In this article, we will explore how the equilibrium interest rate is declining towards zero as total global debt increases and how money printing is the only option left for central banks going forward. This persistent and large-scale money printing will drive fiat inflation, especially in economically weaker countries, applying upward pressure to Bitcoin’s (BTC) price long-term.
In the past, the Federal Reserve’s main tool to stimulate the economy was cutting the Fed funds rate. However, the Great Recession of 2008 changed everything. First, the Federal Reserve cut the Fed Funds Rate, which controls interest rates at the top level of the economy, from about 5% to nearly 0%. This was not enough to stop the financial meltdown, so the Federal Reserve printed trillions of dollars. Indeed, the Federal Reserve balance sheet history shows this clearly, with $1.3 trillion printed before 2008 even ended, and another $2.3 trillion printed from 2009 through 2014. All in all, the Federal Reserve had to print $3.6 trillion to keep the economy afloat, among other major central banks worldwide printing trillions of dollars as well.
The theory was that eventually the trillions of dollars of printed money would be paid back by the corporations and banks that borrowed it. Also, the Federal Reserve thought that it could raise the Fed funds rate back to a healthy level so that it would once again have ‘ammunition’ to stimulate the economy via rate cuts.
The Federal Reserve began to slowly raise the Fed Funds Rate in 2016, and eventually raised it as high as 2.5% by the beginning of 2019. Simultaneously, the Federal Reserve began to take back some of the capital it injected, decreasing its balance sheet from $4.45 trillion at the beginning of 2018 to $3.75 trillion by September 2019.
This caused an economic crisis, with liquidity drying up in the interbank repo market. It likely would have caused a financial meltdown, but the Federal Reserve intervened by cutting the Fed funds rate three times in the last half of 2019, down to 1.5% currently. It also has had to print and inject $850 billion in only five months, which will soon bring the Federal Reserve’s balance sheet to a new all-time high.
It seems the Federal Reserve has discovered the hard way that the world has a maximum possible interest rate called the r* equilibrium, and the r* equilibrium interest rate is declining as global debt increases.
Simply, the maximum possible interest rate has to decrease as global debt rises since global debt obligations would default beyond a certain interest rate. Basically, if the interest rate for banks and corporations is too high, they cannot even make the interest payments on the debt they owe.
Currently, total global debt is $255 trillion, up $12 trillion in only a year, and up $174 trillion since 1999. It seems the growth of global debt is only accelerating while global gross domestic product (GDP) growth is stagnating.
If global GDP growth was increasing, the r* equilibrium interest rate could theoretically stay the same, but if global GDP growth is stagnating and debt is increasing, the r* equilibrium interest rate declines.
Interestingly, there is a chart that shows how economic meltdowns have coincided with the Fed funds rate hitting the r* equilibrium interest rate and how this rate is declining long-term. In 1982, the r* equilibrium interest rate was almost 20%. When the dotcom bubble collapsed, the r* equilibrium interest rate was 7%, and when the 2008 Great Recession happened, the rate was 5%.
Based on recent events the r* equilibrium interest rate is now only 2.5%, and within a few years, it will likely hit 0%. Eventually, the r* equilibrium interest rate will likely go below 0%, meaning that banks and corporations will need to be paid interest to take free money in order to not default on their debts.
Thus, the Federal Reserve will never be able to raise interest rates to healthy levels, and the era of cutting the Fed funds rate to stimulate the economy is almost over. The Federal Reserve has just a handful of rate cuts left before the Fed funds rate drops below zero, which will inevitably happen. Even at this point, the primary tool that the Federal Reserve has left is to print money, and central banks around the world are in the same boat.
The World Bank warns that this situation could lead to the economic collapse of many developing countries, which makes sense since money printing will lead to currency collapse in economically weaker countries first.
As detailed in a previous Crypto.IQ article, 24 countries are already on the road to hyperinflation and currency collapse. In each of these countries, cryptocurrency is undoubtedly an attractive option, and as more countries fall into hyperinflationary regimes it is likely that crypto adoption will spread, which will apply upward pressure on the price of Bitcoin (BTC) long-term.
Even the world’s strongest fiat currencies like the EUR and USD could eventually begin to devalue significantly due to money printing, at which point crypto will be a number one alternative for people worldwide.
Thus, central banks like the Federal Reserve will be forced to print money for the foreseeable future since the r* equilibrium interest rate is only 2.5% and declining towards 0% as global debt increases. Therefore interest rates can never be raised to healthy levels again, eliminating the ability of Central Banks to use rate cuts to stimulate the economy.
It seems to be a matter of when, not if, this money printing will lead to significant fiat inflation, and in a couple of dozen countries the time has already come. For each country that experiences hyperinflation, crypto is waiting on the sidelines as a readily usable alternative to fiat.