There’s a financial joke that’s been circulating lately that I don’t know the source of. He continues: If inflation continues at current rates, the purchasing power of wealth held in dollars will be halved over the next eight years. But cryptocurrencies can beat this: They can lose half their value in just a few months.
haha. But crypto enthusiasts have indeed marketed their product as an inflation hedge. Coinbase, the largest crypto exchange in the United States, declares that cryptocurrencies are attractive because they are “more resistant to inflation than fiat currencies such as the US dollar.” This, incidentally, is not the same argument people use to hold gold.
However, something funny happened as inflation fears escalated, as seen in this chart that shows Bitcoin’s price in US dollars last year:
So why did crypto prices drop exactly at the same time that inflation spiked? It may be a degree of coincidence: If you believe, like me, that crypto is largely a Ponzi scheme, this may be the moment the plan runs out for new suckers.
But there’s also a more fundamental problem: People who tout cryptocurrencies as a hedge against fiat inflation – a kind of digital equivalent of gold – have fundamentally misunderstood how fiat systems work, and also, for what it’s worth, misunderstand what has historically driven them. price of gold. In fact, it could be predicted that an increase in inflation would drive the price of Bitcoin down – perhaps not causing such an epic crash.
The most important thing to understand is that while the dollar is indeed a fiat currency – that is, the authorities can print more dollars at any time without needing to back those additional dollars with some kind of collateral – America is not Venezuela or Weimar. A republic is a nation that prints money to pay the government’s bills. Our money supply is a policy tool used by the Federal Reserve to help keep prices fairly stable—in fact, while rising at about 2 percent a year—avoiding recessions. Sometimes the Fed gets it wrong when it (and I) can’t see inflation spike coming, as it did last year. But when it does, it tries to fix the error.
What this means is that an inflationary epidemic is not a harbinger of an ever-rising price spiral that you can avoid by buying crypto. Rather, markets believe the Fed will do whatever it takes to bring inflation back to normal levels: The five-year, five-year forward inflation expectation rate is a measure derived from the spreads between regular U.S. bonds and U.S.-indexed bonds. The Consumer Price Index barely moved through this entire section:
And saying the Fed will “do whatever it takes” means it will raise interest rates until there are clear signs that inflation is falling. The Fed only has direct control over short-term rates, but long-term rates have already risen in anticipation of continued tightening from the Fed:
What does this mean for crypto? The rate of return that investors can earn by purchasing bonds has increased, making it less attractive to buy stocks and other assets such as yes cryptocurrency. So cryptocurrency isn’t a hedge against inflation, quite the opposite: When inflation rises, the Fed responds by raising interest rates, which causes cryptocurrencies to fall.
The point is, we had to learn all this from what happened to gold after the 2008 financial crisis. Gold prices rose, and many saw this as a harbinger of runaway inflation:
However, the expected inflation never came. Instead, it was the Fed’s response to persistent economic weakness by keeping interest rates low, and the low yields on bonds forced people to invest in other things, including gold. Whatever the purpose of holding gold – something that, to be honest, remains a bit of a mystery – one thing that gold is definitely not is an inflation hedge. The same goes for cryptocurrency.
So another crypto myth is biting the dust. And it’s hard to avoid wondering which legends remain.
Legendary short-seller Jim Chanos recently gave an extensive interview to Bloomberg where he talked about cryptocurrency, “proving that many of the concepts behind its early adoption were basically non-existent or incomplete. You know, it was going to be a backup currency. No, It’s not. Well, it’s going to be a diversifying entity. Well, no, it didn’t.” And now we also know that this is not an inflation hedge.
Chanos continued to call crypto a “predatory junkyard.” Well, I wouldn’t go that far. Actually, on second thought, I would.
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