Editor of this issue | Colin Wu
Editor of this issue | Colin Wu
The core factor that determines the market is capital. The bull market stems from the continuous inflow of incremental funds and the continuous growth of stock funds; the bear market is the sluggishness of incremental funds and the continuous flight of stock funds.
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2020.1-2021.5 US M1 and M2 money stock (Billions of Dollars) (data source: FRED official website)
However, the carnival dissipated, and the 80/20 rule still took effect. The price of Bitcoin plummeted from its peak, and most of the money earned by investors in the bull market eventually returned, and even lost their principal. The myth of institutional admissions has also been shattered, and even listed companies are called "big leeks" when they buy at a high point. The market trading volume continues to be sluggish, and the differences between long and short positions have obviously intensified. In this uncertain market situation, it is advisable to review the fundamentals that previously drove the cryptocurrency market up.
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1 Background of the implementation of quantitative easing monetary policy in the United States
(1) Economic development has been disrupted by the epidemic
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(Data source: CEIC official website)
(2) Severe unemployment rate
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2019.12-2021.3 U.S. unemployment rate (data source: CEIC official website)
(3) Maintain the federal funds rate at 0-0.25% for a long time
As the U.S. government failed to effectively control the epidemic, the U.S. economy and financial market fell into recession due to the epidemic. In March 2020, the U.S. pulled the federal funds rate range to zero and maintained the federal funds rate at 0-0.25% for a long time Low range range level. The effective space for regulation of the traditional monetary policy with interest rate as the intermediary target tool has basically been lost.
2017.6-2021.6 U.S. effective federal funds rate (Percent) (data source: FRED official website)
To sum up, the monetary policy background for the implementation of quantitative easing in the United States can be summarized as follows:
The epidemic cannot be controlled for a long time, domestic consumption and investment are sluggish, and the U.S. economy is regressing;
Unemployment soars, the public panics and expectations suffer;
The traditional dovish monetary policy has failed.
Based on this situation, in order to reverse the decline, the United States implemented an open-ended quantitative easing monetary policy to maintain the smooth operation of the market and ensure the effective transmission of monetary policy by repurchasing medium- and long-term bonds such as treasury bonds without setting a quota. It can also be simply understood as indirectly printing more money and injecting a large amount of liquidity into the market, so it is jokingly called "unlimited QE" by investors.
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2 The loose monetary policy of the United States affects the transmission mechanism of cryptocurrencies
(1) Exchange rate transmission
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2019.11-2021.6 US dollar index DXY (data source: Trading View)
As the number one rival of the U.S. economy, China, with the first effective control of the domestic epidemic situation in China, the effective resumption of work and production, the rapid recovery of the Chinese economy, and the appreciation of the RMB against the US dollar, the exchange rate of the RMB and the US dollar is facing great pressure to appreciate . If Bitcoin is regarded as a currency, it can be compared to the RMB mentioned above. Bitcoin is negatively correlated with fiat currency. Under the environment of devaluation of fiat currency, the exchange rate of Bitcoin to USD will maintain an upward trend. Therefore, in the wave of economic globalization, under the influence of the profit-seeking nature of capital, the dollar will inevitably flow out, and a considerable part of "hot money" will flow to countries or markets with better investment returns. Coupled with the increase in the nominal wealth of American residents due to the quantitative easing monetary policy, a considerable part of the funds will flow into the cryptocurrency market (mainly Bitcoin), which will have an impact on the price of Bitcoin.
In general, the exchange rate transmission mechanism of the US quantitative easing monetary policy to the cryptocurrency market can be as follows:
The United States implements quantitative easing monetary policy, the dollar base currency increases, the dollar money supply increases, and residents' book wealth (nominal wealth) increases;
The liquidity of the US dollar increased, and the fluctuation of the US dollar exchange rate showed a depreciation trend;
"Hot money" flows into the cryptocurrency market led by Bitcoin with a good return on investment;
With the influx of incremental funds and the growth of stock funds, the price of Bitcoin rose, and the exchange rate against the US dollar showed an upward trend.
The U.S. quantitative easing monetary policy affects the exchange rate transmission path of the cryptocurrency market (Source: Wu Shuo Blockchain Production)
(2) International capital flow
In response to the impact of the epidemic on the domestic economy, developed countries such as the United States, Japan, and Western Europe have adopted quantitative easing policies to inject a large amount of liquidity into the global economy, forming a large amount of short-term international liquidity. These short-term international floating capital pursues financial products with high returns to obtain rich investment returns, which has obvious characteristics of speculation and arbitrage.
Bitcoin has experienced more than ten years of development, and in 2020, the cryptocurrency market will become more active due to the DeFi boom, and it can still maintain a high return on investment. Therefore, the cryptocurrency market led by Bitcoin has become an investment in major developed economies. It is one of the main markets for international capital to pursue speculative income during the period of quantitative easing monetary policy.
3 Monetary tightening expected
Observability of U.S. Monetary Policy Shifts
(1) The U.S. economy is gradually recovering
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2019.12-2021.3 U.S. private consumption expenditure (100 million U.S. dollars) and 2019.12-2020.12 U.S. foreign investment portfolio (million U.S. dollars) (data source: CEIC official website)
Unemployment rate expected to improve
The CEIC official website predicts that the U.S. unemployment rate is expected to return to below the historical average in 2022. The gradual reduction in the unemployment rate of residents is an important support for economic recovery.
2019.12-2026.12 Forecast unemployment rate in the United States (data source: CEIC official website)
Inflation expectations are solid, and interest rate hikes are inevitable
The Consumer Price Index (CPI) is an index that measures changes in the general level of prices in the market. Generally, market economy countries believe that the maintenance of CPI at 2%-3% is within the acceptable range. Since the United States implemented the quantitative easing monetary policy in March 2020, its impact will produce negative feedback in 2021. Entering 2021, the CPI will continue to rise. In May 2021, the US CPI will increase by 4.9% year-on-year.
2019.12-2021.5 U.S. consumer price index CPI growth (data source: CEIC official website)
In May 2021, the U.S. Producer Price Index (PPI) rose 6.5% year-over-year, compared to a 6.1% year-over-year increase in the previous month. The accelerated rise in the US producer price index has undoubtedly further intensified inflationary pressures.
Figure 10 2019.12-2021.5 U.S. producer price index PPI growth (data source: CEIC official website)
In addition, there are 10-year U.S. bonds, commodity price indexes and other indicators pointing to the high inflation that the U.S. is currently facing. The adjustment of the federal funds rate, that is, the increase in interest rates, is inevitable, and the monetary policy will also turn to tightening.
In Fred's forecast, it is expected that the Federal Open Market Committee (FOMC) will raise the federal funds rate from 2022, that is, raise interest rates, and the median federal funds rate will reach 0.6%.
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4 Impact of U.S. monetary policy turning to tightening will have on the cryptocurrency market
Funds may flee in large numbers in the short term
As mentioned in the international capital flow just now, investors from various countries shifted to the speculative and high-return cryptocurrency market because they avoided the negative impact of the country’s quantitative easing monetary policy, injecting a large amount of money into the cryptocurrency led by Bitcoin. fluidity. However, with the current economic recovery of the economies of developed countries, the funds originally deposited in the cryptocurrency market may flee a large number of funds in the short term, resulting in a reversal of the market capital flow. The flow, stock and flow of these "hot money" will have a profound impact on the cryptocurrency market, thereby affecting the direction of Bitcoin prices.
The author believes that in the current cryptocurrency market, there have been certain signs of capital flight.
"Herding effect", the withdrawal of large funds caused panic
The author believes that the shift in U.S. monetary policy, and when, has created a degree of psychological concern in the cryptocurrency market. Once upon a time, investors are now very concerned about some economic meetings in the United States, which can be large or small, and the short-term impact is dispensable. This actually reflects concerns about monetary policy, because high inflation has made investors clear that raising interest rates is impossible. avoid. And once it is announced exactly when to raise interest rates or when to make a clearer tightening, it will not only affect the flow of short-term capital "hot money" in the world, but also affect the financial situation in the market and the psychological expectations of investors. If large institutions or large companies choose to withdraw large funds, market panic will spread further, further affecting the price of Bitcoin.
The U.S. monetary policy shifts to a tightening path for the transmission of funds in the cryptocurrency market (Source: Wu Shuo Blockchain Production)
(3) The possible long-term deflation will usher in a truly healthy development of the cryptocurrency market
One of the obvious disadvantages of the crazy influx of funds is that the market is flooded with excessive "leek dishes" and "Ponzi schemes". During the crazy period of Meme tokens, a large amount of funds flowed in, and many investors speculated on various animal tokens with the dream of getting rich overnight. Of course, it is undeniable that there are excellent works in it, but it is more of a feather after the craze has passed. The increase in market liquidity has also increased the madness of investors, allowing project parties to find more ways to cut leeks.
Some macroeconomists believe that the United States may achieve monetary tightening in the next decade. If the monetary policy turns to long-term deflation to reverse high inflation, the inflow of funds into the market will decrease, and it will face the situation of exodus of stock funds and segregation. Based on such conditions, it is possible that project tokens in the cryptocurrency market will pay more attention to the value of products and users, and the development of the cryptocurrency market may be healthier. At the same time, in the case of healthy development, attract off-market funds to enter the layout.
