Recession vs Hyperinflation? This is the dilemma Powell and Co. needs to solve. And they need to come up quickly with a plan. The longer we wait for a clear cut decision, the more costly and painful the result will be. Is there a way to avoid recession and save the greenback?
The origin of money
It is difficult to situate the origin of currency in history. But, the consensus is that in the second millennium BCE, somewhere in the Middle East, along the Euphrates River in present-day Iraq, local monarchs used barley as currency. Barley and other grains were loaned by the monarch to farmers, who paid it back after the harvest with interest.
A currency backed by grains can quickly depreciate if the crop is overly productive over a period of time.
The Bronze Age brought metal currencies into the picture. Precious metal-backed money was the key economic driver from Antiquity until modern times.
With the introduction of fiat currencies, governments adopted what is commonly known as the “Gold standard” throughout the modern era. The Gold standard refers to a country’s monetary policy where its fiat currency has a value directly related to gold.
When President Nixon put an end to the convertibility of the US dollar to gold, the global economy (except for the ex-Soviet bloc) moved into a new paradigm. Developed countries adopted monetary policies with “no standard”, whereas there are no upper limits on the monetary base. Thus, governments can print currency depending on their policy and the market’s supply/demand.
The new standard
COVID-19 tested the limits of the “No-standard” monetary system. The reality of rampant inflation shows that a limitless monetary base puts the real economy in a precarious situation. Central banks have currently very limited or virtually no options. Tackling inflation means that the world may need to prepare for a severe recession. Allowing hyperinflation means that ultimately convertible currencies will become worthless.
The only “fix” is to repeal and replace the current currencies with a new version. For instance, the US Dollar would be replaced with a more recent version called US Dollar 2.0. Central bankers mention more and more the need for digital currency. Most currencies are already digital, so this is a cheesy way to say that we need to replace a falling currency with a new one.
Crypto-currencies have existed for almost a decade. It would not be outrageous to think that the easiest way towards a digital currency is to develop a new standard where crypto-backed currencies are used. The new standard would be a crypto-standard, and central banks could issue as much currency as their crypto reserve allows.
The Russian invasion of Ukraine has put an end to the globalisation we have experienced over the last three decades. A less-discussed aspect of the war is its potential impact on accelerating digital currencies. The war will prompt countries to re-evaluate their currency dependencies and impact on accelerating digital currencies ... A global digital payment system, thoughtfully designed, can enhance the settlement of international transactions while reducing the risk of money-laundering and corruption. Digital currencies can also help bring down costs of cross-border payments, for example when expatriate workers send earnings back to their families. Larry Fink, Chairman and CEO of BlackRock
The stock market delivered small positive yields over the past week, amid a low level of new claims for unemployment benefits in the US. The Fed’s intention to act vigorously against inflation is not scaring investors. The average retail investor perceives the stock market as the best hedge possible for inflation. Oil prices reversed trajectory and moved north after a strong rally. Overall, markets expect an unprecedented increase in commodities princess across the board, driven mainly by scare supply.
The beginning of the year brought turmoil on the crypto-market, but the war in Ukraine and the seemingly uncontrollable inflation are generating momentum for the leading crypto-currency. Bitcoin prices bolstered near 45,000 USD amid more speculative announcements concerning digital currencies going mainstream. The only persistent issue is that Bitcoin prices are still coupled with the stock markets, and any major economic downturn can put cryptos on a bearish pattern.
10 year Treasuries
Ten-year Treasury yields climbed for a second week in a row near 2.50%.
Investors ingested Jerome Powell’s announcement concerning Fed’s strategy
against inflation. The overall message is that the Fed will speed up the
interest hike to curb the spike in inflation. A 0.50% hike for May is on the
table, and it is good news for fixed income investors. Moreover, it shows
that equity investors may be on a path of de-risking their portfolio and
moving slowly towards Treasuries.
The Dow Jones Index ended the week into positive territory, above 34,850. After the initial turmoil triggered by the war between Ukraine and Russia, the market calmed down and showed signs of optimism.
Bitcoin ended the week above USD 44,500, moving back into a coupling mode with the other markets. The leading cryptocurrency showed resilience amid a critical situation.
The Gold ounce ended the week on a positive note, near USD 1,960, as investors started to price inflation more seriously. However, the foreseeable commodities crisis and the inflationary context are good arguments for a rally in gold prices.