Federal Reserve Chairman Jerome Powell said at last week's meeting of global central bankers that the Fed may continue to raise interest rates if inflation continues to rise, contradicting market expectations for a pause in rate hikes. Nonetheless, Powell emphasized that the Fed would take cautious actions, so the market reaction was relatively calm and there was no excessive panic.
Some money managers are now looking at how the Fed responded to inflation in the early 1980s and comparing it to the current situation. Powell's attempt to address current inflationary pressures with bold rate hikes is considered by some to be a contemporary Paul Volcker.
The problem, however, is that U.S. economic and monetary conditions are very different today than they were in the 1980s. An important background for Paul Volcker to raise interest rates to solve inflation problems in the 1980s is that in 1980, the US debt-to-GDP ratio was 30%, but now it is 118%. Such a huge debt will have a great impact on raising interest rates, and the U.S. Treasury needs to issue more new debt to repay old debt, pay interest and government spending, which will eventually lead to huge interest payments.
As a result, some are beginning to suspect that what worked in the past under ideal conditions may no longer work in today's competitive era. They argue that the Fed's attempt to use Paul Volcker's economics to steer the economy could push the U.S. in the exact opposite direction from its intended goal.
Currently, the Federal Reserve wants to control the quantity and price of money, but it is difficult to control the sequence. The Fed controls the amount of money by changing the size of its balance sheet, which is called quantitative easing (QE) or quantitative tightening (QT). However, this method of operation has caused some concern.
The Federal Reserve holds and trades trillions of dollars of U.S. Treasury bonds and mortgage-backed securities (MBS), which can have a significant impact on the market, resulting in a loss of freedom in the U.S. fixed income market. To effectively manipulate short-term interest rates, the Fed has to create money and provide funds to depositors. It can be seen that there may be contradictions in policies to curb inflation, and it is difficult to raise interest rates and reduce the size of the balance sheet at the same time.
Today's economic environment has undergone many changes compared to the past, and simply raising interest rates to solve the inflation problem may no longer be applicable. The market has not yet realized that the sooner the Fed loses control of the U.S. Treasury market, the sooner it will resume interest rate cuts and quantitative easing. This has already been demonstrated earlier this year when the Fed abandoned monetary tightening by expanding its balance sheet by tens of billions of dollars in a matter of trading days to "save" the banking system from defaults by banks across the region.
And more investors are becoming aware that the Federal Reserve and the U.S. Treasury Department distribute billions of dollars to wealthy savers every month. This money has to go somewhere, and some of it will likely go to limited-supply financial assets like tech stocks and cryptocurrencies. While the mainstream financial media may sound catastrophic about a sharp drop in cryptocurrency prices, there is actually a lot of cash to be found in these limited financial assets, such as Bitcoin.
Traditional banks and asset managers are suddenly interested in cryptocurrencies because they realize that governments can erode bank profitability and drive inflation, which they need as a tool to fight inflation. Although traditional financial institutions have created a negative image of cryptocurrencies, and even politicians have come to believe this view, the problem is not actually with cryptocurrencies themselves, but with the people who own them.
However, the deeper question is whether we can maintain the founding philosophy of Satoshi Nakamoto in the face of a flood of financial products flooding the traditional financial system. Large asset managers could have influence over bitcoin proposals, such as offering an exchange-traded fund (ETF) that tracks an index of cryptocurrency mining companies, which could lead miners to discover that these companies control their stocks and influence management decisions. We want to remain true to our founding philosophy, but we also need to be wary of temptations.
Summarize
In conclusion, Fed Chairman Jerome Powell is trying to control the inflation problem by raising interest rates boldly, but the economic and monetary situation is different now than it was in the early 1980s. The Fed faces some challenges in controlling the quantity and price of money, and its quantitative easing and tightening operations have raised some concerns.
At the same time, market investors are increasingly aware that large amounts of money may flow into limited-supply financial assets such as technology stocks and cryptocurrencies. This reflects the trend of financial disintermediation, where traditional financial institutions are looking for solutions to remain competitive, and cryptocurrencies are part of this. However, we need to be alert to the concentration of power and possible risks to the values involved to ensure that the process balances the interests of all parties.