We all used to think that cryptocurrencies and decentralized finance were a world apart from traditional finance and the factors that affected it. Then the worst inflation in four decades hit. The US Federal Reserve raised interest rates. The stock market fell and so did crypto prices. Contrary to generally accepted beliefs, cryptocurrencies were not a hedge against inflation. Neither were they a safe haven in times of social unrest and financial distress. The prime mover in bringing on crypto winter was the US Federal Reserve. Is the Federal Reserve a threat to cryptocurrencies today?
How Fed Actions Affect Crypto Today
The crypto world has taken a break from crypto winter. Is crypto spring going to move on to crypto summer or will the Fed and higher rates send crypto back into an early winter? The answer revolves around how high interest rates will go and if higher rates will bring on a much-anticipated recession. The Fed has been more successful than many expected in bringing inflation lower without causing an immediate recession or high unemployment. Now it appears that the members of the Open Market Committee that sets interest rates is split between those who want to keep raising rates, pause for a bit, or stop raising rates altogether.
How the Economy Responds to Interest Rate Increases
Higher interest rates raise the cost of doing business. When rates go very high very fast companies lay off workers and put off any expenditure that they can delay. Consumers become very careful with their purchases. With fewer people with money to spend companies need to quit raising prices or even lower them. The effect is a slower economy. The extreme effect like when the Fed raised rates to 20% in 1979 is a quick and severe recession. This time around the Federal Reserve did not try to shock the economy with one massive rate increase. Rather they raised rates by a quarter or half percent per month. What they are aware of is that there is always a delay from when rates go up and the economy responds by slowing down. Their goal is to stop rate increases and let the economy keep slowing down to where inflation is no longer a problem. An issue in this regard is that the longer that even a low rate of inflation lasts, the more businesses and consumers get used to it. That, as much as a severe recession, is something the Fed really wants to avoid. And that will be the focus of arguments among Open Market Committee members as they work to promptly cure this bout of inflation without causing a recession.
Are We Looking at the Fed Causing Another Crypto Winter?
The short answer is no. Although the last time inflation was as bad as it was at the start of 2022 was at the end of the 1970s the times are completely different. It took years for spending from the Vietnam War and new social programs to drive inflation in the 1970s. There were no constraints on production or supply chains. This time around it took a global pandemic and nearly complete shutdown of supply chains out of Asia combined to drive prices up. Then you can add the short term but massive stimulus by US Congress and two successive US presidents. Some choose to blame follow-up spending on infrastructure but this was a latecomer to the inflation picture. The point is that the principle causes of inflation have backed off. Unlike in 1979 the Fed did not go the shock and awe route of a massive rate increase. They risked letting inflation stay too high for too long but, in the end, have lowered it. They are at the point where the differences between hawks and doves in the Open Market Committee have to do with one or two more rate increases this year of three or four. And, then the issue will be when they can lower rates again. None of this is anything like the kind of persistent rate increases that drove stocks and crypto down for a year.
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