The Federal Reserve enters the Powell 2.0 era: a review of his views on the cryptocurrency market

Source | Bai Ze Research Institute

Early this morning, the White House announced that Biden has nominated Jerome Powell, appointed by former President Trump, to continue as the Chairman of the U.S. Federal Reserve, which is equivalent to the central bank of the United States. Biden stated that Powell played a key role in helping the U.S. recover economically during the pandemic. He also nominated Lael Brainard, widely regarded as the best candidate to succeed Powell, as Vice Chair. Following the announcement, bank stocks such as Bank of America and JPMorgan rose broadly, U.S. Treasury yields increased, and the dollar strengthened.

Under Powell's leadership, the inflation rate has been significantly above the initial target of 2%. Moody's Analytics predicts that the recently passed $1 trillion [infrastructure bill], combined with nearly $2 trillion in [social spending and climate legislation], will increase U.S. inflation by an average of 0.3 percentage points from 2022 to 2024.

High inflation seems to have become the core of market trading over the past year. Scholars in some sectors of the U.S. economy believe that the duration of inflation will be much longer than the Federal Reserve expects, due to a combination of increased consumer demand, supply chain disruptions, and labor shortages. However, many in the crypto community believe that inflation is primarily due to money printing.

But high inflation, the failure to achieve full employment, how to restore the economy, and how to establish a U.S. central bank digital currency are all tricky issues that the Federal Reserve currently faces. Former Federal Reserve official Claudia Sahm believes that the Fed is facing the "most difficult period in history" in 25 years.

Powell's second term will begin in early February next year, and the next few months will be crucial in determining his actions during the next term. Let's review his views on Bitcoin, stablecoins, and CBDCs over the past few years.

Bitcoin as "Digital Gold"

After a long career in banking and government service, Powell first joined the Federal Reserve Board in 2012. At that time, Bitcoin was priced at less than $100 and mainly existed among cryptography enthusiasts and a few original exchanges. Powell did not comment on Bitcoin.

However, when Powell was nominated as Chairman of the Federal Reserve in 2018, Bitcoin was in a completely different position, having surged to nearly $20,000 in December 2017.

In 2019, he referred to Bitcoin as "a speculative store of value, much like gold." His views have not changed in the past two years. In March of this year, when Bitcoin first touched the $60,000 mark, he reiterated at the Bank for International Settlements Innovation Summit that Bitcoin can be seen as an alternative to gold, supporting the views of some crypto market participants that Bitcoin is a new "digital gold." However, Powell also warned about the volatility of crypto assets.

"They are more like a speculative asset, so they are not particularly useful as a means of payment. It is essentially an alternative to gold, not to the dollar. I think the public needs to understand the risks associated with crypto assets, namely the volatility, the energy demands of mining, and the fact that they have no backing."

The Necessity of CBDCs

In fact, over 80% of countries worldwide are exploring digital currencies. China's digital yuan is far ahead, followed closely by emerging market countries like Cambodia, Venezuela, and Ukraine, while Europe is also making progress.

China's digital yuan has been at the forefront, having conducted internal testing in developed cities since 2020, distributing many digital yuan red envelopes to citizens. Moreover, major companies like JD.com and Meituan, as well as subways in certain regions, are actively piloting the currency. As early as 2014, the People's Bank of China initiated research on digital currency, establishing the Central Bank Digital Currency Research Institute in 2016, and completing top-level design, standard formulation, and joint debugging tests by the end of 2019.

In 2019, across the ocean in the United States, a conference at Harvard titled "Digital Currency Wars: A National Security Crisis Simulation" seemed to transform the conference room into a White House intelligence room. Faculty from Harvard and MIT, along with invited former government officials, discussed what the future would look like for the U.S. if the dollar's economic dominance ended and whether the U.S. should develop its own digital currency. During the conference, then-Director of National Intelligence Jennifer Fowler pointed out the need to recognize the crisis posed by China's digital currency, which would also be a challenge for the U.S. This crisis simulation indicated that the issuance of China's digital currency would severely undermine the dollar's dominance in the global financial system.

On the same day as the simulation crisis meeting, Powell wrote a letter to the U.S. Congress, calling for the prompt introduction of a U.S. digital currency in response to concerns about the Federal Reserve's lack of competitiveness in CBDCs. "We have assessed and will carefully analyze the costs and benefits of implementing such a plan in the U.S., and we are closely monitoring the activities of other central banks to determine the potential benefits of developing digital currency."

However, to date, the U.S. has made little progress on CBDCs, possibly due to differing views among Federal Reserve officials on the matter, which have not reached a consensus. While Powell strongly advocates for the development of CBDCs, claiming that "if the U.S. launches a digital dollar, there will be no need for stablecoins," Federal Reserve Vice Chair Randal Quarles believes that, given the current utility of stablecoins, the development of CBDCs may not be necessary.

Stablecoins Need Regulation, But No Intent to Ban Crypto

Although Powell does not believe that Bitcoin poses a real threat to the dollar, this does not mean he will allow crypto assets to go unchecked. He believes that low-volatility crypto stablecoins are an improvement over crypto assets like Bitcoin, but they cannot replace the current global monetary system.

According to data from Coingecko, as of the time of writing, the total market capitalization of stablecoins worldwide is approximately $150 billion, with USDT leading by a wide margin, accounting for about 49% of the market share, followed by USDC at about 25%.

In July of this year, Powell discussed stablecoins in the "2021 Mid-Year Monetary Policy Report" submitted to Congress. He believes that stablecoins should be regulated in a manner "similar to bank deposits."

The highest market capitalization stablecoin is Tether's USDT, which is also the most scrutinized stablecoin by regulators. Although Tether once claimed that each USDT is backed by real dollars held in a bank, it later disclosed that most of its reserves are in commercial paper or debt. While commercial paper is a company's short-term overnight bond and is mostly investment-grade and highly liquid, if the market begins to decline, people will want to withdraw their money. The economic activity of stablecoins is very similar to bank deposits, and they need to be subject to similar regulatory approaches.

Currently, stablecoins remain a source of concern for Federal Reserve Chairman Powell, SEC Chairman Gensler, and Treasury Secretary Janet, who have formed a working group to initiate a regulatory framework for dollar-pegged assets; the organization's report calls for more regulation of stablecoins, with the leading stablecoin USDT potentially facing the greatest negative impact.

In September of this year, North Carolina Congressman Ted Budd asked Powell a pointed question:

"You said in July that if we had a U.S. digital currency, then there would be no need for cryptocurrencies. So, Mr. Chairman, as a policy issue, do you intend to ban or restrict the use of cryptocurrencies as we see in China?"

Powell immediately clarified, "What is not needed is stablecoins, not cryptocurrencies."

"We have no intention of banning cryptocurrencies. But stablecoins are like money market funds, like bank deposits. However, they are somewhat outside the regulatory scope, so regulation is appropriate."