The United States Federal Reserve raised the interest rates a quarter of a percentage point. It doesn’t sound like a lot. Interest rates are still extremely low but what does this actually mean and why are they doing it?
Normally when a government wants to stimulate investing and business they lower interest rates. This makes borrowing cost lower thus allowing people to take out more loans and spend more. We can really get a good feeling of something like this when we look at the real estate or auto industries. Cars and houses are leveraged based assets and do much better when borrowing costs are low because not too many people can afford to buy these things outright.
The problem with lowering the interest rate is that it also lowers the value of the currency. Interest rates have been kept artificially low for a very long time and has lead to a significant erosion of purchasing power of the US dollar. Another problem is that by having low interest rates which equal low yields on our debt that we sell in the form of bonds which no one is currently interested in buying. We’ve had to instead create money to purchase our own debt that makes our debt even larger. It’s pretty ridiculous but necessary to keep our economy going.
With our debt growing at a rapid pace we are raising interest rates to try and create interest in buying our debt since it has lost interest from most investors. This is a difficult balancing act because on the one hand we need outside investment in our debt to keep things going so we have to have rates that would support that. But, because our economy is on life support we need to have low interest rates to keep our consumer based economy going. Something has got to give at some point.
So, how does this relate to crypto currencies? Cryptos in a sense were created to prevent what I just detailed is happening in our debt markets. The blockchain keeps all parties involved honest and is decentralized which would stop one person or country from monopolizing it. These are all very good attributes but it should be noted that the low interest rates and the creation of fiat currency was also the leading cause of the cryptos rising in value. I don’t mean that in an inflation context, I mean that in a context of allowing for the market to have an unprecedented risk appetite by back stopping their losses.
Let’s think about the context of our economic environment, the governments around the world are willing to (and have been) propping up the markets from losses for the past 10 years straight. Up until a couple months ago the Dow Jones Industrial Average index hadn’t even had a single down day of at least 1% in over 2 years. The amount of manipulation is astonishing. This was also the environment that pushed the price of bitcoin to over 20k as well as other crypto currencies to extremely high valuations. The price spikes weren’t because of inflation because that didn’t kick in yet, it was due to the massive amount of risk appetite.
Now, with the US government raising rates (they plan on doing 2 or 3 more this year) this will slowly kill market liquidity. By that I mean the ease in which we borrow money. This in turn will choke out the risk trade. The pace of this may be contingent on a lot of different factors but this is the general idea. The US government may decide to change their mind if this happens. I don’t think they would continue if the market starts to tank but then again they are running out of options.
Just some of my thoughts I wanted to share. I could be wrong. There are some very clever people working in the banking sector (and some not so clever). I’m in awe of them keeping this thing going as long as they have, maybe they can hold it together a bit longer?
Image source: reverse.mortgage