The failure of several banks globally and increased weakness of the dollar plausibly highlight the value proposition of holding Bitcoin.
The banking sector in the United States has faced a series of challenges and shocks in 2023 that have led to the failure of several large and medium-sized banks. As of the publication of this article, the following U.S. banks have been liquidated or collapsed in 2023: Silicon Valley Bank (SVB), First Republic Bank (FRB), Silvergate Bank and Signature Bank. Notably, FRB, SVB, and Signature Bank were the second, third and fourth largest bank failures in U.S. history.
Outside the U.S., Switzerland-based bank Credit Suisse, which was founded in 1856 and had more than $1.3 trillion worth of assets under management at the end of 2022, had to be acquired by UBS to avoid collapse. And there could be more bank failures coming. For example, Pacwest Bancorp’s stock is down more than 80% since this crisis began in March.
Bitcoin, on the other hand, has performed well since this crisis began, rising from below $20,000 to roughly $26,500 at the time of this writing. This is in part due to the fact that the troubles in the banking industry have illustrated a key value proposition of Bitcoin, which is that users are in complete control of their digital cash and do not face any counterparty risk. According to a recent report from Standard Chartered, this narrative could take the Bitcoin price to levels over $100,000 by the end of 2024.
However, there is a much more problematic crisis underlying the current issues with the banks in the form of the increased weakness of the U.S. dollar.
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Why Are Banks Failing?
The common theme found with most of the troubled banks right now has been the rise of interest rates. When interest rates rise, newly-issued debt becomes more attractive than debt that has been issued in the past, due to the higher rate of interest that is paid on the debt. As interest rates rose rapidly over the past year or so, the value of what were assumed to be low-risk assets held by banks, such as mortgage-backed securities and U.S. treasuries, decreased in value.
According to a recent report from the Federal Reserve, 722 U.S. banks were facing unrealized losses of more than 50% of their capital as a result of rising interest rates by the end of the third quarter of 2022. When these huge unrealized losses at the banks are combined with the fact that the Federal Deposit Insurance Corporation (FDIC) only protects bank deposits up to $250,000, people get nervous about the potential loss of their money, which can lead to withdrawals and, potentially, a run on the bank.
This is exactly what happened in the case of SVB in March 2023, for example. SVB was a bank that specialized in serving tech startups and investors in Silicon Valley. It had a large portfolio of long-term bonds that lost value when the Federal Reserve raised interest rates. This created a capital shortfall for SVB and eroded its financial stability. When SVB disclosed its losses, many of its customers panicked and withdrew their deposits, totaling $42 billion in one day. This drained SVB's liquidity and forced it to close its doors.
Losses on long-term debt instruments were also taken by both Silvergate Bank and FRB before their respective closings; however, the exact reasons for Signature Bank’s forced closure by regulators at the New York State Department of Financial Services are still somewhat unclear.
“If you look at the Silicon Valley Bank issue, it’s not so much their issue as much as a worldwide issue,” explained billionaire hedge fund manager Ray Dalio in a recent interview.
The Federal Reserve’s Dilemma
So, why is the Federal Reserve continuing to raise interest rates if it’s causing some banks to fail? The answer is that rates are going up in an effort to prevent further weakening of the U.S. dollar.
The Federal Reserve currently faces a difficult challenge in managing monetary policy amid high inflation and the risk of recession. One half of the Federal Reserve’s dual mandate is to keep inflation at manageable levels, with the current target being 2% per year. But inflation rose to 7% in 2021. After falling to 6.5% in 2022, the inflation rate for the 12-month period ending in April 2023 stood at 4.9%.
The Federal Reserve has tried to lower inflation by raising the federal funds rate, which is the interest rate that banks charge each other for overnight loans. This makes borrowing more expensive and reduces demand for goods and services in the economy. Therefore, raising the interest rate too much or too quickly can slow down economic growth or even trigger a recession.
In other words, the Federal Reserve has to balance the tradeoff between lowering inflation and avoiding a recession. This is not an easy task, as history shows that every time a central bank has raised interest rates to fight inflation since 1950, a recession has followed. With the most recent raise to the 5% to 5.25% target range, interest rates are now at levels not seen since right before the onset of the Great Recession in late 2007.
Bank Failures on Bitcoin
So, what does all of this mean for Bitcoin?
It depends on the potential response from the federal government when banks fail. Lawmakers and regulators can either decide to let the market run its course and allow customers to lose their money or they can essentially bail out the bank and make sure depositors are protected. Incredibly, both scenarios illustrate a different value proposition of Bitcoin.
In a situation where a bank is allowed to fail and depositors lose all of their assets over the $250,000 FDIC insurance limit, the fact that funds held in a bank are not necessarily safe becomes more apparent to the market. In fact, billionaire hedge fund manager Hugh Hendry recently claimed the U.S. Treasury Department and Federal Reserve may potentially restrict Americans from withdrawing money from their bank accounts.
This is where the “not your keys, not your crypto” adage comes from in the Bitcoin space. The only way to hold a digital asset without this sort of counterparty risk is with crypto. Bitcoin is digital cash, and the owner of the private key is in full control of the asset.
Of course, the reality is no depositors have lost money from the banks that have failed so far. That said, it’s unclear if the worst of the crisis is already over.
The Weakening Dollar Is the Real Issue
For situations where the government decides to bail out a bank, or potentially a large number of banks, a further expansion of the money supply could become a concern. After all, where will the money for the bailouts come from? This points to another key value proposition of Bitcoin, which is that its 21 million coin supply is infallible and “set in stone,” as Bitcoin creator Satoshi Nakamoto stated many years ago. Bitcoin holders do not need to trust a centralized party to not inflate the supply.
This gets to the investment thesis around Bitcoin more generally. A bet on Bitcoin is a bet that fiscal responsibility is not coming to the U.S. government (or any other major government for that matter) anytime soon. It’s a bet that the debt ceiling in the U.S. will be lifted, deficit spending will continue, politicians will continue kicking the can down the road, and money printing will be chosen over the short term pain needed to restructure the economy.
Regulators and lawmakers made it clear that they’re going to “meet the needs of all their depositors,” including amounts over the usual $250,000 FDIC limit, to protect the stability of the U.S. banking system when this crisis first began. Biden emphasized that this is through an “emergency lending program” that does not use taxpayers’ money, unlike the 2008 bank bailouts. Additionally, there are emerging signs that the Fed may be ready to pump the brakes on further interest rate hikes. CME Group data currently puts the odds of a pause of interest rate hikes in June at around 64%.
It should also be pointed out that the dollar is on a path towards continued weakening whether more banks fail or not, as the underlying issue is the debt that already exists and the government’s continued deficit spending. At the same time, other countries around the world have been gradually moving away from holding U.S. dollar-denominated assets in reserves and increasing their gold allocations. This has brought up the whole debate on de-dollarization. In other words, there is a potential for the demand for U.S. government-issued debt to decrease as the supply continues to increase. If there aren’t enough buyers for the debt, the Federal Reserve could print the money to purchase it (increasing inflation) or interest rates would have to rise to attract other buyers. Higher interest on the debt would mean a higher percentage of the federal budget going towards interest payments, compounding the debt issue and potentially contributing to inflation later down the road. In addition to lowering their reliance on the dollar as a reserve asset, some countries, particularly the BRICs, are also looking to conduct trade in currencies other than the U.S. dollar. All of these factors could contribute to the continued weakening of the U.S. dollar.
The current banking crisis simply has the potential to speed up this deeper crisis in the dollar, as was the case with the COVID-19 pandemic and the increase in government spending associated with it. Throughout history, when politicians have had the option between cutting spending and raising taxes on their constituents or simply printing more money, they have tended to choose the latter.
Dalio said in his recent interview:
“Either that debt will be paid off with hard money, in which case there’s not much printing and so on, or it will be paid off with printing a lot of money to make it easier to pay off. I think, in the end, it’s always the case that they print a lot of money and make it easier to pay off.”
As Warren Buffet recently pointed out, the reality is there aren’t any true alternatives to the U.S. dollar in the realm of fiat currencies.
Could it be a mistake to leave Bitcoin, or "rat poison squared" as Buffett fondly called it, out of the equation? Bitcoin is still developing as a trustworthy store of value, with unique properties like the lack of counterparty risk in the digital realm.
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