Bitcoin Makes the US Dollar Look like Monopoly Money

2015 could go down in history as the year the US dollar became the only currency worth its weight in gold. The greenback smashed just about every other currency of any note. The one exception to the rule was the Israeli shekel, which gained 0.3% on the USD.

Elsewhere, it was slim pickings. The Japanese yen and Swiss franc held firm against the greenback. As for the rest though, the less said the better. The Aussie dollar finished the year 10.2% lower against the USD. NZ, Norway, Canada, Russia, and Brazil all lost ground too. The Ukrainian hryvnia lost as much as 34%.

What was behind the US dollar’s rise? We could put it down to three key factors.

The first were the gains that came as a result of the battering commodity currencies took. As commodity prices fell throughout the year, investors sought safety in the US dollar. In addition to this, weaker global growth also played its part. It contributed to the flight to safety that took place on news of slowing growth rates around the world.

Thirdly, the dollar’s gains were partly a response to the rumours of an imminent US interest rate lift off. And, for much of the year, it looked as if they’d be just that — rumours. It wasn’t until December that the Federal Reserve finally acted, lifting rates by 0.25%. Despite more talk than action from the Fed, this nonetheless contributed to the dollar’s strength for much of the year.

All told, the greenback finished 8.3% higher against a basket of major currencies for 2015.

Yet, before we proclaim 2015 as the year of the greenback, let’s back it up a little.

There was in fact one other currency that outperformed the US dollar by some distance. And that’s putting it mildly. In fact, the US dollar wasn’t the best performing currency of 2015 — far from it. It ranked a (very) distant second to the real success story of 2015: Bitcoin.

What is Bitcoin?

Trying to explain to someone what Bitcoin is, and how it works, is easier said than done.

For starters, Bitcoin isn’t your typical currency. Which makes it harder to relate to concepts most people are familiar with.

Instead, Bitcoin is completely digitalised. You can’t hold any Bitcoins in your hand. No physical form of the currency exists.

It’s also what’s known as a cryptocurrency. It uses sophisticated encryption methods to ensure the integrity of any transaction. As far as one can make out, that’s good because…well, who knows? It sounds like a good thing, and that’s all that matters, right?

But there’s another reason why Bitcoin is drawing so much attention. If you’re still confused by what it actually is, don’t worry. Most people, myself included, are in the same boat. Even Bitcoin’s website does a poor job of explaining how it all fits together.

Perhaps the clearest explanation of what it is comes courtesy of an article from The Economist, which reads:

Unlike traditional currencies, which are issued by central banks, Bitcoin has no central monetary authority. Instead it is underpinned by a peer-to-peer computer network made up of its users’ machines, akin to the networks that underpin BitTorrent, a file-sharing system, and Skype, an audio, video and chat service.

Bitcoins are mathematically generated as the computers in this network execute difficult number-crunching tasks, a procedure known as Bitcoin “mining”. The mathematics of the Bitcoin system were set up so that it becomes progressively more difficult to “mine” Bitcoins over time, and the total number that can ever be mined is limited to around 21 million. There is therefore no way for a central bank to issue a flood of new Bitcoins and devalue those already in circulation.’

The most important bit is the reference to central banks at the bottom. Without the ability to increase the supply in the system, you could think of Bitcoin more like gold than any traditional currency. It’s not backed by gold itself, but it’s as good as gold. How? Because there’s a limited supply to how many Bitcoins can be mined (literally, but that’s a story for another day).

That also happens to be the reason why it’s won so many supporters. You could look at Bitcoin as a counter-movement to the traditional global currency system. Which makes Bitcoin’s recent rise timely, especially considering the fear surrounding currency markets at present.

More and more people are questioning whether central banking policy is rooted in sound theory. Are they doing more harm than good with their monetary policy instruments? It’s debatable.

One way or another, we’ve seen a worldwide campaign of currency devaluations in the past year. In theory, devaluing currencies should make goods cheaper to export. And the more goods a country exports, the more income they receive.

Of course, there’s a side effect to this as well. Goods become more expensive to import, which only adds to consumer costs.

And there’s an even bigger problem, as everyone is devaluing currencies at the same time.

Remember that exchange rates are relative. For every currency that loses values, another must see gains. Action, reaction; winners, losers. You can’t have every currency weaken at the same time. The winner, or loser (depending on how you see it), in this case is the US dollar. Either way, it makes devaluations something of a zero sum game.

Bitcoin’s topsy-turvy history

Since it launched in 2009, Bitcoin has been on something of a rollercoaster rider. But it’s been a crazy ride, if nothing else.

In 2013, Bitcoin was the single best performing currency in the world. It seems almost unbelievable, but it gained an eye watering 5,249% on the USD.

2014 proved was more difficult for the digital currency. It was the worst performing currency during the year, down 56% against the USD.

Yet 2015 finished as another year of impressive gains for Bitcoin. It finished the year up 35% against the greenback. And, with the new year a week old, Bitcoin has already picked up where it left off in 2015. Following this week’s currency devaluation in China, Bitcoin is up US$25 dollars on the greenback. One Bitcoin now trades for US$455.

Whether or not Bitcoin has a mainstream future remains unclear. The fact that it circumvents central banks is one reason to remain sceptical.

Central banks have controlled monetary policy for close to a century. Ceding control to a digital upstart seems unlikely anytime soon. It would have to work in the interests of the banking cartel were it to ever become a serious alternative to existing currencies. Right now, that doesn’t seem viable.

Regardless, it seems that the good times will keep coming for the digital currency this year. With US rates likely to edge up further, and devaluation still the go-to move for most central banks, we can expect more of the same in 2016.

That means weaker currencies (especially commodities currencies), a stronger US dollar, and an even bigger Bitcoin.

Mat Spasic,

Junior Analyst, Markets and Money

PS: US interest policy is likely to dominate discourse for much of 2016. Yet as the Fed looks to increase rates, Aussie interest rates are likely to stay at record lows. That’s the verdict according to Markets and Money’s Phillip J. Anderson.

Phil went against the mainstream, arguing that interest rates would remain low for decades…even as economists were predicting rate hikes. His new report, ‘Why Interest Rates Could Stay Low for the 21st Century’, is a timely reminder of what the future holds. In the report, he warns that you won’t be able to count on your savings to fund your retirement. Inflation, stemming from low rates, will only eat into your reserves.

But there are ways you can benefit from this…provided you act now. Phil wants to show you the best way to invest in this low rate environment. That’s why he’s prepared a four-step strategy to help you boost your portfolio. You’ll learn exactly where to park your cash over the coming decades. And how this could help grow your wealth over time. To download the report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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