Erik Weijers, 3 months ago

The dollar milkshake theory and the implications for crypto

The world is addicted to dollars. World trade is a delicious dollar milkshake served up by the US Central Bank. But what happens when it gets thirsty itself and sucks at the straw? Then those dollars flow back, and world economies get into trouble. With price drops as a result - including crypto. That's what we've experienced over the past year. When will the milkshake be refilled?

World trade is still mostly done in dollars and countries have some of their debt outstanding in dollars. Therefore, problems arise when the dollars are "sucked out". The term dollar milkshake comes from investor Brent Johnson. He is not alone in his theory but the image he uses is so attractive that it has caught on the most. The 'dollar wrecking ball' is another image for the damaging effect of a rapidly rising dollar - but it does not include the aspect of capital flowing back and forth.

Higher US interest rates = higher dollar

To curb inflation in the U.S., the Fed has been raising interest rates since late 2021. Although interest rates are not historically high - quite the contrary - the pace at which these interest rate changes have been made is record-breaking. The U.S. Central Bank (the Fed) has never sucked at the straw as fast as it is sucking now. Putting money in, for example, U.S. government bonds is therefore becoming more attractive again.

The result: an exploding dollar exchange rate. The problem is that the world needs dollars to pay for oil and to pay off debts in dollars. So, there is extra bidding on the remaining dollars that are still swimming around in the milkshake. Supply and demand are out of balance and the rate of the dollar rises. That effect is self-reinforcing when economies outside the U.S. end up in recession - which is now the case - and thus have less purchasing power in dollars. But their dollar debt burden gets bigger and bigger. Ouch.

In the chart below you can see how the dollar index (the DXY, the price of the dollar expressed as an average of a basket of other major currencies such as the euro and the yen), has risen by over 17% within a year. And the end does not seem to be in sight, given the trend of the chart.

Negative correlation between Bitcoin and the dollar

It has not escaped anyone's attention that the price of Bitcoin (and other crypto, and stock prices) has been falling since the dollar has been rising. This is no coincidence: usually Bitcoin is negatively correlated with the dollar. Why? When people see the Fed sucking at the straw, they are encouraged to buy dollars. And so, they must sell something else first, like their Bitcoin. Bitcoin is regarded by investors as riskier than the dollar.

The expectation of many analysts is therefore that only when the dollar rate stops rising can the stock and crypto markets recover. For this reason, all analysts turn on their TVs when Jerome Powell of the Fed speaks again. His words are weighed: will there be a pivot? That a pivot must come is certain - the question is when. The American economy cannot cope with high interest rates: people and companies can no longer pay their mortgages and debts. In addition, the US cannot continue to watch as a global recession leads to destabilization and possible wars.

What to do?

Crypto investors have had to clench their fists as their portfolios have crashed. But there is light at the end of the tunnel, as mentioned above. The moment the milkshake is refilled, crypto will be the market that benefits the most - just as it took the hardest hits. After all, it is the smallest and most volatile market. On top of that, it's easy for European crypto owners to profit from a rising dollar. Namely by exchanging their euros for dollar stablecoins like USDC.

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