- Inflation targets at 2% seem a distant memory.
- But that could be great for crypto.
Wolfgang Münchau is a columnist for DL News. He is co-founder and director of Eurointelligence, and writes a column on European affairs for UnHerd. Opinions are his own.
When global inflation started to rise in late 2021, I predicted that macroeconomists would go through progressive stages of mourning.
Remember Team Transitory? That was the stage one — denial.
Then they all blamed Vladimir Putin. That was the stage of anger.
We are now entering stage three — bargaining. We want to bring inflation down, but not too fast. Number four in the stages of grief is depression.
Stage five is acceptance — that we will forever say goodbye to the 2% inflation target.
“This is the world for which crypto was create”
This is the world for which crypto was created — a world in which governments believe it is expedient to tolerate higher inflation and debt.
The post-Covid inflation shock proved so persistent because the pandemic permanently destroyed productive capacity, because governments raised too much debt, and because central banks monetised it through purchasing programmes, and failed to row back in time.
Today, only the European Central Bank appears to have hit the target of 2%, but this is an optical illusion. The euro is down some 15% on the year. Oil prices are down 10%. Gas prices 20%. Electricity prices 30%-40%.
If the eurozone was really on a long-term trajectory towards a stable inflation rate of 2%, we should right now be close to 0-1% inflation because once energy prices and the exchange rate stabilise, the headline rates will go up again.
My own, admittedly very rough estimates for steady-state inflation rates are 3% for the eurozone, 3.5% for the US and 4% for the UK.
In theory, independent central banks could stem against this. In practice, all central banks are discovering that they are less independent than they thought they were.
Even a central bank as independent as the Fed cannot stem against a hostile administration.
The Bank of England is under no formal pressure from the UK government, but it acts as though it is.
Journalists know that self-censorship is worse than outright censorship. But the biggest dependency of all is Europe’s dependency on the US. If the US de-anchors from the 2% inflation, so does everybody else.
“So let us play through the scenario of a 3-4% global inflation rate.”
So let us play through the scenario of a 3-4% global inflation rate.
You might think this is not a big deal. It is just one or two percentage points more. But this is the wrong way to think about it.
An inflation rate of 3% is 50% higher, and 4% is double the previous 2% target. Over time, the gap in the price between the old target and the new reality will become really big.
If you hold a 10-year bond, an unexpected rise in interest rates from 2% to 4% would halve the value of your bond. But bondholders will, with a delay, recoup their losses by demanding higher interest rates. The interest rates on long-term debt will rise.
But this is not it. If central banks do not have the balls to defend a 2% target, markets will conclude that they do not have the balls to defend a 3% target either, in fact no target at all.
“The central banks are not going to re-grow their spine, are they?”
The credibility of a central bank is premised on past action. Inflation expectations will become de-anchored. If 3% is new the 2%, then what stops 5% from becoming the new 3%?
The central banks are not going to re-grow their spine, are they?
My story about the delusions of macroeconomists is grounded in their models.
In those models, inflation cannot conceivably overshoot, except for short periods. 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 pretend 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%.
So what 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.
