The impact of changes in global capital flows on Bitcoin

Author: fejau Translator: Block unicorn

I want to write down some of the things I have been thinking about. How will Bitcoin perform in an unprecedented major shift in the pattern of capital flows? I think Bitcoin will usher in a wonderful trading opportunity once the reduction is over. In this article, I will elaborate on my thinking. Let's get started.

What are the key drivers of Bitcoin prices in history?

I will draw on Michael Howell's research on the historical drivers of Bitcoin prices and use it to further understand how these intertwined trends may evolve in the near future.

As shown in the above chart, drivers of Bitcoin include:

• General investor preference for riskier, higher-beta assets

• Correlation with gold

• Global liquidity

My simple framework for understanding risk appetite, gold performance, and global liquidity is to focus on fiscal deficits as a percentage of GDP to quickly understand the fiscal stimulus that has dominated global markets since 2021.

Higher fiscal deficits as a percentage of GDP mechanically lead to higher inflation, higher nominal GDP, and thus higher corporate revenues, since revenue is a nominal metric. This is a big boon to earnings growth for companies that can enjoy economies of scale.

For the most part, monetary policy has played second fiddle to fiscal stimulus, which has been the dominant driver of risk asset activity. As @BickerinBrattle’s regularly updated chart shows, monetary stimulus in the US has been so low-profile relative to fiscal stimulus that I will leave it aside for this discussion.

As shown in the chart below, the US fiscal deficit as a percentage of GDP is significantly higher than any other major advanced Western economy.

Because the US fiscal deficit is so large, economic growth has dominated and caused the US stock market to perform significantly better than other modern economies:

Because of this dynamic, the US stock market has been the main marginal driver of risk asset growth, wealth effects, and global liquidity, so that global capital flows to where it can benefit most: the United States. Because of this dynamic of capital inflows into the US, combined with a large trade deficit where the US gets goods and foreign countries get dollars, which they then reinvest in dollar-denominated assets (such as US Treasuries and MAG7), the US has become the main driver of all risk appetite around the world:

Now, back to Michael Howell’s work. Risk appetite and global liquidity have been driven primarily by the US for nearly a decade, and this trend has accelerated since the pandemic as the US fiscal deficit is much higher than other countries.

So, while Bitcoin is a globally liquid asset (not just US), it has been increasingly positively correlated with US stocks since 2021:

Now, I believe that the correlation with the US stock market is spurious. When I use the term “spurious correlation” here, I mean it in a statistical sense, because I believe there is a third causal variable that is not captured in the correlation analysis, but is in fact a driving factor. I believe that this is global liquidity, which, as we discussed above, has been led by the US for nearly a decade.

When we dig into statistical significance, we must also establish causality, not just a positive correlation. Fortunately, Michael Howell has also done an excellent job of demonstrating a causal relationship between global liquidity and Bitcoin via a Granger Causality test:

What kind of baseline does all this give us?

Bitcoin is primarily driven by global liquidity, and since the US has been the main driver of global liquidity growth, a spurious correlation emerges.

Now, over the past month, as we have all speculated on the goals of Trump’s trade policy and the restructuring of global capital and commodity flows, some dominant narratives have emerged. I think these narratives include:

The Trump administration wants lower trade deficits with other countries, which necessarily means fewer dollars flowing to foreign countries that are no longer invested in US assets. A lower trade deficit is necessary.

The Trump administration believes that foreign currencies are artificially low, and therefore the dollar is artificially overvalued, and wants to rebalance that. In short, a weaker dollar and stronger foreign currencies will lead to higher interest rates in other countries, which will lead to capital repatriation to capture those rates, which perform better after foreign exchange adjustment, while also supporting domestic stocks.

Trump’s preemptive, ask-before-answer approach to trade negotiations is freeing the rest of the world from the constraints of their (described above) paltry fiscal deficits compared to the US, to invest in defense, infrastructure, and generally protectionist government investment to enhance self-sustainability. Whether or not tariff talks are de-escalated, I think the situation here is irreversible and countries will continue to pursue this goal regardless.

Trump wants other countries to increase defense spending as a percentage of GDP and contribute more to NATO spending, since the United States has been shouldering most of the costs. This will also increase fiscal deficits.

I will set aside my personal views on these ideas, which are already being discussed a lot, and focus on the possible consequences if these narratives are taken to their logical end:

Capital will leave dollar-denominated assets and flow back home. This means that US stocks will underperform relative to the rest of the world, bond yields will rise, and the dollar will fall.

This capital will flow back to a place where fiscal deficits will no longer be constrained, and other modern economies will begin to spend and print money to finance these increased deficits.

As the United States moves from a global capital partner to a more protectionist role, holders of dollar assets will need to increase the risk premium associated with these once-premium assets and mark them up with a larger margin of safety. As this happens, it will cause bond yields to rise and foreign central banks will begin to seek to diversify their balance sheets away from holding only US Treasuries and into other neutral commodities such as gold. Similarly, foreign sovereign wealth funds and pension funds may also seek this asset portfolio diversification.

The counterargument to these arguments is that the United States is the center of innovation and technology-driven growth and no country can challenge this position. Europe is too bureaucratic and socialist to pursue capitalism like the United States. I agree with this idea, which may mean that this is not a multi-year trend, but a medium-term trend, as the valuations of technology stocks will limit their upside for some time.

Going back to the title of this article, the first trade is to sell the US dollar assets that are widely held globally to avoid the ongoing reduction. Since these assets are widely held globally, this reduction may become messy because large fund managers and more speculative investors (such as multi-strategy hedge funds with strict stop losses) will hit their risk limits. When this happens, we will experience a day similar to margin calls, where all assets need to be sold to raise cash. Right now, the goal of the trade is to get through this process and eventually be well funded.

However, when the dust settles on the reduction, the next trade begins - diversification into a more diversified portfolio: foreign stocks, foreign bonds, gold, commodities, and even Bitcoin.

We have already started to see this dynamic take shape on rotational market days and non-margin call days. The US dollar index fell, US stocks underperformed other regional stocks, gold soared, and Bitcoin unexpectedly outperformed traditional US technology stocks.

I believe that as this happens, the marginal increase in global liquidity will turn into the exact opposite dynamic we are used to. The rest of the world will take on the burden of increasing global liquidity, thereby increasing risk appetite.

When I think about the risks of this diversification in the context of a global trade war, I worry about the tail risk of being over-invested in other countries' risk assets because these assets may face some major risks, such as the fact that these assets may be affected by potential bad tariff headlines.

When I think about the risks of this diversification in the context of a global trade war, I worry about the tail risk of being over-invested in other countries' risk assets because these assets may face some major risks, such as the fact that these assets may be affected by potential bad tariff headlines. Therefore, in this shift, I believe that gold and Bitcoin can serve as global diversification assets in this shift.

Gold is currently performing extremely strongly, reaching new all-time highs every day, which reflects this shift in the landscape. However, while Bitcoin has performed amazingly throughout the market landscape shift, its beta correlation with risk appetite has so far suppressed its performance and failed to match gold's outperformance.

Therefore, as we move towards a global capital rebalancing, I believe the next trade is Bitcoin.

When I contrast this framework with Howell's correlation research, I can see how they combine:

The US stock market is not affected by global liquidity, but only by liquidity measured by fiscal stimulus and some capital inflows (but we just established that inflows on this front may stop or even reverse). However, Bitcoin is a global asset and reflects this macro perspective of global liquidity.

As this narrative becomes more established and risk allocators continue to rebalance, I believe risk appetite will be driven by the rest of the world rather than the US.

Gold could not have done any better, so for the portion of Bitcoin that is correlated to gold, we also factor that in.

With all of this, for the first time in my observation of financial markets, I see the possibility that Bitcoin could decouple from US tech stocks. I know, this is a dangerous idea that usually marks local tops in Bitcoin. The difference is that this time we see the potential for a meaningful shift in capital flows that will make it durable.

So for a risk-seeking macro trader like me, Bitcoin feels like the cleanest trade to date. You can’t put a tariff on Bitcoin, it doesn’t care what country it’s based in, it offers a high beta to the portfolio without the tail risk associated with current US tech stocks, I don’t need to take a view on the EU cleanup, and it offers a clean exposure to global liquidity, not just US liquidity.

Bitcoin was born for this market mechanism. Once the dust settles on the reduction, it will be the fastest horse in the race. Speed ​​up.