Inflation & Interest rates...
You guys have no doubt seen the very recent news about the FED's decision to hike interest rates as a bitter measure to curb inflation. The crypto markets have experienced some volatilities in response to the news but I thought it was a good chance to share a bit of an educative article on how interest rates work and what they have to do with inflation
I'm not a financial expert or anything, but being in crypto for several years has taught me a thing or two about economics and provided me with the passion for sharing them. So, without further ado, let's get started...
What is inflation?
source
Inflation, in simple words, is the gradual weakening of a currency and the subsequent increase in the prices of goods and services in an economy. It's something inherent in all global economies due to governments printing money. Inflation is what steals the buying power of people and makes it hard for businesses to set the right price for their products and services and for people to plan their spending. Looking at history, we can see countless examples of currencies losing their values over time. The big elephant in the room though is no other than the US Dollar...
Is it a good or a bad thing?
On the face of it, there is no doubt it is a diabolical plot that robs us of all the fruits of our labor and effort, and it actually is. That is why we love BTC and see it as the lifeboat from the sinking fiat ship. But the thing is there is a bit more to inflation than meets the eye. In fact, economists say that inflation, if controlled, is not always a bad thing. Why? well... think about it. If inflation was nonexistent or it was too low, then people wouldn't be encouraged to spend their money, rather they would tend to save more and spend less in anticipation of lower prices. In other words, they would see money the same as they see gold or BTC. And as you might have imagined, the end result of such a scenario might be to impede the growth of the entire economy. That's why governments and economists would rather try and keep a certain percentage of inflation in place. To push people to spend their money and thus spin the wheel of the economy...
What is the "perfect" percentage of inflation?
According to most policymakers, an acceptable inflation rate is "around 2% or a bit below"
What are interest rates?
In a nutshell, interest rates are the cost of borrowing or the reward of saving. It basically tells you the additional amount you should pay/get if you borrow/lend money. Let's take the current interest rate in the US as an example. As you might know, The FED has set its benchmark rate as 2.25%. So, if you get a loan for say $1000 from a bank, then the additional amount you should repay is 22.5 (1000*2.25%) on top of the initial 1000 you've borrowed. So, the total amount is $1022.5.Vice versa in case you save money in a bank.
The inverse relationship between inflation and interest rates...
Now, we can get into the most important part of this post and that is the mechanism governments use to keep inflation under control and the side effects of that mechanism. You know nothing is perfect after all.
Alright, the mechanism is simply toying with interest rates. When inflation is too low, governments tend to lower interest rates which encourages people to spend more but save less, because it is cheap to borrow but less rewarding to save. As a result, people become more daring to throw their money on products, cars, restaurants, vacations...In general, demand is growing more than supply which gradually brings prices up and so does inflation. On the other side of the spectrum, when inflation is too high as it is now, governments tend to raise interest rates which makes borrowing more expensive and saving more rewarding. This encourages people to save more and spend less and as a result, demand for goods and services goes down which in turn pushes prices down as well. In other words, lowers inflation. However, this also harms the economy and causes businesses to cut costs and lay employess off...in the worst case, it might cause a recession. And speaking of recession, we might have already entered its territory, according to yesterday's GDP numbers!
Hi @qsyal
The objective of the FED to increase interest rates, is related to decrease production, if you ask me that is like stop producing the food, goods and services that humanity needs, is something out of any common sense, that only reaches to give stability to the rich countries, but that puts in trouble the weaker ones.
Best regards, be well.
Rich countries always try to survive and thrive at the expense of weaker ones. It has always been this way since the dawn of history...Not too nice but it's reality...
Thanks for stopping by...Have a good day :)
Your post was upvoted and resteemed on @crypto.defrag
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Thank you for the support :)
Dear @qsyal
I haven't been here for a while and I'm glad to see that you're still around. Still publishing interesting and engaging content.
It came to me as a surprise to see, that markets rallied and pumped after FED announcement. It's like most investors expected that bad news coming from FED will be even worse. And markets pumped in relief that it's not as bad as it could be.
That's at least how it does seem to look like a bit.
While talking about definiation of inflation: did you hear people calling inflation to be a "hidden tax"? I surely see it that way.
I would expect that USD will maintain its position as long as transactions for oil will be conducted in USD. Which is forcing all countries to use USD as a reserve currency.
Also it's worth to mention, that entire world in in debt in ... USD. So demand for that currency will probably continue for many years ahead of us.
Yours, Piotr
Welcome back @crypto.piotr, it is nice and encouraging to see you active again :)
It was a surprise to me as well. How could a piece of bearish news trigger a bullish wave?!! If anything, this also reflect how pessimistic investors were about the FED and its decisions...
Thanks for reading and have a good day :)
The only explanation I could have is that "market" expected even higher raise of interest rates. Many people seemed to expect 1.0 point increase . Instead we ended up on 0.75
perhaps that's the reason
It's me again @qsyal. Just wanted to add something to my previous comment:
You mentioned interesting part:
Indeed that is a good point. Can you imagine situation in which money supply is fixed, but amount of goods and services would be growing? That could (and most likely would) result in deflation.
And deflation seem to be worse than high inflation, recession or even staglation. It is the moment, when people do not want to use their "money" to buy goods and services because they expect that price of those goods/services will only go down
Wouldn't you agree?
ps. great post. Upvoted already.
Cheers, Piotr
You're totally right. Some sort of balanced inflation is needed to encourage people to spend and the economy to spin.
I think it is a bit of a dilemma to pick which one is the worst... They are all so bad for us and for the entire economy. In Syria for example, we've experienced horribly high inflation over the last 10 years. Inflation that kicked goods and services up about 100x! It led most people to stop buying, not because they expect the price of those goods/services to go down, but because they simply no more have enough money to buy
Thanks again for reading and supporting :)