On August 27, 2020, Federal Reserve Chairman Jerome Powell made a statement indicating changes to the U.S. monetary policy during a presentation at the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming.
These changes were met with mixed reviews, as Powell indicated that the Fed will continue to do everything in its power to increase inflation. And while Bitcoin maximalists and crypto-buffs have long argued that inflation is the looming danger of fiat currency, the Federal Reserve reminded us today, that inflation is a feature of the fiat system, rather than a bug.
Earlier this week, I shared a discussion on the tokenomics of the U.S. Dollar in my weekly newsletter, where I present the argument that the U.S. dollar does not need to be backed by a hard asset to maintain value and utility. (In cryptocurrencies circles, the art of creating a token that has both a practical use and a consequential appreciation in price is called ‘tokenomics.’) The U.S. Dollar is a token for both the American and global economy, which is created before it has any value, and establishes its value as it moves though the economy.
The Federal Reserve is in charge of creating a system where the Dollar continues to have value, and as such, has a dual mandate:
- Encourage Robust Employment; and
- Maintain Price Stability
The relationship between unemployment and inflation is modeled by the Phillips Curve, which shows that the higher the level of unemployment, the lower the level of inflation, and vice versa. This is because in a recession, much of the production capacity sits idle. Just think of the restaurant kitchens or car manufacturers that had to decrease production during the pandemic. There is not enough income in the system and therefore monetary stimulus is appropriate to increase production. In theory, as the stimulus gets distributed and more people become employed, competition for workers increases, salaries rise, and consequently so do price levels, leading to inflation.
Since the U.S. employment hit a record high of 14.7% in April, the government had room to print more dollars without approaching inflation. The July unemployment rate was recorded at 10.2%, meaning the Federal Reserve can continue to further stimulate the economy, until we reach a ‘natural rate of unemployment’ of 3.5-4.5%, at which point the Federal Reserve can slow down the stimulus and even begin to decrease the amount of dollars in circulation.
However, it appears that the relationship between inflation and employment is flattening if not breakdown all-together.
Chairman Powell reminded us that having some inflation is important, because interest rates move in tandem with inflation, and interest rates are an important tool in the game of stimulus. The Fed has maintained its target inflation rate of 2%, but even with all of the added stimulus of 2020, inflation is still well below target.
And so, Chairman Powell has announced that the Federal Reserve will take further measures to both achieve and surpass the 2% inflation target. TL:DR: We can expect more monetary stimulus.
“We have also made important changes with regard to the price-stability side of our mandate. Our longer-run goal continues to be an inflation rate of 2 percent. Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent. However, if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent…To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time,” stated Federal Reserve Chairman Jerome Powell on August 27, 2020.
What does this mean for the long term prospects of the U.S. Dollar?
The imminent threat to the reserve status of the U.S. Dollar appears to not come from the ‘money printer’. Like in any business, the real threat is competition, or someone creating a better alternative to your product.
Today, the U.S. Dollar has several competitors:
- Euro – although a real competitor, the Euro is an unlikely threat to the dollar given current economic issues in Europe.
- Digital Yuan – once a far fetched idea, the Chinese Digital Yuan poses a real threat as a more efficient and easily accessible currency across emerging markets. An easy to use and stable digital currency can solve for the problem of remittances and provide a secure solution to the unbanked in Africa, East Asia and South America.
- Bitcoin – Bitcoin’s real competitive advantage is sovereignty. With growing geopolitical uncertainty, there is an increasing demand to hold money or wealth outside political systems. Bitcoin provides just that.
With all eyes on the Federal Reserve, many investors are increasingly mindful that the current fiat system is only 50 years running, and are looking to hedge their portfolios through diversification into uncorrelated assets such as Gold, Silver, Bitcoin and Real Estate.