What can we learn from the changes in the U.S. dollar market in the past three years?

Original author: Ben Lilly

Original compilation: Deep Chao TechFlow

If theres one fundamental question that affects how we design indicators, its this:

What is money?

In particular, what makes people use, consume or hold it. This is a thought exercise to help us better grasp the dynamics of regular government-issued currencies and cryptocurrency tokens.

Some may argue that these principles do not apply to the latter. But we prefer to think of cryptocurrency tokens as native digital currencies. This means that many of the definitions and mental models of traditional money can be applied to our field.

Rather than taking the time to provide you with a high-level overview of what weve mentioned, lets get right to the point.

Inflation is not just a supply issue

Currency has many uses.

We can light it to keep warm, use it to make origami, buy candy, store wealth, store it as collateral, or use it to buy securities.

Each use is unique. And the popularity of each use conveys the value of the currency to the market.

If in a part of the world money is used primarily as fuel for fire, its value is likely to be similar to that of its constituent materials. At the same time, if another part of the world is using their money for a gain... then there could be a big difference in value between the two.

This view of currency may seem strange. After all, we are talking about currency. We mainly use it to buy stuff...right?

But the data tells us different things...and those things change over time.

To help explain what we mean here, let’s try to recall our mental state on March 16, 2020 – the time of the coronavirus.

The Dow Jones Industrial Average fell 12.9% that day.

The overall economy is in a similar situation. Businesses closed, employees were sent home, and uncertainty was at its peak. It was a time when having a dollar in your hand meant more than anything else.

In fact, the U.S. savings rate soared from 7.2% at the beginning of the year to 32% in April... which is double the Feds peak savings rate.

Going into the summer of 2020, the primary use of the U.S. dollar was for holdings.

In the crypto world, we think of this as the hodl indicator.

At the time, holding money to this extent was a huge behavioral change. The impact is now evident.

Fewer dollars circulating in the economy and being used to purchase goods and services means inflation is negligible.

At the beginning of 2020, inflation was 2.5%...by April, when behavior switched from normal to hold, inflation dropped to 0.3%, and even to 0.1% in May.

This change in currency usage directly affects inflation.

At the same time, the money supply, measured in M ​​2 , increased from $15.4 trillion in early March to over $17 trillion in just a few weeks. When it comes to such a large increase in the money supply, we tend to think that inflation will immediately follow. But it didnt.

If anything, this newly minted money is more of a trigger for inflation. But it requires a match.

This match is a shift in the way the dollar is used.

In the world of economics, we express this change in mentality through a mental model called the quantity theory of money, or QTM for short. This view was popularized by economists Anna Schwartz and Milton Friedman in their book A Monetary History of the United States, 1867-1960.

The title may sound like a textbook, but the concept isnt difficult to understand. In simple terms, it basically means that the amount of money in the economy multiplied by the frequency with which the money is used (e.g. velocity, as opposed to the savings rate) affects the value of money.

More money but little spending means no inflation.

More currency, but more cost...well, heres the match we mentioned lit

What we call a trigger situation. This leads us to the next state of mind.

Summer Bash 2021

They ended in the summer of 2021, a year after the COVID lockdowns of 2020 were implemented. Economies around the world are beginning to reopen. There are concerts planned...parades...its a school is out for the summer feeling.

The notion that we no longer need to hoard money out of fear of losing our jobs or the need to live has disappeared. There has been a shift in mentality around currency.

Before, people were like in the arms race during the Cold War. Then all of a sudden, it seemed like everyone figured out there was no need to worry about nuclear weapons.

This shift in mentality caused the savings rate to fall from 26.1% to less than 10% in two months. Here are the savings rates based on May 2021, the start of the 2021 summer carnival...

Dollars are not for holding, but for spending. In other words, the U.S. dollar is used more as a method of payment than as a store of wealth.

More money, more expenses…

Inflation has arrived.

This is inflation on the chart. I guess you can tell which period is highlighted by the red arrow - Summer 2021.

Inflation started 2021 at 1.4%...and by May, it had reached 5%.

Its like the U.S. dollar is a hot potato. No one wants to hold it.

Thinking back to that time, you may remember buying something you really didn’t need. This could be a bigger TV, a computer monitor, some kind of luxury home office chair, or even some renovation work on your house. The rave is real.

No matter what you regret buying during your childlike shopping spree...

Do you wish you had kept that money in your pocket? I mean…

Now that dollar gives you a 5% return. Imagine if you had converted your wealth into USD at the beginning of 2022, and now you would have received a 5% return. I guess youll be a little more satisfied with yourself.

Which brings us to the recent change in mindset regarding usage...

The dollar became a Hodl asset

If we look back at the previous inflation rate chart, we can see that inflation peaked in June 2022 at 9.1%.

It is almost impossible to imagine how the economy allowed inflation to grow from 0.1% to over 9% in one year. The primary form in which money is used matters. And youll see it again with our next usage change.

Below is the savings rate chart above, focusing more on the post-COVID period. We can see that the chart reaches its lowest point in June 2022 - the same month that inflation peaked.

However, the supply of dollars has barely changed...its not a sudden reduction in supply that causes inflation to reverse. So what exactly is going on here?

It was the Fed that changed market behavior.

In the first half of 2022, the central bank raised borrowing rates three times, including a slight increase in March. Then in May and June, we saw borrowing rates go from about 0.25% to 1.5%. This is a huge change.

This major move resulted in actual cash flow by sending U.S. dollars to the U.S. government for borrowing purposes (i.e., purchasing Treasury bonds). Lending those dollars shortly before 2022 could earn you 0.25%. That means for every $100,000 you lend, you get $250.

But by June of that year, the same $100,000 was earning more than $3,100. Thats a 1,140% cash flow increase compared to six months ago. this is very important.

So the markets preferences on how to use the U.S. dollar have changed. The dollar is more about getting significant cash flows than spending them on goods and services. Of course, the increased strength of the dollar helps, but regardless, this is the primary use of the dollar today.

People want to earn returns on assets with stable prices — take note, token economists. We’ve even seen several projects bring this revenue exposure to public blockchains. Thats why its become so popular.

So we have roughly the same supply of dollars, but now they cost less... As I write this in October 2023, inflation has been below 4% for four months. If anything, more people want to hold dollars now than ever before.

We can see this based on rising demand in the Treasury market. In the chart below, each colored line represents a Treasury maturity. The height of the line is the bid amount for each term in each month. The shaded area of ​​each bar is the number of bids awarded by the U.S. Treasury.

I mentioned earlier that inflation has been below 4% for the past four months. The volume of bids for funds at Treasury auctions has been increasing over the past six to eight months.

Below are auctions of US Treasury bonds with maturities of 52 weeks or less.

Below are auctions of Treasury bonds with maturities longer than 52 weeks.

These two charts illustrate the increasing demand for cash flow using U.S. dollars. This is essentially the ultimate form of hodling.

In the summer of 2020, people held money out of fear. By 2023, the dollar holder group is holding to generate cash flow. This is a more productive use of money.

This is why the QTM version of the cryptocurrency I support does not focus on quantity, but on quality. I call this the “Token Quality Theory.”

The story is not over yet

This may seem like a lot of information.

But we can summarize things by looking back at the time frame of March 2020 and thinking about how the use of money has changed in subsequent years.

It evolves from a holding state, to a spending state, to a state where the currency generates income.

In this process, inflation moves from very low to very high and then lower again.

At the same time, the amount of money in circulation has no direct impact on inflation. This means that the money supply does not affect the price of the dollar as much as the use of the dollar does.