What the Fed’s New Inflation Policy Means for Stablecoins

“On Aug. 27, the Federal Reserve Chairman Jerome Powell gave a widely watched speech  entitled ‘New Economic Challenges and the Fed’s Monetary Policy Review’ at the Jackson Hole Economic Symposium. In his remarks, Powell announced the Fed would allow inflation to run above its long-term 2% level. More immediately, the Fed will continue with its policy of keeping the Fed funds rate at (almost) zero and buying Treasury bonds to the tune of $80 billion a month. 

“To put things in perspective, the Fed’s total assets stood at $4.3 trillion in March, and $6.6 trillion in August – a massive increase due to the purchases of U.S. Treasurys and mortgage-backed securities. It is very likely the Fed funds rate will stay at zero for a prolonged period of time – probably for the next five years. In comparison, in Japan, short rates have stayed at or below zero (with a short intermission) for 20 years.

“In theory, the Fed’s massive money printing and the associated ballooning of its balance sheet undertaken to fight the economic impact of COVID-19 would lead to heightened inflation. In practice, inflation stays fairly low due to the global economy’s overall weakness and reduced demand. One possible explanation is that due to the high degree of economic uncertainty, both individuals and businesses tend to hoard their money rather than spend it. 

“In particular, banks, which under normal circumstances are eager to lend, tend to keep their assets at the Fed. Thus, commercial banks are moving away from the fractional reserve to the narrow bank model, while the Fed operates more as a fractional reserve bank. Although Powell’s announcement is of little immediate consequence, in the long term it will have profound implications for the price of equities, oil, gold and cryptos, and, more broadly, to the modus operandi of the entire financial system. 

“At present, deposits at all U.S. commercial banks are $15.6 trillion. At the same time, the total capitalization of all U.S. dollar–based stablecoins is about $15 billion. Banks pay no interest to their customers, thus enjoying access to deposits as a lucrative source of free funding. Yet, despite this deposit advantage, the position of banks is unstable in the long run. They can no longer offer competitive interest rates on deposits and the FDIC insurance proposals cannot offer protection to consumers in the case of any major bank defaults…”