The cryptocurrency market is having a tough time, as most digital assets are down massively in the last week. The declining confidence in fiat currencies spurred by rising debt levels made cryptocurrencies attractive.
Bitcoin broke below $30,000 yesterday. On its way down from $64,000, it lost over 50% of its value in only several weeks. But why would Bitcoin, Dogecoin, Ripple, Ethereum, or any other so-called digital “currency” grow in popularity during the COVID-19 pandemic? The answer comes from rapidly rising debt levels that erode the confidence in fiat currencies.
Debt levels were rising across the world even before the pandemic. In the aftermath of the great financial crisis of 2008-2009, one of the solutions was to borrow some more.
When a country spends more than it earns, it runs a deficit that must be funded. To do so, the country issues debt and pays interest on it. The debt might be bought by domestic or foreign investors and reflect the trust that the government will be able to make timely payments on its debt.
Ballooning Inflation – A Side Effect of Rising Debt Levels
When the COVID-19 pandemic hit the world, the US debt level as a % of GDP was already at 98.2%. By 2050, it is projected to reach close to 200%, with potential spillovers such as excessive inflation and eroding confidence in the US dollar as the world’s reserve currency.
After all, if the government pays, say, 1.5% interest on its debt, but the annual inflation rate exceeds 3%, what is the catch for the investor? Why would anyone buy the government’s debt? Therefore, the key is to find a balance between the issuance of debt, interest rates and economic growth.
The United States is not alone, as taking up more debt was the government’s way to fight the pandemic. But if the United States does have a chance to service its debt in the future, other countries, in particular emerging markets, will have a harder time.
For example, one way to deal with the rising debt as a percentage of GDP is to favour policies that lead to increasingly higher GDP. Hence, the debt ratio will decline as the GDP increases.
While such policies may work in the developed world, they usually don’t in emerging, developing or frontier markets. But all these other markets borrowed massively, too, in the face of the pandemic. Therefore, the increased popularity of digital assets during the pandemic might be explained by the public’s lack of trust that governments can eventually service their debt.