Bitcoin Desperately Needs an Answer: Is Powell the Paul Volcker of 2022?

What If Fed Chairman Jerome Powell Wins the Inflation War? Can Bitcoin Hold Up?

What If Federal Reserve Chairman Jerome Powell Wins the Battle Against Inflation?

After another sharp rate hike, some commentators compared the current Fed chief to Paul Volcker, who, against all odds, led the Fed under Jimmy Carter and Ronald Reagan to introduce aggressive monetary tightening in the early 1980s, pushing inflation to persistently low levels at the expense of two consecutive recessions, ushering in a decades-long period of prosperity known as the Great Moderation.

 Paul Volcker

So can the increasingly hawkish Powell achieve similar success?

Before we address this, let’s note that this is a key issue for Bitcoin, which advocates position as “sound money,” a more reliable system for protecting purchasing power that is immune to the human errors of fiat-based monetary policy.

Whether Bitcoin can succeed depends largely on whether people have confidence in the current fiat system and the monetary policies and central bankers that have been in place since the dollar was decoupled from gold in 1973.

The thinking goes that if people lose confidence in central banks, currencies will falter, fueling inflationary pressures and prompting users to turn to alternatives like gold or Bitcoin.

Therefore, in the minds of Bitcoin enthusiasts, this is a major testing moment for Powell.

To be fair, Bitcoin is also facing a major test given the recent malaise in the cryptocurrency market. But our focus here is on Powell, can he replicate Volcker’s success?

Myths, information and reality

In the 1980s, Volcker almost single-handedly restored trust in the global fiat system, earning him quasi-sage status in financial circles for his tough interest rate hikes and hard political stance based on the long-term health of the economy — in contrast to his hapless predecessor Arthur Burns — and for demonstrating to governments and their constituents the value of central bank independence.

Among economists, some conventional wisdom holds that if a country’s political leaders ignore Volcker’s experience and prevent the central bank from making tough decisions, the market will punish them. Currency failures such as those in Zimbabwe, Argentina and Turkey are examples. By contrast, the long, steady and rarely interrupted growth of the U.S. economy since Volcker’s 1982 recession and its stock market’s 40-year “slow bull run” — the S&P 500 has risen more than 100-fold to last year’s peak — are evidence that those who play by the rules are rewarded.

The reality is much more complicated.

As we discussed two weeks ago, the dollar’s ​​status as the primary reserve currency gives the United States unique monetary policy latitude, with implications for other countries.

In the years following the 2008 financial crisis, the Federal Reserve’s highly accommodative monetary policy pushed “hot money” into developing economies, making policy making there more difficult.

Now that the dollar is recovering, hot money is fleeing back to the United States, forcing central banks around the world to follow the Fed’s monetary tightening to protect their currencies, whether or not their economies require it. The Volcker Doctrine was not implemented on a similar playing field.

Political risk and reputation risk

These global imbalances and the “quantitative easing” (QE) monetary policy they have enabled have reached a breaking point. They have fueled a massive debt buildup in the United States and elsewhere, which will become even more difficult to estimate now that interest rates are rising.

A policy reversal would trigger massive bankruptcies and economic contraction, and there is no guarantee that it would curb inflation.

War-driven commodity price increases, supply chain inefficiencies, and entrenched, self-fulfilling expectations are likely to continue to support this. In this environment, what will Powell's Fed do? Will it get more aggressive and then push the US economy deeper into the abyss?

My bet is “no”, the political risk is too great. Once a large number of US businesses close down and large numbers of Americans lose their jobs, the pressure to soften monetary conditions again will become too great. When this happens, as low-cost funds are once again pushed around the world in search of risk assets, Bitcoin will be one of the targets of these flows.

But the bigger, longer-term question is not whether the Fed will get sucked into such a whipsaw reaction but what effect Powell’s bold new stance will have on his and other central bankers’ reputations over time.

If he succeeds in cooling excessive speculation and ushering in another era of predictable, mild inflation, Powell could provide a shot in the arm for the entire fiat system and its dollar-based center in the coming years that would make it difficult for Bitcoin (or gold, for that matter) to find another way.

A lot depends on this. For Bitcoin, it’s not enough to say that the dollar is gradually losing purchasing power due to inflation. What most people want is predictability. Investors don’t worry about 2% annual inflation devaluing their dollars, but are satisfied with consistency with the Great Moderation. Returning to similar stability would be a huge win for fiat currencies.

This is not 1982

What does success mean, though? Ultimately, it depends on how we view the results. The problem is that Powell is trying to explain his strategy in an environment far more hostile than Volcker faced.

In 1982, America was riding against the wind. The computer revolution was just beginning, putting the country on the cusp of a productivity boom, while the more disruptive consequences of the internet age were still far in the future. The U.S. was on the brink of winning the Cold War and had largely overcome the social tensions of the Vietnam War.

Most importantly, the gap between the rich and the poor is far less extreme than it is now, and the American people are optimistic.

Fast forward to 2022. There’s a war in Ukraine that’s leading to Russia being forced out of the dollar-centric global financial system. The planet faces a climate catastrophe, and a generation of teenagers and 20-somethings is emerging from a global pandemic skeptical of the ossified capitalist order of the 20th century.

At the same time, it becomes more difficult for the Fed or any policymaker to control information. I'm not talking about their communication channels with bond traders, which they use to signal market rate adjustments; I'm talking about communicating with the masses, and we are the masses.

Ultimately, what matters to central banks tasked with protecting the value of fiat currencies is the perception of everyday users of currency. Today, people’s opinions are deeply influenced by social media, which many see as a sprawling, unpredictable system controlled by bots and capital, making it difficult for policymakers to manage their messages and maintain trust.

It is difficult to predict whether Powell’s policies will be successful, but the future of Bitcoin still cannot escape the correlation with policies.