Are Central Banks Running Out of Fire Power?

Central banks continue to attempt to raise interest rates in order to combat inflation. On 27 July the FED raised rates by 0.75%, the second such increase in as many months. Today the Bank Of England raised their rates by 0.5%, the biggest rate rise in 27 years.

Despite this double whammy of bad news for risk assets such as crypto, we saw crypto markets gradually continue to rise over the period. Some are speculating that this is because the FED is already signalling that rate increases will be of limited duration. 

Whilst the rhetoric is around rates going up and up, the reality is that key central bank rates have been falling for 40 years as we can see below.

Even though central bank rates are increasing, they are not remotely close to the inflation rates we are now seeing. Inflation is currently 9.1% in the US, 8.9% in the Euro zone and 9.4% in the UK. That's if you believe the official figures, as many governments have adjusted their methodology for calculating inflation to make it appear lower. Shadow Stats put US inflation at over 12%, using the 1990 methodology. Some people think the true rate of inflation in the key global economies is closer to 20%.

Traditional economic wisdom would require interest rates to be raised above the level of inflation in order to get prices under control. We are not even remotely close to that level. Right now, the European Central Bank is fighting inflation of 8.9% with an interest rate of a whopping 0%.

40 years of economic insanity is starting to come to a head. The 2008 financial crisis was the first warning that the system was starting to creak. Since that date, governments and central banks have kicked the can down the road by maintaining rates at close to 0% and embarking on massive money printing programmes. The result is huge government debt piles, as well as massive corporate and personal debt.

Central banks can't raise rates by any significant amount as it causes the interest payments on government debt to increase exponentially. Rate rises also cause recessions. Even if you want to pretend there isn't a recession by changing the definition, these periods reduce economic activity and decrease tax receipts, placing the government under even more pressure.

Time after time, the central banks have threatened to keep raising rates before eventually backing off. In economic history, every time a government has faced a currency crisis and has had to choose between sound money or printing, they have always chosen to print.

So what does this all mean for crypto? Well, it looks like inflation is here to stay, and it also looks like the central banks are already hinting at running out of firepower. So it's possible that we'll see the banks easing rates later this year which will put some confidence back into risk assets such as crypto.

Meanwhile, the narrative around crypto as a hedge against inflation gets stronger. Crypto might be seen as risky, but keeping your wealth in fiat currencies and being guaranteed to lose 10 to 20% per year is also risky.

So here at DeFinda we are cautiously optimistic about the future for crypto prices.

BlockFi Rate Increases

Meanwhile, we are also starting to see signs of life in crypto yields. BlockFi has just increased its savings rates by 0.5% on large cap cryptos and by 2% on Uniswap.

We welcome any feedback, so please just email us at info@definda.com if you'd like to get in touch.

Matt & the DeFinda team