- The elusive 2% inflation targets seem like a relic of the past.
- Paradoxically, this shift could be a boon for the cryptocurrency market.
Wolfgang Münchau, a DL News columnist and co-founder/director of Eurointelligence, also contributes to UnHerd, focusing on European affairs. The views expressed here are solely his own.
As global inflationary pressures began to intensify in late 2021, I foresaw a predictable pattern of reactions from macroeconomists, akin to the stages of grief.
Remember the “Team Transitory” narrative? That represented the initial stage: denial.
Subsequently, Vladimir Putin became the scapegoat. This was the anger stage.
We are currently transitioning into the bargaining phase. The aim is to curb inflation, but at a measured pace. The fourth stage in the grieving process is depression.
The eventual stage is acceptance: the realization that the 2% inflation goal is unattainable in the long run.
“Crypto’s moment has arrived.”
The circumstances are ripe for crypto’s ascent. Governments now appear willing to tolerate higher levels of inflation and national debt.
The post-pandemic inflationary surge persisted due to several factors: lasting damage to production capacity, excessive government borrowing, and central bank monetization through asset purchasing programs, coupled with a delayed response in reversing these policies.
Currently, the European Central Bank (ECB) is the only institution that gives the impression of achieving the 2% target, but this is a misleading picture. The Euro’s value has declined by approximately 15% this year. Oil prices are down 10%, gas prices are down 20%, and electricity costs have fallen 30-40%.
If the Eurozone were genuinely on course for a stable 2% inflation rate, we would currently be experiencing inflation rates closer to 0-1%. Once energy prices and exchange rates stabilize, the headline rates are set to increase.
My personal estimations, admittedly rough, put steady-state inflation at 3% for the Eurozone, 3.5% for the US, and 4% for the UK.
In theory, independent central banks could push back against this. In reality, central banks are recognizing that their independence is more limited than previously thought.
Even the Federal Reserve (Fed), considered highly independent, can struggle to counter a hostile administration.
The Bank of England (BOE), though not under explicit governmental pressure, behaves as if it were.
Journalists know that self-censorship is even worse than direct censorship. However, the biggest dependency of all is Europe’s dependency on the US. If the US lets go of the 2% inflation target, so does everybody else.
“Let’s explore the possibility of global inflation hovering around 3-4%.”
Let’s explore the possibility of global inflation hovering around 3-4%.
This might seem insignificant – just a percentage point or two higher. But that’s a misleading perspective.
A 3% inflation rate is actually 50% higher than the previous 2% target, while 4% is double. Over time, the cumulative price difference between the old target and the new reality will grow substantially.
If you own a 10-year bond, an unexpected increase in interest rates from 2% to 4% would reduce your bond’s value by half. Bondholders will eventually compensate for their losses by demanding higher interest rates. The interest rates on long-term debt will increase.
And that’s not all. If central banks lack the resolve to defend a 2% target, markets will deduce that they won’t defend a 3% target either, or any target at all.
“Are central banks suddenly going to find their backbone?”
A central bank’s credibility relies on its past actions. Inflation expectations will become unanchored. If 3% is the new 2%, what’s to stop 5% from becoming the new 3%?
Are central banks suddenly going to find their backbone?
My narrative about the delusions of macroeconomists is rooted in their models.
In those models, inflation cannot realistically overshoot, except briefly. In those models, inflation expectations are always anchored.
While the rest of us live in the real world, the macroeconomist lives inside a model. If you point out that inflation has permanently overshot the target, they will call you economically illiterate because the model suggests that this cannot possibly be so.
I don’t claim to be smarter than the markets, but I have noted that financial markets follow macroeconomic consensus even if this conflicts with data.
This is partly so because macroeconomic thinking dominates that consensus. Right now, bond prices are still broadly consistent with inflation eventually falling back to 2%.
What happens if they don’t? With higher inflation debt deflates faster.
In theory, this should be good news for over-indebted governments, except that bond investors will demand higher interest rates. For governments, like that of France, this would be an absolute disaster.
The higher interest rates will cause disruptions for everybody. For the US we could have an interest rate floor of 4-4.5%, with long-term terms rising to 6 or 7%. In Europe, the range might be 3-5%.
This is a financial environment that will benefit vanilla crypto. Its impact on derivative crypto, like stablecoins or other blockchain-based derivatives of fiat-currency financial assets, is harder to predict.
A stablecoin is stable in relationship to the underlying asset — the US dollar and US treasuries. But what if the asset itself is not stable?
Donald Trump’s One Big Beautiful Bill is the biggest debt programme in history. It will put the US into a state known as fiscal dominance — where fiscal policy dominates monetary policy and gives rise to inflation the central bank cannot stem against.
The policy purpose behind US dollar stablecoins would be to extend the reach of US dollar and treasuries by providing the world with a new derivative reserve currency asset.
At a pure technical level, it could make it easier for the US to expand its debt. But it is just another credit bubble, dressed up in new technology.
They said this about subprime mortgages — that stuff is possible that was not possible before because of financial innovation. Every modern bubble comes with the promise that this time is different.
A dollar stablecoin is similar to a collateralised debt obligation from the days before the financial crisis. I am not predicting imminent gloom.
Those old enough to remember will recall that the credit markets boomed for many years. The party ended eventually. A lot of people got very rich. Some managed to get out in time.
The stablecoin gambit is premised on a shaky geopolitical vision — that the US can maintain the global dominance the dollar. If this premise is true, the stablecoins will be the instruments of choice.
What I am seeing is that our fragmented geopolitical world is moving in a different direction.
China, India, Russia, Brazil are diversifying heavily away from the US dollar world, with the creation of their own, alternative financial infrastructure, like Brics Pay.
The EU is politically so weak that it cannot fund its support for Ukraine without either the US, or without the sequestration of Russian assets.
In theory, this should have been a golden moment for the EU — an irresponsible US financial policy that frightens global investors. But who in their right would invest in Europe at this point, given the toxic politics and lack of economic dynamism in the large EU countries?
These are the big underlying forces that push investments in crypto and gold, and we are only getting started.
Gold has so far benefitted relatively more. It is an official reserve asset for almost all central banks.
No central banks have yet adopted crypto as a reserve asset. But Ales Michl, the governor of the Czech central bank, tabled a proposal earlier this year to analyse the possibility of a Bitcoin test portfolio. This is how it starts.
As the US is debasing its currency, and levering its income through stablecoins, it makes sense for others to invest in cryptocurrencies like Bitcoin.
Central banks, unlike investors, are not in the business of making money. But they have to diversify their risks. Cryptocurrencies can help them.
The adoption of cryptocurrencies as central bank reserve assets will take time. It might accelerate through some external shocks, like a war or a stock market crash.
The bottom line is that in a world in which desperate governments resort to funding their ever-rising debt through inflation is one in which cryptocurrencies can only do well.
Currency debasement has been a constant theme of my columns. But it is now starting to happen. For the crypto industry, it is a gift that will keep on giving.