How the Fed failed

For the cryptocurrency market, this has not been a good week, the worst is on Tuesday and Wednesday. First, a report by the US Securities and Exchange Commission showed that the United States may not be so keen on Bitcoin ETFs.

Subsequently, the consumer price index CPI in April was unexpectedly high, which raised concerns that the Fed, which is worried about inflation, may shut down the money printing machine that has supported stock markets, bonds, and cryptocurrencies in the past year. Finally, the worst thing is that Tesla CEO Elon Musk’s indifference to Bitcoin caused the price of Bitcoin to plummet, falling below $50,000.

  What kind of inflation hedge is Bitcoin?

On Monday, the host of CoinDesk’s “The Breakdown” podcast highlighted many signs of rising prices in the U.S. economy, such as lumber, copper, and truck driver wages, and asked if this is a sign of inflation being formed, even if it is not in the data. Be reflected in. Then, on Wednesday, the April consumer price index was announced: an increase of 4.2% year-on-year, the fastest inflation in 13 years.

This naturally makes the global market feel uneasy, because investors inferred that the Fed will need to lift its loose monetary policy stance sooner than expected. Various sell-offs began to appear, including Bitcoin, especially after Elon Musk tweeted on Wednesday night that Tesla would no longer accept cryptocurrencies as a payment method for car purchases, and Bitcoin saw a sharper decline.

Such moments often confuse people inside and outside the cryptocurrency field. Isn’t Bitcoin used to hedge against inflation?

My answer to this is no. It is more appropriate to say that when governments are faced with an unbearable financial burden, they have no choice but to monetize the ever-expanding debt burden and regard Bitcoin as a hedging method to prevent fiat currencies from becoming more distant. A large-scale depreciation in the future. Of course, this will also lead to inflation, because depreciated currencies will translate into higher prices, which is likely to be hyperinflation. But this is different from the short-term, epidemic-driven supply and demand factors currently reflected in the CPI. In other words, if you believe that Bitcoin will become a kind of “Crypto gold” to hedge against a more unstablecoin state, you can argue that the Bitcoin era has not yet arrived.

However, in this case, this week’s CPI data is still very important. While the global economy is far from healthy, the recovery of consumer price inflation may accelerate the long-term liquidation of debt. This is a concern around the world, but Bitcoin is generally bullish.

  Vicious circle

Let’s play a game, shall we?

First, consider the problems that currently plague the market. Investors worry that higher inflation will threaten the Fed’s dual task of achieving full employment and stabilizing prices. Any signs of failure in the latter area may prompt the Fed to reduce its aggressive quantitative easing asset purchase policy, which has promoted the long-term rise in the stock and bond markets in the past year. On the surface, this is a legitimate concern. The Fed’s current long-term inflation target is 2%. Although it has indicated that it is willing to allow inflation to exceed this threshold during and after the epidemic, it cannot let the number go too high without taking action. Failure to take action may undermine its legitimacy, which is what its power and effectiveness depend on.

But consider now that if the Fed starts to tighten monetary policy seriously, the results will be obvious. Naturally, interest rates will rise, possibly very sharply.

Under normal circumstances, this will be welcome, as tight monetary conditions will cool an overheated economy and curb price increases. But now is not a normal period. The global economy under the epidemic is a story of huge economic pain. Many industries are at the opposite of the era of working from home. Unrealized losses are about to appear, and soaring debts, and most importantly, fiscal debts. If interest rates rise too much, they will make these debts unpayable at all.

How much debt is there? According to the latest forecast by the non-partisan Congressional Budget Office, if existing policies and laws remain unchanged, the US federal debt will reach 102% of GDP this year, rise to a record 107% by 2031, and then almost double by 2051. Times, reaching 202% of GDP. The rule of thumb of the International Monetary Fund is that if the ratio of debt to GDP exceeds 80%, the hidden danger of a debt crisis will be planted. There are three sources for this trajectory: debts previously issued to pay for fiscal stimulus after the 2008 financial crisis, new debts needed to pay for the Trump and Biden administration’s response to the epidemic, and to pay for the surge in baby boomers. Unissued debts for medical insurance and social insurance claims.

The bond market is keenly aware of these numbers. Therefore, if interest rates rise too fast, it will go crazy. Even the weakest growth will increase the government’s debt service costs by trillions.

The Fed faces a vicious circle, as do the European Central Bank, the Bank of England, the Bank of Japan, or the People’s Bank of China, all of which face similar or worse debt prospects. They will have no choice but to monetize their debt. 

  Ultimate game

First, the central bank will take indirect measures, as they are already doing. They will expand quantitative easing, buying bonds and other assets in the secondary market. But soon they will not have enough money to buy it. Therefore, they will cover their noses and buy newly issued bonds from the government.

This will weaken the legitimacy of the central bank, but they have no choice. The inevitable result is: the collapse of the value of legal currency, the opposite of which is everything that money can buy: the appreciation of consumer goods, but more importantly, the appreciation of scarce assets: such as gold, real estate, and Bitcoin. By the way, this is the view of legendary investor Ray Dalio. He will explain to me the 75-year debt cycle at the CoinDesk Consensus Conference on May 24 and that currency devaluation is its inevitable result.

This is a pretty scary idea, but it is a problem that people need to pay attention to, not a subconscious reaction to monthly CPI changes.

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