What is FED? How does the FED affect Crypto?
Hello everyone!
It seems that FED is a stranger to anyone interested in investment and finance. Every time FED introduces new policies, it can potentially impact the global economy as a whole.
The crypto market is not exempt from these rules. So, what is FED? What is the role of FED that has such a significant influence? Let’s find out specifically in the article below.
It’s me again, Neo — Admin — Community Manager of Optimus Finance and Growth Marketing of LECLE Vietnam. Let’s go!
1. What is FED?
FED is an abbreviation for Federal Reserve System, acting as the central bank of the United States. It is the largest and most influential organization in the global financial market.
FED was established in 1913 after Federal Reserve Act was signed on December 23 of that year. Before the creation of FED, United States did not have a central bank, and financial power was entirely concentrated in the hands of the government. This led to economic stagnation and in 1907, a banking panic (the Knickerbocker panic) further underscored the need for a central banking system.
FED was established to ensure stability and safety for U.S. financial system, and it operates independently of the government. However, FED and the U.S. government still have interconnections and oversight mechanisms to operate efficiently and achieve common goals.
Due to its independence from the government, it can be understood that FED is privately owned. In fact, decisions made by FED do not require approval from the President or any government official. The connection of FED to the government is demonstrated through its oversight by Congress.
2. Structure and Role of FED
The organizational structure of FED comprises three key entities:
- Federal Reserve Board of Governors: Consisting of Chair, Vice Chair and 5 other members on the Board (a total of 7 individuals). These positions are nominated by President and confirmed by U.S. Senate.
- Federal Reserve Banks: The system includes 12 member banks of FED, each allocated to one of the 12 U.S. states. Each bank has its own president and owns a specific amount of stock in FED.
- Federal Open Market Committee (FOMC): Holding three primary tools to adjust the monetary market (open market operations, interest rates and reserve requirements). FOMC is composed of 12 members (from Boston, New York, Philadelphia, Chicago, St. Louis, Richmond, Cleveland, Atlanta, Minneapolis, Kansas City, Dallas, and San Francisco), including 7 members from the Board of Governors, a president of the New York member bank and 4 other member bank presidents selected on a rotating basis.
The 5 main tasks of FED include:
- Implementing monetary policy.
- Ensuring the stability of the financial system.
- Supervising and operating member banks.
- Promoting a safe and efficient payment system.
- Supporting the promotion of community development and protecting the rights of consumers.
Regarding the implementation of monetary policy, FED, in collaboration with the government, formulates policies to ensure two factors:
- Promoting economic stability in prices.
- Ensuring the labor market.
Thus, it can be seen that while FED is privately owned, the operations of the Board of Governors and the crucial decisions regarding monetary policy adjustments involve government participation through the 7 members of the Board. Therefore, FED’s overarching goal remains to ensure the common interests of the entire American population.
3. The operational history of FED
Ra đời từ năm 1913, giai đoạn này phạm vi hoạt động của FED vẫn còn hạn chế. FED khi đó chỉ đơn giản là cung cấp một “đồng tiền linh hoạt” cho các ngân hàng vay khi thiếu tiền mặt thông qua “cửa sổ chiết khấu”. Tuy nhiên, điều này khiến FED lâm vào thế bị động trước nhu cầu ngày càng tăng của nền kinh tế.
Established in 1913, during this period, the scope of FED’s activities remained limited. At that time, FED simply provided a ‘flexible currency’ to banks in need of cash through the ‘discount window.’ However, this arrangement left FED in a passive position in the face of the increasing demands of the economy.
No one thought that FED could use its control over the credit supply to shape the entire economy.
In the 1920s, FED began buying and selling bonds on the open market to regulate the credit supply, which had been constantly fluctuating. During the Great Depression, FED once again became passive, limiting its operations in the open market and leading to the collapse of thousands of banks.
The causes of this phenomenon are still debated, but one thing is certain: as banks did not demand credit, the Fed did not provide credit. The money market tightened despite falling prices and declining production.
In 1932, President Franklin Roosevelt initiated a comprehensive overhaul of the entire financial system. Commercial banks and investment banks were completely separated, the deposit insurance mechanism was introduced and FED gained more authority over the economy, allowing for various financial institutions to borrow money and accept a wider range of collateral. The creation of the Open Market Committee had a significant impact on the ‘credit conditions of the United States.
FED contributed to the prosperity of the U.S. economy in the 1950s and 1960s. However, due to excessive focus on the labor market, the Fed overlooked inflation, leading to a sharp increase in inflation rates to double digits. This situation forced Congress to redefine FED’s two primary objectives in 1977: price stability and job creation.
Năm 1979, Volcker trở thành Chủ tịch của FED và đã thành công chiến đấu với lạm phát. Người kế nhiệm ông là Alan Greenspan đã duy trì tình trạng lạm phát ở mức thấp và thỉnh thoảng có những đợt suy thoái. Trong bối cảnh khủng hoảng ngân hàng lu mờ, “cửa sổ chiết khấu” của Fed không còn được sử dụng.
In 1979, Volcker became the Chairman of FED and successfully fought against inflation. His successor, Alan Greenspan, maintained low inflation and occasionally faced economic recessions. Against the backdrop of the savings and loan crisis, FED’s ‘discount window’ was no longer utilized.
4. The tools in the hands of FED
The three main tools that FED uses to regulate the market include:
- Open market operations.
- Interest rates.
- Reserve requirements.
All three of these tools are flexibly employed by FED to adjust the supply and demand of money in the financial market, thereby directly influencing the prices of various assets.
4.1. Open market operations
Open Market Operations (OMO) is a term referring to the buying and selling of securities in the market by FED. The primary types of securities traded by FED are bonds. These activities impact bond yields across various terms, exchange rates and market liquidity.
- When FED purchases bonds and other assets, there is more money in the financial market, leading to a decrease in bond yields. As a result, funds are compelled to seek higher yields elsewhere.
- Conversely, when FED sells bonds, money is withdrawn from the market, causing an increase in bond yields. The combination of reduced liquidity and rising yields in safer assets creates conditions for funds to flow out of both business activities and higher-risk assets.
4.2. Interest rates
Interest rates here can be understood as the rates that FED and member banks charge commercial banks or other financial institutions for short-term borrowing when those banks face liquidity shortages.
The partial reserve mechanism of the current financial system encourages the expansion of credit. However, when the reserve levels of commercial banks/financial institutions fall below the required threshold, they are compelled to borrow short-term from FED to ensure liquidity.
This interest rate directly influences the rate at which commercial banks or financial institutions lend to their customers. Therefore, if FED increases interest rates, commercial banks are likely to raise their rates, reducing the demand for credit and diminishing the overall money supply in the market.
Concerning financial assets, as interest rates rise, the money supply decreases. Large investment funds face higher leverage costs, directly affecting profits and prompting them to reduce positions to maintain liquidity.
4.3. Reserve requirement ratio
The reserve requirement ratio is a regulation specifying the fixed amount of money that commercial banks must deposit with the central bank (FED) to ensure the bank’s ability to meet withdrawal demands from its customers.
The reserve requirement ratio serves as a tool for the central bank to maintain financial system stability and regulate the money supply in the market.
- When the central bank increases the reserve requirement ratio, commercial banks are obliged to deposit more money, and they cannot use that money for lending in the market.
- Conversely, when the reserve requirement ratio decreases, commercial banks can lend more money to the market.
FED can adjust the reserve requirement ratio to regulate the money supply in the market, thereby affecting the prices of various assets.
5. The market undergoes fluctuations when FED holds meetings and announces monetary policy. How does this happen?
It can be seen that a crucial task of FED is to keep the U.S. economy stable.
When the economy booms, leading to the emergence of inflation and asset bubbles that threaten economic stability, FED intervenes by raising short-term interest rates. This helps cool down the economy and maintain a sustainable growth pace, leading to a reduction in demand for goods and services. Liquidity decreases, and individuals and organizations face higher borrowing costs, directly impacting spending, savings and input costs.
The flow of money into risk assets also becomes more restricted compared to periods of lower interest rates or loose monetary policies.
From the past until now, crypto has consistently been considered a high-risk asset. Therefore, in theory, there will be less money flowing into crypto during periods of tightening monetary policy.
Many previous opinions suggested that certain cryptocurrencies, such as Bitcoin, serve as an inflation hedge due to their limited total supply and act as a safe haven asset for investors. However, recently, we can observe that it is behaving more like other risky assets such as stocks.
It is demonstrated that cryptocurrencies have reacted to price declines similarly to other risk assets when FED announces interest rate hikes in 2022.
The tightening policies of central banks emerge as the most significant macroeconomic factor driving both the stock market and cryptocurrencies today, explaining the high correlation between these two markets.
Overall, FED interest rate hikes are likely to continue into 2023 as inflation shows no signs of diminishing. Thus, in 2023, we may witness another year where the cryptocurrency market does not shine brightly.
From a positive perspective, inflation may worsen before getting better. For developers and investors who believe in the market’s growth, they maintain that the downtrend period is an opportunity to eliminate unsuitable projects without long-term viability. However, it is essential to acknowledge that blockchain applications are becoming increasingly practical in daily life, and cryptocurrencies will gain rapid acceptance. The key is to have a long-term perspective to approach new opportunities in the future.
When inflation breaks, interest rates will no longer be a major concern for investors in the market. This is inevitable, and when it happens, the cryptocurrency market will continue on its trajectory. However, we need time and readiness to embrace a promising future if we have a visionary outlook for this market.
6. Closing thoughts
In the widespread trend of cryptocurrency adoption, the impact of FED on this industry is entirely unavoidable.
With the tools and resources at its disposal, FED can regulate the flow of money across the entire market. During periods of monetary easing, certain asset classes benefit from a plentiful liquidity environment, and vice versa.
This is not always true, especially for a relatively new asset class like cryptocurrencies. Investment decisions must consider additional factors to achieve expected profitability. However, in the process of crypto investment, we can still view FED as a directional indicator, providing a sense of safety and effectiveness in the investment journey.
What about your thoughts? If you want to know further about cryptocurrency, don’t hesitate to share with us! 😀
This post is for educational purposes only. All materials I used were the different reference sources. Hope you like and follow us and feel free to reach out to us if there is an exchange of information. Cheers! 🍻
#lecle #leclevn #FED #FederalReserve
