The Relationship Between US Government Debt and Bitcoin, Explained

Bitcoiners are looking for persistent USD inflation to validate their favorite asset. That’s unlikely to happen soon, economists say, but low interest rates are still a boon for BTC.

AccessTimeIconJan 20, 2021 at 7:15 p.m. UTC
Updated Sep 14, 2021 at 10:58 a.m. UTC
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The kind of inflation outbreak that might prove bitcoin’s power as a hedge asset isn’t coming in the near term, according to some economists. 

“Right now, low interest rates tell us there’s no evidence that we’re borrowing too much money,” Stanford economist Erik Brynjolfsson said. “Separately, but related, inflation is also very low. The [Federal Reserve] has set a target of about 2% for inflation, and it’s consistently been missing that target on the low side. We don’t see any evidence that inflation is taking off." 

In fact, future economic growth could be in danger if the U.S. doesn’t embrace new stimulus, former Treasury Secretary Lawrence Summers told CoinDesk. He said the potential for inflation isn’t as concerning as the potential for economic growth coming to a halt. 

“I think the greater risks are still on the side of secular stagnation and low interest rates,” Summers said. “There may be some temporary sense of heat in the economy because of all the stimulus that's been provided in the last year.”

Bitcoiners are closely watching inflation indicators such as the U.S. Treasury yield curve steepening in early January, which shows that investors expect economic growth that will require the Federal Reserve to raise rates to control inflation. The five-year breakeven rate, which represents how the bond market foresees long-term inflation, has been above 2% since the beginning of the year.

These indicators point to future rising inflation, but “we’re not seeing it yet,” Brynjolfsson said.

“It’s possible, even likely, that government policy over the coming year will change that and start bringing interest rates back up,” Brynjolfsson said. “The Fed may monetize some of that [debt] by printing money.” 

Right now, the markets are screaming for more debt.

“Supply and demand dictate that when there are more savers than borrowers, then [real] interest rates are going to fall to zero or even negative,” Brynjolfsson said, commenting on a discussion paper by Summers and Harvard economist Jason Furman. “The markets are willing to buy government assets and if the government were to issue more debt it would be snapped up very quickly."

Savings have increased significantly during the pandemic while the supply of investment capital has decreased, Summers said. As a result, real interest rates on servicing government debt are negative and likely to remain that way in the near term, which means the government would make money off of borrowing more. (The real interest rate is the interest rate when inflation is taken into account.)

With little room for central banks to lower rates and a clear runway to borrow more, many advanced economies are turning to fiscal policy to stave off the continuing crisis.

“If you look around the world, there’s a shortage of demand in lots of large advanced-economy countries ... [that] began this crisis at deeply negative interest rates and have had little policy space with interest rates,” U.S. Federal Reserve Chair Jerome Powell said during an event hosted by Princeton University last Thursday. “That all is going to hang around for a while.”

When vaccines create a world that can spend freely again, that may still not produce the high inflation that bitcoiners would be looking for as an affirmation of BTC’s “inflation hedge” thesis.

“As the pandemic recedes and we see a potentially strong wave of spending as people return to their normal lives and begin consuming various services, there could be quite exuberant spending and we could see some upward pressure on prices,” Powell said. “The real question is how large is that effect going to be and will it be persistent? Because clearly a one-time increase in prices that isn’t very large is very unlikely to produce persistently high inflation.”  

In the near term, bitcoin will still profit from a low interest rate environment even if inflation doesn’t skyrocket. The less money investors can make on bond yields, the more money they might instead put into potentially higher-returning assets like bitcoin, Summers said.

“It's a fairly straightforward argument,” Summers said. “When the amount you can earn on bonds goes down, people put less of their money into bonds and more of their money into other assets, and that increases the value of those assets.”

Brynjolfsson added: “The demand for assets like U.S. Treasurys, gold and bitcoin has dramatically exceeded the supply, driving up prices. Specifically, in the case of Treasurys the markets are saying that they would like the government to borrow more, that there aren’t enough secure assets for what people want to do.”


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