There’s a money joke, whose origin I don’t know, has been circulating lately. It goes like this: If inflation continues at current rates, the purchasing power of wealth held in dollars will halve over the next eight years. But cryptocurrencies can beat that: they can lose half their value in just a few months.
haha. But crypto enthusiasts have already marketed their products as an inflation hedge. Coinbase, the largest US crypto exchange, Announces Cryptocurrencies are attractive because they are “more inflation-resistant than fiat currencies like the US dollar.” This is, not coincidentally, the same argument that people use for possession of gold.
But a funny thing happened as inflation fears grew, as shown in this chart showing the price of bitcoin in US dollars over the past year:
So why did cryptocurrency prices crash at the exact same moment inflation took off? To some degree it might be a coincidence: If, as I do, you think crypto is very much a Ponzi scheme, this might just be the moment when the scheme runs out of new suckers.
But there is also a more fundamental problem: people who have promoted cryptocurrency as a hedge against fiat inflation – a kind of digital equivalent to gold – have misunderstood how fiat currency systems work, and also, for what they are worth, misunderstanding the historical driver of the gold price. In fact, rising inflation was expected to cause the price of Bitcoin to fall – although it probably won’t lead to such an epic crash.
The main point to understand is that while the dollar is already fiat currency – that is, the authorities can issue more dollars at will, without having to back those extra dollars with some kind of guarantee – America is not Venezuela or the Weimar Republic, a nation that prints money to pay bills the government. Our money supply is a policy tool that the Federal Reserve uses to help keep prices fairly stable — in fact, rising about 2 percent a year — while avoiding recessions. Sometimes the Fed gets it wrong, as it did over the past year, when (and I) failed to see higher inflation coming. But when that happens, it tries to correct the error.
What this means, in turn, is that the outbreak of inflation does not portend a spiral of constant price hikes, which you can avoid by buying cryptocurrencies. On the contrary, markets believe the Fed will do whatever it takes to return inflation to normal levels: the five- and five-year forward inflation expectation rate, a measure derived from the differences between common US bonds and bonds indexed to the CPI, barely moves through This entire episode:
Saying that the Fed will do “whatever it takes” means that it will raise interest rates until there are clear signs that inflation is abating. The Fed has only direct control over short-term interest rates, but long-term rates have already gone up in anticipation of continued Fed tightening:
What does this mean for cryptocurrencies? Well, the rate of return that investors can get by buying bonds has increased, which makes buying other assets, such as stocks, and cryptocurrencies, less attractive. So cryptocurrencies are not a hedge against inflation, on the contrary: when inflation rises, the Federal Reserve responds by raising interest rates, causing cryptocurrencies to fall.
The thing is, we should have learned all about this from what happened to gold after the 2008 financial crisis. Gold prices soared, which few people saw as a harbinger of runaway inflation:
But the expected inflation never came. What was happening instead was that the Fed responded to persistent economic weakness by keeping interest rates low, and low yields on bonds prompted people to invest in other things, including gold. Whatever the purpose of holding gold—something that, frankly, remains somewhat of a mystery—the one thing gold certainly isn’t is an inflation hedge. The same is true for cryptocurrencies.
So, another cryptocurrency myth is gnawing at the dust. It is hard to avoid questioning the remaining myths.
Recently, legendary seller Jim Chanos gave Bloomberg a extensive interview Speaking of cryptocurrency, he noted, “A lot of the concepts behind its early adoption have proven that it basically, you know, doesn’t exist or you don’t want it. You know, it’s going to be an alternative currency. Well, no, it’s not. Well , it would be a diversified origin. Well, no, it wasn’t.” And we now know that it’s not an inflation hedge either.
Chanos has gone on to call cryptocurrency a predatory junkyard. Well, I won’t go that far. Actually, after a second thought, I will.
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