Does Bitcoin Have a Role in a New Macroeconomic Era?

A great rebalancing between governments, central banks and the concept of money hangs in the balance and Bitcoin may take on a more relevant role than imagined.

When inflation was well below central bank targets of 2%, policymakers lamented (but not really) how they were struggling to stoke price pressures despite rock-bottom interest rates.

Years of low interest rates coupled with low inflation had lulled many policymakers and populations into a collective slumber on the mistaken belief that both low inflation and low interest rates were a feature, not a flaw, of the low-growth, low-rate decades post-2008 Financial Crisis.

But a new macroeconomic era lies on the cusp and it’s not hyperbole to say that the world economy is on the brink of a shift as consequential as Keynesianism was to the post-Second World War economy or the pivot to free markets and globalization that marked the 1990s.

Whether the global economy is able to skirt the low-growth trap of the post-2008 Financial Crisis and tackle major problems such as ageing and climate change, or financial chaos is unleashed because of broken central banks and untethered public spending remains to be seen.

The ructions in the markets of the past several weeks are of a magnitude not witnessed for a generation and do not bode well for the immediate economic horizon.

Caught flatfooted on inflation, the U.S. Federal Reserve is ratcheting up interest rates with aplomb, increasing borrowing costs at the fastest pace since the 1980s, and leaving a path of destruction and dashed foreign currencies in its wake.

With the dollar at its strongest in two decades, the Japanese yen has plumbed depths hitherto considered unthinkable, and the euro dipped below parity with the dollar for the first time since its inception.

The British pound was hammered to such an extent that the Bank of England was forced to shore up the market for gilts (British sovereign debt), pledging to soak up billions of pounds to stabilize its bond market.

Global shares have dropped by 25% in dollar terms and are on track for their worst year in almost four decades while Bitcoin has slumped over 60% from its all-time-high achieved last November.

Alongside a global US$40 trillion rout, there is a gnawing sense that globalization is heading into retreat and the rules-based world order is being upended, as evidenced by Russia’s invasion of Ukraine.

If the rumble of Russian tanks crossing into Ukraine may have marked the definitive end to the idyllic age of globalization, then the quiet panic in credit markets may silently signal an end to the economic placidity of the 2010s.

A New Dawn of Financialization

In the wake of the 2008 Financial Crisis, investment by private firms was lackluster, even at firms making monster profits, while governments still reeling from the fiscal burdens of bailouts showed no appetite to pick up the slack.

Public capital stock actually shrank in the decade after the 2008 Financial Crisis, which explains to some length why economic growth was sluggish and inflation was low.

Because the private and public sectors were doing so little to stimulate economic activity, the responsibility to reflate economies fell to central banks, which are particularly ill-suited to fix a non-financial problem.

Lack of investment can’t be fixed with financialization, but armed with only a hammer, that’s precisely what central banks proceeded to do, holding interest rates at rock-bottom levels and hoovering up huge volumes of bonds at any sign of trouble.

The result of course was a staggering financialization of the global economy that created an outsized role for central banks and those who prosecute their policies, one which they were and continue to be, ill-suited to fill.

On the eve of the pandemic, central banks in the U.S., Europe and Japan already owned a staggering US$15 trillion worth of financial assets, but the equivalent of a financialization Armageddon lay just on the horizon.

In response to the unmitigated economic challenges of a global pandemic, central banks once again stepped in with unprecedented actions which helped to trigger current inflationary conditions.

From government “airdrops” of money to backstops and bailouts, free money temporarily skewed consumption patterns and snapped already stretched global supply chains.

What Happens Next?

Unlike the 2008 Financial Crisis, the next calamity isn’t likely to come from banks — most are far better capitalized and risk-managed than before 2008.

Instead, the next crisis is likely to come from a far more opaque and difficult to address source — the credit markets.

Whilst sovereign debt markets make headlines when they gum up, seizures in the markets for commercial paper and other over-the-counter borrowings which make up the lifeblood of the global economy tend to remain far away from the spotlight and are far more challenging to fix.

As firms that buy debt shy away from risk and the interest rates on everything from mortgages to junk bonds soars, the ability of companies to run operations on credit becomes an increasing issue.

Buyers are already backing away from what were once assumed to be the most liquid and deep credit markets in the world — that for U.S. Treasuries — imagine what is happening beneath the surface for other “lesser” types of credit.

If credit markets stop working smoothly, or worse, altogether, impeding the flow of credit or threatening wider contagion to the broader economy, many assume that central banks will step in.

The Bank of England was the first to blink after it started buying bonds again, undermining its move to raise interest rates, but a necessary intervention to stabilize bond markets that had been thrown into chaos through a combination of a collapsing pound and obscure derivative bets made by Britain’s pension funds.

It’s been widely assumed that if Treasury markets should freeze up, the Fed will unwind its US$60 billion-a-month asset roll off and re-emerge as a buyer of last resort, but there’s no guarantee that such intervention will be timely or effective before serious damage is done.

Inflate This

If bond markets become untethered, one concern is that central bank intervention will contribute to already high inflationary pressures, making matters worse.

While talk of such intervention stoking inflation are relevant, they may also be alarmist — the odds are that inflation in the U.S. will fall from the present 8% to around 4% sometime in 2023, as energy prices ebb and higher interest rates eventually bite.

But the main concern isn’t whether inflation will soar to 20% (unlikely), but if it will ever return to central bank targets of 2% (idealistic).

There’s every reason to believe that inflation is unlikely to return to the halcyon days post-2008 Financial Crisis and that’s because a structural rise in government spending and investment is under way.

Whereas the 2010s saw tepid public spending, ageing citizens will need more healthcare, and Europe and Japan are arming themselves again to counter rising threats from Russa and China.

Climate change and the quest for food and energy security will boost state investments in self-sufficiency and where impossible, the securing of alternative sources either through renewables or offloading facilities.

Industrial policy, which languished against assumptions of a globalized supply chain is now likely to feature front-and-center on many government agendas.

But even as government spending rises, ageing populations in rich economies will cut spending, as older people set aside more of their incomes thus acting to depress underlying real interest rates.

The result of course is that despite all the wrangling about central bank hiking, real interest rates are likely to continue to be low for the next decade and well into the 2030s.

For central bankers, this creates an acute dilemma — should they stick to the original script of 2% inflation which will necessitate a recession and possibly a return to the low-growth, low-rate trap of the 2010s, or chart a different path?

One possibility of course is for policymakers to recognize that 2% inflation targets are not just arbitrary, but unachievable without high human costs in the form of job losses, fierce political backlash and social instability.

Instead, central bankers could try to sell a “4% target” as a “Goldilocks” solution — giving policymakers the headroom to cut rates in a downturn, but also reducing the need to go on a bond-buying rampage whenever anything goes wrong, which causes even more distortions in the economy.

When inflation has been burning white hot at 8%, 4% seems like a good deal and could be a relatively easy sell, but the solution is not without consequences.

For one, central bankers will have their credibility permanently undermined — if 4% inflation is an option, why not 6%?

And moving goalposts also upends many long-term investment decisions which make assumptions about expected rates of inflation.

Decades of investment decisions and contracts inked on the promise of 2% inflation would be disrupted, while even mildly higher inflation would once again redistribute wealth from creditors to debtors.

Yet these trends have been in play over the past several decades anyway.

A New Epoch

Years of low real yields and underperformance of standard 60/40 stock and bond portfolios have led to outsized risk-taking to goose returns.

Investors having to contend with negative real yields have long accepted higher levels of risk with the promise of not just beating inflation, but coming out ahead.

A recent Bank of America survey of wealthy Americans aged 21 to 42 and with at least US$3 million in assets reveals that younger generations increasingly think a traditional portfolio of stock and bonds is not going to deliver above-average returns over time.

Against this backdrop, the immovability and immutability of a nascent asset class like Bitcoin may rise in attractiveness, especially if the promise of bigger government spending gives rise to a cadre of profligate populist politicians, making reckless and poorly executed investments in energy, agricultural and industrial policy.