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Could crypto be the remedy to government debt issuance?

Could crypto be the remedy to government debt issuance?

From George Washington to George W Bush, the US national debt rose to $7 trillion. The debt rose to $34 trillion from Barack Obama to Joe Biden. In a shy 16 years, the debt took a whopping $27 trillion when it took 219 years to grow to $7 trillion. 

Simple facts allow us to understand complex dynamics. Of course, there are nuances to bring in, such as interest rate levels, demographics, wealth distribution, sizes of the economy, etc., and many other factors can change the overall impact and picture of such a topic than debt. Still, the magnitude of what we face worldwide regarding this debt issue is unprecedented. 

We will not repeat how we got here, what it implies for us and that monetary debasement will continue. If you need a refresher, don’t hesitate to check out the articles, The Bull Market has Started: So What’s in Front of Us? and Navigating the Economic Seas

For all the reasons exposed in the previous articles, we know that debt levels will continue to rise around the world for governments, and the US will not be an exception. 2024 will see the pile of COVID debt to be rolled over (refinanced) and the growing interests to be paid.

US debt interest payments now exceed tax revenue
Source: https://www.bea.gov/

Fiscal deficits are already at record highs, with military spending forced to the upside across the globe due to geopolitical tensions (and this for the years to come), and the higher interest rates on short-term debt having to be paid does not help.

Growing spending is the problem

Moreover, this issue is also accentuated due to mandatory spending that will continue to rise with population ageing (see chart below if you are still in disbelief that demographic decline doesn’t drive debt increase). 

Demographic decline drives debt increase

All this will push governments to continue to issue debt and find buyers. 

Debt issuance

Let’s take the US as an example (as the charts illustrate, the fiscal deficits and the debt to GDP ratio trends are about the US). The US government has to roll over every year the debt coming to maturity (having to refinance it with new buyers) and has to pay for the interests owed on the debt that matured. This sequence needs the market to be able to absorb this new debt. As we explained, the financial system is now mainly used to refinance the entire world's debt and needs for this balance sheet capacity. Interest rates are important, but even more important is that the system can roll over and take on new debt. The issue is that we witnessed in the summer and fall of 2023 that the financial market is asking for higher yields to buy US debt as there’s less demand. Indeed, the market is well aware of the economic state of the country and historical buyers (China, Japan, Oil producer countries, the Fed, etc; see chart below) have lately been deleveraging their holdings (for multiple reasons). 

Trend decline in foreign ownership of US government bonds since 2015

This situation brings the US to a complicated spot where they need to refinance a huge pile of debt (once again, COVID debt is to roll soon), pay the interest on this huge pile and finance the fiscal deficit that is at record highs (for all the reasons explained). This is done only by issuing additional debt. So you now have a combination of historical buyers not buying (or buying far less) and sellers needing to sell more than ever. This is a big problem for Miss Janet (US Secretary of the Treasury) and Mister Jerome (Chair of the Federal Reserve). 

Could crypto be the answer? And could stablecoins actually benefit the US and become the new big buyer of short-term US and relieve the US government of a lot of pressure?

To answer this question, we first need to understand how stablecoins work. So let’s dig in.

Stablecoins are crypto tokens that are backed by a specific asset or basket of assets which they use to maintain a stable value against that asset. There are stablecoins for gold for instance (where each crypto token is backed by a given quantity of gold) but the most popular US dollar backed stablecoins. 

Here’s how it typically works: 

A company issues a US dollar stablecoin, and for every stablecoin it issues, it will also hold the same value in US dollar at a ratio of 1:1. This is how the company links the value of its stablecoin to the value of a US dollar. To illustrate this, let’s look at the reserves breakdown of the two biggest US dollar stablecoin issuer.

This is the reserve of Tether:

Tether Reserves Breakdown

And here’s the reserves of Circle, the second biggest stablecoin issuer (with USDC):

Circle reserves

From those tables, we notice something very important: US dollar stablecoins are mostly backed by US government debt of different maturity levels. Looking at Tether, we note that around 65% of its reserves are US Treasury bills. At a current market cap of around $100 billion, this represents approximately $65 billion worth of US treasuries held by Tether alone.

Now if we combine the total market cap of the two biggest US dollar stablecoin issuers (around $130 billion) and assume that 85% of its reserves are US government debt, we note that they collectively hold around $110 billion of US debt.

To put this in context, if stablecoins issuers were a country, they would be in the top 20 biggest foreign holders of US Treasury (which is higher than Germany).

Chart: Major foreign holders of United States treasury securities

Major foreign holders of United States treasury securities
Source: Statista

But what’s more interesting is the positive feedback loop that can happen: the more crypto land grows, the higher the demand for stablecoins, especially when we assume that profit taking will happen mostly in stablecoins, and the higher the stablecoin companies can buy US debt.

When we look at the past bull market, we observe a clear correlation between the price of Bitcoin (in orange) and the total market cap of the biggest stablecoins issuer (in green).

Correlation between the price of Bitcoin and the total market cap of the biggest stablecoins issuer

As we are now in a new bull market and the secular up trend for crypto is clear to us with all cyclical nexus flashing green signals, it is fair to  expect the stablecoin market cap to start a new strong uptrend. In fact this has already started up and their market cap is up 10% YoY.

It is fair to  expect the stablecoin market cap to start a new strong uptrend

As a corollary, their US treasury holdings are expected to continue growing, which is the inverse of the current trend where countries are, more and more, deleveraging on US debt.

This table shows different scenarios in terms of US debt holdings of stablecoin issuers:

Different scenarios in terms of US debt holdings of stablecoin issuers

If we assume that US dollar stablecoins could reach a market cap of $500 billion by the end of this cycle, which seems a reasonable assumption, this could imply that they could hold over $425 billion of US debt, putting Crypto land as the fourth largest country in terms of treasury holdings. The implications for this are simply huge and ironically, crypto could well be a game changer to support the inevitable debt rolled over of the US.
As the US is in desperate need for buyers of their debt, they have a strong incentive to be crypto-friendly, building regulatory clarity for crypto operations in the US, and allowing innovation because this could propel crypto adoption and total valuation to new highs, which would allow US debt to be bought by stablecoins and offer the US government a new buyer with substantial potential resources.

A word for the end…

Could Crypto Land be the saviour of the entire system? Enabling governments to print their way to growth? Indeed, we are firm believers that the only way to get out of this debt spiral is by enabling GDP growth to much higher levels than today, allowing debt to be repaid. In fact, there’s no way we can lower debt levels by cuts and austerity measures in the current state of affairs. A new era of sufficient growth allows debt to be repaid, which will happen only through innovation and exponential trends. These trends are possible only through technology, and crypto will be a fundamental component of this new era. The combination of AI, robotics, cryptocurrencies, crypto assets, blockchain technology, nanosciences, green tech, etc.. holds the potential to change the national economies dramatically and perhaps enable growth metrics we thought were not possible before. Maybe, just maybe, this new relationship between an entirely new economy that is Crypto Land and the fiat world could eventually allow repairs to the system and rescue of the fiat system. And instead of fighting innovation, the US should acknowledge the role that crypto can play in 1. Contributing to growth in productivity and 2. Helping them with their debt problems. 

Time will tell if this is going to unfold. It will not be without hick-ups and hassles. There’s never an opportunity without risk. 

Crypto might become even more prominent with this. The risk-reward ratio remains so positive in our view. Investment in tech and crypto is a great way to accelerate the escape from monetary debasement, but let’s remind ourselves that having it requires sacrifice and discipline. It should be taken seriously and aligned with goals and boundaries. So plan, decide and act. To do so, learning and understanding what’s happening out there is essential. Knowledge is the key to financial freedom, and that’s why we take education and thought-leading seriously at SwissBorg. 

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