In this article we will look at the Wealth Effect and how it relates to cryptocurrency
Anyone who follows the activities of Central Banks has come across this term. The idea of the "Wealth Effect" is one of the desired outcomes of their policy. In short, they look to increase the value of certain assets by either direct purchase such as MBS and Treasury Securities or via low interest rate. We can see the impact of the later on the real estate market.
It is a concept that is meant to change the psychology of the economic public. If people feel "richer", so goes the theory, the greater the likelihood they will spend. A Central Bank often acts to stimulate spending because that is what produces economic activity. As we all know, if spending stops on a national level, recession hits.
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Many question the impact of such actions. It is all based upon human psychology and does appear to have some validity as we will see in a few moments. The question is whether or not cryptocurrency can have the same results and if this could help to stimulate in a greater manner.
Creating Wealth
While many consider this to be a mirage, there is no doubt that these policies do generate wealth. They increase the value of assets on individual balance sheets. Naturally, the question of who benefits is always a consideration.
Let us look at the real estate market. Presently, we are looking at a decade long run. The easing programs of Central Banks around the world have made the cost of money extremely inexpensive. This is exactly what they wanted.
In turn. real estate prices on a global scale have shot up. Since nearly 2/3 of the United States population are homeowners, most of the population benefitted from this.
This is compounded by the fact most properties bought are done so with mortgages. Under this scenario, the payments remain the same. Thus, one is making payments on an asset that has increased in value. Effectively, this is producing an even better return.
So why are people so upset about this?
The answer lies in the fact that they are not aware that they are wealthier. To start, this is the proverbial "on paper" situation. While it is great that their asset went up, to realize those gains requires the selling of the property. For those who do that, a nice fat check shows up at closing. Since most real estate is people's primary residence, the majority cannot do this.
Also, if one does sell the property, if it is their home, they have to replace it. Therefore, most of the gains on the sell side are turned right back when purchasing. The net from this is a lot smaller than the initial push higher.
Here again, we need to question who truly benefits. Those who have second properties or investment units are the ones best suited to take advantage of this. For most, unless they are astute enough to sell their home and rent for a couple years (or longer) until the prices drop, it is a difficult situation to leverage.
Therefore, we do see more wealth created through these policies. The thing to keep in mind is that one needs to sell to financially benefit and it is best to avoid having to replace the asset.
The Wealth Effect of Cryptocurrency
For those who dispute the validity of the wealth effect, one only needs to look at Cypto-Twitter to see what takes place. It is amazing to see the reaction when the market takes a hit. You would think these people had no clue that markets actually go down. It is as if they believe a market is only allowed to go upward.
Of course, when the bull is running, we see the exhilaration. People are stating how things are going even higher. Posts are made about buying cars. Many discuss how they are instantly millionaires. As they say, people spend in thousands and dream in millions.
Watching that behavior, it gets hard to argue that people do not change how they act when their cryptocurrency holdings are going up. They are in a different emotional state which leads to new decisions.
The excitement is present even when people are not selling. Perhaps this is a mistake on the part of most since the tendency is to ride the price up, and then all the way down. However, for those who are not trading, it is what is done.
Thus, a case could be made for cryptocurrency providing a massive wealth effect. The challenge comes from the fact it is a $2 trillion market which is global in nature. We are going to need something much bigger than that to stimulate the global economy.
Nevertheless, those who are involved can see the benefit in their own lives. As the number of people involved expands, we can see how the impact on the overall economy will increase.
Who Benefits
At present, the crypto-world is not filled by the typical Wall Street institutions and large money players. This is changing of course as more get involved with, primarily, Bitcoin and Ethereum. These entities realize the potential so they are positioning themselves to take advantage.
This is where the average person still has a change. It is very early in the adoption cycle. Truthfully, the large money is still on the sidelines, not in crypto yet. We have not seen the pension and sovereign wealth funds enter. Nor have Central Banks started to fill their balance sheets with cryptocurrency.
We can safely conclude this is not always going to be the case. The entry into cryptocurrency will not be limited to Tesla and Microstrategy. At some point, we will see the likes of Apple, Google, and Amazon immersed in this. We can also expect the abovementioned mega-money players to coming knocking too.
As cryptocurrency grows, there are a lot of options, even from a policy standpoint. Imagine if some of the Central Banks around the world got involved in buying of Bitcoin. This is going to happen at some point, just not likely in the near future.
Cryptocurrency offers a way for the wealth effect to happen at a much lower level. Presently, it is only the wealthy who enjoy the majority of the benefits. Those who are at the middle and lower ends of the spectrum are left out. Since they do not own assets, all the financial increase goes to others.
The present state is for most of the established system to fight cryptocurrency. It is seems as a threat, which it is. Nevertheless, they are going to combat it believing that it is business as usual. This is going to be a mistake.
The industry is expanding. We are seeing wealth being created which will alter the perception of people involved. A case certainly could be made that as it all spreads, we could see an economic impact resulting from the wealth effect.
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