Why the Fed Will Go Back to Easy Money

Amid a recession and political paralysis, the Federal Reserve will have no choice but to revert to quantitative easing. What will that mean for cryptos like bitcoin?

May 13, 2022 at 3:31 p.m. UTCUpdated May 13, 2022 at 3:54 p.m. UTC
May 13, 2022 at 3:31 p.m. UTCUpdated May 13, 2022 at 3:54 p.m. UTC

Michael J. Casey is CoinDesk's Chief Content Officer.

If you’re invested in crypto, it’s hard not to think about the red ink in your wallet right now as concerns over the U.S. Federal Reserve’s interest rate hikes have walloped token prices.

But if you want to think about the long-term outlook, it’s better not to look at your “DeFi” holdings but at your “TradFi” portfolio of stocks and bonds. While the losses haven’t been as brutal there as in crypto, those markets are also tanking, and to such an extent that it will eventually prompt a policy response, one that will impact crypto.

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The Fed is currently in a hawkish mode as it is dead set on choking off inflation. But it’s easy to imagine that once Wall Street’s pain feeds into the mainstream economy – which it most certainly will – and when that starts to fuel political easing – which it most certainly will – the central bank will turn dovish again. After that, economic circumstances in the post-coronavirus pandemic world could quickly become so dire that, in the absence of other options for addressing them, the Fed and other central banks will return to the same policy framework of the past decade and a half, with interests near zero and quantitative easing (QE) the norm. And that will be the foundation of a crypto rebound.

The complicating factor here is what this might mean for the Fed’s reputation. If it returns so quickly to a policy solution that has created wild distortions and contributed to the inflation woes of the past year, might that show that our entire monetary system is broken? Might that finally be the moment in which people recognize that we need a new model?

After so many false starts, I’m reluctant to declare that the next cycle is the one in which crypto and Web 3 technologies and ideas rise above the fad-like way in which mainstream investors and businesses otherwise tend to engage with them and instead become more integrated into the global economy. But I do think a dynamic in which central banks feel compelled to deliver “helicopter money” could have an “Emperor’s New Clothes” effect where people question the dominant financial paradigm and look to alternatives.

Broken government = broken money

Before we view what lies ahead of us, let's turn the clock back 14 years to address the root problem.

In the aftermath of the 2008 financial crisis, it became clear in the U.S. that a failure of federal governmental action left monetary policy as the only lever for boosting economic growth. That dependency is now, arguably, even more entrenched.

It wasn’t always the case. In the 1930s, the solution to the Depression lay in the rollout of massive government-funded public works projects and the creation of a welfare backstop for those out of work. This eventually drove economic recovery and created an infrastructure base upon which the U.S. economy’s great 20th-century expansion was built.

But in 2009 and beyond, the Obama Administration was thrust into battle with a Republican-controlled Congress. The two sides searched, against all odds, for a bipartisan agreement to back fiscal spending projects, but other than the controversial trillion-dollar bailout programs that kept Wall Street from imploding, nothing substantial to address mainstream America’s needs was ever passed. Stimulus initiatives became piecemeal and politicized and were ultimately insufficient to give the U.S. economy what it needed to grow.

This was a deeper problem than most people recognized. It directly challenged confidence in the democratic process, which is supposed to be the mechanism by which public resources are distributed in service of a common national interest.

Libertarians, of which the crypto community claims many, might argue that the best thing the government could do was to get out the way. But their idealism tends to ignore the preexisting market distortions created by Wall Street’s politically privileged place in the economy, a privilege that was most clearly manifest during the housing bubble that preceded the crisis. As such, “getting out the way” was in itself a biased action. U.S. banks got their bailouts, but everyone else got crumbs.

The upshot of our politicians abdicating their responsibility in this regard is that the burden for stimulating a moribund economy fell to the Fed, which was forced to cut interest rates so aggressively that it quickly hit the so-called zero bound. With no room left to go lower beyond zero percent, quantitative easing became the solution. Buying bonds and, later, other financial instruments, was a way to keep market borrowing rates low for companies that use the capital markets to raise funds.

The trillions in monetary expansion kept things afloat but also proved to be a brutally blunt instrument. Savers were harmed, borrowers were helped. Hedge funds and other institutional owners of stocks, bonds and other financial instruments made out like bandits while tens of millions struggled to keep their head above water.

Regardless, QE became the default option whenever times got even slightly tough, which is what we saw during the pandemic. The Fed instituted what became known as “Infinity QE,” an unlimited commitment to keep buying assets to keep rates low. Combined with the distortions in demand and supply brought on by the pandemic’s economic disruptions, it was a recipe for the runaway inflation that eventually arose.

So, what now?

Fast forward to 2022. Political divisions are arguably even worse than they were in the Obama era. And confidence in the government to resolve our economic challenges is at all-time lows.

So, what happens when this year’s financial meltdown leads to the inevitable pullback in financing for everything from startup ventures to homes? Growth will dramatically stall and jobs will be lost. And while that slowdown in demand should help to stall inflation, there’s a legitimate fear that COVID-led supply chain problems will mean that shortages and price appreciation continue.

It’s hard to believe Congress will agree to aggressive stimulus to solve this. So, as the midterm elections approach and the problem becomes politicized, the pressure will grow on the Fed to act.

But what then? The effectiveness of monetary policy depends on confidence in the overarching system –- that people trust that the Fed will protect the value of the dollar even as it boosts money supply. It’s not clear that that confidence will last in response to such an about-face.

In other words, the failure of the overarching system, writ large, will become apparent. And that’s where Bitcoin and blockchain solutions pose the alternative.

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Michael J. Casey is CoinDesk's Chief Content Officer.

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