Central banks in the United States and the EU are putting together rescue packages to deal with the corona crisis that is currently panicking the stock markets worldwide. While the measures largely fizzle out, Bitcoin is picking up again without any help. Was it too early to consider Bitcoin as a lifeboat?
If you have already dealt with Bitcoin, you know for sure: The maximum number of Bitcoins is limited to 21 million units. Almost 18.3 million of these are currently in circulation. The protocol states that there will never be more than 21 million monetary units, and it is almost impossible to change this protocol in a decentralized network.
Bitcoin critics sometimes complain that this control of the money supply is too rigid. Too inflexible to respond to crises, too deflationary to create the kind of value stability that central banks define as ideal. The corona crisis, which has dominated the minds, media and stock exchanges for a few weeks, shows again what the central banks mean by managing a crisis.
How central banks and governments are tackling the corona financial crisis
The US Federal Reserve reacted first with several measures: First, it lowered the interest rate to 0%, and second, it announced the injection of $1.5 trillion into the financial system in an effort to calm the panic created from corona crisis. In addition, it wants to offer banks emergency loans on favorable terms and has reduced the rate for the “partial reserve” of the banks to 0 percent.
In the meantime, the European Central Bank ECB has also announced a “pandemic emergency purchase program” for bonds with a volume of 750 billion euros ($820 billion). The Pandemic Emergency Purchase Program (PEPP) is designed to buy both public and private securities.
Extraordinary times require extraordinary action. There are no limits to our commitment to the euro. We are determined to use the full potential of our tools, within our mandate. https://t.co/RhxuVYPeVR
— Christine Lagarde (@Lagarde) March 18, 2020
So far, however, the announcements by the central banks do not seem to have led to the desired success. Both the DAX and the American indices Dow Jones and S&P continue to fall, the “Fear” index of the US stock exchanges has risen to a new all-time high. According to analysts, central bank purchases will not be enough to stop the slump in stock prices.
At the same time, governments must take further measures to prevent the economy from collapsing. This, helping companies that have shut down with programs for liquidity support and facilitating taxes. But all of this is fading from the U.S. program: It plans to use $ 850 billion to lower taxes, target specific industries, and send a $ 1,000 check to every citizen.
Is new money being printed or not?
It is rather complicated what exactly these measures do with the monetary system. If the Fed and the ECB buy securities, this corresponds quite concretely to creating new money. If the ECB actually invested 750 billion euros in the stock markets by crediting itself, it would increase the M1 money supply, which is currently around 6,300 billion euros, by a good 10 percent. However, the money supply can also fall at the same time, for example when loans burst or debts are repaid.
It is more difficult to assess the Fed’s further measures. Lowering the key rate means that banks can borrow from the Fed at lower rates. This could indirectly increase the money supply, as money is created through loans and they are now cheaper. By also lowering the rate of the partial reserve of banks to 0 percent, the Fed can grant loans more or less indefinitely and thus not create central bank money, but still deposit money. Such a measure seems desperate because it threatens to undermine the stability of the banking system.
It is even more difficult to assess the impact of government action. It is clear that these will put a lot of money into circulation. Since central banks are formally independent, governments cannot directly recreate this money. However, it is conceivable that the ECB will fund governments retrospectively with new money, for example by buying government bonds.
In addition, not all countries have as good a financial cushion as the United States and Germany. Many European countries will not be able to sustain the economy for long as sales slump due to global quarantine. If the state of emergency lasts for a few months, many companies will face tight crises and the spiral of ruin threatens to destroy completely many sectors of the economy like tourism for example.
There is a relatively wide range of disaster scenarios for the economy that could prove to be true in the coming months. It could lead to both deflation and inflation, even if inflation seems more logical: the money supply has increased, but the number of goods produced is shrinking because the supply chains are damaged and companies are ruined. At the same time, there is a risk that the measures taken by the state to tackle the crisis will result in an even greater expansion of the money supply.
Bitcoin, the safe haven
So we do not have unrealistic scenarios in which the corona crisis triggers inflation – an expansion of the money supply, accompanied by a reduction in the quantity of goods. If this happens, Bitcoin is still the optimal protection currency: scarce, but flexibly transferable and perfect to save. If there is only a small risk that we will slide into an inflation crisis, the attractiveness of Bitcoin will explode.
There are already many indications that private demand for bitcoins has skyrocketed with the onset of the crisis. Many companies report that their customers buy more than ever. Bitwa.la, for example, explains in a press release that the sell-off of Bitcoin has led to record transaction volumes at Bitwala, and the US company Coinbase, the top contact point for US Bitcoin buyers, also has a record volume with allegedly similarly high levels of buyers. The plunge in price appears to have been driven by companies and institutional investors but has been gratefully received by private buyers to build or expand a position in Bitcoin.
The Bitcoin price has accordingly picked up again. While market prices continue to fall, Bitcoin has risen from $5,100 to near $7,000 in the last two and it is hovering near $6,200 at the time of writing. One could almost think that the cryptocurrency is recommended as a safe haven in times of crisis.