On August 5, 2024, the crypto market experienced a dramatic slump triggered by a number of global events. This article examines the events and their impact on the market, analyzes the causes of the crash and ventures a look into the future. We look at both optimistic and pessimistic scenarios in order to paint a comprehensive picture of the current situation.
In recent days, several key markets around the world have recorded significant losses. The Japanese market collapsed, causing a global cascade effect that dragged the rest of the Asian stock markets down with it. Technology and financial stocks were particularly affected. Last Monday, the main indices in Japan, Taiwan and Korea fell by more than 8 percent, pushing these markets into bear market territory.
At the same time, weak US economic reports and geopolitical tensions are exacerbating uncertainty on the markets. Investors now expect that the US Federal Reserve will have to loosen monetary policy aggressively to prevent a recession. The crypto markets were not spared either: Bitcoin fell below USD 50,000 and recorded a loss of 18% within 24 hours. Overall, the entire crypto market fell by 14%. In the process, 229,886 crypto traders were liquidated, with a total loss of USD 882 million – the largest long liquidations since April 2024.
European markets also opened with losses, influenced by the selling cascade from Japan. The European index fell by around 2.5 percent. Bitcoin suffered its worst one-day drop since November 2022, with a decline of over 16% and liquidations of over USD 1 billion in trades.
In this uncertain economic situation, the role of the US Federal Reserve is crucial. The Fed has called a special emergency meeting and declared that it will not overreact with an emergency rate cut, although the markets are expecting it. If the Fed were to cut interest rates spontaneously, this could send a strongly negative signal to the market.
Three main aspects are discussed in detail below: the Fed’s balance between price stability and labor market stability, the historical relationship between unemployment rates and recessions using the Sahm rule, and the potential impact of a major US market collapse on Bitcoin and other cryptocurrencies. These analyses provide a deeper insight into the complex dynamics underlying today’s financial markets and help to better understand current developments.
The Two Main Tasks of the FED and its Balancing Act
The Federal Reserve, often abbreviated as the Fed, is the central bank of the United States and has two main tasks that it must balance: ensuring price stability and ensuring labor market stability. These tasks are often in conflict with each other, which illustrates the challenges facing the Fed. This article explains these two tasks in detail and highlights the difficulties involved in trying to balance the two.
Price stability
Ensuring price stability is one of the central tasks of the FED. Price stability means that inflation – the general rise in the price level – is kept within a moderate and predictable range. Inflation can be influenced by various factors, including monetary policy, global economic conditions and internal economic activity.
The Fed monitors various indicators to assess price stability, such as the Consumer Price Index (CPI), the Personal Consumption Expenditure (PCE) Price Index, and specific core measures of these indices that exclude more volatile elements such as energy and food.
To combat inflation, the Fed usually raises interest rates. Higher interest rates make credit more expensive, which leads to a reduction in spending and investment. This in turn can slow economic growth and reduce inflationary pressure. In recent years, the Fed has raised interest rates massively in order to cool down an overheated economy and bring inflation under control.
Labor market stability
The second main task of the FED is to ensure labor market stability. This includes monitoring and promoting a healthy and stable labour market characterized by low unemployment rates and stable employment growth. Important indicators in this area are the unemployment rate, the number of new jobs created, the quality of these jobs (full-time vs. part-time) and other economic indicators such as gross domestic product (GDP) and the ISM Purchasing Managers’ Index.
To stimulate the labor market, the Fed typically lowers interest rates. Lower interest rates make loans cheaper, which encourages spending and investment and boosts economic growth. This can lead to a higher demand for labor and a reduction in the unemployment rate.
The FED’s balancing act
The Fed’s biggest challenge is to fulfill these two tasks – price stability and labour market stability – at the same time, as measures to achieve one goal often work against the other. If the Fed raises interest rates to combat inflation, this can lead to a decline in economic activity and an increase in unemployment. Conversely, lowering interest rates to stimulate the labor market can fuel inflation.
This balancing act has become particularly clear in recent years. The Fed has raised interest rates to combat inflation, but this has cooled the economy and weighed on the labor market. The Chairman of the Fed, Jerome Powell, often talks about the need to maintain this balance. However, this is proving to be a difficult task, as long-term high interest rates can lead to an economic slowdown and a potential recession.
The Fed’s tasks of ensuring price stability and labor market stability are often in tension with each other. The attempt to reconcile these two objectives requires careful consideration and flexible monetary policy. Recent developments show how difficult it is to maintain this balance, especially in times of economic uncertainty and global challenges. However, the Fed remains committed to promoting stable and sustainable economic development through its measures.
Rising US Unemployment Rate and the Risk of Recession: The Sahm Rule
Another crucial aspect of the US economy is the relationship between the unemployment rate and recessions. Historical data shows that a rise in the unemployment rate is often a reliable indicator of an impending recession. This chapter sheds light on these relationships and explains the so-called Sahm rule, an important recession indicator.
Historical view of the unemployment rate and recessions
Since the 1970s, it has been shown that an increase in the unemployment rate in the USA almost always leads to a recession. The gray shaded bars in the historical economic data mark the recession phases. A look at this data shows a recurring pattern: whenever the unemployment rate starts to rise, it is followed by a recession.
This pattern has remained consistent over the last few decades. Examples from 1975, the early 1980s, the early 1990s, the early 2000s and during the 2008 financial crisis clearly show that rising unemployment rates are often a harbinger of economic downturns. This dynamic also became apparent more recently with the pandemic-induced recession.
The Sahm rule as a recession indicator
One specific tool used to predict recessions is the so-called Sahm rule. Named after the economist Claudia Sahm, this rule is based on the observation that a significant increase in the unemployment rate is a reliable indicator of a recession. More precisely, the Sahm rule states that a recession is likely if the current unemployment rate is at least 0.5 percentage points higher than the lowest level in the last 12 months.
The current unemployment rate is 4.3%. If this is 0.5 percentage points higher than the lowest level of the last 12 months, which is 3.8%, this indicates an imminent recession. In the last 12 months, the lowest level of the unemployment rate was 3.7% in November, December and January. As the current rate of 4.3% exceeds this threshold, it fulfills the conditions of the Sahm rule and thus signals an impending recession.
Meaning and implications
The observation that rising unemployment rates often lead to recessions has important implications for economic policy and strategic planning by both the government and companies. An increase in the unemployment rate can serve as an early warning system that allows policy makers to take preventative measures to mitigate the effects of a recession.
For companies and investors, knowledge of this correlation is also of great importance. It allows them to prepare for potentially more difficult economic times, whether by adjusting business strategies, securing liquidity or managing risk.
The relationship between rising unemployment rates and recessions, as well as the use of the Sahm Rule as an indicator of economic downturns, provides valuable insight into the dynamics of the US economy. The historical consistency of this pattern underscores the importance of the unemployment rate as a key indicator of economic health and the need to be vigilant to changes in this metric. This helps both policy makers and businesses to proactively respond to economic challenges and take appropriate action.
The Impact of a Major US Market Collapse on Bitcoin
Bitcoin and other cryptocurrencies have grown significantly in importance in recent years. Nevertheless, their future development remains closely linked to the traditional financial markets. Especially in times of market crises, it becomes clear how vulnerable cryptocurrencies are to global economic developments. This chapter sheds light on how far Bitcoin could fall if the US markets experience a major crash.
Historical correlation between market crashes and cryptocurrencies
A look at historical data shows that major market corrections in the US, such as during the bursting of the dotcom bubble and the 2008 financial crisis, had a significant impact on major indices such as the Dow Jones and the NASDAQ. These crises led to dramatic declines: The Dow Jones lost up to 52% of its value during the dotcom bubble, while the NASDAQ plummeted by up to 82%. During the 2008 financial crisis, the Dow Jones fell by 67% and the NASDAQ by 54%.
Bitcoin and previous corrections
Bitcoin was only launched in 2009, after the major financial crises, and was therefore unable to play a role in these early crises. However, in the smaller market corrections that followed, Bitcoin showed significant volatility. For example, during the 2018/2019 correction, the Dow Jones lost 15%, the NASDAQ 19%, while Bitcoin plummeted by a remarkable 65%. Bitcoin reacted similarly strongly during the 2022/2023 market movements, with a decline of up to 70%.
Forecast for a major market collapse
Historical data suggests that Bitcoin correlates strongly with the movements of traditional financial markets during times of economic uncertainty and market volatility. Should the major US indices such as the Dow Jones and NASDAQ fall by 50-80% in a future major crash, it is highly likely that Bitcoin will also experience a significant correction. Based on its previous reaction patterns, Bitcoin could even fall disproportionately sharply, possibly more than the 70% already observed.
Factors influencing Bitcoin during a market collapse
Several factors could influence Bitcoin’s reaction to a market collapse:
- Several factors could influence Bitcoin’s reaction to a market collapse. First, in times of economic uncertainty, investors tend to sell off risky assets. Since Bitcoin and other cryptocurrencies are considered volatile and risky assets, large-scale selling could begin.
- Secondly, a major crash could lead to liquidity issues, which could further increase selling pressure on cryptocurrencies. In times of crisis, access to liquid funds may be restricted, which could result in panic selling and further price declines.
- Thirdly, in times of crisis, governments and regulators could take measures that affect the trading and use of cryptocurrencies. Such measures could create additional uncertainty and further negatively impact market sentiment.
Conclusion
Bitcoin has not yet experienced any truly major market collapses like the dotcom bubble or the 2008 financial crisis, but its past performance in minor corrections suggests that it is highly sensitive to negative market movements. Should a major US market collapse occur, Bitcoin and other cryptocurrencies can be expected to suffer significant losses, possibly even beyond previous corrections.
This knowledge is crucial for investors and market watchers as it helps to better understand and be prepared for the potential risks and volatility of cryptocurrencies in times of crisis. The key is to closely monitor market dynamics and take appropriate precautions.
Author
Ed Prinz serves as Chairman of https://dltaustria.com, the most renowned non-profit organization in Austria specializing in blockchain technology. DLT Austria is actively involved in the education and promotion of the added value and application possibilities of distributed ledger technology. This is done through educational events, meetups, workshops and open discussions, all in voluntary collaboration with leading industry players.
Disclaimer
This is my personal opinion and not financial advice. For this reason, I cannot guarantee the accuracy of the information in this article. If you are unsure, you should consult a qualified advisor you trust. No guarantees or promises regarding profits are made in this article. All statements in this and other articles are my personal opinion.