What the ‘dollar milkshake theory’ means for crypto

This article is part of Crypto Insights, a segment by major crypto exchange Bybit that dives into the latest and most pertinent issues in the crypto space.

Written by Nathan Thompson

A few weeks ago, my wife and I were driving around town in Laos, staring with dismay at the number of shuttered fuel stations. As we made our way back home, the fuel light on our car’s dashboard started flashing.

Amid fuel shortages and out-of-control currency exchange rates, our local supermarket has not restocked Mexican refried beans for weeks. As we fret about the future, many people are looking toward macroeconomic clues to orient themselves in this singular situation we find ourselves in – as have I.

Photo credit: 123rf

I came across the “dollar milkshake” theory, which admirably describes our current predicament. So I have used it to gain some insights into the crypto market.

The theory, coined by Brent Johnson, CEO of Santiago Capital, envisions a scenario where the US dollar sucks up liquidity from other currencies and countries worldwide.

The dollar is now much stronger against most currencies. One of the ways to measure this is the DXY index, which measures the price of the US dollar against a basket of other currencies, weighted heavily toward the euro.

That’s partly because the Federal Reserve has raised interest rates and ceased buying US treasury bonds, which are debt obligations issued by the US government. This has caused yields on US bonds to go up, which means the value of the US dollar increases as more investors buy these bonds.

Meanwhile, central banks of other countries – especially Europe and Japan – continue to buy government bonds – this keeps their yields low, and their currencies suffer inflation and weaken against the dollar.

This situation is worsened by investors “flying to safety” by selling both currencies in favor of the “safer” US dollar as well as US dollar-based assets. They also dump European and Japanese government bonds in favor of higher-yielding US bonds.

“If you’re still getting a negative yield on a two-year bond in Japan and barely getting positive yield on two-year German Bunds, then it stands to reason that you would sell those investments and buy US two-year treasuries to get over 3% return,” former hedge fund manager James Lavish said in a recent newsletter.

US Dollar index (DXY) / Photo credit: Shutterstock / Sodel Vladyslav