Inflation hedge or not, Bitcoin’s true value is the separation of money and state

Inflation hedge or not, Bitcoin’s true value is the separation of money and state
Inflation hedge or not, Bitcoin’s true value is the separation of money and state

For the first week in a while, the non-crypto world was higher than the crypto world.

Everyone is talking about:

Meanwhile, no one is talking about whether or not bitcoin (BTC) is an inflation hedge. Fortunately (unfortunately?), each of the things everyone is talking about is (at least loosely) related to inflation in one way or another. So I do it. I will write whether or not bitcoin is an inflation hedge.

Because everything is about inflation and everything is about bitcoin (even things that are not about bitcoin). Stochastic means “random”, by the way.

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Is it inflationary to cancel student debt?

First, the US government does not pay off everyone’s student loans. What the Biden administration announced was that people who both have federal student loans and earn less than $125,000 a year will have either $10,000 or $20,000 of their student loan balance forgiven. There are nitty-gritty details (which you can get by listening to this NASFAA podcast), but the main question we want to answer is whether or not this is inflationary.

Here’s an argument like that: Canceling student loan debt will put money in the pockets of Americans, and those Americans will use that money to buy more immediately. The immediate consumption bump will meaningfully contribute to more inflation.

Here’s an argument that it won’t be: Canceling student loan debt will leave money in the pockets of Americans, and those Americans will use that money to consume more gradually over the course of their lives. The gradual consumption bump will in no way contribute to more inflation.

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I like the argument that student debt cancellation will not be immediately inflationary. Yes, there were the stimulus checks for the coronavirus pandemic, but there is an important psychological difference between giving someone a check for $3,200 and giving them an official letter saying they owe $10,000 less on an outstanding loan.

Is canceling student loans putting pressure on Jerome Powell?

No, probably not. Probably the opposite. While the White House introduced a program that is not obviously inflationary on the surface, the Federal Reserve chair is still digging deep for the Volcker moment (without completing Volcker). When Powell met with central bankers, economists and the American people Friday morning in his prepared remarks in Jackson, Wyoming, he said that “history cautions against prematurely loosening policies,” which basically means, “We’re going to stay the course because if we change course again, you’re really not going to believe us anymore.”

Powell (and the Fed) also dig deep for credibility. CoinDesk’s Adam B. Levine, host of the “Markets Daily” podcast, made one of the best arguments for it in last week’s episode where he said:

“… [H]history suggests that [Fed’s] decision [on interest rates] will remain far below [necessary] interest rate required to deal with inflation. For much of the 1970s and 1980s, the last time we saw comparable price growth, the rate set by the Fed was somewhere between 8% [and] 20%, many times higher than what the Fed is proposing now. So while central banks and markets will play games with each other, it may all be to look seriously at the problem when the proposed solution doesn’t really have a chance of solving anything.”

What Adam Levine uses to make that claim is the Taylor rule, a rule of thumb used by central banks to set interest rates at a level that will effectively fight inflation. In his estimation, the Taylor rule suggests that interest rates must be >9% to even begin to address the behavioral changes that long-term rising inflation brings about. I tend to agree with Levine and don’t think the markets believe politicians anymore.

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Powell is stuck between a rock and a hard place (at least he’s stuck between some really nice rocks in Jackson Hole).

Does war promote inflation?

Pozsar makes it clear in the aforementioned research note that he means it. I think the memo is worth reading in its entirety, but here’s a summary in case you don’t:

Supply outstrips demand because we went from a world where a) cheap immigrant labor in the US, b) cheap goods from China and c) cheap Russian gas supported low inflation to a world where a) nativist immigration policies drove wage pressure in the US, b) China’s zero- COVID-19 policies have damaged the flow of cheap goods and c) a Russian war in Ukraine has led to skyrocketing gas prices in Europe, supporting high inflation.

Here is the punctuating quote:

“Welcome to the war economy…

… where heads of state matter more than central bank governors.”

Can bitcoin save us?

OK – we didn’t address inflation last week, so now on to crypto’s premier inflation hedge: bitcoin. With inflationary forces still out there, investors are thinking about how best to protect themselves. Is bitcoin a way to do that?

I’m not sure. From a marketing perspective, no, not at all. In recent memory, bitcoin has been correlated with stocks. Stocks are not meant to be inflation hedges; less risky things like gold and commodities are. So bitcoin’s price following (or leading) stocks makes bitcoin not really look like an inflation hedge.

There are two threads worth following here.

Firstly, perhaps inflation is not about the price of goods increasing, it is about currency depreciation. Some variations of this chart are quite popular in bitcoin circles:

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Global M2 and bitcoin price (@mrblonde_macro)

Global M2 and bitcoin price (@mrblonde_macro)

As Global M2 – the amount of money in circulation – changes year by year, bitcoin’s market value appears to follow suit. In short, as economies introduce money into circulation, bitcoin’s price goes up because the extra money in circulation dilutes the rest of the existing money in circulation. So this supports the idea that bitcoin is a hedge against currency depreciation (a fancy way of describing the dilution of money in circulation).

I’m not sure the data strongly supports this idea. Sure, it’s a visual relationship in the previous chart, but the rolling 30-month correlation coefficient between US M2 and bitcoin’s value is moving from negative to slightly positive (see the following two charts). Statistically, this doesn’t really tell you anything. Perhaps the move is due to bitcoin maturing over time as it approaches its final resting place as an inflation hedge? I know that the US does not account for the entire world economy, but still.

Year-over-year change in US M2 and bitcoin market capitalization (FRED, TradingView)

Year-over-year change in US M2 and bitcoin market capitalization (FRED, TradingView)

30-month rolling correlation between M2 and Bitcoin (FRED, TradingView)

30-month rolling correlation between M2 and Bitcoin (FRED, TradingView)

Second, and more specifically, if you agree that we are in a war economy “where heads of state matter more than heads of central banks,” bitcoin is probably investable only because it is separate from “the heads of state.” I’m not saying that bitcoin’s price is immune to actions by heads of state, but I am saying that bitcoin is not issued by any country and that the wider network a) doesn’t need any particular country and b) is resilient enough to avoid China banning it.

So in case bitcoin doesn’t behave as an inflation hedge, there might be something to be said for it acting as a way to bet on the separation of money and state.

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