Last updated on September 23rd, 2016 at 05:43 pm
Recently, the minutes for the Federal Open Market Committee’s (FOMC) April 29-30 meeting have been released to the general public. These minutes revealed that the Federal Reserve is now looking for ways to increase interest rates in the near future in order to remove the inflationary stimulus from the markets as the economy improves. Unfortunately, the Federal Reserve’s cheap money policy, designed to stimulate consumption, has merely pumped up an inflationary bubble that must pop once the easy credit is taken away. No matter how the Fed decides to remove money from circulation, the economy will slip back into recession once that cheap money has been taken away from investors. Any growth that occurred because of low interest rates will necessarily collapse once QE-fueled businesses lose their line of credit. However, the Fed’s April meeting minutes also suggest that, overall, it is unsure whether or not the economy has improved enough to allow the Fed to safely end this seemingly limitless stimulus program. If the Fed decides that the economy has not improved to a satisfactory level, they will continue pumping cheap money into the markets, thus further pumping up the bubble and intensifying the inevitable crash.
The future of the Federal Reserve’s monetary policy has very real implications for the value and acceptance of Bitcoin as a replacement for the US Dollar, as well as all other government fiat currencies. Depending on the Fed’s decided course of action– immediate credit contraction or a prolonged stimulus policy– bitcoin could experience a number of shifts that will affect its value.
Why does a Credit Contraction Cause a Recession?
In the “bust” phase of a business cycle, the removal of cheap credit from the market causes all of the businesses that were propped up by that credit to immediately become unprofitable and go out of business. When these businesses directly affected by the credit contraction fail, the bust starts to permeate throughout the economy. Those who lost their jobs now have no regular income to spend on consumer goods and subsequently their demand in the market falls to a point where they only look to purchase basic necessities. As a result, all the businesses associated with those firms that initially fail due to the credit contraction are negatively impacted.
For example, let us picture a situation in which a new chain of coffee stores starts and becomes profitable by setting up stores in areas of various cities that are experiencing overall economic growth due to the Federal Reserves inflationary policies. All of the workers who frequent these new coffee shops receive their salaries from employers that operate solely because of the existence of cheap credit. Therefore, if the credit stops flowing, these employees lose their jobs and stop buying coffee. Consequently, this chain of coffee stores will go out of business. As we can see, this coffee franchise chain was indirectly linked to the Federal Reserve’s cheap money policy. This phenomenon explains why businesses that are seemingly completely unrelated to the initial issuance of credit can suffer because of its contraction. If a housing bubble arises because of Fed stimulus, the bust would necessarily put construction workers out of business. As a result, any industries that provide construction workers with supplies would suffer as well. Work-boot makers, tool manufacturers, truck dealerships, etc would all suffer.
Such a bust leads to a sharp drop in the prices of consumer’s goods– due to a decrease in aggregate demand as a result of the increase in unemployment– and thereby increases the purchasing power of money. This increase of purchasing power is called deflation. Here is where Bitcoin comes into this scenario:
1. Going back into Recession could Cause a General Panic and a Bitcoin Sell-off
It is possible that, when the Fed increases interest rates and thereby puts and end to the addition of money into the economy, the markets will immediately fall back into a deep recession. If such a sharp drop in the macro-economy occurs, there will be a general panic and all areas of the economy will suffer, including Bitcoin.
It is likely that the majority of Bitcoin holders will be affected in some way by the Fed’s decision to increase interest rates and end the creation of dollars for the purposes of economic stimulation. Even if a Bitcoin holder is not a resident of the United States, the international division of labor inextricably links every nation of the developed world together. Because of these economic ties, a disaster in one country will undoubtedly take a toll on the rest of the industrialized world. Thus, an immediate return to recession in America would cause a noticeable drop in economic activity in the rest of the world. This slump in the global economy means that an international increase in the purchasing power of money would occur.
Depending on the severity of the global recession, many Bitcoin holders would have a substantial incentive incentive to sell their bitcoins in exchange for the various deflating fiat currencies. Such a rise in demand for fiat currencies could trigger a massive sell-off on the Bitcoin markets. Due to the lack of wide acceptance of Bitcoin, individuals would likely prefer to hold the currencies of their respective governments rather than the digital currency. It would become evident to the individuals that it would be more profitable to posses a sum of deflating currency that is accepted everywhere rather than bitcoin which is– while deflationary– not as widely accepted as fiat currencies. Therefore, it seems likely that if the Fed’s decision to raise interest rates produced a sudden return to recession, the result would be a sell-off of Bitcoin as a result of the increased purchasing power of fiat currencies.
However, due to the nature of the current American business cycle, it appears to be highly unlikely that a Fed decision to contract credit would produce an immediate recession. Rather, the likely result of a credit contraction would be a very gradual return to recession. This likelihood brings us to a second possibility for bitcoin’s future.
2. A Gradual Return to Recession would Produce an equally Gradual Increase in the Value of Bitcoin
As was mentioned above, the likely result of the Fed contracting credit would be a very gradual descent into recession rather than an instantaneous market crash. Such a descent would clearly not cause a massive sell-off of Bitcoin because of the fact that there would be no enormous increase in the purchasing power of fiat currency. Fiat currency would indeed experience deflation. However, deflation would be spread out over a prolonged period of time, which would make it much less noticeable than it would be in the previous scenario. So, Bitcoin holders would likely opt to hold on to their bitcoins because their holdings in Bitcoin would still be gaining in value faster than fiat currencies.
The result of this scenario could actually mean that, once the recession has completely regained its hold on the macro-economy, Bitcoin would experience an increase in demand and a subsequent spike in both merchant acceptance and purchasing power. The deflationary tendency of Bitcoin, along with newly developing methods of increasing Bitcoin’s acceptance in physical stores, could possibly entice people to trade in their fiat money for Bitcoin. Alternatively, a growth in jobs that pay in Bitcoin could occur, and people could end up trading their entire fiat incomes for Bitcoin incomes. Either way, the end result would be a massive growth in the Bitcoin economy.
While this scenario is hypothetical, it could easily happen in reality. Individuals are becoming increasingly aware of the pitfalls inherent in central banking and are beginning to search for alternatives to the current system of government-controlled monetary system. We know people are already searching for these alternatives. If they weren’t, Bitcoin wouldn’t have become anywhere near as valuable as it is presently. As the dissatisfaction with the results of central banking policies grow, this desire for monetary alternatives will increase in magnitude.
3. What if the Fed Decides to Continue its Cheap Credit Policy?
The implications of this possible decision are not as far-reaching as the two scenarios discussed above. If the FOMC decides that the economy has not recovered enough for a credit contraction and continues on their policy of inflationary stimulation, one of the two scenarios will still occur at some point. The only difference between contracting credit now and continuing stimulus until a later date is that the latter will prolong the recession and intensify it when it does inevitably occur. Therefore, it follows that regardless of the course of action taken by the FOMC, at some point in time the American economy will slide back into a recession and the potential implications it has for Bitcoin will possibly take effect.