BitMEX Founder: Russian Sanctions Show US Dollar Reserves Are Not Safe, Gold and Bitcoin Will Change the Monetary System

The Ukraine-Russia war has been ongoing for over three weeks, with various countries imposing economic sanctions on Russia. However, as the world's largest exporter of raw materials, many countries rely on Russia for natural gas supply, and sanctions against it are bound to result in a lose-lose situation. On the 17th, BitMEX co-founder Arthur Hayes also shared his views on the sanctions issue. Let's take a look at what "Energy Cancelled" discussed.

In addition, we have also provided counterpoints to help balance the perspective.

This article summarizes the key points, and for any doubts, please refer to the original article.

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Introduction

Arthur Hayes believes that removing the world's largest energy-producing country from the financial system will have severe and unexpected consequences as it involves losses for commodity producers and traders across all aspects of the global financial system.

Furthermore, the current PetroDollar and EuroDollar currency systems are reaching their limits, and Arthur Hayes believes that a new neutral reserve asset will likely be gold, which will be used to facilitate global energy and food trade. He argues that gold is preferred by central banks and sovereign nations over Bitcoin. However, as gold succeeds, Bitcoin will also benefit in the future.

"From the gold-reserve-based Bretton Woods I, to the Bretton Woods II supported by domestic funds and government debt, to the Bretton Woods III supported by external funds such as gold and commodities, the 'money' will no longer be the same after this war. Bitcoin (if it still exists) may benefit from all of this," as quoted from a report titled "Bretton Woods III" by Zoltan Pozsar, a currency market expert at Credit Suisse, on March 7. Arthur Hayes agrees with this view.

Note: Inside Money is a currency tool considered a liability on another participant's balance sheet, government bonds are a liability of sovereign nations but an asset in the banking system, traded similarly to cash, depending on the issuer's credit level. Outside Money is a tool not considered a liability on another participant's balance sheet. Gold and Bitcoin are perfect examples of this.

Balance of Trade Between Countries

Arthur Hayes then discusses the trade relationships between countries, where some import more than they export, while others export more than they import, resulting in a balanced trade relationship. To reduce friction costs in trade among countries, the US dollar serves as the reserve currency, with most commodities priced and traded in dollars, leading to a high demand for the US dollar.

One of the costs of the US dollar being the global reserve currency is that it allows countries to invest in each other's capital markets freely, bearing the cost of currency issuance. However, since 1971, the US dollar is no longer backed by gold but by US government debt. With the assumption that foreign reserve holders will buy US debt in large quantities, the cost of printing dollars has significantly decreased for the US, allowing them to print as much as they want, leading to an extremely financialized economy.

The US transformed from a post-WWII factory to a service-oriented economy, gradually weakening its manufacturing sector. Since 1971, the share of manufacturing in the nominal GDP has more than halved. Ultimately, the US exports financial services to the world, not products.

The open access to global commodities, fierce domestic market competition, reduced competitiveness and relocation of industries have contributed to large annual trade deficits, a consequence of being the issuer of the global reserve currency and the largest economy.

Physical Currency vs. Digital Currency

Before the advent of computers and the internet, all forms of currency were physically exchanged. This method was resistant to scrutiny and ensured anonymity, but the process was lengthy and not conducive to a globalized economy. With the introduction of computers and the internet, digital forms of common accounting units, paper money, and digital gold emerged, facilitating value transfer through centrally authorized digital networks like SWIFT.

Since then, international "money" is no longer a tangible asset but a series of digital data. Whether it's legal tender or related fiat derivatives like government bonds, stocks, etc., they all exist as digital data.

Arthur Hayes argues that in this scenario, a country that reserves global reserve currency or related assets does not truly own its assets; the reserves are actually controlled by the country operating the network. As long as savers believe that the country operating the network will respect their property rights, international trade can occur without friction.

Arthur Hayes poses a question after his explanation: "Should assets be reserved in this centralized and permissioned digital currency network?" Under this operating model, these countries appear to be more like "renting" their assets.

$12 Trillion in Foreign Exchange Reserves

Excluding gold, approximately $12 trillion of reserves are stored in a few fiat currencies, with the US dollar accounting for a significant share, around 65%-70%.

As explained earlier by Arthur Hayes, these assets depend on multiple centralized and permissioned digital networks. If reserved in US dollars, the US controls the network; if in euros, the EU controls it; if in yuan, China controls it.

Currently, most countries hold reserves in Western currencies. However, with China's increasing importance in the global economic system, more trade is conducted in yuan, leading many central banks in developing countries to hold some yuan reserves, making it the only fiat currency widely held by central banks in developing countries.

Following Russia's aggression against Ukraine, the West decided to confiscate various G10 currencies held by Russia, resulting in a loss of approximately $300 billion in foreign exchange reserves. Additionally, Russia was removed from the SWIFT system, leading many multinational companies to impose sanctions on Russia.

Note: G10 currencies refer to the 10 most popular trading currencies in the forex market, known for their stability, including the pound sterling, Australian dollar, Canadian dollar, euro, Japanese yen, New Zealand dollar, Norwegian krone, Swedish krona, Swiss franc, and US dollar.

Arthur Hayes states that when even the reserves of Russia, one of the world's largest energy exporters and food producers, can be unilaterally confiscated by operators of a digital fiat currency network, no central bank of any country should use Western currencies as their foreign exchange reserves.

Rising Power of China

Arthur Hayes then shifts his focus to China, which, as the low-cost factory for countries worldwide, has accumulated a substantial amount of foreign exchange reserves since joining the WTO in 2001. With Russia as a cautionary example, China's reserves are no longer considered safe.

However, it is unlikely that such large reserves, including a significant amount of US debt, can be liquidated directly in the market. Arthur Hayes believes that the best way for countries with substantial reserves is to invest the principal in gold and other storable commodities like wheat, grains, and industrial commodities like oil, copper, and nickel after US debt matures.

As a result, as gold and commodities flow from the West to the East, the currencies of countries with trade deficits, especially Western nations, will become weaker. The value of gold and the yuan will gradually rise as a result.

Reduced Demand for US Debt

Prior to the confiscation of Russian assets, trade surplus countries believed their reserves were safe and inviolable, and the US did not need to worry about its large trade deficits as these countries had a significant demand for US debt. However, if these trade surplus countries indeed convert their reserves into gold and other commodities, the US will need to raise interest rates on US debt to boost demand, which could lead to some private companies being unable to bear the burden, resulting in an economic recession.

However, even if these events lead to a nominal increase in US interest rates, structurally, the US aims to deleverage its balance sheet and pay for the cost since WWII, resulting in actual interest rates remaining negative in the long term.

Gold vs. Bitcoin

In the final section of the article, Arthur Hayes discusses the differences between gold and Bitcoin as reserve assets. As the core of the entire article, external funds like gold or Bitcoin provide financial security, where there should be no way to prevent you from using the funds. However, internal funds like US debt, after Russia's sanctions, rapidly lost value.

Given the current international acceptance levels, gold remains the best choice as an external reserve asset. However, due to the challenges in transporting gold, central banks may be willing to use cryptocurrencies for small but increasing transactions, making Bitcoin the ideal choice for such currencies.

Arthur Hayes believes that in the future, a single Bitcoin could be worth millions of dollars, while an ounce of gold could be worth thousands of dollars. The reason for this situation is not the continuous rise in the value of these assets but the ongoing decline in the value of the fiat currencies used to price them.

"This is the beginning of a currency system revolution, nothing can remain unchanged forever. The dominance of the PetroDollar/EuroDollar has ended, and this transitional change will be quite chaotic and tumultuous, leading to massive inflation from the perspective of fiat currencies," Arthur Hayes said.

Debatable Aspects of Arthur Hayes' Argument

Independent Taiwanese writer James Chiu argues that Arthur Hayes' logic is not entirely correct, especially concerning the Ukraine-Russia conflict and foreign exchange reserves.

Foreign Exchange Reserves Represent a System

James Chiu states that foreign exchange reserves are not simply about what a country or company wants to buy; of course, they can choose not to select US bonds and the US dollar. However, if they choose gold, which has poor liquidity, high volatility, and no interest payments, and is incapable of becoming a settlement currency under the US dollar system, they must first sell gold, exchange it for currency, and then use it as a settlement tool. In the current US dollar system, gold cannot be a settlement currency without being sold at a discount.

"Therefore, when discussing what foreign exchange reserves should buy, the larger issue behind it is who can be the next settlement currency," he believes that Arthur Hayes overlooks the self-reinforcing process of the US dollar system and lacks the reasons why other countries are willing to hold reserves in US dollars.

Realities of Gold and Bitcoin Reserves

James Chiu points out that Arthur Hayes fails to consider the settlement issue when selling gold reserves. Goldman Sachs estimates a discount of 1.5% per 100 tons sold, with a 35% discount on total sales. This is a scenario the market can handle. Perhaps discussing an increase in the proportion of gold in foreign exchange reserves is still somewhat reasonable.

He explains that based on the difficulty of transporting gold, Russia may choose Bitcoin as an alternative, which is more speculative. He indicates that foreign exchange assets serve as a buffer for countries to protect their domestic markets, seeking the most stable and liquid assets. With Russia holding 2,300 metric tons of gold valued at $150 billion, a 35% discount would be applied, but how long can $150 billion sustain? For example, purchasing rubles to maintain the exchange rate could last weeks to several months.

"How much discount would Bitcoin need to be sold?" James Chiu questions. While gold is still widely accepted by most countries, how much time is needed for most countries to accept Bitcoin? Moreover, sanctions are a double-edged sword for the US as Russia is barred from how many dollars, leading to the withdrawal of liquidity from the market, and the US must also pay a price.

James Chiu concludes that when discussing foreign exchange reserves, it is actually a discussion about the US dollar system and global financial transaction methods. If the conclusion is directed solely towards "Bitcoin can become foreign exchange reserves," it may not be a very objective statement.