Viewpoint: Global liquidity is the key factor driving Bitcoin prices.

Written by: fejau

Compiled by: Luffy, Foresight News

I want to write down some content that I have been repeatedly thinking about, which is how Bitcoin might perform during a significant shift in capital flow patterns that has never been seen since its inception. I believe that once the deleveraging process is over, Bitcoin will face an excellent trading opportunity. In this article, I will elaborate on my thoughts in detail.

What are the key drivers of Bitcoin prices?

I will draw on the research findings of Michael Howell regarding the historical drivers of Bitcoin price trends, and then utilize these findings to further understand how the interwoven factors may evolve in the near future.

As shown in the picture above, the price of Bitcoin is driven by these factors:

• Investors' overall preference for high-risk, high beta assets
• The correlation between Bitcoin and gold
• Global Liquidity

Since 2021, I understand that a simple framework of risk appetite, gold performance, and global liquidity is to use the proportion of fiscal deficit to Gross Domestic Product (GDP) as a quick observation indicator to gain insight into the dominant fiscal stimulus factors in the global market since 2021.

Mechanically speaking, the higher the proportion of fiscal deficit to GDP, the more it will exacerbate inflation and increase nominal GDP. Therefore, for enterprises, since revenue is a nominal indicator, their revenue will also increase accordingly. For those companies that can benefit from economies of scale, this is a positive factor for their profit growth.

To a large extent, monetary policy has always been secondary to fiscal stimulus, which is the main driver of risk asset activity. As shown in this chart frequently updated by George Robertson, U.S. monetary stimulus has been very weak compared to fiscal stimulus; therefore, I will not consider monetary stimulus factors in this discussion.

From the chart of major developed economies in the West below, we can see that the fiscal deficit of the United States accounts for a much higher proportion of GDP than that of other countries.

Due to the enormous fiscal deficit in the United States, revenue growth dominates, which makes the U.S. stock market perform better compared to other economies:

The US stock market has always been a major marginal driver of the growth of risk assets, the wealth effect, and global liquidity, thus becoming a gathering place for global capital, as capital is treated best in the US. This dynamic of capital inflows into the US, coupled with a huge trade deficit, has led the US to exchange goods for foreign-held US dollars, which foreigners then reinvest in dollar-denominated assets (such as US Treasury bonds and the "Seven Giants" tech stocks), making the US the main driving force for all risk appetites globally:

Now, returning to the research of Michael Howell mentioned earlier. Over the past decade, risk appetite and global liquidity have been primarily driven by the United States, and since the COVID-19 pandemic, this trend has accelerated due to the extremely large fiscal deficit of the U.S. compared to other countries.

This is precisely why, although Bitcoin is a globally liquid asset (not just related to the United States), it exhibits a positive correlation with the U.S. stock market, and this correlation has been strengthening since 2021:

Now, I believe that the correlation between Bitcoin and the US stock market is false. When I use the term "false correlation," I mean it in a statistical sense, that is to say, I believe that a third causal variable that is not shown in the correlation analysis is the real driving factor. I think this factor is global liquidity, which, as we mentioned earlier, has been dominated by the US for nearly a decade.

When we delve into statistical significance, we must also determine causal relationships, not just positive correlations. Fortunately, Michael Howell has also done some excellent work in this regard, as he identified the causal relationship between global liquidity and Bitcoin through the Granger Causality test:

What conclusions can we draw from this as a benchmark for our further analysis?

The price of Bitcoin is mainly driven by global liquidity, and since the United States has been the dominant factor in global liquidity growth, a false correlation has emerged between Bitcoin and the U.S. stock market.

In the past month, as we have all been speculating about Trump's trade policy objectives and the restructuring of global capital and commodity flows, several major viewpoints have emerged. I summarize them as follows:

• The Trump administration aims to reduce the trade deficit with other countries, which conceptually means that the flow of dollars to foreign countries will decrease, and these dollars would have been reinvested in U.S. assets. To avoid this situation, the trade deficit cannot shrink.
• The Trump administration believes that foreign currencies are artificially suppressed, and the dollar is artificially overvalued, and hopes to rebalance this situation. In short, a weaker dollar and stronger currencies of other countries will lead to higher interest rates in those countries, thus encouraging capital to flow back to the home country to obtain these interest rate returns, as these returns will be better from the perspective of foreign exchange adjustments, while also promoting the development of the domestic stock market.
• Trump's approach of "shoot first, ask questions later" in trade negotiations is encouraging other countries to break free from their relatively thin fiscal deficit situations compared to the United States, and to invest in defense, infrastructure, and overall protectionist government investments to make themselves more self-sustaining. Regardless of whether tariff negotiations ease (such as those with China), I believe that "the genie is out of the bottle," and countries will continue this effort without easily turning back.
• Trump hopes that other countries will increase the proportion of defense spending to GDP, as the United States has borne a large amount of costs in this regard. This will also increase the fiscal deficit.

I will set aside my personal views on these points for now, as many people have already expressed their opinions on this. I will briefly focus on the potential impacts that could arise if these points were to develop according to their logic:

• Funds will leave dollar-denominated assets and flow back to the home country. This means that the performance of the U.S. stock market will lag behind other regions of the world, bond yields will rise, and the dollar will depreciate.
• The countries to which these funds flow back will no longer be limited by fiscal deficits, and other economies will begin to spend heavily and print money to fill the ever-increasing fiscal deficits.
• As the United States continues to shift from a global capital partner to a protectionist role, holders of dollar-denominated assets will have to raise the risk premium associated with these previously considered high-quality assets and must set a wider margin of safety for these assets. When this occurs, it will lead to rising bond yields, and foreign central banks will be interested in diversifying their balance sheets, no longer solely relying on U.S. Treasuries but instead turning to other neutral assets such as gold. Similarly, foreign sovereign wealth funds and pension funds may also make such diversification adjustments to their portfolios.
• In contrast to these views, the perspective is that the United States is the center of innovation and technology-driven growth, and no other country can replace this position. The bureaucracy and socialist nature of Europe are too strong to allow for the development of capitalism like in the United States. I understand this viewpoint, and it may imply that this will not be a long-term trend, but rather a more likely mid-term trend.

Returning to the title of this article, the first round of trading involves selling off the globally over-allocated dollar assets and avoiding the ongoing deleveraging process. Due to the severe over-allocation of these assets globally, when large fund managers and more speculative participants like multi-strategy hedge funds reach their risk limits, the deleveraging process can become chaotic. When this happens, days similar to margin call notifications will emerge, and a large amount of assets will need to be sold to raise cash. The key at this moment is to survive this process and maintain sufficient cash reserves.

However, as the process of deleveraging stabilizes, the next round of trading begins. Diversify the portfolio to include foreign stocks, foreign bonds, gold, commodities, and even Bitcoin.

In the days of market rotation and without additional margin calls, we have begun to see this dynamic gradually take shape. The US Dollar Index (DXY) has fallen, US stocks have underperformed compared to stocks in other regions of the world, gold prices have surged, while Bitcoin has shown remarkable resilience compared to traditional US tech stocks.

I believe that with the occurrence of this situation, the marginal growth of global liquidity will turn into a completely opposite state compared to what we are accustomed to in the past. Other regions of the world will take up the banner of increasing global liquidity and risk appetite.

When I think about the risks of diversifying investments in the context of the global trade war, I worry that deeply investing in risk assets in other countries may bring tail risks, as negative headlines regarding tariffs may emerge, affecting these assets. Therefore, in this process of transition, gold and Bitcoin have become my top choices for global diversified investments.

Gold is currently performing exceptionally strong, setting new historical highs every day. However, despite Bitcoin showing remarkable resilience throughout the shift in dynamics, its beta correlation with risk appetite has so far limited its gains, failing to keep pace with gold's outstanding performance.

So, as we move towards a global capital rebalancing, I believe the next trading opportunity after this round of transactions lies in Bitcoin.

When I compared this framework with Howell's correlation study, I found that they are mutually compatible:

• The US stock market will not be affected by global liquidity, but only by liquidity measured by fiscal stimulus and some capital inflows. However, Bitcoin is a global asset that reflects the broad status of global liquidity.
• As this view gradually gains acceptance and risk allocators continue to rebalance, I believe that risk appetite will be driven by other parts of the world rather than the United States.
• The performance of gold couldn't be better, and there is some correlation between Bitcoin and gold, which aligns with our expectations.

Considering all the above factors, I have seen for the first time the possibility of Bitcoin decoupling from US tech stocks. I know this is a high-risk thought and often marks a local peak in Bitcoin prices. However, what is different this time is that the flow of funds may undergo significant and lasting changes.

So, for a macro trader like me who pursues risk, Bitcoin feels like the most worthwhile trade to participate in after this round of trading. You cannot impose tariffs on Bitcoin; it does not care which country's borders it is within. It offers high beta returns for the portfolio and has no tail risks associated with U.S. tech stocks. I do not need to judge whether the EU can solve its own problems, and it provides exposure to global liquidity, not just U.S. liquidity.

This market pattern is precisely an opportunity for Bitcoin. Once the dust of deleveraging settles, it will be the first to take off and accelerate forward.