Hedging against Inflation may be contributing to the very problem.
“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
— Milton Friedman.
Since the start of the COVID-19 Pandemic, difficult economic circumstances have caused a rapid increase of public spending, and record low interest rates around the world.
Whilst stimulus spending has been much needed during this difficult year, the ever increasing money supply has started to cause a great deal of alarm. As we emerge from the pandemic restrictions, the concern is inflation, and long term bond yields have started to raise in anticipation.
Too much money, chasing too few goods.
Economic history is littered with the devastation that accompanies rapid inflation. The most famous example is perhaps the German Weimar Republic, in the aftermath of WW1, when inflation was so great that the economy stopped accepting domestic currency, the Mark, as legal tender. The monthly inflation rate stood at nearly 30,000% and citizens famously burned money for warmth, rather than purchase fire wood with the money that they burnt.
A German money burning money instead of wood during Hyperinflation.
In 1919, one loaf of bread cost 1 Mark; by 1923, the same loaf of bread cost 100 billion Marks.
The domestic currency had entirely lost its integrity as a store of value and a stable method of transaction.
Although this sort of hyper-inflation seems unlikely in todays developed economies, the threat of basic inflation above GDP growth is very possible, and in many schools of thought, imminent.
If this comes to pass, the real value of domestic currencies will decline, interest rates will have to rise and the already tremendous debt burden will worsen.
Economic growth will grind to a halt.
If people start to anticipate inflation, cash will no longer be considered king, and individuals will look for other, more reliable stores of value.
Historically, Gold has been this reliable store of value during periods of inflationary pressure. There is a historical precedence for it as a store of value, and unlike a fiat currency, it cannot be printed at demand. There is finite supply of Gold in the earth’s crust.
In the past few years, many fiat-money skeptics have suggested Bitcoin as the best possible store of value. Like Gold, it is finite in supply. The entire supply of Bitcoin has been capped at 21 Million, 18 Million of which has already been mined. Bitcoin however does have some great advantages over Gold. It is far easier to store and transport, one is able to hold large quantities directly on the blockchain, as opposed to gold which would have to be held on an exchange or brokerage. This leaves the investor subject to the integrity and security of a third party.
So if one was worried about the endless printing of money by Central Banks, Bitcoin seems to have some very real advantages.
But will the inflation so many anticipate come to pass? Will too much money start to chase too few goods? Will traditional money lose value, instigating us all to look for alternative stores of value?
Perhaps. Milton Friedman Predicted it.
However, money supply has been increasing faster than ever, and interest rates in the developed countries of the world have hardly risen above 0% in a decade, but prices haven’t risen accordingly. Even in the Great Recession of 2008, huge fiscal spending never resulted in worrying inflation pressures, even while the value of Gold increased as investors ran to hedge themselves.
Perhaps the additional money in circulation in the past year has simply allowed the economy to consolidate supply side shocks that have been caused by the COVID 19 pandemic.
Perhaps it has to do with the manner in which Central Banks are injecting stimulus into the economy today. Quantitive easing — essentially buying debt from Banks. The additional liquidity that has been injected into the banking system may simply remain on the balance sheets of these banks?
Lastly, and perhaps most interestingly, we may simply not be looking for inflation in the right place. The traditional measure of inflation is the CPI. The consumer product index basket of goods, filled with daily essentials and necessities.
But what about non traditional assets? Throughout the pandemic, money has been poured into the stock markets. The Dow Jones and the Nasdaq are trading at all time records. Companies like Tesla are trading at over 1000 times Price / Earnings Ratio, and people are spending millions of dollars on non traditional assets also whilst sitting at home during the pandemic.
The most prominent of these assets is Bitcoin, which trading at nearly 7500% more than this time last year. Other unconventional markets like NFT’s and Trading Cards have been exploding too.
Could it be that people are throwing money at assets like Bitcoin as a hedge against inflation, all the while contributing to inflation in places that our conventional CPI measure of Inflation doesn’t cover?
How ironic would that be?
After all, as of today, an asset like Bitcoin has no intrinsic value. Its value is derived purely as a function of supply and demand.
Something certainly seems off. Aren’t we meant to be coming off the greatest international disaster since the world wars?
What happens when stimulus spending stops and interest rates rise, and the economy goes into a downward spiral?
People will need the money to pay back their loans.
Liquid assets like Bitcoin will be the first to tank.
