Bitcoin (BTC-USD) is an ideal investment to hold, in my opinion, no matter what the Federal Reserve does. In this article, I talk about the different directions the Fed can take, what the outcome of this would be for the economy, and what would happen to the price and value of Bitcoin.
Ultimately, no matter what the Fed does, I believe Bitcoin will thrive. Loose monetary policy will inflate assets, which is good for Bitcoin. On the other hand, further monetary tightening, while bad at first, would eventually lead to complete economic collapse, which would cause a run on the dollar, leaving Bitcoin as one of the few assets capable of storing value.
Monetary Policy has been used as an economic tool for 1000s of years. The economy was "stimulated" in Roman times by creating more coins out of less pure metals. During World War II, the Federal Reserve lent the Treasury a hand by capping interest rates, and before that, various attempts were made to promote growth by purposely devaluing the currency.
Today, economists believe they have perfected the art of monetary policy, and indeed, it seems like the whole market hinges on the words of those in charge of the Fed.
While the Federal Reserve has managed to maintain a semblance of normalcy since the gold standard was abandoned in 1971, it has built an incredibly fragile and ever-expanding house of cards, by which I mean debt, of which there is only one real way out; a sharp contraction of credit, a long-recession, and a much less dollar dependent global economy.
Since the dot-com bubble's collapse, or perhaps before, the Federal Reserve has been paving the way for this outcome. Every crisis, dot-com, housing, and more recently COVID, is met with the same response, more fiscal and monetary stimulus. In other words, cover the problem with a mountain of debt. Debt has, in fact, become systemic, which is why there is no way we can "normalize" policy without a big shake-up.
The Federal Reserve is in a Catch-22 situation because it can't normalize policy without destroying the economy, but not normalizing will also eventually destroy the economy. There are at least 3 reasons the US cannot return to normal monetary policy anytime soon:
For starters, corporations, and households, in America have become reliant on cheap debt.
The chart above shows the debt-to-GDP ratio, which has increased by over 50% since 1995. This is becoming an even bigger problem as growth slows and debt keeps increasing due to interest payments.
The same can be said of the Federal budget:
We now have nearly 140% of debt to GDP. This graph is not just increasing, it is increasing exponentially, and there is nowhere else it can go. Every year, the population gets older and social security costs to increase. More debt is the only way to sustain the current status quo.
This leads me to my third point, which is that a significant change in policy, i.e. normalization, would completely disrupt society and probably lead to political turmoil, which the Fed would want to avoid at all cost.
There are two possible ways that this can play out.
First of all, the Fed could swallow the pill, raise rates and cut off QE for good. What would happen in this scenario? Mortgage rates would be much higher, which would deflate the housing market. This would have a real impact on consumer spending, which would affect companies. These companies would be forced to reduce their activity and level of debt simultaneously. Many wouldn't be able to keep operating without the possibility of refinancing their lines of credit, which are not subject to much higher interest rates. To cope with these higher rates, the deficit would have to be reduced sharply, which would further depress economic activity.
Ultimately, the economy would suffer a 1930s-type depression, caused by a big credit crunch. Most likely, at some point in this cycle, the Fed would once again try to improve the situation by inflating the bubble again. However, the only thing that would inflate away is the value of the currency. The US could, and probably would, monetize Treasuries, but the rest of the economy, deep in a fully-fledged deleveraging cycle, would not respond to stimulus. The private sector would refuse to create more debt, and only once the dust has settled, and the system has been cleared of the excesses of previous decades could the US return to a semblance of normalcy.
We are getting a taste of this now, but I don't think the Fed will allow a full-blown implosion. The more likely scenario is that the Fed will, at the very least, try to keep the game of musical chairs going. The Fed will tighten for a bit, but it will eventually have to return to quantitative easing and 0% interest rates as the economy stalls and the debt/GDP levels threaten to become unsustainable.
Now, the Fed can likely get away with this for some time, and it has already been because the rest of the world is also in the same trap. Despite unprecedented levels of QE, the US dollar continues to be held as the world's reserve currency, and it is paradoxically stronger than ever, at least when compared to other currencies.
So as long as we all agree, we can continue to inflate our debt away forever, but history shows that, eventually, something will move the needle enough to cause a shift. A shift which would likely end up pushing us into scenario one again.
In the first scenario, Bitcoin would serve as a means for the rich to preserve their wealth and protect themselves from exposure to the dollar, which at this point would probably be facing a collapse. The USD has managed to hold its value due to the fact that it is the world's reserve currency and is supported by the world's most prosperous economy.
However, with the US economy in disarray, it's only normal to assume that this would cast a shadow of doubt over the US dollar, given the possibility of some kind of default in US Treasuries. It's likely that foreign countries would sell Treasuries en masse, which would cause a run on the dollar, and would see it replaced by some other standard of value.
As an American, holding Bitcoin would be one of the most convenient ways of maintaining global purchasing power. In fact, a collapse of the US dollar could bring sound money alternatives like Bitcoin and gold back to the forefront of the world economic system.
In scenario number 2, where the Fed continues to print money ad infinitum, or at least tries, Bitcoin would also fare very well. The continued oversupply of dollars would cause a steady loss in the value of the currency. This could go on for decades, with assets steadily increasing in value while purchasing power dissipates. Instead of deflating the debt away, we would be inflating it away.
But with inflation becoming a constant affair, people would quickly begin to turn to alternative assets, which would exacerbate inflation even more. Eventually, once systems are in place to replace the dollar, the world would turn its back on the US currency, probably in favour of a commodity-backed currency.
The American government could try to defend the USD value, but it would inevitably lead to scenario 1, where the US economy enters a deflationary credit crunch.
In either case, we'd find ourselves in a situation where the US dollar eventually loses its value and place in world hegemony. Once again, Bitcoin and other limited resources like gold, land and oil would be the best place to be invested when this happens.
The great thing about Bitcoin is that it can act as a "risk-on" type asset while the current debt bubble continues, but once it bursts, it will become even more valuable due to its use as an alternative currency and store of value.
This may seem far-fetched right now, but there is clear evidence of Bitcoin's value all around us. Bitcoin is being used in many places where currency and political stability are not guaranteed, like in Africa.
More than that, though, if we get a system-wide failure like many have been talking about for years, Bitcoin not only becomes a store of value but potentially the most helpful tool we could have to rebuild our financial system.
Bitcoin already has a financial system of its own, which is largely insulated from outside shocks. Onboarding is easy, anyone can join the Bitcoin network, and the system is self-regulating. This is the magic of decentralized systems.
Bitcoin and the DeFi ecosystem built around it and other cryptocurrencies could become the lifeboat that the world needs during its darkest hour.
In conclusion, no matter what the Fed does, Bitcoin is a must-own. In the best-case scenario, for them, we keep the music going for the next 100 years. In that time, though, the dollar would suffer a steep loss of value, while Bitcoin would continue to appreciate due to its limited supply and its increased use as a store of value.
However, more likely sooner rather than later, we could see a big credit crunch and a sharp fall in the value of the USD. At that point, it will become clear to those not holding Bitcoin just why owning it is so important.
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Disclosure: I/we have a beneficial long position in the shares of BTC-USD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.