Money Reimagined: Why Quantitative Easing Is Here to Stay

Welcome to Money Reimagined. 

Another week, another NFT blowout. This one was capped by the biggest deal of all: a $69.3 million sale in Christies’ auction of digital artist Beeple’s “EVERYDAYS: THE FIRST 5000 DAYS.” Aside from the fact we seem to be at the peak of the Gartner hype cycle for non-fungible tokens, this and other wild deals underscore a wider issue in the global economy: How many excess dollars are sloshing around in search of finite things to buy? As we discuss in this week’s essay, global economic forces are likely to ensure that fund flow continues for some time.

NFTs are, again, the focus of this week’s “Money Reimagined” podcast. In the third in our series on the topic, Sheila Warren and I talk to Roham Gharegozlou, CEO and founder of Dapper Labs. A pioneer in NFTs, Dapper Labs created the ERC-721 token standard on which most Ethereum NFTs are built, used it to bring the groundbreaking CryptoKitties concept to the world, and then decided to build its own tailor-made blockchain, known as Flow, to better serve the industry. Now, with the popular NBA Top Shot game running through Dapper’s app, Roham is uniquely placed to peer into the future that NFTs portend, not just for art but for the entertainment business at large. 

Have a listen after reading the newsletter. 

A paradox: The U.S. dollar’s reserve currency status, usually seen as a source of American might, is now hindering the Federal Reserve’s monetary sovereignty. 

The European Central Bank’s aggressive move this week to expand its “quantitative easing” stimulus program leaves the Fed little choice but to continue its own hyper-expansive policy, even if it wants to end it. 

That’s positive for bitcoin and underscores how a failing global financial system needs the kind of alternatives crypto innovators are dreaming up. But it also speaks to the emerging impotence of central banks, including of the most powerful one in the world.

Late last month, U.S. bond yields rose amid speculation the Fed will start to unwind its massive monetary stimulus once the U.S. economy emerges from the COVID-19 pandemic. In response, stocks, bonds and cryptocurrencies fell while the dollar rose. Fed Chair Jerome Powell amplified that speculation during last week’s Wall Street Journal Job Summit, when he gave no word of deliberate actions to curb the tightening market conditions. Bitcoin fell further on that news. 

But while Powell and the Fed wouldn’t put their money where their mouth is, the European Central Bank did. On Thursday, the ECB announced it would accelerate a $1.85 trillion bond-buying program to contain what President Christine Lagarde described as an “undesirable” rise in bond yields. 

The news not only boosted European stocks and bonds, it sent the S&P 500 into record territory in the U.S. In part that’s because markets saw it as a sign the Fed’s own capacity to tighten policy was now weakened.

This inter-relationship between U.S. and European policymaking results from an unprecedented degree of global capital integration. 

Global finance is more dollarized than ever. About half of all cross-border loans and international debt securities were denominated in dollars at the start of the COVID-19 crisis. By the third quarter last year, non-U.S. banks’ dollar liabilities expanded even further, reaching a record $12.4 trillion, according to the Bank of International Settlements. Even as international trade shrank – which should reduce demand for dollars – foreign banks’ jittery customers converted local-currency deposits into the U.S.’ “safe haven” currency.

Dollarization increases the relative influence of U.S. policymaking on European financial conditions and decreases the domestic economy as a factor. So as yields rose in the U.S., eurozone borrowing costs also rose, even though a sluggish vaccine rollout and high debt levels have left the European Union economically worse off than the U.S.

That out-of-sync outcome meant the ECB had to counter. It couldn’t control dollar-denominated rates, but it could at least drive down euro rates. 

In turn, this latest move has the potential to send an opposite ripple effect across the Atlantic, via the euro-dollar exchange rate. And this raises a dilemma for Powell and his colleagues. 

Here’s the problem: The Fed might at some point feel a need to signal tighter monetary policy. That would raise U.S. bond yields and widen the premium over newly lowered eurozone yields, which would then drive even more European money into dollars and increase the greenback’s value versus the euro. The result: U.S. products would become more expensive for Europeans and European exports to the U.S. would be cheaper in dollar terms. 

Under normal circumstances, a principled, free trade-respecting U.S. government would resist temptation to act in support of U.S. exporters or locally based companies that compete with imports. And, officially, the Fed never targets the dollar and doesn’t listen to politicians’ concerns about corporate interests. 

These are not normal circumstances. 

For one, the scenario I described entails the dollar rising as a result of European actions that are themselves a reaction to conditions in the U.S. These second-round, reinforcing effects separate exchange rates from economic factors.

Second, a currency appreciation would come at an especially difficult time for U.S. companies. The U.S. economic outlook might be better than Europe’s, but that’s hardly saying much. This is the worst economy since the Great Depression, one that warranted a new $1.9 trillion stimulus package last weekend. Small businesses across the country are hurting, badly. 

So, while you’ll never hear it from the Fed, it will be concerned about the economic fallout from a strong dollar. This will damp its capacity to tighten policy. 

Foreign exchange markets, where the dollar counterintuitively weakened on Thursday, seem to know that. The standard response is for a currency to fall on weaker monetary policy. But the ECB move resulted in the dollar, not the euro, heading south. That’s partly because the restored buoyancy in stock markets pushed investors into “riskier” bets, but it’s also because the Fed now has less room to change its current, easy-money course. 

So, who’s in charge here? The Fed or the ECB? In reality, it’s neither. Both have seen their power to manage their economies diminished. 

On the surface, central banks appear omnipotent these days. Their bond-buying has sharply and uniformly driven down short-term rates around the world (see the chart below). In filling financial institutions’ balance sheets with monetary reserves, they have pushed all risk assets ever higher with unprecedented cross-market correlation. Now more than ever, investors hang on every utterance from the Fed. 

Yet, because of investors’ hyper-sensitivity to even the most subtle changes in policy, central banks’ hands are tied. The slightest signal that the Fed is considering tapering quantitative easing can send markets into paroxysms. 

Central banks put their monetary machines into top speed. Now they can’t slow them down. 

The default, then, is for more of the same.

As this continues, it will slowly erode trust in fiat money. A relentless increase in money supply, coupled with persistent increases in the prices of assets controlled by hedge funds and few other privileged investors but not by the general public, all without real improvements in most people’s lives, is a recipe for mistrust.  

As gloomy as that sounds, it’s constructive to bitcoin. The leading cryptocurrency’s digital scarcity stands as a counterpoint to “QE infinity.” And it gives those of who want to reimagine money a reason to explore alternatives to this broken, inequitable system.

Until the financial crisis of 2008, charts like the one below were used to praise the “Great Moderation,” an almost two-decade period of resounding success for central banks. Inflation was tamed by the tough love of high interest rates, famously imposed by Fed Chair Paul Volcker in the early 1980s, which allowed benchmark short-term rates to consistently decline. The falling cost of credit unlocked capital for the world. 

But since the crisis, which was stoked by that cheap credit, rates have leveled off. And that’s for one simple reason: they’re at zero, with nowhere else to go. (Though, as you’ll see, in Switzerland, Japan and most recently the eurozone, they’ve gone slightly negative, a wacky situation in which lenders pay borrowers for the right to lend them money.) This is a far less heartwarming story.

As central banks sought to boost lending during the crisis, they slashed rates to the “zero bound” and adopted Japan’s approach to quantitative easing. Under QE, which Japan began in the 1990s, central banks buy bonds and other assets from commercial banks, seeking to drive down long-term bond yields to encourage loans to comparatively riskier investments. As shown by a chart of central bank balance sheets in a prior edition of Money Reimagined, those asset acquisitions have continued ever since and have significantly accelerated during the COVID-19 crisis. 

Over time, congregation around zero has created a ”sameness,” not only across countries and currencies but across assets and asset classes. When the base rates are all at zero and central banks are actively driving down long-term rates as well, there’s less room for differentiation. Value investing or stock picking becomes irrelevant. Investors buy everything because they can, except when there’s a signal that QE might be ending. No nuance. All correlation.

The chart, in other words, is a visual representation of the dilemma described in the column above. The all-powerful central bankers who brought us the Great Moderation have run out of ammo.

It was bound to happen. After weeks of big-money headlines (Beeple’s $69 million sale being the latest) and celebrity endorsements, the NFT phenomenon has hit a backlash. 

To critics, non-fungible tokens are no longer tools of artist empowerment. They’re a waste of energy and a symbol of greed and wanton destruction. 

We don’t have time to go down the rabbit hole of the longstanding crypto-energy debate. So let’s just grab a sampling of the latest version of that spat on Twitter. 

One of the positives of the NFT phenomenon is that it’s pushing crypto into mainstream discussion. Although that comes with some ill-informed opinions, it will ultimately heighten pressure to seek a third way among the divisions. The debate won’t kill off NFTs but it will drive innovators to come up with solutions that make them more inclusive and more sustainable. 

We’ll start with a well-known marketing guru, linking to a post he made to his long-running blog that talked of the dire consequences of NFTs: 

On the other side, here’s a prominent member of the crypto community metaphorically rolling her eyes at a Wired article that amped up the NFTs-kill-the-planet line, while pointing to many examples of everyday energy excess that rarely get critiqued:

This digital artist passionately called for an end to attacks against Black, indigenous and people of color who are minting NFTs and urged their critics to become better informed about the solutions underway to address the energy challenges:

And, finally, an environmental journalist who parroted some of the more exaggerated claims of crypto energy usage but goes in search of a pro-environment NFT solution:

The week brought news that private trading in Coinbase shares signaled a valuation for the crypto company close to $100 billion ahead of its initial public offering. That staggering number would be the highest valuation for a U.S. tech company’s IPO since Facebook came to market in 2012 at $104 billion. Are Brian Armstrong and his team really worth that much?

In a CoinDesk opinion piece that rains on its parade, Cove Markets head of marketing Thomas Meyer says, “sorry Coinbase, you’re not worth $100 billion.” He warns its trading fee revenue is exaggerated by a temporary boom in crypto markets, and that Coinbase will inevitably face stiff competition from other exchanges and crypto services. 

Changpeng Zhao, the CEO of rival exchange Binance, is having none of that. Although he told CoinDesk TV that Binance has no plans to go public, he also thinks Coinbase “should be valued much higher” than $100 billion. 

What makes this all difficult, writes Ben Schiller, CoinDesk’s managing editor for Features and Opinion (and editor of this newsletter), is that crypto valuations entail a higher degree of subjectivity. The value of cryptocurrencies – and therefore companies that service the industry – depends less on their definable utility and fundamentals and more on how well each one appeals to a large enough community to gain network effects.