6 min read · Dec 22, 2023
Given the role of the inflationary monetary economy and the liquidity trap that has come into focus with zero or negative interest rates, many are looking to Bitcoin as an inflationary hedge or protection against inflation.
Ultra-rich investors and billionaires are collectively taking a position to compare Bitcoin to gold, and this particular comparison has some nuances.
But the common theme of Bitcoin being a hedge against an inflationary environment has been compromised, especially after the recent halving.
What is the reason for this? What are the historical and economic reasons why we might see Bitcoin as an anti-inflationary force? What does it mean to say that it has a deflationary philosophy?
Here it is useful to define inflation and look at some historical examples. In general, inflation is a general increase in the price of services and goods in a country over a sustained period of time.
This is Wikipedia’s definition, but it’s helpful here to understand why this might be the case: Inflation is generally caused by a general decline in the purchasing power of fiat currency.
It is called hyperinflation if the decline in purchasing power reaches a critical inflection point where there is a decline in the value of fiat currency and an increase in the prices of goods and services in a very rapid period of time.
What might cause this decline in the value of securities? An increase in the money supply, an outflow of foreign investors from a particular currency, or even investors attacking the currency (example: what George Soros did to the Bank of England).
Some of them are subject to the direct discretion of monetary authorities, while others reflect a form of international flow that is unrestricted except in rare cases.
As a result, the prices of goods like food and other necessities become more expensive for people, as wages tend to be more stable than rapidly increasing factor prices.
Any business that requires initial inputs also becomes more expensive to run.
Contraction is the opposite force. Here, prices decrease as the value of the paper currency increases in relation to various goods and services.
There may be different reasons for this, ranging from a controlled money supply in the form of central bank restrictions or an increase in innovation.
The Las Vegas Strip generated $2.1 billion in gambling revenue, the highest quarterly profit rate in history. Bitcoin is now where oil was in 1890.
A striking example of this is technology-driven deflation, where consumer prices for computing power have fallen dramatically, for example, as technological innovation fits more processing power into smaller chips.
You can see this in how your mobile phone has more computing power than a rocket that sent astronauts to the moon.
Or in how human genome sequencing used to cost $1 million in US dollars, and now sometimes costs less than a few thousand.
Inflation is usually linked to unemployment in what is called the Phillips curve.
Typically, increases in inflation are associated with lower unemployment, as the money supply is distributed and spent more evenly among employees, who tend to have higher money multipliers. This is also true as the number of employees increases.
They have more bargaining power vis-à-vis employers, and wages should rise.
However, this is not always true. For example, the 1970s witnessed a period of increasing inflation and unemployment.
Unemployment inflation is part of the misery index that measures the sum of the unemployment rate and the inflation rate.
When inflation increases, the average citizen usually feels tight, especially with their savings.
They are motivated to spend more in the moment, but they receive less with each passing moment in terms of the nominal value of the money they have.
Instead of spending $1 on a loaf of bread, they have to spend $1.10 and so on.
This is what happened in the 1970s in the United States, a period when gold boomed as a hedge against currency depreciation in an economy suffering from mass unemployment.
The way the world looks as a result of the Covid-19 pandemic: massive inflationary monetary policy, with a massive expansion of the money supply due to monetary policy.
Prices in some key areas such as basic foodstuffs continue to rise due to supply shocks caused by lockdowns.
Lockdowns also shuttered businesses that largely operate in physical locations, leading to a significant increase in unemployment.
Bitcoin is theoretically treated as a hedge against this possibility, deriving its value from both speculative interest as a hedge, as well as a deflationary and controlled money supply and its use as a potential primary medium of exchange in a more digitally oriented global economy.
Cryptocurrencies like Bitcoin are built on the same principles as well, and the 21 million Bitcoin limit means that at a certain point.
There should be fewer bitcoins in demand for them, which means that in terms of value, the price per unit should rise as supply decreases.
It’s worth taking a look at some well-known examples here to see how inflation shakes out, and how Bitcoin can act as a countervailing force.
One of the most famous examples is the Weimar Republic. Hyperinflation took hold after foreign debt and irresponsible economic reparations pushed the value of the German mark so low that people piled notes into wheelbarrows to make payments.
Storm inflation has occurred throughout history in places like Venezuela, Hungary, and Zimbabwe, examples and places with higher inflation rates in a relatively small period of time.
But hyperinflation in the Weimar Republic is often referred to as the darkest and darkest historical case.
Because much of the resulting economic distress eventually led to the electoral victory that helped secure the rise of Adolf Hitler as head of the German state.
Another example is the previously mentioned period in the 1970s of stagflation in the United States.
This was a period of relative economic stagnation and oil price shocks that sent prices up across the board.
Full employment policies came about as part of the Federal Reserve’s mandate due to high inflation and high unemployment rates throughout the 1970s.
The Federal Reserve had to raise interest rates above 20%, while tightly controlling the money supply in order to control inflation.
Although significant price increases led to a recession, people were priced out of car loans and mortgages.
Finally, a classic and often cited example of the consequences of deflation in economics is the deflation in Japan in the 1990s, with the deflationary mentality continuing to this day.
Through these examples, however, the unifying theme that transcends them is inflationary economics based on the Keynesian theory of economics.
Which became the standard in mainstream economics, and the deflationary Austrian economics popularized by Hayek.
Contrasts In a world where consumption is shut down by the government, starting a business in certain sectors of the economy has never been cheaper.
Bitcoin was originally designed to encourage a deflationary stance and hold value at a relatively stable pace due in part to the “gold standard.”
In this way, the community acts as a place where investors and community participants can raise their hands against the inflationary consensus.
In this way we can see Bitcoin and cryptocurrencies like them acting as a real and meaningful hedge against inflation, as well as the economy and politics that guide them.
Now, more than ever, inflation hedging plays a crucial role, and Bitcoin may play a role in the 21st century just as gold did in the 20th.
