Bitcoin and the Fed Issue #2

August 29, 2022

“The burdens of high inflation fall heaviest on those who are least able to bear them”

- Jerome Powell

Nuance. What is nuance? By definition, it is a subtle distinction or variation. Applied here in the context of macroeconomics, it is the ability to pick up on small variances of events or mechanisms within a very complex machine, and the second or third order effects that these catalysts can have on other parts of the machine, and position oneself in anticipation. The first part of this year has subjected all of you to the grip of the aforementioned. Many of you are still trying to sort out how to navigate this terrain amongst the chaos. This thread is intended to serve as a brief thought-provoking piece covering some of the chaos unfolding in the world around us, and (hopefully) help many of you position yourselves to have a positive outcome.

 It’s hard to believe that it’s only been a mere six months since the Fed embarked on their mission to undo the negative effects of unleashing the largest amount of QE since the Great Recession. Self admittedly, they were far behind the curve in recognizing a quickly growing high inflationary threat and have been tasked with taming the beast that they created. For anyone who has been trading this market, it likely feels like a lifetime. You’ve either been chopped to pieces in endless ranges or experienced a significant amount of draw down, as the Fed has ramped up interest rates and begun to crush the demand side of the equation. Alarmingly, when I read my timeline, I still see an echo chamber that is intent of fooling itself into believing that the Fed’s mission is almost complete. It’s peculiar that many believe an inflationary environment that took two and a half years of unparalleled Fed support to create (also preceded by a high level of support over a decade prior), can be undone in such a short amount of time. Especially when you consider a macro back drop as ravenous as the one we are experiencing currently, and continually squeezing the supply side of the equation. Make no mistake, high inflation tends to be very sticky, and it is not easy to pry it’s claws from an economy.

So, let’s cover some basic economic fundamentals first. Back up to the first sentence of the second paragraph. Undoing the negative effects of the largest amount of QE since the great recession. That is correct, despite what you may be reading, you can have too much of a good thing, and monetary stimulus and loose policy is no exception to this rule. When over applied, this stimulus can unleash an avalanche of demand that eventually leads to negative downstream effects. It can cloud the judgement of many who feel that they are getting wealthier rapidly, via investments or owned assets. But therein lies the problem. You have to remove yourself from the shoes of those who have, and put them in those who do not have. You see, unchecked inflation skews wealth to one side of the equation. So why is that an issue? Because no matter how much wealth 1% of the population obtains, they can only spend/consume so much. The wealth must be spread more equally amongst the entire population, so that it can be used to fully used to consume and grow a healthy economy. In effect, too much skew of wealth to 1% of population creates a ton of waste. Furthermore, it creates resentment amongst the population. To continue to grow, you need the 99% to be motivated to show up for work. The essence of the point here is that the 1% needs the 99% more than they would like to admit. They need them to be motivated to work, and they need them to consume, otherwise in theory eventually the economy of that country will collapse, along with sovereign currency of said nation (Venezuela is a good example of this). If the 99% is crushed under of the weight of inflation that is too high, they simply struggle to afford the basic necessities to live, and no longer have discretionary income to spend on non-essential items such as luxury items, bigger and nicer homes, home renovations, vacations, toys, and well, I think you likely get the picture. Eventually this leads to stagnation in the economy (also known as stagflation), where growth stalls or stagnates. Eventually it also causes capital flight, as money flees the sovereign currency to a more deflationary one, because their wealth is being reduced at such a rapid rate, and bigger returns on that wealth are needed to continue to grow it. On the flip side, some amount inflation is essential to grow an economy in a steady fashion. Generally, it is accepted that this number is somewhere around 2% annually, which is the Fed’s target inflation number. Again, you should be starting to see the picture of how a healthy amount of low inflation is a positive thing, and too much is a negative thing. Again, it also reduces the wealth gap by spreading that wealth more evenly amongst the population.

Excessive or high inflation also tends to be sticky for many reasons, which is why it is difficult to lower once it has embedded itself. One of the primary reasons is the conditioning of certain expectations. Once prices go up, entities are reluctant to reduce those prices, as they are accustomed to them, along with the higher cost of doing business, and that is the expectation in order to see a profit on their bottom line. The same is also seen in wages, known as inflationary wage spiral. Job market participants becomes accustomed to higher wages, and it is difficult to bring down, because they become conditioned to expect the higher number. Through the action of reduced demand (and also costs), eventually both of these parties (entities and wage earners alike) are forced to succumb via loss of volume and jobs, respectively. The Fed is very aware this, as even seen as recently at the Jackson Hole summit where Jerome Powell commented that expectations of this high inflation must not become anchored.

Moving on, let’s cover some of the multiple ongoing or brewing macro events hampering the Fed’s current efforts to reign inflation back in. It is imperative to remember that the Fed’s tools work primarily to affect overall demand. They are only able to affect supply secondarily, through the increase or decrease of demand. Across the globe we are seeing situations that continue to constrict supply, whether through direct reduction of supply, or destruction and impediment of supply chains. The first and primary is the war in Russia. Historically, Russia accounts for over twelve percent of the world’s oil supply. They have effectively cut off the west due to sanctions imposed by the US, arising from their mission to bring the Ukraine back under sovereign rule. As you well know, this is not likely to end anytime soon, with Vladimir Putin continually doubling down on his war efforts. This has been further exacerbated by the US’s current administration to implement green energy, and ween the nation off of fossil fuels, shuttering domestic production outfits since the moment they took office. Furthermore, the disagreement of terms of the Iran Nuclear Deal has caused them to exit the oil market in an attempt to leverage negotiations, constraining oil supply even more. Shifting gears, perhaps one of the most overlooked potential crises is the escalating tensions between the China and the US. China seems intent to run Russia’s playbook and reunite Taiwan back under it’s sovereign rule. It important to note that Taiwan’s production of advanced semiconductors accounts for 92 percent of the world’s supply. If that supply chain were to be compromised, it could cause a catastrophic rise in the prices of the aforementioned chips, which are used in the production of almost everything from automobiles, appliances, phones, military equipment, computer, etc. The cost to produce goods for some of the biggest corporate behemoths in the world could skyrocket if this were to happen, sending inflation numbers right back up, adding to the complexity.

In summation, it should be easy to see now why the Fed’s fight on high inflation will not be easily won. While it may appear as such on the surface, once you consider the nuance, it becomes clear that the path ahead is littered with difficulty.

by Pentoshi

Original Post: https://www.getrevue.co/profile/pentosh1/issues/bitcoin-and-the-fed-issue-2-580567