What is Bitcoin’s fundamental value? That’s a good question
As it hits new highs, there is no shortage of bold predictions about Bitcoin reaching US$100,000 or more.
Often these are based on not much more than extrapolations by people with vested interests: the price has gone up a lot so it will keep going up. If it gets above its previous high, it must keep going up.
There is also “charting” or “technical analysis” – looking at graphs and seeing patterns in them. There may be fancy terms such as “resistance levels” and “Tenkan-Sen”. There is talk about “fundamentals”.
Let’s examine this last idea. Does Bitcoin have a fundamental value?
Calculating fundamental values
A fundamental value in traditional financial-speak means a value based on what return (or cash flow) is generated by an asset. Think of an apple tree. To an investor its fundamental value is in the apples it produces.
In the case of company shares, the fundamental value is the dividend paid from profits. A standard measure used by investors is the price-to-earnings ratio. In property, the fundamental value reflects the rent the investor earns (or the owner-occupier saves). For a bond, the value depends on the interest it pays.
Gold has a fundamental value also, based on its use for jewellery or dental fillings or in electronics. But this value is not why most people buy gold.
Fundamentals for cryptocurrencies
National currencies are different. Their value is in being a trusted and accepted unit of exchange.
In the past coins made with gold and silver had a fundamental value because they could be melted down for their precious metals. That’s no longer the case with fiat currencies, whose value depends solely on people trusting that others accept them at face value.
Most cryptocurrencies, such as Bitcoin, Ethereum and Dogecoin are essentially private fiat currencies. They have no corresponding assets or returns. This makes it hard to determine a fundamental value.
In September analysts with Britain’s Standard Chartered Bank argued Bitcoin could peak at about US$100,000 by the end of 2021. “As a medium of exchange, Bitcoin may become the dominant peer-to-peer payment method for the global unbanked in a future cashless world,” said the head of the bank’s crypto research team, Geoffrey Kendrick (a former Australian Treasury official).
Theoretically this could be possible. Globally an estimated 1.7 billion people lack access to banking services. But Bitcoin has been spruiked as the future of payments since its invention in 2008. It has made little progress.
There are at least two significant barriers. First is the computational grunt needed to process payments. Technology may overcome this. The second obstacle is harder: the volatility of its price.
Digital currencies that can maintain a stable value are more likely to become payment instruments. These include the existing stablecoins, Meta’s mooted Diem and central bank digital currencies, already operational in some Caribbean economies.
So far the only significant company to have accepted payments in Bitcoin is Tesla, which announced this policy in March only to reverse it in May.
The only country to adopt Bitcoin as an approved currency is El Salvador (which also uses the US dollar). But it is far from clear what benefits there are. The laws forcing businesses to accept the cryptocurrency have also led to protests.
Bitcoin as digital gold
If Bitcoin has no real value as a widespread means of payment, what about as a store of value, like digital gold? It does have this advantage over most of the “altcoins”. Its supply, like gold, is (arguably) limited.
One tool used by crypto enthusiasts to compare Bitcoin’s scarcity with gold is called the “stock-to-flow” model. This approach claims gold holds its value because the existing stock of gold is 60 times more than the amount of new gold mined each year. The stock of Bitcoin is more than 50 times than the new coins “mined” annually.
But this does not explain why Bitcoin’s price halved earlier this year. Nor does it have any theoretical basis in economics: prices don’t depend just on supply.
Some Bitcoin promoters predict higher prices on the assumption funds managers will eventually invest an abritrary proportion, say 5 per cent, of their funds in Bitcoin.
But such predictions implicitly assume Bitcoin, as the largest and best-known cryptocurrency, will continue to maintain its dominant position in the crypto market. This is not guaranteed. And there is no limit to the number of cryptocurrency alternatives.
Remember Bankcard? This credit card company once had 90 per cent of the Australian market in the early 1980s. It was defunct by 2006. What about MySpace? Before 2008 it was a bigger social networking site than Facebook.
Here we go again
In September The Economist argued Bitcoin “is now a distraction” to the future of decentralised finance, with rival blockchain cryptocurrency Ethereum “reaching critical mass”.
There are parallels between the Bitcoin bubble and the dotcom bubble of 2000, driven by overly optimistic assumptions about new technologies – and human greed.
Just as a few stars such as Amazon emerged from the wreckage of the dot.com bubble, so it is possible some applications of the block-chain technology underlying Bitcoin have enduring utility. But I doubt Bitcoin will be one of them.
John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society and NATSEM, University of Canberra
This article is republished from The Conversation under a Creative Commons license. Read the original article.
Stablecoins: these cryptocurrencies threaten the financial system, but no one is getting to grips with them
Cryptocurrencies have had an exceptional year, reaching a combined value of more than US$3 trillion (£2.2 trillion) for the first time in November. The market seems to have benefited from the public having time on their hands during pandemic lockdowns. Also, large investment funds and banks have stepped in, not least with the recent launch of the first bitcoin-backed ETF – a listed fund that makes it easier for more investors to get exposure to this asset class.
Alongside this has been an explosive rise in the value of stablecoins like tether, USDC and Binance USD. Like other cryptocurrencies, stablecoins move around on the same online ledger technology known as blockchains. The difference is that their value is pegged 1:1 to a financial asset outside the world of crypto, usually the US dollar.
Stablecoins enable investors to keep money in their digital wallets that is less volatile than bitcoin, giving them one less reason to need a bank account. For a whole movement that is about a declaration of independence from banks and other centralised financial providers, stablecoins help to facilitate that. And since the rest of crypto tends to go up and down together, investors can protect themselves better in a falling market by moving money into stablecoins than, say, selling their ether for bitcoin.
A substantial proportion of buying and selling of crypto is done using stablecoins. They are particularly useful for trading on exchanges like Uniswap where there is no single company in control and no option to use fiat currencies. The total dollar value of stablecoins has shot up from the low US$20 billions a year ago to US$139 billion today. In one sense this is a sign that the cryptocurrency market is maturing, but it also has regulators worried about the risks that stablecoins could pose to the financial system. So what’s the problem and what can be done about it?
The problem with stablecoins
Initially introduced in the mid-2010s, stablecoins are centralised operations – in other words, someone is in control of them. Tether is ultimately controlled by the owners of the crypto exchange Bitfinex, which is based in the British Virgin Islands. USDC is owned by an American consortium consisting of payments provider Circle, bitcoin miner Bitmain and crypto exchange Coinbase. Binance USD is owned by Binance, another crypto exchange, which is headquartered in the Cayman Islands.
There is a philosophical contradiction between the decentralised ideal of cryptocurrencies and the fact that such an important part of the market is centralised. But also, there are serious questions about whether these organisations hold enough financial reserves to be able to maintain the 1:1 fiat ratios of their stablecoins in the event of a crisis.
These 1:1 ratios are not automatic. They depend on stablecoin providers having reserves of financial assets equivalent to the value of their stablecoins in circulation, which adjust with supply and demand from investors. The providers promise they have reserves worth 100 per cent of the value of their stablecoins, but that’s not quite accurate.
Tether holds 75 per cent of its reserves in cash and equivalents as of March 2021. USDC has 61 per cent as at May 2021, so both are some way short of 100 per cent. A large part of the assets of both operations are based on commercial paper, which is a form of short-term company debt. This is not cash equivalent and poses a solvency risk in the event of a sudden collapse in the value of these assets.
So what could derail the machine? Currently there is almost unlimited money in circulation, interest rates are still at record lows and with the US government having just voted to accept another economic stimulus package worth US$1.2 trillion, the supply of money is not likely to be reduced significantly any time soon. The only element that could challenge this abundance of money is inflation.
There are several possible inflation scenarios, but the market currently still considers the “goldilocks” scenario to be the most likely, with inflation and growth rising together at high but manageable levels. In this case, central banks can let inflation run at 3 per cent-4 per cent levels.
But if the economy overheats, it could lead to an explosive situation of high inflation and economic recession. Lots of money would be moved out of risky assets and bonds into safer havens like the US dollar. The value of those riskier assets, including commercial paper, would fall off a cliff.
This would seriously damage the value of the reserves of stablecoin providers. Many investors with their money in stablecoins might panic and try and convert their money into, say, US dollars, and the stablecoin providers might be unable to give everyone their money back at a 1:1 ratio. This could drag down the crypto market and potentially the financial system as a whole.
Regulatory actions
Regulators are certainly worried about the stability of stablecoins. A US report published a few days ago by the President’s Working Group on Financial Markets said that they potentially pose a systemic risk, not to mention the danger that a huge amount of economic power could end up concentrated in the hands of one provider.
In October, the US Commodity Futures Trading Commission fined Tether US$41 million for claiming to be 100 per cent -backed by fiat currency between 2016 and 2019. Bank of England Governor Andrew Bailey said in June that the bank was still deciding how to regulate stablecoins but that they had some “difficult questions” to answer.
Overall, however, it seems that the response from the regulators is still tentative. The President’s Working Group report recommended stablecoin providers be forced to become banks, but delegated any decisions to Congress. With several big providers and such a burgeoning international market, my worry is that stablecoins may already effectively be too big and disparate to control.
It is possible that the risks will reduce as more stablecoins arrive on the market. Facebook/Meta has well publicised plans for a stablecoin called diem, for instance. Meanwhile, central bank digital currencies (CBDCs) will put fiat currencies on the blockchain if and when they arrive. The Bank of England is to consult on a digital pound, for example, while the EU and especially China are also moving ahead here. Perhaps the systemic risks of stablecoins will be reduced in a more diversified market.
For now, we wait and see. The speed at which this unnerving risk has emerged is certainly a concern. Unless governments and central banks move up a gear on regulation, a 2008-style crisis in digital assets cannot be ruled out.
Jean-Philippe Serbera, Senior Lecturer, Sheffield Hallam University
This article is republished from The Conversation under a Creative Commons license. Read the original article.
How iwocaPay is reinventing B2B payments
Legacy payment technology has held back B2B businesses for years. But today, fit-for-purpose digital solutions are providing a route forward.
The business-to-business (B2B) payments market was worth well over $850 million in 2020. And it’s expanding fast: with a growth rate of more than 10 per cent a year, it’s predicted to reach nearly $70 billion by 2030.
An increasing demand for and supply of digital solutions is contributing to the sector’s surge in value. Most recently, the pandemic has encouraged organisations to streamline their processes as a way of bolstering profits.
Business owners are realising that the methods they use to take payments impact the overall effectiveness and success of their business. With better technology, there are now better ways of taking money. These go beyond just relying on bank transfers or cards – the latter of which have never been great for B2B thanks to their inflexibility, high costs and delayed payouts.
Digital payments services and embedded finance products such as iwocaPay are capitalising on these trends. This is because they solve a number of problems B2B businesses typically face.
iwocaPay makes it easier for the B2B retailer
Existing payment and finance solutions haven’t worked well together historically - making B2B payments hard to get right.
B2B suppliers need to provide a simplified and cost-effective payment experience, as well as offering flexible payment terms – this requires expertise in providing finance and taking payments.
On the payment side, 80 per cent of B2B businesses still rely on bank transfers to get paid. Bank transfers are cheap but carry friction. In fact, B2B suppliers could get paid twice as quickly by offering a digital payments solution. However, the main alternative, card payments, comes with expensive fees, delayed payouts and chargeback risks.
But a lack of good payment methods is only half the problem. Payment terms have always been a crucial part of B2B transactions. B2B businesses are twice as likely to offer payment terms as B2C businesses – typically of at least 30 days. While extra time to pay helps their customers manage cashflow and make larger purchases, this cashflow burden is usually pushed onto suppliers, who are forced to take on the risk and underwrite their customers. This problem is substantial. The average SMB is owed more than £10,000 at any one moment. B2B businesses are frequently exposed to long payment terms which adversely affect cash flow, making it harder for them to grow, or sometimes even survive.
The good news is that this is changing, as new, better fit-for-purpose B2B payment options emerge. One of the first to launch in the UK, iwocaPay helps to solve the B2B payments problem by thinking beyond just the payment – addressing both the payment experience and the payment terms. With iwocaPay, B2B businesses get a cost-effective, frictionless payment solution with built-in 90-day payment terms. Suppliers can offer their customers the flexibility to choose how and when they pay – either there and then or over three months. And any customer can pay instantly with a two-click solution built on secure and seamless open banking technology. It has all the cost-effectiveness of a bank transfer, with the bonus of being even easier to use than a card. Business customers can spread the cost over 90 days, while their supplier gets the funds in full as soon as they complete check out. Using this holistic solution, iwocaPay brings the best of payments and finance to the point of transaction. As a bonus, it all syncs up to accounting platforms such as Xero to make reconciliation automatic.
iwocaPay makes it easier for the customer
iwocaPay also makes things easier for businesses that are buying from other businesses. How? B2B buy-now-pay-later.
Most business customers need access to credit as a way of enabling their organisations to grow – a process which is usually clunky at best. With traditional banks frequently refusing them this credit, many businesses look to suppliers to provide it instead. So if the suppliers don’t have this offering, they may lose the sale. In fact, research in iwocaPay’s paper Levelling the “Paying” Field shows that as many as 22 per cent of small businesses say they have not worked with a supplier because of their payment terms.
However, offering credit can be very risky for both suppliers and their customer: the supplier takes on most of the credit risk, while their customer takes on operational and reputational risks with no guidance on affordability.
By offering built-in payment terms, iwocaPay can provide immediate access to credit in a way that dramatically reduces these risks. Affordability checks take place, without impeding the customer experience. This creates a smooth process that satisfies business customer expectations by emulating the experience they have as ordinary consumers when they are shopping online. It’s B2B buy-now-pay-later at its best.
eCatering works with thousands of foodservice operators, supplying them with all kinds of professional catering equipment, from commercial refrigerators and freezers and stainless steel kitchen furniture to cooking equipment and food prep machines. Our customers in the hospitality sector were heavily impacted by the lockdowns: many needed new equipment for their reopenings after spending a lot of time being out of action, but because of extreme downtime and big losses, businesses found themselves unable to pay for items outright and needed alternative payment methods to be readily available. With traditional banks frequently refusing them this credit, many of these restaurants, hotels and pubs looked to their suppliers – such as us – for alternative finance options. So we adapted quickly to try to support them, and began offering financing solutions for them on the equipment we sold. We did this through iwocaPay, which allowed us to offer built-in payment terms and provide immediate access to credit for our customers. It meant we were able to start offering foodservice operators a buy now, pay later service. Operators were able to get the equipment they needed straight away, but were able to spread the cost of it over 90 days, with the first 30 days free. It’s become a very popular option for our customers. Being able to use a stable pay-later method helps both us and them with cash flow as the industry recovers from the pandemic.
Catering equipment supplier – eCatering – tells us why they use iwocaPay
iwoca: building the future of the payments industry
iwoca's success is demonstrated in the fact that the lender has made finance available to well over 50,000 small businesses. Lara Gilman, co-lead at iwocaPay, said: “Despite the pandemic we've continued to invest heavily in expanding our capabilities to offer the most appropriate product to businesses, when and where they need it.”
The future of the payments industry is flexibility, powered by technology. Buyers want the frictionless and simple payment process that iwocaPay enables. Suppliers need to access their funds quickly and unlock money tied up in invoices: iwocaPay allows them to get paid faster with funds from sales in their account instantly. And both suppliers and customers want flexible payment terms to be available to a wider range of buyers, something that becomes possible because iwoca is taking on the credit risk.
Unlike traditional payment methods, iwocaPay brings together instant payments, free transactions and flexible financing. By eliminating the stress of getting paid, it allows SMEs to focus on what they’re good at: growing their business.
iwocaPay is part of a suite of products. With recent UK pandemic-linked products such as the Coronavirus Business Interruption Loan Scheme (CBILS) and the Recovery Loan Scheme (RLS), iwoca has built out the capability to provide larger and longer-term loans which some businesses need when making bigger investments. It recently launched a Revenue Based Loan, which is proving very popular with small businesses and embedded finance partners. With Open Lending, iwoca is now reaching more than two million businesses where and when they need it through embedded finance partners. And now, with iwocaPay, it has created a first-of-its-kind B2B checkout product which gives buyers control of the payment terms they want and gives sellers peace of mind.
The flexible terms that can be offered through iwoca’s digital solutions are increasing sales and improving customer relationships for B2B suppliers. This is because iwocaPay blends the best of finance and payments – suppliers get paid immediately and buyers get the flexibility they need.
To find out more about how iwocaPay can transform your customers’ payment experience, get started here or contact salesteam@iwoca.co.uk.
INDUSTRY VIEW FROM IWOCA
‘Dataraising’ – when you’re asked to chip in with data instead of money
Fundraising appeals are part of everyday life, both online and off.
Requests for financial donations arrive by snail mail, email, social media and text messages. Cashiers at chain stores and supermarkets ask if you want to chip in for charitable causes. If you’re in the U.S., you might also be getting nearly constant texts asking you to contribute to political campaigns.
In my book “How We Give Now,” I explore how acts of giving extend beyond donating money to nonprofits, including an interesting trend on the rise that I call “dataraising.” It’s a term I coined while writing the book to describe nonprofits or researchers soliciting donations of data.
Perhaps surprisingly, dataraising is not entirely new. Medical research, for example, has long relied on volunteers to participate in clinical trials to gather enough data to study a disease.
The steps to participating in clinical trials – signing up, learning the protocols, agreeing to contribute your data – were developed to limit the harms that can follow when researchers just take people’s data. These protocols, imperfect as they are, distinguish informed data donations from the usual online data experience, in which companies’ terms of service afford them extensive claims to data while leaving individual users few choices and even less recourse.
There are apps for this
One reason for the growth in dataraising is that it is becoming easier to do for technological reasons.
For example, Apple launched Research Kit in 2015. It’s a set of software protocols that lets medical researchers design studies that use data directly from a person’s iPhone.
To participate in phone-based research, people download an app for a study. The best studies use consent processes that aren’t the usual legal forms with one of those “I agree” buttons at the end. Instead, these consent processes ask people to use their phone in ways that will generate only only the specific data researchers are collecting.
For example, the consent process for a study on Parkinson’s disease might ask you to swipe your fingers across the screen and then put the phone in your pocket and walk across the room. These actions generate data that shows signs of tremors in the hands and movement.
A 2021 industry study of mobile health apps counted more than 1,500 research projects based on digital health data with ResearchKit up to that point.
Android users can also participate in similar studies using Google’s Health Studies App, which launched in 2020.
Some apps are for the birds
But data donations facilitated by technology power more than just medical research.
Apps such as eBird, run by Cornell University’s Ornithology Lab, and iNaturalist, a collaboration between National Geographic and the California Academy of Sciences, rely on donations of cellphone photographs to power their biodiversity databases.
Civic science initiatives, also known as citizen science initiatives, assist with everything from water quality monitors to butterfly counts. These initiatives rely on contributed data, as do many genealogical websites.
Dataraising is also making it easier to document the history of specific communities.
For example, the Densho Archive, an online repository of historical artifacts related to the U.S. internment of Japanese Americans during World War II, contains donated photographs, letters and newspaper articles.
Other forces driving this trend
Legal changes, organizational innovation, social movements and increased attention to the harms of concentrated data are also playing a role in the spread of this practice.
In the United Kingdom, ride-share drivers can contribute their data to the Workers’ Info Exchange. Known as WIX, it uses the aggregated, analyzed information to protect workers’ rights and fight back against “robo-firing” – when companies design algorithms that automatically fire workers without any human involvement.
Organizations like WIX depend on people’s having access to their data, a right guaranteed by the European Union and in California through the California Consumer Privacy Act.
Helping solve vexing problems
As digital systems become more critical to everyday life, donated data can help answer more kinds of questions.
The consumer advocacy organization Consumer Reports is dataraising by collecting assorted cable TV bills. This data will help the group’s sleuths evaluate corporate claims about broadband speed, access and prices.
Mozilla, the nonprofit maker of the Firefox browser, has launched a browser plug-in called Rally. It makes it easy to share data over the internet with academic researchers.
And Kaiser Health News and National Public Radio have teamed up to conduct “Bill of the Month” investigations. Through this collaboration, the news outlets’ journalists are analyzing and reporting on the hidden fees and mysterious charges that are rife in the U.S. medical system.
When dataraising falters
The easier it gets to collect data from anyone, the more important it becomes to plan for troublemakers, provide people with tools to control their information, and make sure that participants treat one another with respect.
The iNaturalist app, for example, is used in a lot of classrooms, and students love to pull pranks, tagging their fellow classmates as bugs or snakes. Because it’s used globally, cultural and linguistic competence is key. What may seem lighthearted in one context can be deeply insulting elsewhere.
Digital data shared through online networks – especially those dedicated to public goods – require careful attention to protect participant safety. For example, people may want to donate data regarding how far they walked but not where they went. Although phone default settings may make it easiest to transmit location data and leave it up to researchers to calculate the distance traveled on foot, to make user safety a high priority, apps could calculate distance on the phone without transmitting someone’s location.
It’s also important to aspire to equitable access to people who want to donate their data for these purposes, which is hard since not everyone owns a smartphone. And I believe that those involved in these studies should meaningfully give consent that can be retracted at any time.
Over the years, participants in the civic science movement have created resources and manuals to promote good data governance and limit harassment of the people taking part in these efforts. Their goal is to enable equitable participation, make data security a priority and let individuals control their data. In some cases, protecting the identity of those who donate data is critical.
There are dedicated community managers and tiers of training for those who use iNaturalist, along with rules for the curators who manage its website, for example.
Voluntary practices like those are valuable. But in my view, the donation of data should be regulated. There are plenty of experts with professional and lived experience in online harms, data rights, community building and philanthropy to inform such efforts.
Megan Price of Human Rights Data Analyst Group contributed to the ideas discussed in this article.
Lucy Bernholz, Senior Research Scholar of Philanthropy and Civil Society, Stanford University
This article is republished from The Conversation under a Creative Commons license. Read the original article.
Inflation: why it is the biggest test yet for central bank independence
Central banks are being tested by the recent resurgence in inflation, with the US recently reporting an annual rate of inflation of 6.8 per cent, the highest in nearly 40 years. The question they are all asking is whether this inflation is temporary (“transitory”) or persistent.
If it is only transitory, it would be counterproductive to deal with it aggressively. If central banks tighten monetary policy unnecessarily by sharply raising short-term interest rates or quickly unwinding those government asset purchases (known as quantitative easing or QE) which supported many economies during the Covid economic shock, it will needlessly push back the recovery.
Central bankers’ public statements all hint at the difficult decisions ahead. The chair of the US Federal Reserve, Jay Powell, signalled recently that the strong US economy combined with rising inflation meant the Fed would “taper” its QE asset purchases more quickly (they are currently due to end by June 2022).
The Bank of England is due to end its asset purchases this month, and Huw Pill, the chief economist, has indicated that “the conditions now existed for him to vote for higher interest rates”. The European Central Bank’s chief, Christine Lagarde, has struck a more dovish note, saying it is unlikely the ECB will increase interest rates in 2022, despite inflation well above its 2 per cent target, as it considers it transitory. It is unclear whether the ECB will extend its QE programme beyond March 2022.
So how significant is the current inflationary shock, and what are its causes?
Inflation causes
Today’s inflation is due primarily to the disruption the pandemic has caused to key global supply chains. In sectors like electronic goods and vehicle production, bottlenecks and shortages of key inputs such as semiconductors emerged as consumer demand recovered more rapidly after the first pandemic wave than suppliers could keep up with. Similarly, shortages of shipping containers and freight capacity have increased costs.
The rapid economic recovery in 2021 has also put pressure on energy prices, especially spot gas prices in Europe. Meanwhile, there have been labour shortages to contend with: the UK and US are among those nations that seem to be seeing labour-force participation falling due to people retiring. The UK and certain northern European economies have also not been seeing enough of the short-term migrants that they need for sectors like hospitality and goods transportation. When there are fewer workers available, employers have to pay higher wages to fill posts.
Inflation expectations
How should monetary policy respond? For central banks, the key question relates to inflation expectations. If consumers and businesses believe that inflation will continue at similarly high levels, as they did in the 1970s, they will try to incorporate it into wage claims and in setting future prices. Inflation will then become more persistent.
What is the evidence for these “second-round effects” on wages and price-setting? There is some evidence from consumer surveys and bond prices that inflation expectations in the US, eurozone and UK have increased marginally in the latter half of 2021, but they still seem contained.
One difference with the 1970s and 1980s is that labour markets are more flexible, in the sense that trade unions have less wage-bargaining power in the private sector, and there is greater international competition as a result of globalisation. Rather than setting off a wage-price spiral, rising prices might therefore be absorbed by wages falling in real terms (meaning they would increase below the rate of inflation).
That depends on the Covid supply disruptions being temporary, as ultimately, with tightening labour markets across most countries, employers would eventually have to pay wages that keep pace with inflation. Unfortunately, the omicron variant is a sign that as Covid becomes endemic, economic recovery might be punctuated by occasional disruptions and further supply shocks, potentially increasing the pressure on employers to pay higher wages.
Central banks and independence
The key to gauging whether inflation remains transitory will be future labour market and expectations data. Suppose that by early to mid-2022, inflation appears to be dissipating, central banks might only need to increase rates gradually to anchor expectations.
But if the data points to inflation remaining stubbornly higher than central banks’ inflation targets (say 4 per cent-5 per cent) for a longer time-horizon, it would be evidence that a wage-price spiral has set in. Central banks would then have no alternative but to substantially increase short-term interest rates and reduce QE – potentially reducing economic activity until wage and price increases moderated. As we know from the 1970s and early 1980s, this can cause painful recessions, leading to unemployment.
At any rate, QE needs to be ended carefully. It has created extra demand for government bonds and increased the supply of money available to invest in other assets such as stocks, so tapering has the potential to cause volatility in these markets. This is likely to be compounded by investors selling stocks in the belief that tighter monetary conditions will mean less economic growth.
The QE purchases have also greatly enlarged central banks’ balance sheets. For example, the Fed balance sheet has increased from around US$4 trillion (£3 trillion) to US$8.7 trillion since the start of the pandemic. Besides tapering, this is going to have to be unwound. It can either be done very slowly as QE-debt matures, or – if central banks feel they need to tighten monetary policy more aggressively – by selling these bonds on to the market. This might mean selling at a loss, in which case governments would have to rebuild central banks’ balance sheets. By making central banks dependent on governments in this way, it might compromise their independence.
There is also a more immediate challenge to central-bank independence, which was granted several decades ago to stop monetary policy being subject to political interference and to reassure the markets that inflation would be kept under control. Yet just because a central bank sets rates independently of government, it may not be immune from external pressures during a major economic crisis. Central bankers could succumb to political and media pressure either to move too fast on tackling inflation, or too slowly to preserve the economic recovery.
Some central banks like the Bank of England look set to hold fire on interest rates until early 2022 – despite the comments from Huw Pill – given the uncertainties surrounding the omicron variant. The ECB is similarly holding steady. So all eyes will be on the Fed on Wednesday 15 to see if it is going to taper QE faster than previously announced. For the time being, I would argue that it would be better to wait. The next few weeks will give us more data on both inflation expectations, but also on how Covid might continue to affect our economies.
Anton Muscatelli, Principal and Vice Chancellor, University of Glasgow
This article is republished from The Conversation under a Creative Commons license. Read the original article.