In his letter to the Federal Reserve’s Board of Governors sent earlier this week, U.S. Senate Banking Committee Chair Sherrod Brown put the focus on job preservation. “It is your job to combat inflation, but at the same time, you must not lose sight of your responsibility to ensure that we have full employment … We must avoid having our short-term advances and strong labor market overwhelmed by the consequences of aggressive monetary actions to decrease inflation.” So herein lies the issue with which the FOMC struggles. The Fed is attempting to cool an overheated economy by making everything more expensive. Making things more expensive does not, in and of itself, reduce inflation. In fact, the opposite is true as consumers continue to purchase necessary goods and services as prices initially rise and while credit is available. Instead, what happens, eventually, is that consumers run out of money, stop buying the more expensive things or are prevented from buying things by tanking their credit, and the economy gets cast into a recession meant to ultimately lower prices. But it’s on that way down that we feel the real pain. From the below graph, we see that in times of recession (as indicated by the greyish area), consumer debt tends to plummet as people lose jobs, as they max out existing credit lines and as credit issuers begin tightening their lending box.
Image I: St. Louis FRED data on Consumer Credit
But, leading up to the recession, consumer debt ticks up as consumers salaries no longer cover the standard of living to which they are accustomed. Wage stagnation coupled with credit growth and inflation is a worrying sign.
Image II: St. Louis FRED data on Median Wages (16yr olds+)
No or low credit availability, stagnant wages and higher prices for goods means less purchases. And, less buying of stuff means retailers and every business along the supply chain will have to reduce its workforce to stay in business. Unfortunately for Senator Sherrod and the rest of the working class, the FOMC cannot both fight inflation and save jobs. This is where the impact on crypto currency and digital asset purchases will be felt most.
The common demographic for crypto buyers are 18 to 45 year-olds. This bloc in the U.S. also carries some of the highest debt-to-income ratios of around 200% to 220%. As a result, disposable income and discretionary spending will all but disappear during this upcoming recession impacting everything from travel and entertainment to purchasing crypto. Most investors fail to create a viable selling strategy, and as a result can hold onto losing positions for decades awaiting a rebound. Given the relative lack of trading sophistication amongst crypto hodlers, even with prices on average 65% to 75% down from their earlier-in-the-year highs, there is a large population of folks just sitting on those losses. Maybe we will see some tax harvesting at year end, which will put pressure on a number of tokens. However, given the tendency of the relevant demographic to holdback from disclosing more than is minimally required by the Internal Revenue Service and caps on credits for capital losses, the risk of a large year-end sell-off may be overstated. Additionally, with losses across the asset class spectrum, harvesting small losses on crypto positions may be juice that is not worth the squeeze.
Capitulation by miners is a real and present danger to tier 1 crypto prices. In the recent announcement by Argo Blockchain regarding its failed capital raise, Argo mentions plans to sell machines and bitcoin to cover operating costs. This is a problem that only gets worse with time if market conditions persist; namely, miners having to sell off large stockpiles of coins to cover operating expenses. The second biggest threat to bitcoin and ethereum prices remains capitulation or the belief that it’s “now or never” to sell. A prolonged recession without significantly positive news that would draw exponentially more adopters to the fray will be even more bad news for an industry struggling to still get its technology and premise widely accepted.
The mid-term election in the U.S. puts the entire House of Representatives up for vote and 35 out of 100 Senate seats in play. The significance of this election is the very bipolar nature of the U.S. government, and while generally overstated, still a large part of the population overall. While both parties are using the economy and social issues to try and mette out a base of support, it is unclear that either party as winner of the election will be able to affect significant change.
The Federal Reserve does not take instruction from Congress, and frankly, act independently to fulfill its charter. Given the enormity of the two contradictory requirements of low unemployment and low inflation, neither party is going to mess with one of the last remaining vestiges of economic growth: Digital Assets.
So whether the Federal Reserve at its FOMC adjust their thinking to consider the impact on crypto prices or not, I think risk assets more broadly are going to have to bear the weight of this market. The elections will give an indication of where popular sentiment is on a variety of topics, but neither parties’ success will result in immediate improvement of our economy’s health.
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