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Narratives among crypto bulls are ephemeral except one: Bitcoin (BTC) is an antidote to unconventional Federal Reserve monetary policies.
It has recently reached a fever pitch on Crypto Twitter, thanks to venture capitalist and angel investor Balaji Srinivasan saying he’d wager that bitcoin will hit the $1 million mark within 90 days. The former Coinbase chief technology officer also predicted a U.S. banking crisis that would crash the dollar and spur hyperinflation – an excessively fast rise in the price of goods and services. The U.S. dollar, the de facto global reserve currency, has yet to suffer through this type of extreme devaluation.
Balaji’s prediction follows the Fed opening liquidity taps in the form of dollar lending programs to contain the banking sector instability in the wake of Silicon Valley Bank’s collapse. Similar forecasts predicting Weimar Republic-style U.S. hyperinflation made plenty of noise following the covid-spurred crash of March 2020 and the 2008 global meltdown. On both occasions, the Fed poured trillions of dollars into the system through outright asset purchases or quantitative easing (QE).
Hyperinflation almost always results from a large amount of money “chasing” the same amount of goods and services being supplied in an economy. In other words, the money created through QE or other measures must be spent on the stagnant stock of goods and services to boost inflation. Assets like stocks or cryptocurrencies can hyperinflate in terms of valuations if the newly created money enters financial markets instead of the real economy (as it did following the 2008 and 2020 crashes).
The Fed’s latest measure – the Bank Term Funding Program (BTFP) – is not QE, even though it has caused a QE-style expansion of the Fed’s balance sheet.
“There’s a lot of confusion and hyperbole out there about the implications of U.S. government measures to stem the banking turmoil. It’s not QE [quantitative easing] and while inflation will remain sticky, it won’t be hyperinflation,” Martha Reyes, a member of the advisory council at the Digital Economy Initiative, told CoinDesk.
In QE, the Fed snaps up Treasurys and mortgage-backed securities from financial institutions with no pre-defined holding period. When the Fed purchases bonds from a bank, the latter’s cash reserves at the central bank rise, providing it with a liquidity cushion and greater incentive to lend. Increased lending then encourages more spending and investment, putting upward pressure on prices either in the real economy or asset markets.
Under the BTFP, the Fed is loaning money to banks to allow them to meet their immediate financial obligations. Banks need liquidity to service the deposit flight seen after large interest rate hikes by the Fed. A liquidity shortage can lead to widespread bank runs, a catastrophic outcome.
The borrowing banks have to return the money after a year along with the interest rate charged as per overnight index swap (OIS) rate plus 10 basis points. It’s not free money like QE!
“BTFP is not QE. It is a program to help stabilize banking liquidity. This new BTFP program will allow banks to pledge [Treasurys] or mortgages in return for immediate liquidity for up to one year. It is a liquidity program available in times of stress and is short term,” emerging markets trader and analyst Seng Liew said in a LinkedIn post.
“Conventional vanilla banking is about the mismatch between deposits and assets. In SVB’s case, they had deposit redemptions of $42bn which is just over 20% of the bank assets when Silicon Valley deserted them in one day. That caused the failure, not the investment in the assets. Since the pandemic corporate loan growth has been mediocre away from the huge increase under the PPP loan program. Hence most banks invested the bulk of their liquidity in U.S. [Treasurys] and mortgages,” Liew added.
In other words, the money received from the Fed in the form of loans through BTFP or other programs like the discount window is unlikely to be used in a way that will lead to stimulus in the economy or financial markets.
“QE is increasing the balance sheet for monetary purposes. This is about financial stability, and all expansion of the balance sheet is not QE,” Marc Chandler, chief market strategist at Bannockburn Global Forex and author of “Making Sense of the Dollar,” told CoinDesk in an email.
Dollar death fears overblown
Hyperinflation predicted by Balaji can also materialize through a sharp, sudden devaluation of the greenback. Currency devaluation imports inflation from abroad, raising the general price level in the economy.
History, however, tells us that investors tend to flock into the dollar-denominated assets during times of stress, including those caused by stateside issues.
The dollar index, which gauges the greenback’s value against major currencies, surged by 11% in the second half of 2008 even as Lehman Brothers collapsed, causing a worldwide contagion. The index stabilized in the range of 75-90 in the subsequent years even though the Fed did multiple rounds of QE. The greenback slipped 11% in ten months after the Fed reopened liquidity floodgates in March 2020, a notable devaluation but far from the outright hyperinflationary crash.
“In the event of a widespread banking panic, which seems unlikely at this time, there will probably be the typical rush by investors into safe assets such as the U.S. Treasury securities. That is likely to help than hurt the dollar in the short term,” Eswar Prasad, professor at Cornell University, told CoinDesk, calling the hyperinflation forecasts “unduly hyperbolic.”
“It will be interesting to see if the narrative of crypto being perceived by investors as a safer asset than fiat currency holds up if the current turmoil in the banking system intensifies,” Prasad added.
Banking crisis is deflationary
A full-blown banking crisis, as predicted by Balaji, can actually cause a credit freeze, as observed after the collapse of Lehman Brothers in 2008, and lead to deflation – a general decline in prices for goods and services, typically associated with a contraction in the supply of money and credit in the economy. Deflation usually boosts demand for cash.
Banks are more likely to keep the money borrowed from the Fed with them to ensure healthy liquidity levels instead of lending it out.
Credit freeze refers to a situation in which international interbank markets freeze and interbank lending beyond very short maturities virtually evaporates, cutting the supply of liquidity to households and businesses.
“Loans to illiquid institutions are lifelines, pure triage that cannot escape the banking system and manifest as velocity. They slow the economy as lending at these banks freezes,” Danielle DiMartino Booth, CEO of Quill Intelligence LLC, tweeted.
Despite the obvious differences between QE and BTFP and the deflationary impact of an outright banking sector crisis, many in the market are expecting rapid price gains in bitcoin. The cryptocurrency has rallied over 40% in two weeks.
Perhaps the disconnect from obvious reality results from Pavlovian conditioning – the behavioral and physiological changes brought about by experiencing a predictive relationship between a neutral stimulus (ultra-easy monetary policy since 2008) and a consequent biologically significant event (surge in risk assets).
Interest rates were stuck at or below zero for the most part between 2008 and 2021, barring the Fed’s minor tightening cycle that saw rates rise by 225 basis points between December 2015 and December 2018. Besides, most central banks, including the Fed, embarked on multiple rounds of quantitative easing.
The prolonged easing bias has permanently paired the neutral stimuli and the consequent event in the minds of investors. As such, every Fed move is either being misread as QE or an advance indicator of an eventual launch of QE.
Lyllah Ledesma contributed reporting to this article.
Edited by James Rubin.
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Omkar Godbole was a senior reporter on CoinDesk’s Markets team.
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Omkar Godbole was a senior reporter on CoinDesk’s Markets team.