The putrid smell of Bitcoin shorts’ carcasses just became more pungent. The Bitcoin price pump from below $3,000 to almost $6,000 in under one month is truly astounding.
In that span of time China shut down three of the world’s largest exchanges. The New York Agreement signatories proceeded further with the scheduled SegWit2x hard fork. And heads of large banking institutions called Bitcoin a fraud.
Where to from here? How high can Bitcoin go? Is this just a flash of greatness to be followed by a century of misery?
The clues to the future of Bitcoin lie in the global currency and debt markets. The money printing orgy that allows central banks to monetise the debt of governments and large corporates created the environment for Bitcoin to thrive. Therefore, an examination of the total stock of money and government debt could give clues to the future price of Bitcoin.
M2 is a measure of the money supply that includes all elements of M1 as well as “near money.” M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds and other time deposits.
The government debt statistics are in USD billions were obtained from a Bank of International Settlements report. The data is as of 30 June 2017.
Money is not just M2, but in our financialised world, sovereign-credit acts as a very important monetary instrument. It is why many economists label the currency system a debt-based monetary system.
Other debt instruments such as corporate debt, provincial or municipal debt also function as money. Each country is different in the ways in which other types of debt function as money. To remain consistent I only considered government issued debt.
Gold (XAU) is the analogue “I don’t trust the government” monetary instrument. Bitcoin (XBT) appears to be the digital version. For gold and Bitcoin I used the current value of the total supply of each currency as its M2 value. For government debt, each has a value of 0.
The above chart depicts the relative size of M2 + Government Debt for the four most important fiat currencies (USD, EUR, JPY, and CNY), Gold, and Bitcoin. The first salient observation is that Bitcoin’s market value barely registers on the graph vs. these larger currencies.
Debt must be paid back at some point with base money, M2. Therefore the more debt a country has vs. it’s base money, the more leveraged their financial system. Governments usually don’t worry about how debt will be repaid because they can continue to issue new debt to pay off old.
However, when the market refuses to roll over debt an affordable interest rate, debt must be extinguished. One theory of how overly indebted governments could reduce the Debt / M2 leverage ratio is to tender debt-backed money at higher and higher prices for real money such as gold. Paul Brodsky in Apropos of Everything I, II, and III lays out an excellent argument for why central banks would extinguish debt-money vs. gold. I don’t believe it is likely that central banks will add Bitcoin to their pool of assets. The more likely scenario is that inflation sensitive investors will tender their debt-money for a relatively cheap real digital monetary instrument such as Bitcoin.
The only reason Bitcoin deserves treatment in is this thought experiment is that against all odds, it is still here after 9 years. The price after falling 80% from 2013 highs to 2015 lows, is now almost 5x higher than the previous 2013 all time high. The other positive aspect is that after years of ignoring Bitcoin, many financial institutions are investigating how they can play the game.
The aggregate amount of government debt outstanding for the four fiat currencies listed is $38,334 billion. At current prices, gold and Bitcoin are worth 20% and 0.25% of the aggregate government debt respectively.
If Bitcoin is digital gold, than theoretically it could reach the same ratio as gold relative to aggregate government debt. That implies a Bitcoin price of $461,333 or an 80x increase in price.
Modesty is a virtue. Assume that Bitcoin achieves a 1% valuation relative to aggregate government debt. That results in a price of $23,065 or a 4x return from current levels.
The battle for $10,000 is one of perception. Bitcoin is still not very useful as a pure monetary transaction instrument given its price volatility. However as a store of value, if savers view it as a hard form of digital money, they will diversify out of debt-money into Bitcoin. This psychological transformation is underway. The longer the price stays at these levels, the more people will believe Bitcoin will exist decades in the future.