward
However, it’s important to note that while bitcoin offers promising prospects, it comes with its own set of risks, including regulatory uncertainty, technological issues, and market volatility. As such, investors should approach bitcoin, like any other investment, with caution and due diligence.
The potential decline of the USD as the global reserve currency due to political strife and fiscal concerns offers both a challenge and an opportunity. The challenge is navigating the uncertainties of a shifting global currency landscape. The opportunity lies in the exploration of alternative investment options like bitcoin.
With its decentralization, immunity from inflation, potential for diversification, and substantial growth prospects, bitcoin presents a compelling case for inclusion in investment portfolios. However, the complexities and risks associated with bitcoin require careful consideration. As the potential for a weakened USD looms large on the horizon, it is up to each investor to assess their risk tolerance, investment goals, and seek advice as necessary in this shifting financial landscape.
Ultimately, the rise of bitcoin and other cryptocurrencies may not only signify a shift in investment strategies but could also usher in a new era in global finance.As the world adjusts to this new paradigm, it becomes increasingly important to understand and adapt to these changes, as they will shape the financial future for individuals, institutions, and nations alike.You cannot lead where you are not ready, willing and able to go.
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