Grayscale: How the US Election and Macroeconomics Affect Bitcoin

Source: Grayscale;

Compiled by: Deng Tong, Jinse Finance

• In the upcoming election, important macro policy issues will include the scale of government deficits and debt, inflation and Federal Reserve independence, and the role of the United States in the world.

• Bitcoin is an alternative currency system that competes with the dollar. Therefore, U.S. government policies that affect the economy or the outlook for the dollar may also impact Bitcoin.

• Grayscale Research believes that the dollar may depreciate, and we think Bitcoin may benefit from policy changes that lead to (i) an increase in U.S. government debt, (ii) erosion of Federal Reserve independence and increased inflation risk, and (iii) a decline in U.S. leadership abroad.

As Bitcoin approaches its historical highs, candidates participating in the 2024 election have begun to weigh in on cryptocurrency market topics. For example, former President Trump stated in an interview with CNBC this week that Bitcoin has "gained a life," and he allows supporters to purchase goods with Bitcoin. [1] Ahead of the election, a survey conducted by Harris Poll on behalf of Grayscale indicated that cryptocurrency investors may pay attention to candidates' views on Bitcoin and any clues regarding potential cryptocurrency legislation from the next Congress.

But Bitcoin is also a macro asset: it is an alternative currency system and a "store of value" that competes with the dollar. Therefore, macroeconomic and geopolitical issues in the U.S. election (such as the amount of deficit spending and the U.S. role in the world) may affect demand for the largest cryptocurrency. We believe that election outcomes that increase the risk of dollar depreciation may be favorable for Bitcoin in the medium term.

Macro Issue #1: Government Deficits and Debt

To some extent, rising government debt may negatively impact a country's currency.[2] For the large and institutionally mature U.S., the risks facing the dollar primarily stem from the "twin deficits" mechanism. This theory posits that because the marginal demand for government bonds may come from foreign investors, budget deficits and trade deficits often expand simultaneously.

About half of U.S. government debt is held by foreign investors, and federal budget deficits have historically led to an expansion of trade deficits.[3] Additionally, for the country as a whole, international liabilities (i.e., debts owed to foreigners) far exceed international assets, with the U.S. net liabilities currently totaling 65% of GDP (Chart 1). As the federal debt stock is expected to increase significantly in the coming years[4], foreign investors' interest in U.S. government bonds may become more limited or nonexistent, leading them to move away from the dollar and potentially turn to alternatives like Bitcoin.

Chart 1: Foreign investors may lose interest in purchasing U.S. Treasury bonds

Both President Trump and President Biden have left a record of rising government debt and pro-cyclical budget deficits, although the pandemic has complicated the interpretation of these historical records. Before the pandemic[5], despite a declining unemployment rate, President Trump still led to an increase in public debt levels and an expansion of budget deficits (Chart 2).[6] Government analysts also estimated that the 2017 tax law increased the budget deficit in the medium term.[7] After the pandemic, President Biden similarly governed during a period of increasing federal budget deficits and historically low unemployment rates. Furthermore, neither candidate prioritized balancing the budget during their second term. President Trump indicated he wanted to implement additional tax cuts, while estimates suggest President Biden's green energy investment plan would significantly expand the deficit.[8]

Chart 2: Both President Trump and President Biden governed under large budget deficits

As public debt under both candidates may increase, a more important consideration may be whether either party controls both the White House and Congress simultaneously. According to current practices[9], a party that gains a simple majority in Congress can pass fiscal policy legislation, and both President Trump and President Biden enacted significant legislation under a unified government at the beginning of their terms. The impact on Bitcoin: If one party controls both the White House and Congress, demand may rise as it would be easier to pass legislation that expands the deficit.

Macro Issue #2: Inflation and Federal Reserve Independence

Grayscale collaborated with Harris Poll to survey potential voters' views on cryptocurrency and the upcoming election. Notably, respondents indicated that inflation is the most pressing issue facing the country (Chart 3).

Chart 3: Inflation is the most pressing issue in the U.S.

We believe Bitcoin can be viewed as a "store of value" asset that can hedge against dollar depreciation—where inflation or nominal depreciation erodes purchasing power. One way this election may affect the risk of dollar depreciation is through its impact on Federal Reserve independence. Academic research has found that independent central banks—those responsible for maintaining low and stable inflation without daily control by elected officials—are more capable of achieving price stability.[10] Therefore, actions that undermine central bank independence may increase the likelihood of high inflation and dollar depreciation in the medium term. Federal Reserve Chairman Jerome Powell's term will expire in 2026, so the next president will have the opportunity to shape the institution.

During his tenure, President Trump frequently criticized the Federal Reserve publicly, stating he was "not at all happy" with Powell's selection and that the FOMC's (Federal Open Market Committee) policy choices were "far off."[11] He has continued to criticize recently, claiming Powell is "political" and that any interest rate cuts are aimed at "helping the Democrats."[12] In contrast, President Biden has taken a more traditional approach, stating that his method for reducing inflation follows the principle of "respecting the Federal Reserve and its independence."[13] The impact on Bitcoin: If President Trump is elected and the market believes he may weaken the Federal Reserve's independence in a second term, demand may rise.

Macro Issue #3: The U.S. Role in the World

Outside the U.S., many of the largest holders of dollars are foreign governments. For most countries, the dollar holds the largest share in foreign exchange reserves (official foreign assets held by governments) (Chart 4). Therefore, international demand for the dollar may be influenced by economic and political factors. For example, countries with U.S. military bases often hold more dollars in their foreign exchange reserves.[14] As demand for the dollar depends on political and economic factors, actions by the next president to reduce U.S. geopolitical influence may weaken demand for the dollar, which in turn could open space for competing currency systems like Bitcoin.

Chart 4: The dollar dominates global trade and finance

President Trump has a more negative view of U.S. international commitments than President Biden, and his rhetoric and actions occasionally provoke friction with allies. Trump frequently criticized NATO, withdrew the U.S. from the Trans-Pacific Partnership (TPP), imposed tariffs on various imports (including products from Canada, Mexico, and the EU), and pressured Japan and South Korea to provide greater financial incentives for U.S. military protection.[15] As a candidate, Trump proposed a comprehensive 10% increase in tariffs and stated that tariffs on China would exceed 60%.[16]

The Biden administration has provided more support for existing alliances and multilateral institutions. Examples include support for NATO and funding for Ukraine (emphasized in his recent State of the Union address) and a more positive attitude toward the TPP. The Biden administration has also abandoned major new tariffs. However, following Russia's invasion of Ukraine, the U.S. and its allies sanctioned the Russian central bank—arguably the most significant policy decision regarding the dollar's international role in recent years. This action led to Russia's economy "de-dollarizing"—shifting from the dollar to gold and other currencies. In the future, other countries facing sanction risks may also attempt to move away from the dollar and diversify. The impact on Bitcoin: More isolationist policies or aggressive use of extraterritorial sanctions may suppress the dollar and support alternatives like Bitcoin.

Bitcoin on the Ballot

In addition to macro policy issues on the November ballot, cryptocurrency investors will also be watching for guidance on specific industry legislation. The last Congress debated several pieces of cryptocurrency legislation. These included two comprehensive bills[17], the McHenry-Thompson Bill and the Lummis-Gillibrand Bill, both addressing registration requirements for cryptocurrency exchanges and the jurisdiction of the SEC and CFTC over cryptocurrency assets. Two other important bills that cryptocurrency investors will be watching include the "Stablecoin Bill," which aims to enhance regulatory transparency for stablecoins[18], and the "Digital Asset Anti-Money Laundering Bill," which focuses on preventing illegal financial activities involving cryptocurrencies.[19]

Regardless of how the U.S. cryptocurrency regulatory environment evolves, macroeconomic and geopolitical trends driving the dollar and Bitcoin upward seem likely to persist. We believe these trends include large government budget deficits and rising debt, increasing and more volatile inflation, and declining trust in institutions. Bitcoin is another "store of value" that competes with the dollar. If the long-term outlook for the U.S. economy and the dollar deteriorates, we expect demand for Bitcoin to rise.

For the presidential election, both candidates have previously served as president, allowing investors to partially assess the impact of re-election based on their past statements and actions. Given the historical record, if either Trump or Biden also controls Congress, government debt may continue to rise. Although the U.S. economy is healthy, a return to large deficits could pose downside risks for the dollar. Similarly, any policies that increase inflation risk and/or reduce foreign government demand for the dollar could lead to currency depreciation and potentially benefit the dollar's competitors (such as other national currencies, precious metals, and Bitcoin).

References

[1] Source: CNBC.

[2] Economists believe that excessive government borrowing can affect a country's currency through three main channels: (i) a "fiscal risk premium" arising from default risk, (ii) the government's "fiscal dominance" causing the central bank to keep interest rates too low to help finance government borrowing, or (iii) through the "twin deficits" effect. For representative research literature on these topics, see Carlson and Osler, "Determinants of Currency Risk Premium," Federal Reserve Bank of New York Working Paper, February 1999; Calomiris, "Fiscal Dominance and the Return of Zero Interest Rate Bank Reserves," Federal Reserve Bank of St. Louis Review, Q4 2023; Bluedorn and Leigh, "Revisiting the Twin Deficits Hypothesis," IMF Fiscal Policy Conference, June 2011.

[3] For example, see Kumhof and Laxton, "Fiscal Deficits and Current Account Deficits," IMF Working Paper, October 2009.

[4] Source: Congressional Budget Office, "Budget and Economic Outlook: 2024 to 2034," February 2024.

[5] We consider the U.S. pandemic outbreak period to be from March 2019 to Spring 2022.

[6] From December 2016 to February 2019, publicly held federal government debt increased from 76% of GDP to 80%; Source: Grayscale Investments calculations based on Bloomberg data.

[7] Source: Congressional Budget Office, "Budget and Economic Outlook: 2018 to 2028," April 2018.

[8] Source: Congressional Budget Office, "Budget and Economic Outlook: 2024 to 2034," February 2024.

[9] Through adjustments, this process typically requires that policy changes expanding the deficit expire before the end of the ten-year budget scoring window.

[10] For an introduction to this topic, see "Why Central Bank Independence Matters," World Bank Research and Policy Brief, November 2021.

[11] Source: CNBC.

[12] Source: Fox Business Channel.

[13] Source: Politico.

[14] Source: Eichengreen, Mehl, and Chitu, "Mars or Mercury? Geopolitics of International Currency Choice." NBER Working Paper, December 2017. Also see Goldberg and Hannaoui, "Determinants of the Dollar Share in Foreign Exchange Reserves." Federal Reserve Bank of New York Staff Report, March 2024.

[15] Source: Reuters.

[16] Source: CNN.

[17] The two comprehensive bills refer to the 1. "Financial Innovation and Technology for the 21st Century Act" (McHenry-Thomson Bill) and 2. "Responsible Financial Innovation Act" (Lummis-Gillibrand Bill).

[18] U.S. Congress.

[19] CoinDesk.