As Inflation Fades, Jerome Powell’s Biggest Problem Will Be Republicans
NFTs — “non-fungible tokens” — are proof of ownership of digital products, most commonly images, music or short videos, that exist on a blockchain. A blockchain is a digital ledger where digital items are stored, and — theoretically at least — cannot be hacked or stolen. Cryptocurrencies — such as Bitcoin or Ethereum — are kept on a blockchain; now NFTs are there too.
Bored Ape Yacht Club (BAYC) is a collection of bored ape NFTs, like the one shown here that was posted for sale recently. Serena Williams apparently has purchased at least one of BAYC’s NFTs. So have Eminem, Stephen Curry and Shaquille O’Neal.
Why those celebrities bought NFTs is a reasonable question. Just as you cannot put your cryptocurrency in your pocket, or bite it to see if it is real, you cannot keep other people from putting a picture of the image you own on their wall — or using it to illustrate their blog.
If none of this makes sense to you, take heart: it probably doesn’t really make sense to them either. Just think of NFTs as the latest shiny thing to come along that people want to be part of, like your cousin who will not stop talking about the killing he made in a cryptocurrency he bought that has a picture of a dog on it. Perhaps those celebrities wanted to buy the digital images to support the artists that produced them. Perhaps being part of the crypto ecosystem — now branded as Web 3.0, or Web3 for short — enhances their personal brand value.
Or perhaps, as crypto critic Molly White has argued, they simply got caught up in the “litany of scams, failures and frauds” that White argues have been the sum and substance of Web 3.0; a universe where boosters and venture capitalists scheme “to separate regular people from their money.”
And White’s perspective has been vindicated. As prices of BAYC NFTs, along with much of the crypto universe of assets, has come crashing down — as illustrated by the chart here showing the crash in the overall NFT market — it is the small investors who have taken the hit. Sure, the Winkelvoss brothers — of Facebook and The Social Network fame — have lost a billion here or a billion there, but like the other now-billionaire crypto boosters, they are doing just fine.
The crash in NFT prices is a classic example of a market bubble. Indeed, the very existence of NFTs, along with the rise of cryptocurrency as an “asset class,” should be a lesson in financial hubris that we learn from. Of course, we never learn from financial bubbles, as economists Carmen Reinhart and Ken Rogoff observed in their 2011 book This Time Is Different: Eight Centuries of Financial Folly.
Everyone denies that they are part of a bubble, until the world comes crashing down around them. Crypto enthusiasts in particular have chafed at comparisons between the rise of Bitcoin and the 17th-century market frenzy in which Dutch traders drove the price of tulip bulbs sky-high, before “tulipmania” came to a crashing end. After all, one crypto advocate wrote late last year, “Bitcoin is a technology, tulips are plants, and no discerning person would take the comparison much further.”
Perhaps comparing Bitcoin and blockchain to tulip bulbs is a bit over the top. After all, cryptocurrency offers very real value as a covert means of exchange for those engaged in money-laundering, tax evasion, and myriad other criminal activities, while tulips are pretty flowers. But a comparison of the trading frenzy that has surrounded ownership of digital images of bored simians to tulipmania in 17th century Holland actually seems fairly straightforward.
It is hard to assess the Web 3.0 bubble and ensuing crash outside of the context of the rest of the market bubbles that built up over the decade since the 2008 global financial collapse, and the integral role played by the Federal Reserve Bank. The fear among central bankers and Treasury officials of a prolonged depression in the wake of the 2008 collapse led to unprecedented efforts to push interest rates across the globe to zero, and below. These efforts were spurred on by belief that the deflationary cycle that characterized Japan’s “Lost Decade” following the 1990 collapse of the Japanese Asset Bubble was in part due to a failure of the Japanese central bank to respond aggressively to sustain economic growth. Driving interest rates to and below zero, drove asset values to historically high levels.
Asset values from stocks and bonds to real estate respond directly to central bank interest rate policies. Not to get too far into the weeds, but this is because the value of cash flow generating assets (stocks generate earnings/dividends, real estate generates rents, etc.) generally reflect projected future earnings discounted at prevailing interest rates. Therefore, as interest rates decline, asset values rise. Accordingly, as the US Federal Reserve Bank pushed interest rates towards zero in the wake of the 2008 financial collapse, and as rates were pushed to below zero in Europe, stocks, bonds and real estate each exploded in value, with stocks in particular rising 500% over the ensuing decade.
This historical relationship is presented in the graphic shown here that was produced by Nobel laureate economist Robert Shiller. It presents the inverse relationship between stock “price/earnings ratio” (which calculates a stock price as a multiple of a company’s most recent annual earnings) and long-term interest rates. As illustrated here, stock market peak reached in 2021 marked the second highest level of stock valuations — stock prices on average rose to nearly 40 times company earnings — in the past 150 years, exceeded only by the “dot-com” bubble that peaked in 1999, and surpassing the market highs reached just before the market crash in October 1929 that ushered in the Great Depression.
Accordingly, no one should be surprised that the NFT market collapsed as Federal Reserve Bank policies shifted in response to inflation fears. Just as central bank zero-interest rate policies and quantitative easing drove those asset values to new heights, the reversal of Fed policies over the past several months to push interest rates upward brought asset prices crashing back down (though by historical standards, as the graph above shows, they remain very high).
Nor should anyone be surprised that the NFT price implosion has been more severe than the stock market as a whole. After all, investor enthusiasm for NFTs, like the Web 3.0 investment universe as a whole, grew out of the dramatic rise in stock prices in response to zero and negative interest rate policies since the post-2008 global financial collapse. As traditional stock, bond, and real estate investments became increasingly overvalued, investors naturally began to search for new “alternative investments” that might offer new investment possibilities. First money poured into unregulated hedge funds. Then private equity became all the rage. Then crypto rode the wave. And finally NFTs, the newest newfangled investment to come around, joined the party.
In a 1996, then-Fed Chairman Alan Greenspan gave a seminal speech entitled “The Challenge of Central Banking in a Democratic Society,” in which he reflected on the challenge that investor “irrational exuberance” and ensuing market bubbles present to central bankers, whose job includes seeking to prevent damage to the broader economy as those market bubbles inevitably collapse. His comments came as the dot-com bubble was just beginning its ascent — the NASDAQ Composite Index had nearly doubled over the twenty-four months preceding Greenspan’s speech, and would increase a further 300% before the dot-com bubble burst three and a half years later — and six years into Japan’s “lost decade.”
This time around, Jerome Powell faces an additional problem, beyond, as Greenspan suggested, having to balance the need to raise interest rates to slow the economy down and bring inflation into line, against the damage to the economy that might be caused by the ensuing collapse of stock and other asset markets. The widely held view is that the Fed waited too long to take inflation seriously. While inflation emerged on the horizon during the first half of last year, it was not until early this year that the Fed acknowledged that it was more than a transitory phenomenon. During the intervening months, the public perception took hold that inflation is out of control. That has left the Fed fighting a fundamentally different battle: it is fighting public expectations about inflation as much as it is fighting inflation itself.
To an extent that seems remarkable given where we were just a couple of months ago, market fears of inflation have evaporated. Global commodity prices have begun to fall, and, in a symbolic breakthrough, oil dipped below $100, suggesting that the price of gasoline should soon follow. However, as Bloomberg’s John Authers observed, inflation fears are only abating because recession and deflation now loom as the greater risks. Nonetheless, Powell has indicated that the Fed plans to continue to raise interest rates. If zero growth was going to be sufficient to tame inflation a few months ago, now it is apparent that the Fed is willing to tolerate a recession of some duration to bring public expectations of future inflation into line.
Powell is going to have a tough fight on his hands, one that goes well beyond the prices at the pump that have driven popular anger. He will be fighting a Republican Party that will be loath to let go of inflation as a central theme for the 2022 and 2024 elections. GOP strategists smell blood in the water, as memories of the 1980 presidential election — when double-digit inflation helped bring about the Reagan Revolution and twelve years of GOP rule — dance like sugar-plums in their heads. Every Jerome Powell press conference touting the Fed’s success in bringing inflation back into line will no doubt be met by a barrage of political ads, harangues by Tucker Carlson and Sean Hannity, and social media posts from Mar-a-Lago reassuring the faithful that, indeed, the sky is falling.
Whether, or when, the prices of bored ape NTfs recover from the drubbing they have taken over the past months remains to be seen. To add some perspective, it took the NASDAQ fifteen years from the collapse of the “dot-com” bubble in 2000 to get back to the level it had reached at the peak of the bubble, notwithstanding the fact that the NASDAQ includes the FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) that have been central to the market rally over the past decade.
But even a restoration of Fed zero interest rate policies — as former Treasury Secretary Larry Summers now apparently expects — and a relatively quick bounceback in the stock market, may not help. If one considers tulipmania to indeed be the more apt analogy to the NFT bubble, the future is less rosy. Tulip bulbs never returned to the prices reached during the peak of the bubble in 1637 (when a single bulb apparently sold for as much as the annual salary of a skilled artisan); and those celebrities looking to recover what they invested in their digital images of bored ape over the past year may have to wait a while.