Bitcoin after deleveraging, the next winner of global capital flows

Original author: Fejau

Original compilation: Deep Tide TechFlow

I'd like to write about a question I've been thinking about for a long time: how Bitcoin might behave in the event of a major shift in capital flows, a situation that Bitcoin has never experienced since its inception.

I think there will be an incredible trading opportunity for Bitcoin once the deleveraging is over. In this article, I will elaborate on my reflections.

What are the historical key drivers of Bitcoin price?

I will take Michael Howell's research on the historical drivers of Bitcoin's price and use it to further understand how these crossovers are likely to evolve in the near future.

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As shown in the chart above, Bitcoin's drivers include:

• Investors' overall appetite for high-risk, high-β assets
• Correlation with gold
• Global Mobility

Since 2021, I have used a simple framework to understand risk appetite, gold performance, and global liquidity, which is to focus on fiscal deficits as a percentage of GDP, as an easy way to understand the fiscal stimulus that has dominated global markets since 2021.

A higher fiscal deficit as a percentage of GDP mechanically leads to higher inflation, higher nominal GDP, and therefore higher total income for businesses, because income is a nominal indicator. For companies that are able to enjoy economies of scale, this is a boon for their profitable growth.

For the most part, monetary policy plays a secondary role in risk asset activity, while fiscal stimulus has been the main driver. As @BickerinBrattle regularly updated chart shows, monetary stimulus in the U.S. is so weak relative to fiscal stimulus that I'm setting it aside for this discussion.

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As the chart below shows, among the major advanced Western economies, the U.S. fiscal deficit as a percentage of GDP is much higher than that of any other country.

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With the U.S. running such a large deficit, income growth has been dominant, and has led to the U.S. stock market outperforming other modern economies:

! Bitcoin after deleveraging, the next winner of global capital flows

As a result of this dynamic, the U.S. stock market has become a major marginal driver of the growth of risky assets, the wealth effect, global liquidity, and therefore an attraction for global capital: the United States. As a result of this dynamic of capital inflows into the U.S., coupled with a large trade deficit that led the U.S. to trade commodities for foreign-acquired dollars, which were then reinvested in dollar-denominated assets such as Treasuries and MAG 7, the U.S. became a major driver of global risk appetite.

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Now, back to the research of Michael Howell above. Risk appetite and global liquidity have been largely driven by the U.S. over the past decade, a trend that has accelerated since the pandemic when the U.S. runs such large fiscal deficits compared to other countries.

As a result, Bitcoin, despite being a global liquid asset (not just in the US), has been positively correlated with the US stock market since 2021.

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Now, I think the correlation with the U.S. stock market is fake. When I use the term "spurious correlation" here, I'm statistically thinking that the third dependent variable that doesn't show up in the correlation analysis is the actual driver. I believe that this factor is global mobility, which, as we stated above, has been dominated by the United States for almost a decade.

As we delve deeper into statistical significance, we must also establish causal relationships, not just positive correlations. Luckily, Michael Howell has done some great work in this area as well, establishing a causal relationship between global liquidity and Bitcoin through the Granger causality test.

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So, what kind of benchmark does this give us?

Bitcoin is primarily driven by global liquidity, and since the United States is the main driver of increased global liquidity, a false correlation has emerged.

Over the past month, some of the main narratives have surfaced amid our speculation about Trump's trade policy goals and the restructuring of global capital and commodity flows. I think of it as:

• The Trump administration wants to reduce its trade deficit with other countries, which mechanically means reducing the flow of dollars to foreign countries that will not be reinvested in U.S. assets. A reduction in the trade deficit cannot happen without that.
• The Trump administration believes that foreign currencies are artificially depressed and therefore the dollar is artificially strong and wants to rebalance this. In short, a weaker dollar and stronger foreign currencies will lead to higher interest rates in other countries, prompting capital repatriation to capture these interest rates that perform better under FX-adjusted conditions, as well as domestic equities.
• Trump's "shoot first, ask later" approach to trade negotiations has led the rest of the world to move away from a meagre fiscal deficit compared to the U.S. (as noted above) and instead invest in defense, infrastructure, and generally protectionist government investments to make it more self-sufficient. Regardless of whether tariff negotiations are downgraded (e.g. in China), I believe this is a foregone conclusion, and countries will continue to pursue this goal.
• Trump wants other countries to increase their defense spending as a percentage of GDP and contribute more to NATO spending, as the U.S. bears a significant expense in this regard. This will also increase the fiscal deficit.

I'll put aside my personal views on these points for a moment and focus on the implications they might have if we proceeded with the logical endpoints of these narratives:

• Capital will leave dollar-denominated assets and repatriate to the home country. This means that the U.S. stock market is underperforming relative to the rest of the world, bond yields are rising, and the dollar is weakening.
• This capital will flow back to places where fiscal deficits are no longer constrained, and other modern economies will begin spending and printing money to finance these increased deficits.
• As the U.S. shifts from a global capital partner to a more protectionist role, holders of dollar assets will have to increase the risk premium on these once-perfect assets and mark a broader margin of safety for them. As this process progresses, it will lead to higher bond yields and foreign central banks will seek to diversify their balance sheets away from just US Treasuries and towards other neutral commodities such as gold. Similarly, foreign sovereign wealth funds and pensions are likely to pursue this diversification.
• The flip side of these arguments is that the U.S. is the epicenter of innovation and technology-driven growth, and no country is going to overturn that idea. Europe is too bureaucratic and socialist to pursue capitalism as much as the United States. I am sympathetic to this view, which could mean that this is not a multi-year trend, but a medium-term trend, as the valuations of these tech companies will limit their upside for some time.

Going back to the title of this article, the first trade is to sell the dollar assets that the world holds too much to avoid the ongoing deleveraging. Because the world holds too much of these assets, this deleveraging can become chaotic when risk limits are touched by more speculative players such as large money managers and multi-strategy hedge funds with tight stop-losses. When this happens, we see similar days of margin calls, where all assets need to be sold to raise cash. Now, the strategy of trading is to survive and keep your money abundant.

However, as deleveraging subsides, the next step in trading begins – a shift to a more diversified portfolio: foreign equities, foreign bonds, gold, commodities, and even Bitcoin.

On market rotation days and non-margin call days, we have already begun to see this dynamic forming. The U.S. dollar index (DXY) fell, U.S. equities underperformed elsewhere, gold soared, and bitcoin unexpectedly strengthened relative to traditional U.S. technology stocks.

I believe that as this happens, the marginal increase in global mobility will shift to the exact opposite dynamics to which we are accustomed. Other regions will take on the burden of increasing global liquidity and risk appetite.

As I think about the risks of this diversification in the context of a global trade war, I'm concerned about going too far into the tail risk of risky assets in other countries because there are some landmines in terms of potentially bad tariff news. This, therefore, makes gold and bitcoin options for global diversification in this shift.

Gold has been rising in absolute terms and is now hitting new all-time highs every day, reflecting this institutional shift. However, while Bitcoin has shown unexpectedly strong throughout the regime shift, its beta correlation with risk appetite has so far limited its performance, failing to keep pace with gold's performance.

So, as we move towards a global rebalancing of capital, I believe the trade after that is Bitcoin.

When I contrast this framework with Howell's correlation study, I can see them combined:

• The U.S. stock market cannot be affected by global liquidity, only by liquidity as measured by fiscal stimulus plus some capital inflows (but we have just identified that aspects of this flow may stop or even reverse). However, Bitcoin is a global asset, reflecting this broad perspective of global liquidity.
• As this narrative establishes and risk allocators continue to rebalance, I believe risk appetite will be driven by other regions rather than the US.
• Gold is doing very well, so for the Bitcoin portion related to gold, we can tick here as well.

In light of all this, for the first time in the financial markets, I see the potential for Bitcoin to break away from US tech stocks. I know that this idea often marks the local apex of Bitcoin. The difference is that this time we see the potential for significant changes in capital flows, which will make them durable.

So, for a risk-averse macro trader like me, Bitcoin feels like the purest trading here. You can't impose tariffs on Bitcoin, it doesn't care which border it's in, it provides a high beta to the portfolio without the current tail risk associated with US technology, and I don't have to say a word about whether the EU can put its affairs in order and provide pure exposure to global liquidity, not just US liquidity.

This market system is the reason why Bitcoin was born. Once the dust settles on deleveraging, it will be the fastest horse, accelerating.