SBF and Crypto Collapse Part of Pandemic Hangover

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When historians look at the dramatic rise and fall of the cryptocurrency market, they will conclude that it could not have happened without the pandemic. And they would be right.

In 2020, when much of the world was locked down and economies shut down due to the spread of Covid-19, financial assets of all stripes began a spectacular rally that continued into 2021. It was hard to explain, even for the experts. Ultimately, they attributed this to too much money flowing into the global financial system. Ordinary? Yes, but very true.

The combined money supply of the United States, China, the Eurozone, Japan and eight other major developed economies jumped $21.5 trillion in 2020 and 2021 to a record $102.3 trillion. dollars, according to data compiled by Bloomberg. In other words, more money was created in 2020 and 2021 than in the previous seven years combined. This unprecedented increase had two sources: generous public spending programs designed to support economies during the pandemic; and central bank policies that essentially printed money to be injected directly into the financial system to keep it from collapsing.

Looking back, it is clear that governments and central banks overreacted. The financial system has been flooded with liquidity in a remarkably short period of time. It was as if new assets had to be invented to absorb all the new money, especially with bonds paying nothing and stock market values ​​at historically high levels. The crypto world has become a key release valve. The number of digital currencies has exploded from less than 3,000 towards the end of 2019 to around 10,000 by 2022, according to research firm Statista. The value of the crypto market has grown from less than $200 billion to $3 trillion. The money poured in despite the crypto having very little practical use other than pure speculation. It’s not like you can walk into any restaurant, car dealership, or department store and pay with Bitcoin. That day may come, but it is still a long way off.

Financial engineers don’t stop there. They quickly invented the non-fungible token, a cousin of crypto. As Bloomberg News explains, NFTs are essentially digital certificates of authenticity. An NFT is a unique and irreplaceable identifier created by an algorithm: a distinct barcode for a piece of digital art or a collectible. This helps solve a problem digital artists have had for a long time, which is how to create rarity for an item that can be reproduced endlessly.

Like crypto, the NFT market has exploded. Trade reached $17.6 billion last year, a 21,000% increase from 2020, according to Nonfungible.com. Investors have gone crazy for bored monkeys, cryptokitties, and hat-wearing penguins. The price to join the Bored Ape Yacht Club by purchasing an NFT of an image of a bored ape has jumped to $420,430. Crypto entrepreneur Justin Sun paid half a million dollars for a photo of a rock with laser eyes.

No one should have been surprised by the crypto frenzy. It was the culmination of a dozen years of policy mismatch between monetary and fiscal authorities globally.

Coming out of the 2008 financial crisis, governments largely focused on austerity to reduce heavy debt loads, leaving central banks to fuel the recovery from the worst recession since the Great Depression.

Central banks decided they had no choice but to resort to drastic measures to prevent their economies from falling back into recession and avoid deflation. So they brought interest rates down to near zero – or lower in some cases – and began a policy of quantitative easing. As part of QE, they injected money directly into the financial system by buying assets such as government bonds to prevent market interest rates from rising.

Once on this path, they could no longer stop and risk jeopardizing a soft recovery.

Investors, of course, knew this and became emboldened to pay ever higher prices for financial assets because central banks were unwilling – unable! — let the markets fail. Central banks knew they were stuck. They pleaded with governments to take some responsibility, to no avail. European Central Bank President Christine Lagarde has openly pushed for a looser fiscal policy. Then-Federal Reserve Chairman Ben S. Bernanke was “so aggressive on the monetary policy side” due to a lack of fiscal stimulus, said Philip Orlando, chief equity strategist at Federated Investors. Inc., to Bloomberg News in 2016.

As the pandemic spread, central banks had no choice but to step on the QE accelerator. The collective balance sheet assets of the Fed, ECB, Bank of Japan and Bank of England have grown from around 10% of their countries’ combined gross domestic product in 2007 to around 35% at the start of 2020. , according to data from Bloomberg. They reached 59% at the peak at the end of 2021.

The pandemic has forced governments to finally loosen their belts. The combination has led to an undeniable speculative frenzy in the markets. Crypto in particular has soared. But all of these fads must end, as evidenced by the bankruptcy of Sam Bankman-Fried’s crypto empire last week and the downward spiral of Bitcoin, which has collapsed 75% since its peak a year ago.

Governments are reverting to austerity in the face of rising prices. Just ask Liz Truss, whose time as UK Prime Minister was among the shortest in history after the bond market balked at her stimulus proposals. And central banks are tightening monetary policy and reducing the money supply to fight inflation rates that haven’t been this high since the early 1980s.

This is not to say that governments and central banks were wrong to act quickly and vigorously to support their economies and the global financial system. Imagine the alternative if they hadn’t. We could have looked at economic Armageddon. On the contrary, the speculative frenzies of the past decade that peaked during the pandemic and are causing so much financial pain today probably could have been avoided if central banks had not been forced to do all the heavy lifting in the decade following the financial crisis. Perhaps if the fiscal authorities had done their part at the time, the central bank’s quantitative easing programs could have been much more restrained, which would have helped contain the bubbles. This is the real lesson learned from all of this. More from Bloomberg’s opinion:

• FTX is a feature, not a bug, of financial innovation: Aaron Brown

• The Far West of crypto claims another victim: Lionel Laurent

• Crypto can survive FTX’s possible demise: Tyler Cowen

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This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Robert Burgess is the editor of Bloomberg Opinion. Previously, he was Global Editor of Financial Markets for Bloomberg News.

More stories like this are available at bloomberg.com/opinion

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