While the inflationary monetary economy and liquidity traps are concentrated with zero percent interest rates or even negative interest rates, many view Bitcoin as a hedge against inflation or protection against inflation. Billionaire investors line up to compare Bitcoin to gold. This particular comparison has some nuances but the broad macro-theme of Bitcoin being a protection against an inflationary environment has broken through, especially after the recent halving.
Why that, and what are the historical and economic reasons that we could see Bitcoin acting as a counterforce to inflation and what does it mean to say that it has a deflationary philosophy?
It is useful here to define inflation and look at some historical examples. In general, inflation is a general increase in services and goods in a country over an extended period. This is the definition from Wikipedia, but it is useful here to understand why this could be the cause: inflation generally results from a general decrease in the purchasing power of a fiat currency. We speak of hyperinflation if the fall in purchasing power reaches a critical inflection point where the fall in the value in currency and the increase in the prices of goods and services occur in a very rapid period of time.
What could cause this decrease in fiduciary value? An increase in the money supply, foreign investors flowing from a particular currency, or even investors attacking a currency (what George Soros did at the Bank of England, for example). Some of them fall under the direct discretion of the monetary authorities, while others reflect an international flow of capital which can rarely be limited.
As a result, goods like food and other essentials become more unaffordable for people, as wages tend to be more fixed or static than the prices of rapidly increasing factors. It also becomes much more expensive to operate a business that requires raw inputs.
Deflation is the opposite force. Here, prices fall as fiat money increases in value relative to different goods and services. There can be different causes for this, ranging from a controlled money supply in the form of central bank restrictions or increased innovation.
A vivid example of this is technology-driven deflation, where, for example, consumer prices for computing power have fallen exponentially, as technological innovation has incorporated more processing power into more chips small – you can see it in the way your cell phone has more computing power than the rocket that sent astronauts to the moon or in the way the sequencing of a human genome cost a million dollars in USD, and now sometimes costs less than a few thousand.
Inflation is generally correlated with unemployment in what is called a Phillips curve. Usually, increases in inflation are correlated with declines in unemployment, as money supply is distributed and spent more evenly among wage earners, who tend to have high monetary multipliers. It is also true that as the number of people employed increases, they have more bargaining power against employers and wages should increase.
However, this is not always true. The 1970s, for example, saw a period of rising inflation and unemployment.
The inflation that accompanies unemployment is part of the poverty index which measures the combined sum of the unemployment rate and the inflation rate. When inflation rises, the average person usually feels the pinch, especially with their savings. They have an incentive to spend more in the present moment, but they get less with each passing moment for the face value of the money they have. Instead of spending $ 1 for a loaf of bread, they should spend $ 1.10 and so on.
This is what happened in the 1970s in the United States, a period when gold exploded as a cover to drag the monetary value into an economy where mass unemployment. The COVID-19 world looks like this: there is a massive inflationary monetary policy, with an aggressive expansion of money supply due to monetary policy, and prices continue to rise due to supply shocks caused by closures. The closings have also resulted in the closure of businesses that operate mainly in physical spaces, resulting in a massive increase in unemployment.
Bitcoin is theoretically positioned as a hedge against this scenario, drawing its value both from speculative interest as a hedge, as well as from its deflationary and controlled money supply and from its use as the main potential medium of exchange. in a global digital economy. Cryptocurrencies like Bitcoin are also built around these same principles. The limit of 21 million Bitcoins means that at some point there should be less Bitcoins compared to the demand for them, which means that in terms of value, the price per unit should increase as the ‘supply is decreasing.
It is instructive to examine here some well-known examples of how inflation has rocked and how Bitcoin could serve as a fighting force.
One of the best known examples is the Weimar Republic, the democratic antecedent of Nazi Germany. Hyperinflation reigned after foreign repair debts and economic irresponsibility pushed the value of the German brand so high that people crowded paper tickets into wheelbarrows to make payments.
Hyperinflation has occurred throughout history in places like Venezuela, Hungary and Zimbabwe, examples and places with higher inflation rates in a relatively small window of time – but l Hyperinflation of the Weimar Republic is often cited as the most historic and gloomy case, as much of the economic unrest generated ultimately led to electoral victory which helped secure the rise of Adolf Hitler to the head of the German state.
Another example here is the 1970s stagflation period cited earlier in the United States. It was a period of relative economic stagnation and oil price shocks that pushed prices up across the board. Full employment policies under the Federal Reserve’s mandate were due to high inflation and high unemployment rates throughout the 1970s. The Federal Reserve had to raise interest rates to more than 20% , tightly controlling the money supply in order to control inflation – although drastic rate hikes have led to a recession, people being excluded from car loans and mortgages.
Finally, the classic example of the consequences of deflation which is often cited in economics is deflation in Japan in the 90s with a deflationary mindset which continues today.
In all of these examples, however, the unifying theme beyond them is the inflation-Keynesian economy which has become the norm in the traditional economy, and the Austrian-based deflationary economy popularized by Hayek, contrasted in a world where consumption is stopped by government mandate, and it has never been so economical to start a business in certain sectors of the economy.
Bitcoin is technologically structured to encourage a deflationary attitude and a relatively stable store of value which partly reduces 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. This is how we can see Bitcoin and cryptocurrencies like this act as a real hedge against inflation – and the economic and political thinking that drives it.
Today, more than ever, inflation hedges are important. Bitcoin could play a role in this role for the 21st century, like gold for the 20th century.