Why Will the Fed Return to Easy Money?

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If you own cryptocurrency, it's difficult not to be concerned about the red writing in your wallet right now, as the US Federal Reserve's interest rate hikes have slashed token prices.

If you want to think about the long term, though, you should look at your "TradFi" portfolio of stocks and bonds rather than your "DeFi" holdings. While the losses haven't been as severe as in crypto, other markets are also in free fall, and to such an extent that it will eventually require a governmental response, which will have an impact on crypto.

The Fed is currently in hawkish mode, determined to suffocate inflation. But it's easy to imagine the central bank becoming dovish once Wall Street's misery spreads to the rest of the economy - which it almost certainly will – and when that fuels political easing – which it almost certainly will. Following that, economic conditions in the post-coronavirus pandemic world may quickly deteriorate to the point where, in the absence of other options, the Fed and other central banks will revert to the same policy framework as the previous decade and a half, with interest rates near zero and quantitative easing (QE) as the norm. And that will be the basis for a cryptocurrency recovery.

What's more complicated is what this could signify for the Fed's reputation. Could it be that our entire monetary system is flawed if it returns so rapidly to a policy solution that has caused enormous distortions and contributed to the past year's inflation woes? Could this be the turning point when people realize we need a new model?

After so many false starts, I'm hesitant to declare that the next cycle will see crypto and Web 3 technologies and concepts rise beyond the fad-like way that mainstream investors and businesses deal with them and instead become more integrated into the global economy. However, I believe that a situation in which central banks feel obligated to give "helicopter money" could result in a "Emperor's New Clothes" effect, in which people doubt the dominant financial paradigm and seek alternatives.

Shattered government equals broken currency

Let us go back 14 years to solve the core problem before we look at what lies ahead.

Following the financial crisis of 2008, it became obvious in the United States that a lack of federal government action had left monetary policy as the main tool for stimulating economic growth. That reliance is arguably more more ingrained now.

It wasn't always like this, though. The remedy to the Depression in the 1930s was the implementation of enormous government-funded public works projects and the establishment of a welfare safety net for the unemployed. This eventually sparked economic recovery and laid the groundwork for the United States' remarkable twentieth-century expansion.

However, the Obama Administration was pitted against a Republican-controlled Congress in 2009 and beyond. Despite their best efforts, the two parties were unable to reach a bipartisan consensus on fiscal spending projects. Apart from the contentious trillion-dollar bailout programs that protected Wall Street from collapsing, nothing substantive to address the needs of ordinary Americans was ever passed. Stimulus plans became fragmented and politicized, and they were ultimately insufficient to give the US economy the boost it required.

This was a more serious issue than most people realized. It directly questioned public trust in the democratic process, which is supposed to be the mechanism for allocating public resources in the public benefit.

Many libertarians, including those in the crypto community, feel that the greatest thing the government could do is get out of the way. Their idealism, on the other hand, tends to overlook the pre-existing market distortions caused by Wall Street's politically privileged position in the economy, which was most visible during the housing bubble that preceded the crisis. As a result, "getting out of the way" was a prejudiced action in and of itself. Banks in the United States received bailouts, but everyone else got crumbs.

As a result of our politicians abdicating their responsibilities in this area, the Fed was obliged to lower interest rates so aggressively that it swiftly reached the so-called zero bound. Quantitative easing became the solution when there was no room to go lower than zero percent. Buying bonds and, later, other financial instruments was a means for corporations that use the capital markets to generate funds to keep market borrowing rates low.

The trillions in monetary expansion kept everything afloat, but it was also a brutally cruel instrument. Borrowers were aided, while savers were hurt. Hedge funds and other institutional stock, bond, and other financial instrument owners made out like bandits, while tens of millions of people fought to stay afloat.

Regardless, whenever conditions were even somewhat tough, as they did during the epidemic, QE became the default option. The Fed implemented "Infinity QE," an infinite commitment to continue buying assets in order to keep rates low. It was a recipe for rapid inflation, especially when combined with the demand and supply distortions caused by the pandemic's economic upheavals.

So, what's next?

Forward to the year 2022. Political polarization is arguably worse than it was throughout Obama's presidency. And public trust in the government to address our economic problems is at an all-time low.

So, what happens if this year's financial crisis leads to an expected reduction in funding for everything from startups to homes? Jobs will be lost as growth slows dramatically. While the decrease in demand should help to keep inflation in check, there is a valid concern that COVID-related supply chain issues could result in more shortages and price increases.

Congress is unlikely to agree to aggressive stimulus to remedy the problem. As the midterm elections approach and the issue gets more politicized, the Fed will face increasing pressure to act.

But then what? The efficacy of monetary policy is dependent on public faith in the overall system — that people believe the Fed will safeguard the dollar's value while expanding the money supply. It's unclear whether that confidence will hold up in the face of such a 180.

In other words, the overall system's failure will be exposed in its entirety. And that's where Bitcoin and blockchain-based solutions come in.

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