Crypto Pundits Romance the Hyperinflation and Dollar Death Narrative. Is it a real scare?

Narratives among crypto bulls are volatile except for one: Bitcoin (BTC) is an antidote to unconventional monetary policy by the Federal Reserve.

It has recently reached a fever pitch on Crypto Twitter, thanks to venture capitalist and angel investor Balaji Srinivasan saying he would bet that bitcoin will reach the $1 million mark within 90 days. The former Coinbase CTO also predicted a US banking crisis that would crash dollars and trace hyperinflation – a too rapid increase in the prices of goods and services. The US dollar, the de facto global reserve currency, has yet to suffer through this kind of extreme devaluation.

Balaji’s prediction follows the Fed opening liquidity withdrawals in the form of dollar lending programs to limit banking sector volatility in the wake of the Silicon Valley Bank collapse. Similar forecasts predicting Weimar Republic-style hyperinflation in the US made a lot of noise after the Covid-spurred crash of March 2020 and the global meltdown of 2008. On both occasions, the Fed poured trillions of dollars into the system through outright asset purchases or quantitative easing easing (QE).

Hyperinflation is almost always caused by a large amount of money “chasing” the same amount of goods and services supplied in an economy. In other words, the money created through QE or other measures must be spent on the stagnant stock of goods and services to increase inflation. Assets such as stocks or cryptocurrencies can hyperinflate in terms of valuations if the newly created money enters the financial markets instead of the real economy (as it did after the crashes of 2008 and 2020).

The Fed’s latest measure – the Bank Term Funding Program (BTFP) – is not QE, although it has caused a QE-like expansion of the Fed’s balance sheet.

“There is a lot of confusion and exaggeration out there about the implications of the US government’s actions to stop the banking crisis. It is not QE [quantitative easing] and while inflation will remain sticky, it will not be hyperinflation,” Martha Reyes, a member of the advisory council at the Digital Economy Initiative, told CoinDesk.

In QE, the Fed intercepts government bonds and mortgage-backed securities from financial institutions without any predefined holding period. When the Fed buys bonds from a bank, the latter’s cash holdings at the central bank increase, giving it a liquidity cushion and greater incentive to lend. Increased lending then encourages more spending and investment, and puts upward pressure on prices either in the real economy or in the asset markets.

Under the BTFP, the Fed lends money to banks to allow them to meet their immediate financial obligations. The banks need liquidity to service the flight of deposits after large interest rate increases by the Fed. A lack of liquidity can lead to extensive bank runs, a disastrous outcome.

The borrowing banks have to return the money after a year along with the interest charged according to the overnight index swap rate plus 10 basis points. It’s not free money like QE!

“BTFP is not QE. It is a program to help stabilize bank liquidity. This new BTFP program will allow banks to pledge [Treasurys] or mortgage loan against immediate liquidity for up to one year. It is a liquidity program that is available in times of stress and is short-term,” emerging market trader and analyst Seng Liew said in a LinkedIn post.

“Conventional vanilla banking is about the mismatch between deposits and assets. In SVB’s case, they had deposit redemptions of $42 billion, which is just over 20% of the bank’s assets when Silicon Valley left them in one day. That caused the failure, not investment in the assets. Since the pandemic corporate loan growth has been mediocre away from the huge increase under the PPP lending program, so most banks invested most of their liquidity in the U.S. [Treasurys] and mortgages,” Liew added.

In other words, the money received from the Fed in the form of loans through the BTFP or other programs such as the discount window is unlikely to be used in a way that will lead to stimulus in the economy or financial markets.

“QE expands the balance sheet for monetary purposes. This is about financial stability, and any expansion of the balance sheet is not QE,” Marc Chandler, market strategist at Bannockburn Global Forex and author of “Making Sense of the Dollar,” told CoinDesk in an e- mail.

Hyperinflation predicted by Balaji could also materialize through a sharp, sudden devaluation of the dollar. Currency devaluation imports inflation from abroad, and increases the general price level in the economy.

However, history tells us that investors tend to flock to dollar-denominated assets in times of stress, including those caused by sovereign problems.

The dollar index, which measures the dollar’s value against major currencies, rose 11% in the second half of 2008, even as Lehman Brothers collapsed, causing worldwide contagion. The index stabilized in the 75-90 range in the following years, even though the Fed did several rounds of QE. The dollar fell 11% in ten months after the Fed reopened the liquidity floodgates in March 2020, a notable devaluation but far from the outright hyperinflationary crash.

“In the event of a widespread banking panic, which seems unlikely at this point, there would likely be the typical rush by investors to safe assets like US Treasuries. That would likely help rather than hurt the dollar in the short term,” said Eswar Prasad, a professor at Cornell University, to CoinDesk, calling the hyperinflation forecasts “unduly hyperbolic.”

“It will be interesting to see if the narrative that crypto is perceived by investors as a safer asset than fiat currency holds up if the current turmoil in the banking system intensifies,” Prasad added.

A full-blown banking crisis, as predicted by Balaji, could actually lead to a credit freeze, as observed after the collapse of Lehman Brothers in 2008, and lead to deflation – a general decline in the prices of goods and services, typically associated with a contraction in the supply of money and credit in the economy. Deflation usually increases the demand for cash.

Banks are more likely to keep the money borrowed from the Fed to ensure healthy liquidity levels rather than lending it out.

Credit freeze refers to a situation where international interbank markets freeze and interbank loans beyond very short maturities practically disappear, reducing access to liquidity for households and businesses.

“Loans to illiquid institutions are lifelines, pure triage that cannot escape the banking system and manifest as velocity. They slow down the economy when lending at these banks freezes,” Danielle DiMartino Booth, CEO of Quill Intelligence LLC, tweeted.

Despite the obvious differences between QE and BTFP and the deflationary effect of an outright banking sector crisis, many in the market expect rapid price gains in bitcoin. The cryptocurrency has risen over 40% in two weeks.

Perhaps the disconnect from manifest reality is a result of Pavlovian conditioning – the behavioral and physiological changes caused by experiencing a predictive relationship between a neutral stimulus (ultra-easy monetary policy since 2008) and a subsequent biologically significant event (increase in risk assets).

Interest rates remained largely at or below zero between 2008 and 2021, with the exception of the Fed’s minor tightening cycle which saw interest rates rise by 225 basis points between December 2015 and December 2018. In addition, most central banks, including the Fed, embarked on several rounds of quantitative easing.

The long-standing relief bias has permanently linked the neutral stimuli and the subsequent event in the minds of investors. As such, every Fed move is either misread as QE or an early indicator of an eventual launch of QE.

Lyllah Ledesma contributed reporting to this article.