Crypto pundits are romanticizing the narrative of hyperinflation and dollar death. Is it real fear?

Narratives among crypto bulls are short-lived, except for one: Bitcoin (BTC) is an antidote to the Federal Reserve’s unconventional monetary policy.

It recently peaked on Crypto Twitter thanks to venture capitalist and angel investor Balaji Srinivasan, who said he would bet Bitcoin will hit $1 million within 90 days. Coinbase’s former chief technology officer also predicted a U.S. banking crisis that would plummet the dollar and fuel hyperinflation — an excessively rapid rise in the prices of goods and services. The US dollar, the de facto world reserve currency, has not yet experienced this type of extreme depreciation.

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

Hyperinflation almost always results from a large amount of money ‘chasing’ the same amount of goods and services provided in an economy. In other words, the money created by QE or other policies must be spent on stagnant stocks of goods and services to boost inflation. Assets like stocks or cryptocurrencies can hyperinflate in terms of valuations if the newly created money enters financial markets instead of the real economy (as was the case after the 2008 and 2020 crashes).

The Fed’s most recent move – the Bank Term Funding Program (BTFP) – is not QE, although it has led to a QE-style expansion of the Fed’s balance sheet.

“There is much confusion and exaggeration about the impact of the US government’s actions to contain the banking turmoil. It’s not QE [quantitative easing] and while inflation will remain sticky, it will not be hyperinflation,” Martha Reyes, a member of the Advisory Board for the Digital Economy Initiative, told CoinDesk.

In QE, the Fed snaps up government bonds and mortgage-backed securities from financial institutions with no predefined holding periods. When the Fed buys bonds from a bank, the bank’s cash reserves with 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 in the real economy or asset markets.

Under the BTFP, the Fed lends banks money to help them meet their immediate financial obligations. Banks need liquidity to service the deposit flight seen after large rate hikes by the Fed. A liquidity squeeze can lead to widespread bank runs, a disastrous outcome.

The borrowing banks have to return the money after one year along with the calculated interest rate according to the Overnight Index Swap (OIS) rate plus 10 basis points. It’s not free money like QE!

“BTFP is not QE. It is a bank liquidity stabilization program. This new BTFP program will allow banks to commit [Treasurys] or mortgages against immediate liquidity for up to one year. It’s a liquidity program that’s available in times of stress and is short-term,” said Seng Liew, an emerging markets trader and analyst, in a LinkedIn post.

“Conventional vanilla banking is about the mismatch between deposits and assets. In SVB’s case, they had $42 billion in deposit repayments, a little over 20% of the bank’s assets, when Silicon Valley left them in a day Investments in the assets Since the pandemic, corporate loan growth has been mediocre , apart from the huge increase under the PPP lending program. As a result, most banks invested most of their liquidity in the US [Treasurys] and mortgages,” Liew added.

In other words, the money the Fed receives in the form of loans via BTFP or other programs like the discount window is unlikely to be used in a way that will result in stimulus to the economy or financial markets.

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

The hyperinflation predicted by Balaji can also occur through a sharp, sudden depreciation of the dollar. Currency devaluation imports inflation from abroad and raises the general price level in the economy.

However, history teaches us that during stressful times, including those caused by government problems, investors tend to invest in dollar-denominated assets.

The dollar index, which measures the value of the greenback against major currencies, rose 11% in the second half of 2008 even as Lehman Brothers collapsed, sparking global contagion. The index stabilized in the 75-90 range in subsequent years, despite the Fed conducting several rounds of QE. The greenback slipped 11% in 10 months after the Fed reopened the liquidity floodgates in March 2020, a notable depreciation but far from an outright hyperinflationary crash.

“In the event of a widespread banking panic, which currently seems unlikely, there will likely be the typical investor rush for safe-haven assets like US Treasuries. That will likely help rather than hurt the dollar in the short-term,” Eswar Prasad, a professor at Cornell University, told CoinDesk, calling the hyperinflation forecasts “unduly hyperbolic.”

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

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

Banks are more likely to hold money borrowed from the Fed to ensure healthy levels of liquidity than to lend it.

Credit freeze refers to a situation where the international interbank markets freeze and interbank lending virtually evaporates beyond very short maturities, constraining the supply of liquidity to households and businesses.

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

Despite the obvious differences between QE and BTFP and the deflationary impact of an outright crisis in the banking sector, many market participants expect Bitcoin to make rapid gains. The cryptocurrency has rallied over 40% in two weeks.

Perhaps the disconnect from apparent reality results from Pavlovian conditioning—the behavioral and physiological changes induced by experiencing a predictable relationship between a neutral stimulus (extremely easy monetary policy since 2008) and a resulting biologically significant event (rise in risky assets). be evoked.

Interest rates stayed at or below zero for most of 2008 and 2021, apart from the Fed’s minor tightening cycle, which saw interest rates rise by 225 basis points between December 2015 and December 2018. Also, most central banks, including the Fed, began multiple rounds of quantitative easing.

The continued easing bias has permanently paired the neutral stimulus and resulting event in the minds of investors. As a result, any move by the Fed is misinterpreted as either QE or a leading indicator of eventual QE adoption.

Lyllah Ledesma contributed reporting to this article.

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