Inflation Uncertainty… Can Crypto Hel

By Author: Aaron Jaeger
Total Articles: 94
Comment this article

Memories can be fuzzy or fragmented, getting more better with time. However, some memories are supported by fact and create relevance today. One example that is relatable and leads us to today’s topic that is hot on everyone’s lips, from economists, to politicians, to your neighbor: Inflation.

Growing up, I recall when the cost of gasoline surged past $1/gallon. It was relevant because I knew that filling up my 16-gallon tank would no longer be a ten-dollar bill and a five spot but eat up my lone $20 in my wallet and leave me with a few coins. In the middle of this year (2021), my family and I drove out of California, rolling past the gas stations, many of which had gas prices starting with ‘$5.xx.’

It is undeniable that prices have increased over time and very noticeably over the past year, with gasoline being one example of many commodities that has surged. From groceries to lumber to natural gas, the price points have jumped. Quantitatively, the Consumer Price Index (CPI), which measures the increase in the price of a basket of goods over time, is a good measure when we talk about the broad concept of ...
... inflation. Over the past ten years, the annual CPI is +/- 2%. Through October, the prior 12 month’s CPI was 6.2%[1].

Accordingly, the subject about the trajectory of inflation is a hot topic that goes beyond the owners of the dismal science (economics). Acutely, the average American consumer will be adversely affected by additional, future potential spikes in the pricing of commodities that outstrip the increase in wages. Beyond our borders, global inflation pressure mounts as well, as Europe has hit a 24-year high.

So… what is the outlook for inflation in 2022 and beyond? Traditionally, predicting inflation, is not a perfect science. The economic volatility with COVID-19 and subsequent variants (e.g. Delta and now more recently, Omnicron) create a broad and deep uncertainty. Government spending in reaction to the pandemic as well as trillions of new government initiatives pump additional money into the system. Supply-side stress caused by supply-chain disruption creates another variable in an already complex equation. Finally, analysts and pundits even disagree on the measurements of inflation[2], suggesting that the rate is far higher than the publicly available reports.

As well, the answer to the future inflation question has a very high degree of politicizing. One point of view may have inflation reverting to the mean, such that the inflation we saw in 2021 was a result of a cost-push theory. Specifically, that the pandemic and supply chain disruption[3] led to a short term or temporary situation that will normalize.

An alternative view is that the outlook is that inflation will be prolonged. Government printing money with stimulus checks and new spending initiatives coupled with years of prolonged easing of monetary supply has led to a demand-pull inflation. The folksy reference is summed as: “We see too many dollars chasing too few goods.”

A more extreme opinion exists that we will not just have inflation, but rates that may sky-rocket to the Jimmy Carter era when the rate was double digits[4] and culminate to stagflation. The combination of demand-pull and the cost-push create a cumulative effect and significant impact on the price points for the American consumer[5] that outpaces economic and wage growth.

What we can be for certain is that no one is holding a crystal ball. In April of 2021, the Federal Open Market Committee predicted a 1.6-2.8% increase for 2021[6]. Just three months prior to writing this article (at the end of August 2021), the White House forecasted a 4.8% increase[7].

Moreover, the inability to forecast even six months into the future indicates an uncertainty, if not outright volatility. What exemplifies this takeaway is what Jerome Powell, Chairman of the Federal Reserve stated addressed Congress. On December 1, 2021, regarding the current state of inflation, Powell stated he was “ready to retire the use of the word ‘transitory’ to describe inflation.” In the same context, he said the “risk of higher inflation has increased[8].”

Even if the outcome is a moderate increase of 2-4% in 2022, keeping dollars stashed in a bank account will diminish your purchasing power. Accordingly, inflation hedges are often used, even in perceived non-volatile times to protect wealth. Classic inflation hedges are precious metals like gold or silver. Investors also look to real estate as a tangible asset that provides protection in inflationary times. But if you believe – like many – that these assets are already over-heated, then these asset classes are not necessarily safe havens.

But what about cryptocurrencies? Can a cryptocurrency like Bitcoin be a hedge against inflation? Is there a corollary to inflation, much less a fiat currency like the US dollar?

Cryptocurrency is still in its relative infancy. Early on, we have seen volatility in its value and its detractors state that cryptocurrency is not only intangible but does not have any intrinsic value. For something to be worth something – it actually has to be worth something.[9] And like the Beanie baby craze of the early 2000s, the value could readily be zero tomorrow because it is not backed by authentic value.

However, proponents look at cryptocurrency as having inherent value on two key principles: It is useful (in that one can buy tangible goods) and it is finite (rather, crypto is limited in nature). The latter concept prompts the relationship to inflation. Let’s explore this idea with Bitcoin.

Bitcoin was the first cryptocurrency to hit the market. The design of the currency created a fungible token that that has the characteristics to that of the US dollar, with the exception that Bitcoin is not an oversight of any government. For a detailed comparison, see Exhibit A. The primary function is that Bitcoin can be used to purchase *something* much less that the adoption of the currency continues to persist.

A major ‘pro’ compared to the US dollar is that the number of bitcoin is finite. US government can (and does) print money to increase the money supply and thus devalue the value of each dollar. Whereas, the total number of Bitcoin ever to be created (discovered) is limited to 21 Million in total. Thus, by definition, Bitcoin has real deflationary characteristics.