What Stanley Druckenmiller’s Inflation Warning Means for the Cryptocurrency Industry

Hedge fund and foreign exchange giant Stanley Druckenmiller believes that current Federal Reserve policies and U.S. deficit spending are pushing the dollar down the road to collapse.

What Stanley Druckenmiller's Inflation Warning Means for the Cryptocurrency Industry

Hedge fund and foreign exchange giant Stanley Druckenmiller believes that current Federal Reserve policies and U.S. deficit spending are pushing the dollar down the road to collapse. This morning, he told CNBC that the dollar is “very likely” to lose its status as the global reserve currency within 15 years. Druckenmiller’s comments focused on the Fed’s commitment to low interest rates and U.S. bond buybacks, moves that will ultimately support U.S. deficit spending in the fight against the epidemic.

However, Druckenmiller’s comments are positive for a group that is already effectively shorting the dollar: cryptocurrency advocates. Given that the euro is in trouble and the yuan remains suspect, Druckenmiller doesn’t think there will be another fiat currency that can play the role of universal mediation of the dollar in the near term. Instead, he believes the “most likely replacement” for the dollar is a “cryptocurrency-derived ledger system. This is a remarkable set of statements by Druckenmiller, considered by some to be the greatest foreign exchange trader in history. Among other big trades, he was behind Soros’ legendary 1992 shorting of the British pound. Now, he’s echoing one of the most fundamental points made by bitcoin advocates. for 10 years, these people have been contrasting the fixed issuance of bitcoin with the tendency of countries to let their money printing machines run free.

Inflation has not been a major concern for the U.S. economy for decades. In fact, prior to the epidemic, the Federal Reserve had considered inflation too low for nearly a decade. But epidemic spending has pushed the U.S. deficit and debt to record highs, sparking widespread concern about inflation risks. Inflation is probably the biggest headache for dollar-denominated investors, as it erodes their assets and earnings. It could also be an annoyance for workers and consumers, even though wages tend to rise in line with prices.
If the dollar becomes less attractive as a tool for foreign governments and global traders, the loss of its global reserve currency status could be a complete disaster for almost all Americans. According to the International Monetary Fund, some 40 to 72 percent of U.S. paper currency is held abroad, and the dollar accounts for more than 60 percent of the world’s national foreign exchange reserves. Attempts to sell these positions could create a vicious cycle in the value of the dollar if confidence is damaged, which would have a range of negative effects within the United States.

While the long-term trend in U.S. debt is clear, it is far from clear that the time has really come to rein in spending.

Druckenmiller argues that the current U.S. recovery is so strong that further epidemic relief spending is unnecessary and even risky, but relief spending appears to be critical to achieving recovery in the first place. Indeed, some argue that the U.S. response helped it “win the epidemic” by compensating for the widespread collapse in demand. Some also argue that the epidemic’s easing prevented the economy from suffering the same level of damage as the Great Depression, which may have been as damaging to the dollar’s international standing as moderate inflation, if not more so. Druckenmiller does not question the importance of relief spending; rather, he argues more modestly that it is time to curtail it. This is a broadly Keynesian view: increase the deficit when the private sector declines, then reduce it when the overall economy recovers. It is also arguably an afterthought, since the current rescue plans, some of which will last another six months, were in the pipeline before the successful rollout of the U.S. vaccine was established. Its current merits are even disputed; for example, the real unemployment rate in the U.S. is still above 10%, which suggests that there is still a lot of slack in the overall economy.

This is just one of the great differences in what inflation means at different income levels. As noted earlier, investors and the wealthy generally have the most to lose from inflation, as it eats away at dollar-denominated returns and also dilutes the value of dollar holdings. Meanwhile, workers who are unlikely to have significant savings or investments and who have gained the greatest percentage of the benefits from epidemic relief spending will suffer the greatest losses when it ends. Druckenmiller’s reserve currency endgame scenario shows that irresponsible government spending ends up hurting everyone, but in the short term, epidemic relief leaves many ordinary people much better off than they would otherwise be.

This is almost never acknowledged in the broader inflation discussion, but if you compare current inflation concerns to the response to former President Donald Trump’s 2017 tax cut package, it’s obvious. The Congressional Budget Office estimates that the U.S. deficit will increase by $1.9 trillion over the next 10 years, even after accounting for the additional growth from the cuts.

That’s as big a budget gap as President Biden’s “American Rescue Plan,” but after the tax cuts, there is little sign of inflation. More notably, the spending cuts come during a period of economic strength, which conventional wisdom says is economically unnecessary and more likely to be inflationary than spending during a slowdown. Even more confusing is that many of the same people who fear massive inflation also oppose Biden’s attempt to partially reverse Trump’s spending cut plan.

All of this suggests that any cross-country reserve currency, whether cryptocurrency or otherwise, could present a broader challenge. While there are legitimate concerns about inflation, deficit spending is an important tool for nation states to meet local political and social needs, especially to protect the most vulnerable members of society during a crisis. In the worst case scenario, the complete substitution of global currencies for national currencies would limit the fiscal discretion of a government to take such actions. This can be seen in the problems experienced by countries like Spain and Greece after they abandoned their own currencies in favor of the euro.

But for those countries that retain a viable national currency, a supranational reserve currency may be more of a moderating influence than a restriction, especially if it is acceptable to the general public. Now, if your own currency is being mismanaged, the main options are to find another country that is doing better, or to buy gold. However, a neutral, inflation-resistant reserve layer may be a better refuge. If it is easy to buy and hold (e.g., through a public blockchain), distrust of government fiscal policy will soon be punished by a decline in demand for the currency. At the same time, governments would still have the flexibility to issue debt denominated in their own currency when it is truly needed and supported by public sentiment.

But it is hard to see a path that will not wreak havoc on the dollar and the United States as a whole. After all, add another $1.9 trillion in epidemic spending to the current government debt of more than $28 trillion. Druckenmiller said that if market confidence in the dollar wanes, leading to weaker global interest in holding U.S. Treasuries, rising interest rates could require one-third of the annual U.S. budget to go toward interest payments, which are now about 10 percent. That would be bad for everyone.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/what-stanley-druckenmillers-inflation-warning-means-for-the-cryptocurrency-industry/
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