Bitcoin and Today’s Wicked Inflation Share a Common Ancestor

It’s not that the economy is going through a wringer it hasn’t been through before, but it is still a period of rapid change. Today, the Bureau of Labor Statistics announced consumer prices rose 8.5% for the 12 months that ended in March – the fastest inflation rate in 40-odd years. That means we’re all paying more for just about everything.

There are material explanations. The world’s supply chains have been tied in a knot, ports are backed up, and the literal fuel for the economy – oil and gas – is getting more expensive, in part, due to the ongoing Russia-Ukraine war.

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A more heterodox view, perhaps familiar to CoinDesk’s audience, follows the money rather than supposedly exogenous factors. To combat the coronavirus, which stunned the world, U.S. policymakers printed about a century’s worth of dollars in two years.

“It’s going to be a very difficult couple of years or more ahead for the U.S. economy and for the Federal Reserve,” former Kansas City Fed lead and current fellow at the libertarian-leaning Mercatus Center, Thomas Hoenig, told MarketWatch in a February interview.

The Federal Reserve is now in a perilous position of having to keep their word to increase lending rates to slow down the economy and combat inflation. It has to do that without risking popping an asset bubble across financial assets and causing more pain. Everything from stocks to home prices to crypto to yachts has surged during a period of easy money.

See also: Bitcoin Isn't an Inflation Hedge Yet, but Here's How It Could Be | Opinion

Not enough people are willing to say plainly that we’re in an era of great monetary experimentation. This includes the Federal Reserve’s recent ultra-dovish policy to keep interest rates low, low, low to the adoption of alternative monetary structures like Bitcoin that want to keep monetary issuance steady, predictable and final.

Although there are no easy answers or pain-free solutions to the current inflationary crisis, it may be worth noting how today is the result of decisions in the past.

Black sheep

Hoenig is one of those black sheep, heterodox thinkers. A lifelong, soft-spoken institutionalist, he became infamous in 2010 as the lone dissenter of a novel policy of monetary experimentation called “quantitative easing” (QE) – when the Fed buys financial assets from private banks to flood the economy with capital.

Although calling out what was then a truly novel course, Hoenig was branded the “Doomsday Prophet.”

Just two years after the beginning of the Great Financial Crisis (GFC), then reigning Fed Chairman Ben Bernacke was looking to quicken the recovery of the U.S. economy through QE. The Fed had used this tool at the height of the crisis, but Bernacke, in 2010, wanted to pursue long-term intervention.

In QE, money the Fed pays to banks is meant to be reinvested and loaned out to help create jobs for the unemployed. But it also plays with the levers of finance in interesting ways. Under QE, the Fed primarily buys U.S. Treasurys, which are treated as risk-free investments and used by financial institutions as a way to store their cash.

Quantitative easing makes Treasurys more expensive by taking them off the market and pushes banks into riskier investments. The current monetary regime could be seen as an extension and exaggeration of a policy pursued a decade ago.

In 2010, Hoenig, nearing retirement at the time, was the sole voting member of the Federal Open Market Committee (FOMC) against long-term intervention. He worried that QE would eventually destabilize the economy and lead to inflation. That the Fed, by encouraging riskier lending by banks, would create asset bubbles.

There’s some disagreement about Hoenig’s legacy, whether he was right or wrong about the short-term impacts of QE. The decade preceding the coronavirus saw low unemployment and low inflation. But the idea that an asset bubble grew and grew over the past decade seems trivially true.

Crypto is both part of that inflationary environment and charting out a new path for a financial system without middlemen. Bitcoin in particular is aiming to become a global reserve asset that cannot be debased by the decisions of central bankers.

See also: What the Fed Thinks About CDBCs

It’s a nice thesis, but we’re never seen the crypto ecosystem function alongside a traditional financial system with higher rates and less intervention. It might be the case that fewer people look to alternative asset classes if their banks actually pay a saving rate.

Down the pike

Hoenig is now calling for the Fed to be steadfast about raising rates in a “systemic and persistent” way. But he thinks it’s likely it’ll waffle.

“As you get inflation rising, then it puts increasing pressure on the central banks – on the Federal Reserve in particular – to address that [by] increasing interest rates,” he told MarketWatch. The trouble is, that will almost certainly cause “the reversal of the stimulus” with it, he said.

As gauche as it is to compare the Fed, one of America’s most powerful institutions and the keeper of the currency, to Bitcoin, an upstart financial system that reroutes activity to a deflationary environment, it’s worth noting the shared beginning of these modern institutions.

A decade ago, the Fed began an awesome monetary experiment that we’re living with today. Its analogue is Bitcoin, created around the same time.