More than a decade ago, on the heels of the 2008 financial crisis (and during the nascent stages of Bitcoin), Dalio began studying the rise and fall of the three most recent global reserve currencies: the Dutch guilder, the British pound, and the U.S. dollar, he recounted.
As Dalio sees it, currency supremacy moves in three “cycles” that may occur simultaneously: the creation of debt and financial assets; an “internal cohesiveness clash cycle” (“as the wealth gaps grow and the value gaps grow – and political groups grow – you have a greater amount of conflict”); and the rise of another great power to challenge the existing top currency.
That happened to the U.S. once before, Dalio noted. After the 1944 Bretton Woods agreement, global exchange rates were tied to the dollar which, in turn, was backed by gold. However, in the 1960s federal spending skyrocketed due to an expansion of entitlement programs at the same time the U.S. was boosting its defense spending to battle the Soviets in the Cold War as well as pay the escalating costs of the Vietnam War.
The higher debt eventually caused a depletion of America’s gold reserves from about 20 metric tons in the late 1950s to under 10 metric tons by 1970. Sensing the situation was no longer tenable, President Richard Nixon took the U.S. off the gold standard in 1971. The dollar has been a “fiat” currency ever since.
As governments around the world continue their attempts to stave off economic crises with more spending, much has been made about the prospects of inflation. In the 12 months ending April, the annualized inflation rate for the U.S. was 4.2%, well higher than the Federal Reserve’s 2% long-term target, though a large part of that was because the rate is being compared to April 2020, a month where many of the world’s economies ground to a halt.
“We will have a hell of a lot of demand because we put all that money in cash all over the place,” said Dalio. At the same time as the money supply has increased, yields have fallen to lows as investors snap up bonds and other assets such as real estate.
It is that second, monetary type of inflation that will ultimately hold sway, according to Dalio. That could be good for assets such as real estate, stocks and cryptocurrencies, but only up to a point.
“As those prices rise – like a bond – their future expected returns go down,” he said. “As they come closer to the interest rate … then there’s no longer the incentive to buy those things. And you could have trouble. It becomes very difficult to tighten monetary policy, because the whole thing falls apart. Everything’s interest rate-sensitive.”
“In 2015, only 2% of Chinese markets were open to foreigners. Now it’s over 60% [but] if you look at the relative pricing, and so on, it’s a whole different story because they’re not doing quantitative easing,” he said. “They still have an attractive bond market. They have attractive capital markets that are more open. And as they’re more open, big investors – institutional investors, central banks, and so on – view themselves as underweighted there,” meaning their holdings in China are insufficient, relative to the returns they can generate.
“When you buy a Chinese financial asset, like buying an American financial asset, you have to buy their currency. So it’s supportive to their currency and it’s also supportive to their assets,” said Dalio. He said China gains the capacity to bill and lend in its currency when there are capital inflows. “China has been very reticent to do that [so as] not to disrupt the system. But you’re seeing more of the internationalization of the renminbi. It has appeal for borrowers and lenders. … That dynamic is really following the same arc of monetary systems and empires pattern.”
Governments may start to worry should bondholders sell their bonds in favor of bitcoin. “The more we create savings in [bitcoin], the more you might say, ‘I’d rather have bitcoin than the bond.’ Personally, I’d rather have bitcoin than a bond,” Dalio said, chuckling. “And then the more that happens, then it goes into bitcoin and it doesn’t go into credit, then [governments] lose control of that.”
One indicator, Dalio said, is the relative value of bitcoin versus gold. Excluding government reserves and jewelry uses, the value of gold is roughly $5 trillion, he estimated, about five times that of bitcoin. “It’s about 80/20 right now in the world, so that’s something I’d watch, too. But I think those things probably are going to rise relative to bonds.”
This content was originally published here.