The Latest in Bitcoin & The Powell Pivot

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The Latest in Bitcoin & The Powell Pivot

This episode we are going to talk about the crazy week for Bitcoin and the “Powell Pivot” which you may have seen in the news where Fed Chair Jerome Powell had a bit of a change of heart. We’ll talk about what interest rates might do later on, but first let’s start off with this crazy week for Bitcoin. Bitcoin is still a volatile asset class most recently visible through a 20% drop in Bitcoin on Saturday before it finally recovered slightly and ended up closing less than that initial 20% drop. On Monday morning it was still down 10% from Friday’s close. Bloomberg notes that it might be due to institutional investors getting into the Bitcoin trade, which can increase volatility in both directions. If a large investor begins to get out, it can have a large effect on the asset class as a whole. That being said, Bitcoin is still up 65% since the beginning of the year.

Speaking of Bitcoin, El Salvador’s President, Nayib Bukele is embracing it unlike any other government leader in the world. At the end of December, he announced the building of the world’s first Bitcoin City.  It will be powered from geothermal energy because it is being built at the base of the Conchagua Volcano. This geothermal energy would supposedly be more than sufficient to fuel the high energy demands that Bitcoin mining requires. What does Bekele mean by a “Bitcoin city?” According to Reuters, his plan is to issue $1 billion in bonds backed, in part, by Bitcoin. He will take $500 million of those bonds and immediately buy Bitcoin with the other $500 million presumably being used to build the city. The $500 million of Bitcoin the country buys would be “locked up” for 5-years. Bekele’s theory is that in 5-years the Bitcoin could be worth more than they borrowed, and that they would be able to sell the Bitcoin, pay off the bondholders for both issues, and keep the profit. Initially, the bonds will carry a 6.5% coupon interest rates. Not only would Bitcoin be purchased with the proceeds from the bonds, but the city itself would be built in a circular shape, intended to mimic the shape of a large coin. El Salvador has already become one of the first countries in the world to make Bitcoin legal tender. Needless to say, they are going all in.

If you want to be reminded exactly how Bitcoin works, feel free to listen to our podcast on June 21 of 2021 here to learn a bit of Bitcoin 101. But one of the questions this story begs is will people be willing to invest in bonds backed by Bitcoin? Probably so. The euphoria around Bitcoin coupled with the 30% plus increase in the money supply is a recipe for this bond issue having a real chance. Bond holders would be taking a tremendous amount of risk because their loan to the government of El Salvador is essentially predicated on the assumption that Bitcoin continues to go up and up and up. It is certainly possible that the price of Bitcoin continues to increase, but the stability of Bitcoin remains a question mark. 20% drops in a single day like Saturday make it very difficult to make the case that it is a short-term store of value. The argument from Bitcoin enthusiasts is that as the dollar loses value through inflation, other stores of value, like Bitcoin, will gain in value versus that dollar, particularly because there is a limited supply of Bitcoin. That theme has generally been the case this year, but it has been a wild ride with a 50% move to the downside that occurred from mid-April to mid-July. Its value was cut in half in a matter of a few months. It recovered that loss, but again, the volatility in this asset class is jaw dropping. Until it becomes more stable, it will be difficult for Bitcoin to become a reliable means of exchange. It is entirely possible that this happens, but it would appear we have a long way to go.

Because there is no government standing behind the value of Bitcoin, and this is an important concept to grasp, it is only worth however much demand exists to purchase it. As long as there are more buyers of Bitcoin than sellers, it will increase in value. If the opposite is true, then you will see the price going down. Likewise, like any other asset class that is easily convertible to cash, it is vulnerable in the next recession. Anytime people are trying to raise cash, whether it is from fear of recession or legitimate need in recession, a “run” on an asset class can cause a precipitous drop. Asset classes that are primarily fueled by speculation are particularly vulnerable to runs like these. In other words, if a need to raise cash hits the marketplace, Bitcoin could be one of many that are accessed first. Before investing in any asset class, make sure you understand your risks in addition to the rewards so you can go in with eyes wide open.

Well, I mentioned earlier that I would give an update on the “Powell Pivot.” The Chair of the Federal Reserve, Jerome Powell, made a bit of a 180 degree turn this past week. In testimony before Congress, Powell indicated that the stubborn persistence of inflation, particularly in the October numbers, may lead the Fed to consider tapering their bond purchases at a faster rate, which may also open up the possibility that short-term rates begin increasing next year – maybe even as early as Springtime. The Fed Fund Futures market has priced in nearly 3 quarter point rate hikes next year. This would take the Fed Fund’ rate on the top end from 0.25% current to 1% by the end of the year. What would this mean for deposit customers? It would normally mean that savings and CD rates could go up. It will probably mean that again, but those rates may be slower going up than in years past because the money supply has grown over 30% since the start of the pandemic. Banks are flush with cash which will make them less interested in increasing their deposit rates. What would this increase mean for loan customers? Those most impacted would be business customers whose rates are floating and tied to the prime rate. When the Federal Funds Rate increases, the prime rate also traditionally increases in lock step. Businesses will need to budget higher interest cost for 2022, even if the rate increase doesn’t materialize, just so you don’t get caught flat footed. For mortgage customers, the rates might trickle up a little, but so far long-term rates have not gone up in anticipation of the Fed’s potential to raise rates next year. This means that even if short-term rates go up, they are not expected to go up in a dramatic fashion and stay there. The Bond market is forecasting a historically low rate environment to persist – even if it is higher than where we are currently. But keep in mind, the plans of the Fed are on a swivel, and as Chairman Powell demonstrated recently, he’s not afraid to pivot if the data suggests they do so.

You may be in the market to buy a house. If so, we’d love to tell you about our Home Sweet Home Loan program. It’s one of the most unique products in the marketplace. If you’re looking to buy a home, we invite you to start a conversation with us today by contacting your local branch or exploring our website. We hope you’ve found this podcast helpful and informative. If so, we do hope you will subscribe on your favorite podcast app or share it on social media with your friends and family. Until next time… God Bless.

– President Chad P. Wilson, CFP

Today’s episode of “Money Matters” was written and recorded by President Chad P. Wilson of McKenzie Banking Company / Foundation Bank on December 7, 2021. This episode does not constitute financial advice. Please consult a financial professional to discuss your specific needs. MBC/Foundation Bank is an Equal Housing Lender, Member FDIC.