Inflation Targets of 2% Fade into the Distance, Offering Opportunities for Crypto
The once-standard inflation target of 2% seems increasingly elusive, presenting potential advantages for the cryptocurrency market. Wolfgang Münchau, a columnist for DL News and co-founder of Eurointelligence, shares his insights on the evolving economic landscape. His opinions reflect a personal viewpoint on the matter.
As inflation began to rise globally in late 2021, I anticipated that economists would experience a series of emotional responses. Initially, there was the denial phase, exemplified by the “Team Transitory” concept. This was followed by an angry response, where blame was directed at figures like Vladimir Putin. Currently, we seem to be in the bargaining phase, where there’s a desire to reduce inflation, but not too rapidly. The subsequent stages include depression, and ultimately, acceptance that the 2% inflation target may no longer be achievable.
A New Economic Reality Favors Crypto
The current economic climate aligns with the foundational principles of cryptocurrency, characterized by heightened inflation and government debt tolerance. The inflation surge post-COVID-19 has been persistent, largely due to the pandemic’s long-term impact on production capacity, excessive government borrowing, and central banks’ failure to retract monetary easing measures in a timely manner. While the European Central Bank claims to have achieved the 2% target, this is misleading, as the euro has depreciated by approximately 15% this year. Energy prices have also seen significant declines, with oil down by 10%, gas by 20%, and electricity by 30%-40%. If the eurozone were genuinely trending towards a stable 2% inflation rate, current inflation should be closer to 0-1%. My rough projections suggest steady-state inflation rates of around 3% for the eurozone, 3.5% for the United States, and 4% for the United Kingdom.
In theory, independent central banks could control this inflation. However, the reality is that many central banks are discovering their limitations in independence. Even the U.S. Federal Reserve, often seen as a bastion of independence, faces challenges from a government that may not prioritize monetary stability. The Bank of England, while free from formal pressure, appears to act as though it is under duress. Journalists are aware that self-censorship can be more detrimental than outright censorship. Furthermore, Europe’s reliance on the U.S. complicates matters; if the U.S. departs from the 2% inflation target, other nations are likely to follow suit.
Exploring a 3-4% Global Inflation Rate Scenario
Let’s consider the implications of a global inflation rate hovering between 3-4%. At first glance, this might not seem alarming—merely a percentage or two above the previous target. However, it’s essential to recognize that a 3% inflation rate is actually 50% higher than 2%, and a 4% rate doubles the prior target. Over time, the disparity between these targets and the new reality will become pronounced. For instance, a sudden rise in interest rates from 2% to 4% could drastically reduce the value of a 10-year bond by half. Though bondholders may eventually recover their losses through increased demand for higher rates, this will not eliminate the overarching issue. If central banks lack the resolve to defend a 2% inflation target, market confidence will wane, leading to doubts about their ability to maintain any target at all.
The Fragility of Central Bank Credibility
The credibility of central banks relies heavily on their historical actions. If 3% inflation becomes the new norm, what prevents 5% from being accepted as the next threshold? It is unlikely that central banks will regain the assertiveness needed to counteract this trend. My observations regarding the misconceptions of macroeconomists stem from their reliance on models that do not account for prolonged inflation overshooting. These models assume that inflation expectations remain stable, while real-world conditions reveal a different story. Those who highlight the persistent overshooting of inflation targets are often dismissed as economically ill-informed. While I do not claim to possess superior knowledge over market dynamics, I have observed that financial markets often adhere to prevailing macroeconomic beliefs, even when they contradict actual data. Presently, bond prices still reflect a belief that inflation will eventually revert to 2%. But if this doesn’t happen? Increased inflation leads to faster debt deflation, which theoretically benefits heavily indebted governments—though it will also push bond investors to seek higher interest rates. For countries like France, this scenario could be disastrous, as rising interest rates disrupt economic stability. In the U.S., we could see interest rates stabilize between 4-4.5%, with long-term rates climbing to 6 or 7%. In Europe, projections may range between 3-5%. This financial environment creates favorable conditions for traditional cryptocurrencies, though the impact on derivative cryptocurrencies, such as stablecoins, is less predictable.
Challenges for Stablecoins in an Unstable Market
Stablecoins are designed to maintain value relative to underlying assets like the U.S. dollar or U.S. Treasuries. However, what happens when the underlying asset itself experiences instability? The extensive debt program proposed by Donald Trump, dubbed “One Big Beautiful Bill,” stands as the largest in history, potentially ushering the U.S. into a state of fiscal dominance, where fiscal policy overshadows monetary policy and triggers inflation that central banks struggle to control. The rationale behind U.S. dollar-backed stablecoins is to expand the influence of the dollar and Treasuries, effectively creating a new reserve currency asset. Technically, this could facilitate U.S. debt expansion, but it also resembles a credit bubble, cloaked in innovative technology. Similar claims were made during the subprime mortgage crisis, asserting that financial innovation allowed for previously impossible scenarios. Each modern financial bubble is accompanied by the notion that “this time is different.” A dollar stablecoin bears resemblance to a collateralized debt obligation from the era preceding the financial crisis.
While I do not foresee an imminent crisis, history shows that credit markets can flourish for extended periods before collapsing. Many individuals have profited, with some managing to exit before the downturn. The stablecoin strategy rests on a precarious geopolitical assumption that the U.S. can preserve the dollar’s global supremacy. If this assumption holds, stablecoins may become the preferred instruments. However, the current geopolitical landscape appears fragmented, with nations like China, India, Russia, and Brazil increasingly distancing themselves from the dollar-centric financial system, establishing their own alternative frameworks such as BRICS Pay. The EU, politically weakened, struggles to support its commitments, such as aid to Ukraine, without U.S. involvement or the appropriation of Russian assets. This situation could have been an ideal moment for the EU to gain traction, particularly in light of U.S. financial policies that deter global investors. Yet, the toxic political climate and lack of economic vitality in major EU states make it challenging to attract investment.
Emerging Forces Driving Investment in Crypto and Gold
These significant underlying trends are propelling investments towards cryptocurrencies and gold, with the latter currently enjoying more favorable attention. Gold remains a recognized reserve asset for nearly all central banks, while no central bank has yet embraced cryptocurrency as a reserve asset. However, Ales Michl, the governor of the Czech central bank, has proposed exploring the potential of a Bitcoin test portfolio, marking the beginning of a shift. As the U.S. continues to devalue its currency and leverage income through stablecoins, it becomes increasingly logical for other nations to consider investing in cryptocurrencies like Bitcoin. Central banks, unlike private investors, are not primarily focused on profit but must manage and diversify risk. Cryptocurrencies can play a role in this diversification strategy.
The process of incorporating cryptocurrencies into central bank reserves will likely be gradual. However, it could accelerate in response to external shocks, such as geopolitical conflicts or market crashes. Ultimately, in a world where governments resort to inflating their way out of debt, the prospects for cryptocurrencies look increasingly promising. Currency devaluation has been a recurring theme in my commentary, and it is now manifesting in reality. For the cryptocurrency sector, this evolving situation presents a continuous opportunity for growth.
