What does the debt limit showdown mean for Bitcoin?

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US lawmakers are currently locked in a heated, high-stakes, and entirely ridiculous battle over a bizarre quirk of US law known as the debt ceiling. Since 1917, the U.S. appropriations process has separated the actual budget that members of Congress have already approved from the government’s ability to sell bonds to pay it. Treasury Secretary Janey Yellen has said that if new debt is not approved by June 1, the US government could default on its financial obligations, including stopping interest payments on bonds of the Treasury.

This unusual process has become a very attractive tool for a form of theatrical and media politics. With increasing frequency over the past three decades, fiscal conservatives have used the vote to raise the debt ceiling as an opportunity to campaign for lower spending. It makes for good television, with a looming deadline and frenetic deals, but none of the political risks of negotiating over specific items of the US budget.

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For all its ultimate vacuity, the lowering of the debt ceiling has real consequences in the traditional financial sector, including increasing the cost of borrowing for everyone. In the longer term, the repeated debt ceiling impasses have more systemic impacts on the position of the United States as a pillar of global finance.

Both of these impacts have implications for bitcoin.

The most serious people regard the so-called showdown over the debt ceiling as pure political theater. First, because lawmakers who allegedly take a bold stance against the spending have already voted in favor of the spending. And second, because the consequences of a default on the US national debt would be so incomprehensibly catastrophic that economists and others can hardly conceive that a legislator would actually act on the threat.

This theory is less reassuring when you realize that some of the loudest voices in the debt ceiling confrontation come from the House Freedom Caucus, a coterie of far-right populists who seem to think that debt default American would be incredibly based. That reality is leading Democrats to try to cut deals with the tightest Republican factions, including House Speaker Kevin McCarthy (R-CA.), a politically fragile leader who needs protection from his own right wing.

It is still very unlikely that the United States will default on the national debt. But if it does, the price of bitcoin will be far down the list of concerns for almost everyone. Janet Yellen played it down when she described the consequences as severe hardship for American families. A US default would trigger the domestic economic equivalent of a nuclear carpet bombing.

And just like with a barrage of nuclear bombs, the damage would be done in two stages. The initial impact would include the disruption of all sorts of government payments, potentially anything from social security checks to big military contracts. This would cause an immediate and sharp drop in traditional measures like GDP [gross domestic product] and the stock market. Given recent evidence of a strong correlation between bitcoin and tech stocks, this would almost certainly lower the short-term price of bitcoin as well.

A defect is, again, a remote possibility. But its potential impact is so huge that even this small chance is already being reflected in the markets. Yields on 10- and 30-year US Treasury bonds are already rising, reflecting an increased risk of holding them. Both the Dow Jones Industrial Average and bitcoin have fallen over the past two weeks, although other market uncertainties make it difficult to directly connect these moves to the debt showdown.

But the second stage of the default-triggered economic apocalypse would be more complex and persistent and just as deadly as the invisible radiation that lingers after a mushroom cloud recedes.

A US debt default would radically reshape the global financial system, in ways that could potentially increase bitcoin’s role as global financial infrastructure. This is another example of bitcoins’ role as a theoretical hedge against a doomsday scenario: something that’s good for bitcoin precisely because it’s very bad for human society.

A US default would, above all, decimate the international appetite for holding US debt. This would increase the cost of servicing existing debt, likely forcing the United States into a brutal austerity regime. This would significantly slow down the entire global economy, another downward pressure on bitcoin.

But at the same time, US default would accelerate international efforts to decouple the US dollar as an instrument of trade and investment. The biggest appeal of the dollar is its strength and stability, and a default would obviously damage that faith. Saudi Arabia, Russia and China have all made major moves recently to pull key oil trade off the dollar, but a default could bring those efforts closer to rhetoric than reality.

This anxiety would most likely create at least additional marginal demand for bitcoin as an instrument of international commerce.

But as the cartoon bunny says, that’s not all, folks.

When I and others scoff at the debt ceiling stalemate as pure theater, it’s not because we disagree with the nominal goal of cutting government spending. On the contrary, the criticism is that a semi-annual stalemate on the debt ceiling is a very bad way to pursue fiscal responsibility.

This is unacceptable precisely because debts and deficits are extremely serious problems, not only in the United States, but throughout the world. In the United States, 7% of federal spending is devoted to servicing the debt. These taxpayer dollars no longer do anything to strengthen the economy or improve the lives of its citizens. And every time we run an annual budget deficit, that spending on debt service increases.

Were clearly on an unsustainable path. But so does everyone. The global national debt level now stands at 102% of GDP, an all-time high that is just above the debt-to-GDP ratio of around 100% that is considered sustainable for an individual country. This has led to growing concern over what some have called a Great Reset, a cascading series of interlocking national defaults that are wiping out debt holders at scale.

Because national debt represents such a large share of global balance sheet assets, the impacts would be catastrophic, and instability in the US debt market is just as likely to set off the cascade as anything else.

This scenario is part of the much larger case of bitcoin’s ascendancy as a global reserve and trading instrument (leaving aside, for the moment, very real technical limitations). In an environment of rising defaults, bitcoin’s neutral currency layer could very well be an important safety net simply because it’s unfettered by national debt risk. The US debt limit showdown, in all its childish ridiculousness, highlights just how serious and unpredictable this risk is.

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