Bitcoin and Inflation: Everything You Need to Know

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Crypto enthusiasts often speak of Bitcoin as a hedge against inflation. Why?

The argument is that central bank money pressures will lead to inflation or a decline in the value of money over time. In contrast, Bitcoin has a fixed limit of 21 million coins that can ever be created. This limited supply enables Bitcoin to withstand inflation.

The COVID-19 pandemic provided ideal conditions for this theory to be tested as countries around the world began injecting trillions of dollars into their economies. Many countries, including the US, printed money to meet the incentive requirements for their citizens.

US Federal Reserve chairman Jerome Powell said yesterday the central bank welcomes higher inflation in 2021 as a sign that the economy is recovering from the collapse of the pandemic.

Governments hoped that expansionary monetary policies, in which central banks increased the amount of money available to people, would keep economies moving if certain parts of the economy were idle for longer. According to a report by McKinsey Global, the stimulus measures taken by countries had exceeded $ 10 trillion by June 2020. U.S. government spending alone stood at $ 6.5 trillion in 2020, up 48% year over year.

“There’s a crazy amount of money being printed right now, so the value of the money is going down. For assets with limited supply such as Bitcoin, real estate or stocks, these price tags go up, ”Oki Matsumoto, CEO of the Monex Group, told CoinDesk.

It is true that despite dramatic declines in global economic output and unemployment, market tremors drove up asset prices: the stock market ended the year with record gains. Even Bitcoin, which is seen as a marginal value, saw its price surge historically, gaining more than 250% by the end of 2020.

These gains were partly influenced by traditional investors who viewed Bitcoin’s potential as a hedge against inflation.

And yet the kind of inflation investors expected isn’t here, at least not yet. In fact, US inflation remained stable through 2020. Some economists don’t think inflation will be rampant in America anytime soon. Others think a little post-pandemic inflation might even be a good thing.

What is inflation anyway?

It depends who you ask.

The US Federal Reserve defines inflation as the increase in the price of goods and services over time, but many associate it with a change in the amount of money or total circulation.

“In the Bitcoin world, they don’t use the term“ inflation ”the way economists use to raise consumer prices in general. Instead, they tend to use it to increase the amount of money, ”said economist and CoinDesk columnist Frances Coppola.

The crypto argument that printing more money leads to inflation sounds compelling, Michael Ashton, inflation advisor and JPMorgan alum, told CoinDesk. When the relative quantity of two goods changes, the one that increases in quantity tends to get cheaper, he said, adding that it does so all the time with foreign exchange.

The reason the Mexican peso has been cheap compared to the US dollar for a long time is because the supply of Mexican pesos has consistently outperformed the supply of US dollars, Ashton said. Because there are a lot more pesos than dollars out here, he explained, the value of the peso in the currency markets goes down.

“That’s part of the crypto argument. They say, “We will limit how fast the supply of cryptocurrencies can grow.” Since we are printing all of these dollars, it means the dollar will have to depreciate sharply compared to crypto. Therefore, the price of crypto should rise over time, ”Ashton said.

According to Calvo, the view that you can control the price level of goods and services through the supply of money is not limited to the crypto world, but is shared by investors in general and for good reason. If you look at many countries over a long period of time, you can see a link between increases in money supply and inflation, Calvo added.

Calvo, Coppola and Ashton all agree, however, that increasing the amount of money in the economy – for example with an economic stimulus package – does not guarantee a rise in the price level.

“As you increase your money supply, you may or may not increase consumer price levels, depending on what is still going on in the economy at that point. So there are a number of other factors to consider, ”said Coppola.

Printing money, is inflation rising?

Not really, at least in the US

The US Federal Reserve has an inflation target of 2% as measured by the consumer price index (CPI). Despite fears of inflation due to spending related to pandemics, the U.S. inflation rate in 2020 was 1.5%, well below target.

One explanation for the relative stability of US inflation is money speed, which quantifies how quickly money changes hands in an economy. If the money supply increases but people are not spending a lot of money quickly, inflation can stay balanced.

After the pandemic, consumer spending suffered worldwide, with countries such as the US, India, Japan and Germany seeing sharp falls in household spending. When several states were locked down in the US, people stayed home instead of eating out, partying and gatherings stopped, and travel screeched to a halt.

Less spending meant that the demand for goods and services in general had fallen. Global energy demand fell 6% in the first few months of 2020, the biggest drop since World War II, according to the International Energy Agency (IEA).

“Weaker demand and significantly lower oil prices are holding back consumer price inflation,” the Federal Reserve wrote in its June 2020 monetary policy report.

The World Bank actually forecast a decline in global commodity prices.

Under these conditions, the US government distributed economic funds.

“So people are collecting money, but that is not reflected in the price level,” said Calvo.

Ashton stated this could be because the money speed is very slow. People aren’t getting rid of US dollars fast enough that the price level doesn’t rise dramatically.

“If you put a lot of money in people’s bank accounts, they can’t spend it right away. So, mathematically speaking, the speed of money must decrease. That’s exactly what happened, ”said Ashton.

What about outside of the US?

American fears of inflation may be partly due to events in other parts of the world. Some investors may look at countries like Argentina and Venezuela, where printing money has resulted in very high inflation.

“Investors generally look ahead and say we see a lot of money going into the economy. Hence, there is a risk that this will happen in the US. So we need to invest in things that will protect us from this inflation when this happens. This is the conventional argument, “Inflation is coming, we have to protect ourselves from it,” said Coppola.

But in the countries they look at, things work differently, added Coppola.

Venezuela and Argentina are hyperinflationary economies in which the price level is growing rapidly and excessively, triggered by an increase in the supply of money or a shortage of supply relative to demand.

In Venezuela, for example, printing money led to a staggering rise in food prices last year. The International Monetary Fund (IMF) reported that the inflation rate in Venezuela was a whopping 6500% in 2020.

In hyperinflationary countries, years of political and economic instability have depleted the ability to print money without leading to uncontrollable inflation, Calvo said. Coppola added that countries struggling with hyperinflation have other problems, like high foreign currency debt, war, occupation or something political.

Argentina, for example, has had a long and complicated economic crisis, filled with astronomical debt obligations and political instability, in which citizens often struggle to convert their Argentine pesos into more stable assets or currencies.

“In Argentina the minute [the government] The money supply is increasing very quickly. You see the consequences for the price level, “said Calvo, adding:” Some countries have the privilege of printing money when needed. Nothing happens. Argentina does not have this privilege. ”

Interestingly, the pandemic did not particularly boost inflation in Argentina either. By mid-2020, inflation in Argentina had hit a two-year low, according to a report by Focus Economics.

With the Argentines also under lockdown during the pandemic, the slowing economy and low demand coupled with a surge in government spending did not cause a significant spike in price levels, Calvo said.

If inflation isn’t rising, why are people hedging against it?

People may be buying bitcoin as a hedge against future inflation, and they’re not crazy about it.

The US Federal Reserve will hold interest rates near zero until inflation rises enough to hit its 2% target, according to a statement made to the media by Federal Reserve Vice Chairman Richard Carida.

US politicians know exactly what they are doing, said Phillip Gillespie, CEO of crypto liquidity provider B2C2 Japan.

“They will basically suppress interest rates and raise inflation,” Gillespie told CoinDesk.

However, economists say one of the biggest challenges in the Federal Reserve’s 108-year history will be to bring price levels down to maintain the inflation target when the country reopens and spending increases.

Of course, investors are reacting to the fate and darkness of inflation by betting against it and making an alternative asset like Bitcoin the breakout star of inflation hedge for 2020.

According to JP Koning, Canadian financial writer and founder of popular blog Moneyness, Bitcoin inherited many of the same selling points that made gold a preferred hedge against inflation such as scarcity and portability.

Continue reading: MicroStrategy CEO explains why Bitcoin is a million times better than antiquated gold

But when it comes to hedging against inflation, Bitcoin is hardly alone.

“If you look around your house, everything is an inflation hedge,” Koning said. “Your house itself is an inflation hedge, your table, your personal capital, your education are all inflation hedge because all of these things will increase in value as the purchasing power of the currency declines.”