Is The Fed Behind Bitcoin's Ongoing Surge?

How can we understand the interplay between the economy, governed by the Federal Reserve, and Bitcoin?

Debt-Fueled Economy

On a micro-level, we all have our own priorities as to when we spend money. However, in broad strokes, many individuals are willing to spend more money on something if they can have it right away, instead of spending less money on a future purchase. After all, time is the ultimate resource—it’s non-renewable, and can’t be bought.

Moreover, there is not just a limited living time, but windows of opportunity that keep closing throughout life—youth, family-building, physical ability, getting in on some social trend or product line, etc. At least in part due to these reasons, we have constructed a society that lives on debt, quite literally.

U.S. national debt had already climbed to unpayable levels prior to the COVID-19 pandemic. Now, in post-pandemic life, we are seeing a whole new level of national debt, currently sitting at $27.2 trillion.

Likewise, the Federal Reserve’s total assets have climbed to $7.14 trillion, as of early November 2020.

What Is The Value Of Money?

As you can see from those two charts, we have left behind the frontier of financial normalcy. We must then ask the inescapable question, is this never-before-trekked frontier of managing the nation’s finance sustainable? According to Federal Reserve Chairman Jerome Powell, it is. At a press conference on November 5, Powell made it clear the Federal Reserve is ready for another round of stimulus support.

“I just would say that I think we’ll have a stronger recovery if we can just get some more fiscal support, when it’s appropriate… the size Congress thinks is appropriate,” he said.

If you understand that the Fed saved the stock market amid the pandemic, and provided vital support for businesses and citizens via relief packages and paychecks, it is easy to support such efforts. However, what are the consequences of such drastic, repeated interventions in such a short time span?

Consider the factors determining the value of the U.S. dollar:

• The demand for Treasury notes increases the dollar value and vice-versa
• Exchange rates and foreign exchange reserves held by foreign governments

In short, like with any other good or service, the value of the dollar lies in its demand. When its demand is lowered, its value declines, which we call inflation. During that period, prices soar which spurs people into a buying spree. In turn, manufacturers meet the new demand by driving prices more. 

To prevent that from happening, one of the Federal Reserve’s primary missions is to regulate inflation, by either reducing money supply or increasing interest rates. When interest rates are high, other banks follow, which means that borrowing is discouraged. In turn, this drops spending and prices, so the inflation is slowed as well, keeping it under 2%.

On the other hand, when interest rates are low, it spurs spending and investments. This is why we have seen cycles of low and high-interest rates. Currently, we are in the near-zero interest rate cycle. This will likely remain until U.S. employment numbers rise significantly. 

However, if low-interest rates become too low, they can be detrimental. Instead of spurring growth, they can then limit the money supply through Main Street, as Chairman Powell pointed himself:

“We have seen this adverse dynamic play out in other major economies around the world and have learned that once it sets in, it can be very difficult to overcome. We want to do what we can to prevent such a dynamic from happening here…”

In the end, it’s hard to predict what the outcome will be, as such delicate interventions at a massive scale have never been attempted before.

Bitcoin’s Role In The Financial System

Just one year after the 2008 financial crisis, Bitcoin launched as the brainchild of Satoshi Nakamoto. Unhackable (if you keep your private keys) and without a central entity to tamper with, Bitcoin has a finite pool of 21 million digital assets, called ‘bitcoins’, with currently 18.5 million in circulation. Neither Bitcoin’s total supply nor its rate of introducing new bitcoins to its circulating supply can be altered. This means that, if everyone were to use Bitcoin as a currency, it would create a deflationary economy. Whether or not that is a good thing is in dispute.

What is not in dispute is that the Fed propped up the stock market during the March crash. This leaves Bitcoin as one of the few safe havens left outside of gold, which has its own problems due to costs related to its physical nature. In fact, an analysis from JPMorgan recently posited that Bitcoin might supplant gold, as it is driven by younger generations who are comfortable with digital code as a store of value. 

Furthermore, Bitcoin is undergoing an adoption renaissance:

• In Square Inc’s SQ Q3 2020 revenue earnings report, out of $3 billion total, Bitcoin transactions accounted for over half of Square’s revenue, at $1.63 billion
• PayPal Holdings Inc PYPL, the largest payment processing platform in the world, with over 346 million customers, will integrate Bitcoin into its ecosystem, including Venmo, by mid-2021
• Mode Global Holdings will use at least 10% of its cash reserves in Bitcoin, as its treasury reserve asset
• Thanks to the immutable nature of Bitcoin transactions, more small businesses are integrating Bitcoin as a payment method, as a defensive measure against fraudulent chargebacks. 

Already riding positive social media coattails, the confluence of these events jumpstarted Bitcoin into another bull run reminiscent of 2017. In other words, Bitcoin’s price at $15k means that its market cap is higher than Walt Disney Co DIS, PayPal, Coca-Cola Co KO, and Netflix Inc NFLX.

Moreover, as one event pushes another, it creates a domino effect. For instance, in the wake of the pandemic, millennials have been busier than ever trading stocks and options. In order to accommodate millennials, many of the leading options brokers now offer access to cryptocurrencies, illustrating a byproduct of increased access to Bitcoin.

Takeaway

Put simply, the Federal Reserve is engaging in an experiment. It may succeed, or it may fail, causing hyperinflation. Being outside this system and native to the internet, the sovereign system of Bitcoin provides one of the easiest safeguards against this eventuality. Although China is well underway to unleash digital yuan as a global counter to dollarization, it is still a fiat currency.

Bitcoin will remain outside these grand geopolitical games. Its price will fluctuate as it has been, but its upward trajectory could very well continue—at least in part—thanks to the Fed.