MacroVoices #504 Brent Johnson: The Genius of Stablecoins

Key Concepts

Dollar Milkshake Theory: Brent Johnson's framework explaining how global debt crises could lead to a strengthening US dollar.
Stablecoins: Digital tokens pegged to a stable asset, typically a fiat currency like the US dollar.
Genius Act: A (hypothetical) US legislative act that provides official sanctioning for stablecoins, potentially reinforcing the dollar's global dominance.
Sovereignty: A nation's ultimate power and control over its jurisdiction, which can be eroded by external currency influence.
Eurodollar System: A vast market of dollar-denominated transactions that exist outside the United States.
SWIFT System: A global financial messaging network used for international money transfers, often leveraged for sanctions.
Secular Inflation: A prolonged period of rising prices, which can initially benefit stock markets.
MAG 7 Earnings: Earnings reports from the seven largest technology companies, which heavily influence market performance.
Gold as a Reserve Asset: The increasing preference of central banks for gold over US Treasuries due to concerns about fiat currency debasement and geopolitical risks.

Brent Johnson on the Dollar Milkshake Theory and US Dollar Stablecoins

Update on the Dollar Milkshake Theory

Brent Johnson provides an update on his "Dollar Milkshake Theory," originally conceived as a framework to understand potential outcomes of a global sovereign debt crisis. The theory posits that in such a scenario, the US dollar would strengthen due to capital flowing into it. While a full-blown sovereign debt crisis hasn't materialized as predicted, Johnson notes that six key predictions have largely played out:

Rising Interest Rates: After 40 years of decline, interest rates have begun to rise.
Bond Market Break: Higher rates have led to a downturn in bond prices.
Dollar Strength: Increased interest rates have attracted capital, causing the dollar to appreciate against foreign currencies.
US Equity Outperformance: Capital inflows have also supported US stock markets.
Gold Appreciation: Gold has risen due to fiat currency debasement and uncertainty surrounding the monetary system.
US Outperformance: The United States has generally outperformed other global economies in asset appreciation.

Despite significant money printing and expansion of the Federal Reserve's balance sheet, the dollar has remained relatively flat since the COVID-19 pandemic, which Johnson interprets as a sign of its entrenched position. He maintains his view that despite widespread predictions of the dollar's demise, geopolitical tensions and the lack of viable alternatives will likely lead to its continued strength and further entrenchment.

The Rise of US Dollar Stablecoins as a "Game Changer"

Johnson introduces US dollar stablecoins as a significant development that could extend the US dollar's global hegemony. He explains that stablecoins are digital tokens pegged to tangible assets or existing currencies, deriving their value from these underlying assets. For example, a US dollar stablecoin is priced in relation to the US dollar.

Key aspects of stablecoins discussed:

Backing and Transparency: The core idea is that stablecoins are backed by reserves (e.g., US dollars in a bank). Skepticism has existed regarding the adequacy and transparency of this backing.
The Genius Act: The passage of the "Genius Act" is highlighted as a pivotal moment, providing official sanctioning and government backing for stablecoins. This legislation is expected to mandate stringent backing requirements and transparency, increasing confidence in these digital assets.
Reinforcing Dollar Hegemony: Contrary to fears that cryptocurrencies would threaten the dollar's reserve status, stablecoins, particularly US dollar-backed ones, are seen as a mechanism to reinforce it.
Fiat vs. Fiat Battle: Johnson emphasizes that stablecoins are primarily competing with other fiat currencies, not with hard assets like gold or Bitcoin. The US dollar's inherent stability and global acceptance make dollar-backed stablecoins more attractive than many local currencies.
Bypassing Capital Controls: Stablecoin technology allows individuals and institutions to hold and transact in US dollars, bypassing traditional banking infrastructure and capital controls in other countries. This directly impacts national sovereignty by reducing a government's control over monetary flows.
Weaponization of Currency: The US dollar stablecoin, facilitated by the Genius Act, is viewed as a powerful tool for the US to exert influence and control over global monetary architecture. It offers enhanced visibility and control compared to systems like SWIFT.
Comparison to SWIFT and Eurodollars: The US dollar stablecoin system is presented as a potential successor to traditional Eurodollar rails and SWIFT, offering greater transparency and control for the US government. The historical example of LIBOR being replaced by SOFR is cited as a precedent for the US consolidating control over key financial benchmarks.
Saudi Arabia Oil Pricing Example: The possibility of the US convincing major commodity exporters like Saudi Arabia to adopt US dollar stablecoins for transactions is raised, mirroring the historical shift to dollar-denominated oil pricing.

Counterarguments and Global Response

Competition from Other Nations: While acknowledging that other countries (like China and Russia) will likely develop their own stablecoins (e.g., Yuan or Ruble stablecoins) to counter US influence, Johnson argues that they face an uphill battle against the established US dollar network.
Gold-Backed Stablecoins: The idea of gold-backed stablecoins is discussed, but Johnson believes they are less likely to gain widespread adoption for liquidity needs compared to dollar-backed stablecoins. He points out that most people don't want to hold physical gold and that the US holds significant gold reserves, potentially negating any advantage for other nations.
Blockchain Control: The discussion touches on the nature of blockchains. While public blockchains offer transparency, the US government's goal with stablecoins is likely to involve a degree of control, potentially through licensed entities or a government-backed system, rather than a fully decentralized, ownerless blockchain.

"Empire by Code" Paper

Johnson elaborates on his 30-page paper, "Empire by Code," which explores the implications of stablecoins and the Genius Act. The paper argues that these developments represent a significant shift in global monetary architecture, potentially as impactful as the US severing the dollar from gold in 1971. The core thesis is that digital currencies, once seen as tools for rebellion against state control, are now being co-opted by powerful states, particularly the US, to enhance their control over the global monetary system. The paper emphasizes that this is not just about currency but about a new form of global control.

Macroeconomic and Market Outlook

Equities

Eric Townsend believes the market is in the early stages of a secular inflation trend, which is initially positive for stocks. He cautions that the negative impacts of inflation, seen in the 1970s, will emerge later as feedback loops intensify. In the short term, while the market is technically overbought, Townsend anticipates further upside before a significant downturn. Patrick Szna notes that the S&P 500 is making higher highs and lows, but the breadth of the market is weak, with the MAG 7 stocks carrying the index. The performance of these mega-cap stocks post-earnings will be crucial for the short-term market direction. Significant cushions exist in systematic trading triggers, providing room for short-term corrections without triggering larger sell-offs.

US Dollar

Patrick Szna observes that the US Dollar Index (DXY) is firming towards the upper end of its consolidation range, with many predicting a breakout. He suggests that gold's price action, specifically its ability to stay above $4,000, will be a key indicator for the dollar's next move. A sustained breakout above 100 on the DXY could signal significant downside risks for other markets, including equities. The dollar has shown strength against the Yen, Pound Sterling, and Euro, raising the question of a potential counter-trend squeeze.

Oil

Eric Townsend notes that the geopolitical risk premium in oil has subsided, with WTI stabilizing around $60. He acknowledges President Trump's desire for lower oil prices but highlights that escalating geopolitical risks could easily drive prices higher. While a short-term dip is possible, Townsend remains bullish on oil long-term, anticipating a sustained rally after potential volatility. Patrick Szna sees support for crude oil near previous year lows, but the bounce has only reached the 50-day moving average. He is bullish on crude oil for the next year but emphasizes the need to identify the end of the current downtrend and a transition to a bullish phase.

Gold

Eric Townsend believes gold is at a critical juncture around the $4,000 level. While oversold indicators suggest a potential recovery, a dollar breakout could lead to further selling. He downplays the current pullback, noting that a significant retracement is expected after a rapid $1,000 rise. Townsend anticipates a "blow-off top" and sharp reversal in the long-term gold bull market but believes it is not imminent. Patrick Szna reiterates that prior corrections found support near the 50-day moving average (around $3,900). He views the current pullback as a mid-cycle consolidation within a long-term bull market, suggesting tactical opportunities to sell puts for income at attractive buying levels. He highlights elevated implied volatility in gold, making put selling a strategy to generate carry and accumulate exposure at desired prices. The trade of the week involves selling the December gold futures $3,900 put, collecting premium while positioning to buy gold at an effective cost base of $3,846.

Uranium

Eric Townsend points to a US government announcement of significant investment in Westinghouse and potential subsidies for AP-1000 reactor projects as the driver for the surge in uranium and nuclear-related stocks. This signals a strong commitment to nuclear energy, suggesting the uranium and nuclear bull market is in its early stages. He acknowledges the risk of a temporary downturn due to overbought conditions but believes any dips will be buying opportunities. Patrick Szna notes that while uranium stocks have surged, physical uranium is just beginning its ascent, suggesting opportunities in instruments like the Sprott Physical Uranium Trust.

US Treasury Yields

Patrick Szna discusses the impact of the FOMC meeting, where dovish expectations were tempered, leading to a slight increase in the 10-year Treasury yield. The probability of a December rate cut has decreased. The key question is whether this is a temporary fluctuation or a more significant shift in market sentiment. Further data will be needed to confirm the trend.

Conclusion and Takeaways

The discussion highlights the enduring strength of the US dollar, potentially bolstered by the strategic implementation of US dollar stablecoins under the "Genius Act." This development is seen as a sophisticated move to reinforce dollar hegemony and enhance US control over the global financial system, rather than a threat. While other nations may attempt to counter this, the established network effect of the dollar presents a significant advantage. The conversation also touches upon the ongoing trend of central banks favoring gold as a reserve asset, the initial positive impact of secular inflation on equities, and the potential for continued volatility in oil. Gold is viewed as a long-term store of value that benefits from global trust erosion, with current pullbacks seen as healthy consolidations within a broader bull market. The uranium sector is poised for significant growth due to renewed government commitment to nuclear energy. The overarching theme is the evolving global monetary architecture, with digital innovation playing a crucial role in shaping future financial landscapes and geopolitical power dynamics.