In the face of instability and uncertainty brought about by the COVID-19 pandemic, central banks took drastic steps to stabilize economies. This article will review the measures undertaken by central banks to combat the economic crisis, and explore investor responses as they navigate the current economic environment.
COVID-19’s Economic Crisis
The pandemic led to an unprecedented economic crisis, with businesses shutting down, supply chains disrupted, and millions of people losing their jobs. In response, central banks around the world took several actions to mitigate the economic fallout and stabilize their economies.
- Lowering Interest Rates: Central banks, such as the U.S. Federal Reserve, the European Central Bank, and the Bank of England, aggressively cut their interest rates to near zero or, in some cases, into negative territory. These rate cuts aimed to stimulate borrowing and spending by making it cheaper for businesses and households to obtain credit. Lower interest rates also helped reduce the burden of debt servicing, providing relief to borrowers during the economic downturn.
- Quantitative Easing (QE) Programs: Central banks initiated or expanded their quantitative easing, which involves purchasing large-scale government bonds and other financial assets to inject money into the economy. By increasing the money supply and lowering long-term interest rates, QE programs aimed to encourage lending, spending, and investment.
- Liquidity Support: Central banks implemented various programs to provide liquidity support to financial institutions and markets. These measures aimed to ensure that banks had enough funds to continue lending to households and businesses, preventing a credit crunch. For example, the Federal Reserve established various emergency lending facilities to support short-term funding markets.
- Forward Guidance: Central banks used forward guidance to communicate their commitment to maintaining accommodative monetary policy for an extended period or until certain economic conditions were met. This strategy aimed to provide clarity and reassurance to markets, businesses, and households, helping to manage expectations and boost confidence in the economy’s recovery.
- International Cooperation: In response to the global nature of the COVID-19 crisis, central banks also engaged in coordinated efforts to alleviate the economic impact. The U.S. Federal Reserve, for instance, established temporary U.S. dollar liquidity swap lines with several foreign central banks to ensure the smooth functioning of international dollar funding markets.
This succeeded in stabilizing economies, but the massive cash injections along with supply chain constraints eventually led to record high inflation, reaching over 9% in the US during the summer of 2022.
To combat record high inflation, the US raised interest rates at the fastest pace in nearly 40 years. While essential, this is a blunt tool for tackling inflation and left many banks and corporations in a bind; as they were forced to layoff large numbers of employees, restructure, and in some cases faced financial insolvency.
In 2022 alone, over 15 million Americans were laid off, leading to fears among workers that their job and financial status was at risk. In a June 2022 poll, 78% of American workers feared losing their job in the next recession, and 56% said they aren’t financially prepared to lose their job. This story is similar or worse in most countries, as the global economies struggle to contend with economic stability and inflation.
Bank runs are when when a large number of customers of a bank or other financial institution withdraw their deposits at the same time over fears about the bank’s solvency, often leading to the banks defaulting and abruptly closing.
In March of 2023 several banks reported being potentially insolvent due to a combination of poor planning and unprecedented actions taken by the US Government in combatting inflation. This led to the early stages of a bank run at Silicon Valley Bank, the collapse of Silvergate Bank, and Signature Bank, before Federal and state government agencies intervened. The government acted quickly, taking control of the banks and replenishing cash reserves to restore confidence, but its a clear sign that economies are strained.
If not addressed quickly, banks may be forced to sell off assets at a loss, halt lending activities, or even collapse, which can trigger a domino effect across the financial sector. As credit availability dries up, businesses and households are left with limited access to funds, hampering investments and consumption, ultimately leading to economic stagnation or recession.
Cryptocurrency is not immune to the macro market actions. In 2022, cryptocurrency markets saw several of their largest, albeit centralized, businesses shutter.
This was partially due to central bank actions which saw consumer purse strings tighten, reducing the flow of new capital into crypto markets. Additionally, crypto markets had to contend with contagion from a top cryptocurrency (Terra Luna) crashing to zero due to flaws in their algorithmic stablecoin; and the second largest crypto exchange, FTX, collapsing due to mismanagement and fraud. By the end of the year, dozens of exchanges, and hundreds of crypto-native projects lost all of their funds in these events, or were otherwise forced to close or into bankruptcy.
In March of 2023 issues in the US banking markets impacted stablecoins. One of the most trusted stablecoins, USD Coin (USDC), revealed some of their cash reserves were at Silicon Valley Bank (SVB). SVB was seized by the government that week to avoid a larger bank run and default. Due to heightened fear from last year’s Terra Luna stablecoin failure losing investors billions, many feared a repeat with USDC. This fear grew to affect additional stablecoins, until news was received that the US Government took over SVB and all investors would be made whole using government funds, if necessary.
Managing Risk in the Current Climate
Given the uncertain economic outlook and recent distrust of banks, many investors and businesses are turning to perceived safe havens like gold, US treasuries, and in some cases, Bitcoin, to preserve their capital.
If you are an investor with a low appetite for risk, a diversified portfolio across each of these is generally the best option in the unlikely event of a worsening economic climate.
- You can buy Bitcoin from any major crypto exchange, such as Coinbase (coinbase.com) or Binance. Business owners can contact Coinbase for over-the-counter (OTC) support to invest with lower fees.
- You can buy treasuries directly from the US Government here: www.treasurydirect.gov
- You can buy gold from any number of sites, but one of the trusted ones is www.jmbullion.com/gold
Crypto investors looking to hedge risk via cryptocurrency should start with Bitcoin. Bitcoin is the oldest, most trusted and least volatile long-term store of value among cryptocurrencies. If you also want to invest in altcoins, note that they will be more volatile than Bitcoin, but Ethereum or Litecoin offer sufficient liquidity and trust to make them an secondary option for capital preservation.
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