by Jamie Holmes
Almost ten years since the global financial crisis and interest rates are still very low in the US. Higher inflation to reduce the debt load and the realization of the true state of the US economy may spark a positive fundamental driving BTC-USD to new highs over the medium term.
Never for so long have interest rates been so low. On July 26, the FOMC, the rate setting committee of the Federal Reserve, will outline its plans for 2017, with most expecting no further interest rate increases until December 2017. However, with the debt-to-GDP ratio at an all-time high for the U.S., in excess of 100 percent, any further rate increases will hurt the economy.
In a recent semi-annual meeting, Janet Yellen conceded that stock markets are overheated; she stated that there are “strong valuation” pressures across a variety of assets. The Fed have been slower than the market when it comes to the expected interest rate adjustment path, only just catching up with the market's anticipation with a June hike, and the central bank appears dovish going forward.
One problem that has persisted since the global financial crisis is debt and if rates go any higher than 2 percent in the US, it could cause another major recession. Credit creation by commercial banks is starting to slow down which will act as a drag on demand. The federal government also faces up to another debt ceiling, which stands just above $19 trillion and may be raised even further.
There are several ways to reduce debt-to-GDP; increase economic activity, which has proven to be difficult over the past decade, with a shrinking workforce and declining productivity. Alternatively, the economy could target higher inflation, which would erode the debt in US dollar terms. Other avenues are to write off the debt and use tax revenue to pay it off, both of which are unlikely.
Eliminating debt using inflation now seems to be the Federal Reserve’s goal. By tightening monetary policy any further, the negative consequences on the economy could become disastrous, with the U.S. unable to service any of its debt and risk losing its safe haven currency status.
If liquidity is not drained from its balance sheet, or is done very slowly, and rates are not to be above 2 percent will allow them to do this. Investors should take away from this that normalization of monetary policy is going to kicked down the road further and will take longer than expected, as policymakers face a growing stock market bubble on one hand, and a sharp, protracted recession if they raise rates.
Rates should have been raised toward more normal levels of around five to six percent a long time ago. By enforcing an ultra-loose policy, much of the economic activity has become reliant on easy money and we have many ‘zombie’ businesses operating. Even the Bank of England had realized this, recently stating that productivity levels would be around one to three percent higher had they raised rates to pre-crisis levels, however, they also state that this would have resulted in higher unemployment. But this unemployment may have just been a temporary price to pay, and would later be reabsorbed back into more productive industries unreliant on easy money.
To inflate the debt, the Fed will hold off from any more rate hikes until 2019, barring perhaps one in December 2017, and we should see the US Dollar weaken against currencies over the long term, with the euro, other G10 currencies and even emerging market currencies making gains in 2017. Bitcoin will also look a lot stronger against USD over the medium term, based on an inflation differential, and this should contribute to an stronger upward fundamental for BTC-USD. Also, for the first time in history, we could be seeing an important shift in this differential. Below show calculations of the inflation rate per annum present in the Bitcoin economy.
We see a decline from 7.2 percent per annum in 2016 to 4.2 percent in 2017, and is expected to fall further to 4.0 percent in 2018. Using the Shadow Government Statistics to calculate the true inflation of the US economy, we see that is around six percent, so it could be correct to assume that this fundamental shift has already occurred.
Economists from the Center for Economic and Policy Research examined the use of the inflation mechanism to handle debt-GDP ratio in 2009, with their findings suggesting that inflation levels of around 6 percent for four years could reduce debt-GDP by 20 percent. Once then debt burden is relieved somewhat, then monetary policy normalization can continue, but note it is estimated to take four years of 6 percent inflation just to get the debt-GDP ratio around 80 percent.
From its inception until 2016, bitcoin has displayed much higher inflation rates but with a decreasing rate, which is only starting to fall below the annualized inflation rates of economies such as the US and the UK. If the Federal Reserve makes it clear of little intention to unwind their balance sheet significantly, inflation may be used as a tool to deal with the debt problem, which will only galvanize the attractiveness of bitcoin to investors and traders. The Fed has more credibility on the line at the moment and with many foreign investors in US debt, especially China and Japan, it is very tempting for them to erode it by encouraging inflation; but it could easily go wrong and accidentally slip into double digit inflation like it has done so many times in the past.