this is an op-ed by jordan wirsz, investor, award-winning entrepreneur, author, and podcast host.
Bitcoin’s correlation to inflation has been widely discussed since its inception. There are many narratives surrounding bitcoin’s meteoric rise over the last 13 years, but none as prevalent as the fiat currency’s debasement, which is certainly seen as inflationary. now the price of bitcoin is going down, leaving many bitcoiners confused as inflation is at its highest in over 40 years. how will inflation and monetary policy affect the price of bitcoin?
Reading: Is bitcoin a hedge against inflation
First, let’s look at inflation. the federal reserve mandate includes a 2% inflation target, but we just released a consumer price inflation figure of 8.6% for the month of may 2022. that’s over 400% of the federal reserve’s target federal Reserve. In reality, inflation is likely to be even higher than the CPI print. wage inflation is not keeping up with real inflation and households are starting to feel it in a big way. consumer confidence is now at an all time low.
why isn’t bitcoin rising while inflation is running amok? Although fiat degradation and inflation are correlated, they are really two different things that can coexist in juxtaposition over periods of time. Much has been made of the narrative that bitcoin is a hedge against inflation, but bitcoin has behaved more like a barometer of monetary policy than inflation.
Macro analysts and economists are feverishly debating our current inflationary environment, trying to find comparisons and correlations with inflationary periods in history, such as the 1940s and 1970s, in an effort to forecast where we go from here. while there are certainly similarities to inflationary periods of the past, there is no precedent for bitcoin’s performance in circumstances like these. bitcoin was born just 13 years ago from the ashes of the global financial crisis, which unleashed one of the largest monetary expansions in history up to that point. For the past 13 years, bitcoin has seen an easy monetary policy environment. the fed has been dovish, and every time the hawk reared its ugly head, the markets turned and the fed quickly pivoted to restore calm to the markets. Keep in mind that during the same period, bitcoin rose from pennies to $69,000, making it perhaps the highest-performing asset of all time. the thesis has been that bitcoin is a “correct asset”, but that thesis has never been called into question by the significantly tighter monetary policy environment, which we find ourselves in at the moment.
The old saying that “this time is different” could prove true. the fed can’t pivot to suffocate the markets this time. inflation is totally out of control and the federal reserve is starting from a near zero rate environment. here we are with 8.6% inflation and near-zero rates while looking the recession square in the eye. the federal reserve is not going up to cool the economy…it is going up against a cooling economy, with already a quarter of negative gross domestic product growth behind us in the first quarter of 2022. quantitative tightening has only just begun. the fed does not have the room to maneuver to slow down or ease its tightening. it must, by mandate, continue to raise rates until inflation is under control. meanwhile, the cost conditions index is already showing the biggest tightening in decades, with almost no move from the fed. the mere hint of federal tightening sent the markets out of control.
There is a huge misconception in the market about the Fed and its commitment to raise rates. I often hear people say, “The Fed can’t raise rates because if they do, we won’t be able to pay our debt payments, so the Fed is lying and will change sooner rather than later.” that idea is objectively incorrect. The Fed has no limit to the amount of money it can spend. why? because you can print money to make whatever debt payments are necessary to keep the government from defaulting. It’s easy to make debt payments when you have a central bank to print your own currency, isn’t it?
I know what you’re thinking: “wait a minute, you’re saying that the Fed needs to crack down on inflation by raising rates. And if rates go high enough, the Fed can just print more money to pay your bill payments.” higher interest, which is inflationary?”
does your brain hurt already?
This is the “debt spiral” and inflation conundrum that people like bitcoin legend Greg Foss regularly talk about.
let me be clear, the above discussion of that possible outcome is widely and vigorously debated. the fed is an independent entity, and its mandate is not to print money to pay our debts. however, it is entirely possible that politicians will move to change the fed’s mandate given the potential for incredibly pernicious circumstances ahead. This complex and nuanced topic deserves much more discussion and thought, but I’ll save that for another article in the near future.
Interestingly, when the Fed announced its intention to raise rates to quell inflation, the market didn’t wait for the Fed to do it…the market went ahead and did the Fed’s job. in the last six months, interest rates have roughly doubled, the fastest rate of change in the history of interest rates. libor has jumped even higher.
This record rate increase has included mortgage rates, which have also doubled in the last six months, sending chills through the housing market and crushing home affordability at a rate of change never seen before.
All of this, with just a tiny, tiny 50bp hike by the Fed and the very start of their rate hike and balance sheet liquidation program, it just started in May! As you can see, the Fed barely budged an inch, while the markets crossed a chasm of their own. the feds’ rhetoric alone sent a chilling effect through the markets that few expected. look at global growth optimism at new record lows:
Despite the current volatility in the markets, investors’ current miscalculation is that the Fed will take its foot off the brake once inflation is under control and slowing. But the Fed can only control the demand side of the inflation equation, not the supply side of the equation, which is where most of the inflation pressure comes from. in essence, the fed is trying to use a screwdriver to cut a piece of wood. wrong tool for the job. the result may very well be a cooling economy with persistent underlying inflation, which is not going to be the “soft landing” that many hope for.
Does the federal government really expect a hard landing? One thought that comes to mind is that we might actually need a hard landing to give the Federal Reserve a path to lower interest rates again. this would give the government the ability to pay off its debt with future tax revenue, rather than find a way to print money to service our debt at persistently higher rates.
Although there are macro similarities between the 1940s, 1970s, and the present, I think it ultimately provides less information about the future direction of asset prices than monetary policy cycles.
Below is a graph of the US exchange rate. money supply m2. You can see that 2020-2021 saw a record increase since the covid-19 stimulus, but look at the end of 2021-present and you will see one of the fastest exchange rate declines in m2 money supply in recent history.
In theory, bitcoin is behaving exactly as it should in this environment. Unprecedented monetary policy equates to “increasing numbers technology.” Record monetary tightening equals “the number goes down” price action. it is quite easy to determine that the price of bitcoin is less tied to inflation and more to monetary policy and asset inflation/deflation (as opposed to core inflation). the chart below of fred m2’s money supply resembles a less volatile bitcoin chart… “increasing number” technology: up and to the right.
now consider that for the first time since 2009 (actually the entire history of fred’s m2 chart), the m2 line could be turning significantly lower (take a look). bitcoin is just a 13-year experiment in correlation analysis that many are still theorizing about, but if this correlation holds then it stands to reason that bitcoin is much more tied to monetary policy than inflation.
if the fed needs to print much more money, it could coincide with an increase in m2. that event could reflect a “monetary policy change” significant enough to start a new bull market in bitcoin, regardless of whether or not the fed starts cutting rates.
I often think, “what is the catalyst for people to allocate a portion of their portfolio to bitcoin?” I think we’re starting to see that catalyst unfold right in front of us. Below is a Bond Total Return Index chart demonstrating the significant losses bondholders are taking on their chins right now.
The “traditional 60/40” portfolio is being destroyed on both sides simultaneously, for the first time in history. the traditional safe haven isn’t working this time, underscoring the possibility that “this time will be different.” bonds can be a deadweight allocation for portfolios going forward, or worse.
It seems that most of the traditional portfolio strategies are broken or bankrupt. the only strategy that has worked consistently over millennia is to build and secure wealth by simply owning what is valuable. work has always been valuable and that is why proof of work is tied to true forms of value. bitcoin is the only thing that works so well in the digital world. gold does too, but compared to bitcoin, it can’t meet the needs of a modern, interconnected global economy as well as its digital counterpart. if bitcoin didn’t exist, then gold would be the only answer. Fortunately, bitcoin exists.
Regardless of whether inflation remains high or calms down to more normalized levels, the bottom line is clear: Bitcoin is likely to start its next bull market when monetary policy changes, however slightly or indirectly.
this is a guest post by jordan wirsz. The views expressed are entirely my own and do not necessarily reflect those of BTC Inc. or bitcoin magazine.