Will the Federal Reserve ever begin buying Bitcoin?

Could the Federal Reserve's Interest in Bitcoin Signal a Change in Economic Policy?

 

The Federal Reserve has recently started showing interest in the cryptocurrency, Bitcoin.

Some experts believe that this could be the first step towards Bitcoin gaining acceptance as an alternative form of currency, but others believe that this could be just another experiment and that the cryptocurrency won’t get any closer to mainstream adoption than it already has.

We look at both sides of the argument to determine which will prove true.

 

A Brief History of Money

Money has been around for thousands of years, so it’s difficult to pinpoint exactly when and where its use first began.

Historians have traced its evolution from primitive bartering systems (where goods or services were exchanged for other goods or services) to its eventual development into something that could be exchanged for gold and silver coins.

Coins could then be stored, traded, and used by merchants to facilitate commerce.

It wasn’t until paper money came into existence that anyone besides governments was able to make money—and even then, making money was generally reserved for those with specific privileges like banks and individuals authorized by government agencies.

Throughout its long history, money has primarily served one purpose: act as a medium of exchange.

 

How Central Banks Like the Fed Create Money

When central banks print money, they’re essentially printing an IOU. The U.S. dollar is created (or printed) by and for the benefit of the U.S. government, which can spend that money at its discretion to pay bills or fund public projects like building roads and schools.

Many other countries use similar systems—the Bank of England, for example, prints pounds; Japan issues yen notes that it can spend through its Ministry of Finance—but only central banks have authority to create legal tender that gets passed into circulation as official currency.

Banks that are part of a country’s central bank system also have access to reserves of cash held by their national governments.

This is why when you deposit $100 in your checking account, your bank doesn't hold onto all $100; it lends out some of those dollars to other customers and keeps some on reserve with the Fed. Your bank will keep some fractional amount on reserve because if everyone tried to withdraw their money at once, there wouldn't be enough physical cash available.

Banks typically keep about 10% on reserve, but during times of financial crisis, these ratios get higher so there's more cash available for withdrawals.

 

The Fed’s Influence on U.S. Financial Markets

The U.S. economy is intertwined with financial markets, so it’s no surprise that many are wondering what influence changes to Federal Reserve policy may have on stock and bond prices.

The federal funds rate—the interest rate set by central banks for overnight loans between banks—is seen as an important gauge of whether the stimulus will be increased or decreased.

The fed funds rate affects interest rates across other asset classes and helps investors identify when Fed policies might change. (Source: FRB New York, Federal Reserve Bank of New York, last accessed October 9, 2016.)

In addition to affecting interest rates, changes to government bond yields can also send ripples through currency markets since bonds and currencies are closely tied to one another. But does Fed policy affect cryptocurrency prices as well?

 

What Would Happen if the Fed Bought Bitcoin?

It depends on whether or not you think it would make sense to use dollars to buy bitcoin. On one hand, they could always just make more dollars (in fact, they've been doing so for years), and buying bitcoin wouldn't change that.

On the other hand, if you believe that bitcoin has intrinsic value, then those dollars are now part of that calculation. What would happen if we suddenly saw more Satoshi printed out than expected?

I don't think we know enough about cryptocurrencies yet to be able to guess with any accuracy what effects a sudden surge in supply might have on their price – or whether a negative impact might be negligible compared to the potential benefits of using cryptocurrency as money (or monetary policy).

As an economist, I'd like to see how things play out before making any assumptions.

 

Investing in Cryptocurrencies

With bitcoin trading well below its record high, investors are looking for other opportunities to make money. One of those options is cryptocurrencies. Now you can invest in cryptocurrencies and earn interest on your investment but that could also be because prices fluctuate often.

Is there another alternative that would keep you safe if cryptocurrency prices declined? There is—and it’s regulated by one of the most powerful banks in America. Keep reading to learn more!

The U.S. central bank regularly makes short-term loans to commercial banks (known as reserves) which allow them to meet their legal obligations.

The vast majority of these reserves are kept at central banks across different countries such as Great Britain or Germany; however, some reserves remain with financial institutions in specific regions (like New York City) called local reserve depository institutions.

The Fed has recently taken notice of an increase in outstanding loans made to these local reserve depository institutions as they have increased by $2 billion since 2016; creating a large  pool of available capital within New York City...something that might not bode well for cryptocurrency markets!

Conclusion

The Fed is looking at Bitcoin, which has steadily grown in value over time. On March 10, 2017, the digital currency was valued at $1100 per unit of currency. For comparison purposes, ten years ago it was worth about 1 cent each.

The question for investors is whether or not that growth trend will continue going forward into future years and decades. There are two main schools of thought when it comes to how best to look at an investment vehicle like Bitcoin.

One school believes that you should buy low and sell high; while another argues that you should invest early on before there’s any chance of failure.

The reality is probably somewhere in between, but one thing is certain: we’re all watching closely to see what happens next with Bitcoin as well as other cryptocurrencies around the world. It’s been an exciting ride so far—and who knows where it will go from here?