GM DOers!
Crypto = Macro 🌍
I’ve been saying this a lot lately. 🗣️
I’ve also been sharing charts about global liquidity, inflation, and other confusing macro-related topics.
You might be wondering… what the heck does this mean? 🤔 And why the hell do I keep talking about this stuff?
The reason I have been sharing this stuff is that if you understand the direction of the macro environment, then you understand the direction of the overall crypto markets.
📊 As shown in the chart below, crypto is directly correlated to macro and global financial conditions (...more on why in a second).
“Macro”, by the way, is short for macroeconomics, which is a branch of economics that deals with the performance, structure, behaviour, and decision-making of an economy as a whole.
Ultimately, why this is vital information for you is because if you understand macro you can capitalize on the opportunity of crypto. 💰
When macro moves in our favour, the value of our beloved cryptocurrencies will increase, which means on-chain activity will increase, which means funding into the web3 ecosystem will increase, which means that innovation and adoption will increase. 📈
All of this matters to us at the forefront of web3. Whether we are building, investing, or participating, we need to understand the direction this space is going.
All of that starts with Macro. ✨
So, what I’m going to do is provide a 2-part masterclass on macro, the business cycle, and how it impacts our lives and web3.
This will give you a better understanding of financial markets and, ultimately, how the world works. 🌎
While this may seem overwhelming, don’t worry, I’m going to explain this to you in simple and easy-to-understand terminology… as we always do here at Web3 Academy!
…and by the way, I’m writing about Macro because the PRO community voted for it (sorry @crypadvisor.eth, the only one to vote no 🤷).
PRO members, join the discord to have a say! 💬
In this first part of our masterclass, we'll break down the essential macro components - inflation, global liquidity (M2), interest rates, and unemployment - and explain why they matter to you as a web3 DOer. 👩💼👨💼
In the second part of the masterclass, I’m going to discuss the current macro environment and where things are likely to go in the future. Of course, we will also dive into how that will impact our beloved web3 technologies.
Before we get into it, It’s important to understand one more thing. Macro is a very complex topic with unlimited variables that can impact it and its components. 🧠
This is why you will see some very smart people with completely opposing views. For example, some will say that inflation is here to stay and others will say it’s dead.
How is this possible? Well, depending on how you evaluate the world, you may come up with a different hypothesis.
What I’m going to do is give you the foundational knowledge to understand what this all means, so you can make more informed decisions based on the analysis you read from other macro insiders. 🎯
My recommendation is to consume multiple takes and then make your own opinions and hypotheses from that. In part 2, I will, of course, share my opinion with you, too.
Ok, let’s start at a high level on the components of macro.
A Bird’s Eye View Of Macro 🦅
Central banks are the drivers of our economies. They control the cost of capital and the flow of money.
While most countries have a central bank, the United States of America’s is the most important currently. Why? 🤔
Because they control the reserve currency of the world, USD. More than 80% of all transactions globally occur in USD and most trade is priced in USD. So what the Federal Reserve (aka The Fed = Central Bank of USA) does, really matters to the entire world 🌎
If you want to understand macro, you need to understand the Fed, regardless of where you are in the world.
The Fed has a dual mandate (aka the Fed exists for 2 reasons):
To keep inflation at around 2%/year - The theory on inflation is that some inflation is a good thing in order to stimulate the economy and achieve growth. 📈 However, that inflation must not go too high as to make prices of goods and services unstable ⚖️ (more on this later).
To ensure maximum employment - i.e. the % of people who are able to work and contribute to the economy.
✅ That’s it. That’s the entire purpose of the Fed.
Now, in order to do that, the Fed uses something called monetary policy, which essentially gives them 2 tools to work with:
Provide or remove liquidity (in crypto terms, we call this increasing/decreasing the total supply of the currency).
Raise or lower interest rates (aka the cost of capital).
In a very simplified version, these 4 components are what drive our economies and make up the overall macroeconomic environment.
Let’s break down each of these 4 components further and then discuss how they make up the business cycle 🔄
Inflation: The Money Eater
Inflation is the rise in the overall price level of goods and services in an economy. 📈
A little bit of inflation, like the 2% annual target set by the Federal Reserve, is beneficial because it encourages spending and investment, leading to economic growth and job creation (if we know things will go up in price, businesses and people will more likely spend rather than save). 🛍️
However, too much inflation can erode purchasing power and destabilize the economy, while too little can result in stagnation (no growth).
🔧 To maintain this delicate balance, the Fed monitors and manages inflation using the monetary policy tools mentioned above.
What affects inflation, however, is a lot more complicated than most people realize.
Supply and demand dynamics play a key role in determining inflation. When there are more buyers (demand) for goods than there is supply and prices will rise.
This is why home prices increase when the cost of capital (interest rates) is low and the economy is booming (people are making money). People can afford to buy houses (demand) yet there are only so many houses available (supply). 🏡
If Demand > Supply = 📈
If Demand < Supply = 📉
Inflation can also rise when the cost of producing goods and services increases, which is why oil and gas are such an integral part of economies (they are used to transport and manufacture almost everything).
💰 Another type of inflation is called monetary inflation.
This is when a central bank increases the money supply by printing 🖨️ more money. Another term used for this type of inflation is currency debasement.
In more mild scenarios, debasement doesn’t necessarily impact the price of all goods and services, however, it does impact the price of the currency vs. hard assets like Real Estate, Gold, and Bitcoin.
During extreme currency debasements, like what we’ve seen in countries like Zimbabwe or Venezuela, it results in hyperinflation and impacts the price of everything. 😱
Just to put things in context for you, here is a chart of the US Consumer Price Index (CPI), which is the main tool used to track inflation.
📊 It is essentially tracking the price of a basket of goods and services (housing, food, healthcare, etc.).
The key takeaway here is that there are various ways in which inflation can occur and it can impact different areas within an economy and its goods and services.
Understanding what is driving inflation and what it will affect is important. 👍
Employment: Jobs, Jobs, Jobs
Employment simply looks at the % of people who have jobs that are willing and able to work. 💼
High unemployment rates can signal a struggling economy, which can affect consumer spending and demand for goods and services (i.e. inflation rates). This would also mean that fewer people might be adopting new technologies.📱
Employment, however, is not as straightforward as it may seem. Understanding wages as well as the demographics of those employed is key to understanding how it will impact the growth of the economy and inflation.
For example: When the Baby Boomers (the largest demographic group) entered the workforce in the 1970s it was extremely inflationary. 💥.
Millions of people in the US & Europe all started working and earning an income at the same time.
This meant that the demand for goods increased, while the supply hadn’t caught up to the demand yet, and thus, sustained inflation occurred.
📊 Again, for context, below is the unemployment rate in the US since the 50s.
Central banks must study the dynamics of employment and inflation, and use the tools they have wisely to achieve their mandate of maximum employment and 2% inflation/year.
Let’s take a further look into their tools and how they impact employment and inflation 🔍
Liquidity: The Money Printer 🖨
Think of the Federal Reserve as the puppet master, pulling the strings behind the scenes to control the flow of money in the economy.
Liquidity can be a very complicated subject to understand as there are many nuances to it, so I’m going to over-simplify it to help you wrap your head around what’s happening.🧠
Essentially, the Fed can print money and give it to banks to inject money into the economy and encourage borrowing, spending, and investment in the economy (aka quantitative easing).
The Fed can also take out money from the banks, effectively decreasing the money supply and slowing down growth (quantitative tightening). 📉
As to how the Fed does this is where things get really complicated.
The main point to understand, however, is that in the cases mentioned above, the Fed is not giving money directly to the people, it’s controlling everything from behind the scenes with the banks, who then decide what to do next with that liquidity.
Conversely, in 2020 we saw something completely different. The Fed decided to skip the banks completely and directly provide stimulus checks, effectively putting $1,000s into the hands of every single American at the same time.
I will talk more about this in Part 2 of this report, but hopefully, you can understand the inflationary impact that the second means of liquidity would cause versus the alternative.
📊 Below is a chart of the Fed's assets on its balance sheet. This is showing the easing or tightening of the money supply and is a tool that the FED really only started to use in extreme measures since the financial crisis in 2008.
Ultimately, by controlling the flow of money, the Fed can influence overall spending, investment, and, ideally, inflation and employment. 🎯
Interest Rates: The Price of Money
Now, let's talk about interest rates.
Imagine you want to borrow money to buy a fancy new 🚘 car, however, you can’t afford it. If the cost of borrowing (i.e. the interest rate) is low, you're more likely to take out a loan, spend that money and ride off into the sunset.
The same idea applies to businesses and consumers on a larger scale. When the Fed lowers interest rates, borrowing becomes cheaper, encouraging spending and investment. 💸
This can boost economic activity, leading to job creation and helping to achieve the Fed's goal of maximum employment.
On the other hand, when the Fed raises interest rates, borrowing becomes more expensive, which can slow down spending and investment, and help control inflation (lowering demand) if it's getting too high.
📊 And for perspective, here are the US interest rates since the ’50s. As you can see, we’ve been living in a very low interest-rate environment since the financial crisis of 2008.
In summary, the Federal Reserve uses its powers over liquidity and interest rates to maintain a delicate balance between promoting economic growth with maximum employment and low, steady inflation.
Connecting the Dots: The Macro Symphony 🎼
These macro components don't work in isolation - they're like musicians in an orchestra, creating the rhythm of the business cycle. 🎶
However, rarely is it a nice smooth rhythm - it’s more like a wild roller coaster ride instead. 🎢
The blue line above would be the ideal scenario for our economies, a linear path of growth.
However, unfortunately, the world simply doesn’t work like that.
More often than not, the Fed and/or the economy overshoot to either side, creating peaks and troughs along the way.
To tie everything together, let’s walk through the “typical” business cycle and uncover how the 4 components influence one another.
📊 Following the image above which showcases the full business cycle from one peak of expansion to the next, let’s imagine for a second what the world is like during the peak expansion of an economy.
Interest rates are low, enabling banks to give away money like it’s Monopoly money.
As a result, businesses are bringing in plenty of investment and are fully staffed, making unemployment low.
Because everyone is working (and the cost of capital is low), people are buying homes with ease, restaurants and malls are packed, and companies are selling products like hotcakes.
The stock market and crypto are booming, and life is good for many. 📈 Think back to the vibes of 2021 - that’s peak expansion.
As a result of excessive lending, spending and investing (demand), inflation begins to rise, as supply isn’t meeting the intense demand for most products and services.
House prices soared and the cost of gas, food, and other things are beginning to increase as well.
At this point, the Fed is getting worried and steps in to limit the amount of money in the system.
The problem, however, is that simply limiting or even removing money takes time to impact the economy. ⏳
Most people and businesses already have lines of credit, credit cards, loans, and tons of capital from the big expansion, so the spending doesn’t stop.
The Fed then needs to start increasing interest rates to slow down demand. An increase in interest rates means it costs more to get debt, like a mortgage or a business loan.
Not only does this mean more people can’t afford to take on debt, it also means their existing debt (mortgage, loans, etc.) costs more (if you own a house right now on a variable mortgage then you know exactly what I’m talking about). 🏠
This results in increased expenses for most of the working class of America and, as a result, they can no longer afford that second house or boat, or even take the family out to a restaurant as often.
📉 This leads to the economy beginning to contract.
How bad this contraction gets depends on how much businesses and people over-leveraged (i.e. took out loans they can’t afford) as well as how much the past demand impacted inflation.
Regardless, as demand collapses the economy slows down, and businesses that aren’t profitable need to lay off staff or shut down. 🚫
Unemployment rises, people need to sell their investments and cancel their subscriptions, and innovation stifles.
At some point, the FED has to step in and start stimulating the economy again so that people can find jobs and afford to pay their mortgages and buy food.
So the FED starts to lower interest rates and, more often than not, begins pumping the system with money again.
Of course, as the average person's expenses begin to lower (though never as low as they were previously) they begin to spend again (humans aren’t good with money).
This leads to businesses doing better and allows them to begin hiring again.
Once interest rates get low enough, humans do as they usually do, they get greedy and start taking out leverage (debt) to buy the home, the car, or expensive dinners, and the economy expands once again. 🏠🚗🍽️
This is the way that our world functions.
A business cycle based on human greed and the urge to have more, is managed by a single organization that controls when we can and can’t have it.
Wild, right? It is what it is… for now 🤷
The Road Ahead: Preparing for Part 2 🚀
Congratulations, you've made it through Part 1 of our Macro & Business Cycle Masterclass. 🎓🥳
By now, you should have a better understanding of the key macro components, their roles in the economy, and how they interconnect to form the business cycle.
But we're not done yet! 🚧
In Part 2, we'll dive deeper into the current macro environment, explore how it may evolve in the future, and discuss the implications for web3 technologies.
With this knowledge, you'll be better equipped to navigate the ever-changing world of web3 and make more informed decisions about your investments 💰, projects 🏗️, and overall involvement in the space. 🌐
If you’re new to macro, make sure you re-read this at least one more time and take a moment to let Part 1 sink in and get ready for the next leg of this educational journey.
Stay tuned for Part 2, where we'll continue to unravel the fascinating world of macroeconomics and its impact on the web3 landscape.
See you there! 🫡
ABOUT THE AUTHOR
Kyle Reidhead
Founder of Web3 Academy and Impact3
Find him on Twitter
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Disclaimer: This article is for informational purposes only and not financial advice. Conduct your own research and consult a financial advisor before making investment decisions or taking any action based on the content.
