Global markets and the economy are collapsing – but not all is disastrous
The main mission of the Federal Reserve is to ensure full employment and price stability. In the shadow of unprecedented inflation, Federal Reserve Chairman Jerome Powell has a grim choice to make: let the economy slip into recession or restore price controls.
At its last meeting on June 15, the Federal Reserve raised interest rates by 75 basis points to a range of 1.5% to 1.75%, marking the most aggressive hike since 1994. The tool CME FedWatch shows fed funds futures traders see a % chance of the central bank raising interest rates to 2.25%-2.50% at its July meeting.
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Target rate probabilities for the July 27 Fed meeting
Source: FedWatch CME Tool
Although Powell recently acknowledged that stabilizing price pressures could take “a bit of pain” – and possibly higher unemployment – he has been silent on a recession.
During the period from 2008 to 2021, the Fed’s aggressive monetary policy has distorted economic expectations about the cost and availability of financial resources – a situation in which businesses and individuals take disproportionate risks, increase their debt and engage in risky financial projects and speculative bubbles.
In protracted and aggressive monetary policy, the psychological vulnerability is the conditional belief in an inexhaustible money supply and ultra-soft financial conditions. Investors under these conditions are influenced by the illusion of a safe investment environment. This leads to a critical overshoot of institutional participation in speculative hype, which inevitably creates a reliance on artificial liquidity, leaving regulators in a bind.
Trillion-dollar bubbles, coupled with the extreme involvement of corporations and retail investors, hamper monetary policy regulators. Therefore, regulators are directly involved in creating these bubbles when they verbally intervene in the market and inject money into it.
In addition to the speculative hype, ultra-soft monetary policy conditions are generating a critical mass of “bad” non-performing debt for companies that cannot be covered by real cash flow. These
zombie companies drain business soil, diverting resources from the economy to inefficient and economically unviable projects.
When monetary policy tightens, excessive cheap liquidity, blind faith in a bright future, and distorted expectations interfere with the market, causing unsolvable problems and contradictions. While macroeconomic indicators may seem to paint a good picture, they are misleading in a world where unlimited money printing exists.
Reserve currency status allows the regulator to keep rates low over a long period and bail out bankrupts through asset purchases. Zombie companies thrive because unprofitable businesses are not depleted. Due to negative economic returns, there is a need to maintain negative real interest rates for the foreseeable future, thereby eroding the reserve status of the currency. As a result, debt markets are exploding and bubbles that have inflated at negative real interest rates are collapsing. A zombified economy does not have the resources to recover quickly and be globally competitive.
We are currently experiencing the beginning of the collapse of the debt and equity markets, as well as the loss of reserve currency status. Stock markets around the world are experiencing their worst quarter on record.
However, it is likely that the sale is still in its infancy. Stock prices bottom when the Fed eases. Since World War II, the S&P 500 has fallen a median of 24% during recessions. This makes the current stock declines – which occur without a recession – particularly steep.
Source: Deutsche Bank
A recession offers a way out
It is blindingly obvious that the only way to respond to the hyperconcentration of financial market participants in speculative excitement and the avalanche of tiered margin positions is to let a recession occur, triggering an uncontrolled collapse of assets. That’s what the great inflation fighter – former Federal Reserve Chairman Paul Volcker – did four decades ago.
The Federal Reserve cannot meet its targets without a contraction in the economy, say economists including former Fed Vice Chairman Alan Blinder.
Recessions bring pain, fear and uncertainty, but the economic landscape is full of them. They could end the capital misallocation in which a handful of companies account for a quarter of the S&P 500, which includes 500 companies. It can also clean up the deadwood market – weak companies – allowing stronger ones to grow. Ultimately, this would lead to a stronger economy.
Why is this relevant for crypto?
There has been a lot of discussion that Bitcoin and stock markets are correlated. The crypto market is no different from traditional markets – it is not independent, despite what we would like it to be. Specifically, the involvement of institutional investors in the type of speculation described above has exacerbated this reliance.
This is a watershed moment – whether Bitcoin will finally decouple from stocks and act as a standalone asset with its own value proposition – or will sink with the stock market.
Bitcoin’s 60-day correlation to the S&P index reached its all-time high of 0.74 on May 25, 2022, but is currently down to 0.64 – still a very high level.
However, the 20-day correlation between Bitcoin and the Nasdaq 100 has fallen from around 0.88 in early May to just 0.30 currently.
This is a positive sign that Bitcoin could regain its independence with the long-term view that blockchain has economic value.
Even so, some pain will be unavoidable, like in the stock market. The crypto market will benefit if the house of cards of risky and inflated tokens collapses. The collapse of the Terra stablecoin and the Luna token urges investors to be cautious and contributes to the advancement of digital asset technology. Their stablecoin was built the wrong way, and the market couldn’t mature until it knew about it.
Global markets and the global economy are certainly going through tough times. Although a recession may seem catastrophic, instead of pulling our hair out in frustration, we can accept it as a necessary reality and understand that it is not necessarily a bad thing – just like medicine, which is not not pleasant but which is necessary for health. It will heal the economy, eliminate artificial liquidity, restore the adequacy of the markets including the cryptocurrency market, bringing them to a mature and stronger state, creating a truly safe investment environment, not an illusion .
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