The Finatical

Week of January 10th, 2023 - Stable Coin, Federal Reserve Rate Hikes, Health Insurance-Induced Inflation Reduction

Finatic

Aditya Bagga

Ksheeraj Sanga

, and 3 others

Jan 10, 2023

Introduction

Think crypto is too risky? Think again! Stablecoins seem to be an alternative form of cryptocurrency that aim to be far less volatile than the crypto you probably know about, such as Bitcoin, Ethereum, Dogecoin ;) , etc. So how do stablecoins stay stable? Simple: their value is tied to that of other currencies. For example, a stablecoin’s value could be tied to the U.S. dollar, so the coin’s value should stay at $1, and this can make them less volatile, allowing them to be more reliably used to do things you can do with a normal currency, such as making purchases.

Risks

However, there’s a big problem with some stablecoins that can make it so they aren’t really stable. Sometimes, the assets they are backed by aren’t actually stable. This is demonstrated by the fall of Terra UST, a stablecoin that was supposed to be pegged to the dollar. However, it crashed and is now worth around 2 cents. So how could this happen? Yellowcard.io says that “The team and developers of Terra used millions worth of bitcoin as the reserve of the stable coin. However, the price of bitcoin went down and so was the price of Terra UST. When the developers finally sold some of its bitcoin, it only led to the price of this stablecoin going down more.” This is why when investing in stablecoins, you need to make sure the developers are transparent about what they use to back it up, or else, it might not actually be stable.

Importance

While some stablecoins may not remain stable, they do have importance in the world of cryptocurrencies and finance in general. When they are stable, they can serve as a method of deviating from currencies issued by central banks, while creating less risk for buyers and sellers who want to use crypto. As a means of exchange, stablecoins perform better than more volatile cryptocurrencies. Along with this, investors in cryptocurrencies who want to keep them for long-term growth don't want to deal with the extreme volatility of so many crypto coins, and stablecoins do appear to have potential for long term investing.

While stablecoins do have their own risks, the concept of a stable cryptocurrency that could be used as an alternate method to pay for things is very intriguing. If crypto is really the future of transactions and we move away from central banks, stablecoins will likely serve as the foundation for this new era. For now though, all crypto, even stablecoins, seem to have more risk than reward and their values are frequently based on speculation.

Financial Trends

Federal Reserve Hikes Rates A Half-Point

The Federal Reserve once again issued another 0.5 interest rate hike, this past Wednesday to continue its effort in cooling down inflation. Despite this interest rate hike being lower compared to the previous super-size of 0.75 percentage points, the central bank is far from finished with issuing higher interest rates. The latest decision by the Fed is only a small part of their new rate-hiking cycle, which aims to reduce inflation while also preventing the economy from falling into a recession, feared to happen very soon. According to a professor of finance and economics at Columbia University Business School, Laura Veldkamp, “Every single time since WWII the Federal Reserve has acted to reduce information, unemployment has shot up, and we are not seeing that this time, and that’s what stands out”.

These are some positive outlooks to the scenario, however, the combination of higher interest rates and inflation has hurt household budgets the most, and the majority of them are struggling to sustain themselves in this economy. The federal funds rate, which is established by the central bank, is the interest rate at which banks borrow and lend money to one another. The results of higher Fed rates influence borrowing costs for consumers in the form of loans both directly and indirectly. Currently, this has left many Americans in a troublesome situation, as people are tending to depend more on credit at the same time as interest rates are rising at the fastest pace in decades.

Health Insurance’s Impact on Inflation

In an economy surrounded by high inflation, the cost of health insurance is trending the opposite, as they have deflated in costs and are set to drop in cost each month until the fall of 2023. For instance, the health insurance process fell by 4% in October and 4.3% in November, while the average price for all U.S. goods and services rose by 0.4% in October and 0.1% in November. However, the decline in health insurance costs may not necessarily be related to consumers’ actual financial experiences with the premiums that are associated with health insurance. On paper, the decline in prices is unique in the manner that BLS (Basic Life Support) calculates health insurance inflation. According to the senior economist at Capital Economics, Andrew Hunter, “It’s not a very good reflection of prices consumers are going to be seeing”.

Health insurance prices have historically been a tricky quantity for economists to quantify. While it is known that consumers pay insurers regular premiums, it is difficult to assess the value that consumers receive for those premiums. Their costs do increase over time, but the question is, are consumers getting a reasonable value in return? In order to quantify health insurance prices, economists have leaned away from measuring the change in premium prices directly and developed an indirect method based partly on health insurers’ profits. The BLS updates its profit-related calculation once a year, in October. As a result, the health insurance CPI will remain negative through September 2023.

Financial Guidance

“Unless commitment is made, there are only promises and hopes; but no plans.” ― Peter F. Drucker

Until the plan itself is carried out or you make some sort of commitment to it, those plans will just remain promises and hope, with no outlook for the future.

Term of the Week

Moral Hazard: The concept of moral hazards refers to the idea that in certain situations, an entity can increase its exposure to risks due to the fact that they may not bear the full responsibility that comes with taking that risk. For example, health insurance is a common example of something that can potentially be subject to moral hazard, as coverage and the resulting subsidization of medical bills means that people may be less careful in terms of their health and take more risks, as they do not bear the full cost.