It could be mere coincidence that Bitcoin’s plunge today closely followed a speech by the Bank of Japan’s Governor suggesting interest rates would soon go up.

Then again, it probably isn’t. Bitcoin is an artefact of the cheap-money era, created to exploit the virtually unlimited credit with which Western central banks flooded markets after the 2008 financial crisis. After more than a decade of ultra-low interest rates, investors came to assume the money they were raking in reflected their genius, rather than a central bank that was doing all the heavy lifting. That changed after the pandemic inflation spike, when central banks decided it was time to reverse course. By raising interest rates and ending the quantitative easing programmes they used to keep bond yields low, central banks withdrew money from the markets. That sucked the air out of the crypto bubble, and in 2022 Bitcoin crashed.

Embattled crypto leaders, who had now produced paper billionaires with interests to defend, looked for and found a saviour in Donald Trump. Pouring money into his election campaign, along with those of Congress members who supported the industry, this new breed of crypto-oligarch scored a coup when Trump won the election on a pledge to make America a Bitcoin superpower. Exploiting the newly supportive environment, the “crypto treasuries” these oligarchs operated, whose sole purpose was to juice the price of Bitcoin, were able to borrow cheaply and sell shares dear to raise the capital needed to pour money back into crypto.

In October, Bitcoin hit an all-time high of over $125,000. But when Federal Reserve governors then began indicating that they might be done lowering interest rates, the cryptocurrency plunged once more. As it did so, it dragged down the share prices of the crypto treasuries, choking off the new supply of money they might raise to rescue the market. They could only watch helplessly, their hands tied.

A speech last month by the influential President of the New York Federal Reserve, in which he indicated a willingness to cut rates at the December meeting of the Fed’s interest rate-setting committee, briefly stanched the bleeding, as Bitcoin joined the broader market’s relief rally last month. But a cut at next week’s meeting doesn’t necessarily mean the good days are back, and the BOJ Governor’s message shows why.

The BOJ had been pursuing an easy money policy for years in hopes of reviving the moribund Japanese economy. This created a carry trade that subsidised Western markets: investors could borrow yen for next to nothing, convert it into foreign exchange, then use that to buy the higher-yielding bonds of other countries. That demand for those bonds, in turn, drove up their price, which drove down their yield — keeping Western interest rates low.

But inflation has now returned to Japan, and the new government is planning a major fiscal stimulus which will both stoke it further and provide a new supply of bonds. If the Bank raises interest rates in response, that will end the carry trade. And given that Western governments are themselves heavily indebted, the global supply of government bonds exceeds the demand.

That’s why bond yields rose sharply today. We’ll see what the Fed says at next week’s meeting, but it may be that the money tide is changing for good. Given the stock market’s own dependence on cheap money, Bitcoin’s crash would herald a broader market fall. If it doesn’t rebound soon, the consequences could extend far beyond the world of cryptocurrency.

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John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a Religion (Simon & Schuster, 2017).

jarapley

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