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Is Powell Paul Volcker of 2022? The answer is important for Bitcoin

author:CoinDesk Chinese

By Michael J. Casey (Chief Content Officer, CoinDesk)

What if Jerome Powell wins the inflation war?

After the Fed raised rates sharply this week, some commentators compared the Fed chairman to one of his predecessors, Paul Volcker. Fed leaders under Jimmy Carter and Ronald Reagan introduced aggressive monetary tightening in the early 1980s, which pushed the United States into recession but pushed inflation down to persistently low levels. This led to a decades-long period of prosperity, known as the "Great Moderation." Can an increasingly hardline Powell achieve similar success?

Before we address this, let's note that this is a key issue for Bitcoin, whose advocates position it as a "robust currency," a more reliable system for protecting purchasing power from human error based on statutory monetary policy.

Bitcoin's success depends largely on confidence in the existing fiat monetary system, which central bankers have defined since the dollar was pegged to gold in 1973. The idea is that if people lose faith in central banks, currencies can falter and exacerbate inflationary pressures and prompt users to turn to alternatives like gold or bitcoin.

Therefore, in the minds of Bitcoin enthusiasts, this is an important test moment for Powell.

To be fair, given the shrinking cryptocurrency market, Bitcoin is now also being put to a major test. But our focus here is on Powell. Can he do another Volcker?

Myths, messages and reality

In the 1980s, Volcker almost single-handedly restored trust in the world's legal system. Taking the politically difficult position of strengthening the long-term health of the economy gave him the status of a quasi-saint in the financial world – the opposite of his predecessor, the hapless Arthur Burns. Volcker also demonstrated to the government and its constituents the value of central bank independence.

Among economists, the conventional wisdom now holds that markets punish a country's political leaders if they ignore Volcker's legacy and prevent central banks from making tough decisions. Currency failures such as Zimbabwe, Argentina and Turkey are examples. By contrast, the long, largely stable, and rarely interrupted expansion of the U.S. economy since Volcker's recession in 1982, and the simultaneous 40-year growth of its stock market — the S&P 500 grew more than 100-fold when it peaked last year — is evidence of return for those who play by the rules.

The reality is much more complex.

As we discussed two weeks ago, the dollar's status as the primary reserve currency gives the United States a unique degree of monetary policy freedom and has had an impact in other countries.

In the years following the 2008 financial crisis, the Fed's highly accommodative monetary policy pushed "hot money" into developing economies, making policymaking it more difficult there. Now that the dollar is picking up, hot money is fleeing back to the United States, forcing central banks around the world to follow the Fed's monetary tightening policies to protect their currencies, whether or not their economies need to do so. Volckerism is not exercised on a level playing field.

Political and reputational risks

These global imbalances and the "quantitative easing" (QE) monetary policies they allow have reached a tipping point. They have fueled massive debt accumulation in the U.S. and elsewhere, and now that interest rates are rising, it will become more difficult to estimate.

A policy reversal would trigger massive bankruptcies and economic contraction, and there is no guarantee that it will dampen inflation. War-fueled commodity price increases, supply chain inefficiencies, and entrenched, self-fulfilling expectations are likely to continue to support this. What would Powell's Fed do in this environment? Will it work harder to push the U.S. economy deeper into the hole?

My bet is "no". The political stakes are too great. Once U.S. businesses fail en masse and a large number of Americans lose their jobs, the pressure to soften monetary conditions again will become too great. When that happens, Bitcoin will be one of the targets of these flows as low-cost money is once again pushed into the world in search of risky assets.

But the bigger, longer-term question is not whether the Fed will get involved in this whipsaw reaction, but what impact Powell's bold new stance will have on his reputation and that of other central bankers over time.

If he succeeds in cooling off speculation and ushering in another predictable era of moderate inflation, Powell could provide a shot in the arm for the entire fiat system and its dollar-based center in the coming years. This will make it difficult for Bitcoin (or gold, for that matter) to come up with alternatives.

A lot of things depend on this. For Bitcoin, it is not enough to say that the dollar is gradually losing purchasing power due to inflation. What most people want is predictability. Investors do not have to worry that the 2% annual inflation rate will exhaust their dollar value, but are satisfied with this consistency during the Great Easing. Restoring to similar stability would be a huge win for fiat currencies.

This is not 1982

However, what does success mean? At the end of the day, it depends on how we think about the results. The problem is that Powell is trying to explain his strategy in the hostile environment Bivolcker faces.

In 1982, the United States bucked the wind. The computing revolution has only just begun, putting the country on the cusp of productivity booms, while the more disruptive aspects of the internet age are still far into the future. The United States is on the verge of winning the Cold War and has largely overcome the social tensions of the Vietnam War. Most importantly, the gap between rich and poor is far less extreme than it is now. Americans are optimistic.

Fast forward to 2022. The war in Ukraine led to the withdrawal of Russia (and possibly China) from the dollar-centric global financial system. The planet faces a climate catastrophe, and an entire generation of teenagers and 20s are emerging from a global pandemic and are skeptical of the rigid capitalist order of the 20th century.

At the same time, it has become more difficult for the Fed or any policymaker to control information. I'm not talking about the channels of communication they have with bond traders that they use to signal market interest rate adjustments. I'm talking about communicating with us, we're the public.

At the end of the day, what matters to the central bank responsible for protecting the value of money is the judgment of the day-to-day users of the currency. Today, these people's views are influenced by social media, a massive, unpredictable system captured by bots and trolls. This makes it difficult for policymakers to manage their information and maintain trust.

Powell's success is far from guaranteed. This means that Bitcoin is still relevant at the moment.

The article represents the personal views of the author and does not reflect CoinDesk's position or make investment advice.

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