Bitcoin and inflation: maturing into a real asset

The data shows that Bitcoin is beginning to play a role in hedging inflation. Observing the change of Bitcoin price relative to the change of inflation, we can find that the statistical significance of this relationship is getting stronger and stronger.

  • Producer prices are affected by the rise in commodity prices. In developed countries, the growth rate is 7.1%, exceeding the historical data of 90%. This is where inflation is beginning to rise.
  • During the epidemic, wage growth was unusually high because low-income workers were fired. As these workers return to employment, wages are more likely to fall rather than rise in the coming months.
  • The data shows that Bitcoin is beginning to play a role in hedging inflation. Observing the change of Bitcoin price relative to the change of inflation, we can find that the statistical significance of this relationship is getting stronger and stronger.
  • We are still not sure what will happen to inflation in the next 5 years, but we believe that increasing physical assets to protect the investment portfolio from the tail risk of out-of-control inflation is a prudent measure.

Signs of potential inflation problems are beginning to emerge, the most obvious being the tightening employment environment (and the consequent rise in wages) and rising producer prices worldwide. However, investors are still divided, and their views on the inflation outlook fall into two schools: some believe that the effect of inflation is temporary in nature, and some believe that inflation is rising to a level that threatens economic stability.

On a global scale, the data highlights that, from a historical perspective, current inflation is not that high. The current level is similar to that after the 2008 financial crisis. Inflation at the time exceeded the historical figure of 55% since 1970. Producer prices are affected by the rise in commodity prices. In developed countries, the growth rate is 7.1%, exceeding the historical data of 90%. This is where inflation is beginning to rise.

Bitcoin and inflation: maturing into a real asset

During the recovery phase of the new crown pneumonia epidemic, the unemployment rate has fallen much faster than during the global financial crisis, which means that the labor market has begun to heat up. This then infers that salaries may increase with it, as we saw in the United States this year. However, despite the unusually high wage growth during the pandemic, this data has been distorted due to the dismissal of low-income workers. As these workers regain employment, wage growth in the next few months is likely to be depressed rather than increased.

Therefore, it is difficult to determine whether higher inflation is really coming. Global shipping interruptions have caused some supply bottlenecks, and broader supply chain issues and inventory challenges have exacerbated short-term inflation, but this does not necessarily mean that it will lead to longer-term inflation problems. Therefore, we believe that it is still difficult to say exactly how inflation will change, although we admit that the problem lies directly in the hands of central bank officials, and history shows that they will be more inclined to respond passively rather than proactively.

The central bank’s dilemma

We can sympathize with the plight of the central bank. Severely stepping on the “monetary policy brake” after such an unprecedented easing policy is likely to cause a misalignment in the bond market, which will result in greater market volatility. The Fed and other central banks are trapped by liquidity designed to ease market pressures-so it is difficult to undo them easily.

This is why the market is so concerned about the recent June Federal Oversight and Monetary Commission (FOMC) statement. The minutes of the FOMC meeting highlight the Fed’s overall very dovish attitude (even if the minutes are unexpectedly hawkish). At the same time, they are considering the threat of inflation by raising inflation expectations and hinting at expectations of interest rate hikes in 2023. The FOMC still believes that inflation is temporary in nature, so it is happy to “overheat” inflation for a period of time.

The problem is that the Fed’s “result-based” approach, which is the so-called “wait until inflation arrives before taking action”, is risky. Especially considering the rapid changes in the world economy and technology, some traditional indicators of tracking inflation may no longer be reliable.

Investor behavior also shows that many people do not believe in results-based methods. Due to a series of capital inflows since mid-2020, the assets of inflation hedge products managed on exchanges have increased by 74% in the past year.

Bitcoin and inflation: maturing into a real asset

These record capital inflows also show that perhaps concerns about inflation are becoming a consensus rather than an isolated view. It also implies that many investors believe that the Fed and other central banks may be behind the curve.

Regardless of the outcome of inflation, there is still considerable tail risk-the central bank may lose control of inflation. Therefore, as emphasized by capital flows above, inflation hedging has become more and more popular. During inflation, a small number of hard assets will perform well, and we think Bitcoin is one of them.

Bitcoin as an inflation hedge

Conceptually, it makes sense for Bitcoin to hedge against inflation. This is what economists call “real assets”-an asset whose supply is limited and predictable, and is often denominated in US dollars. Therefore, when the supply of US dollars increases or the supply of other legal currencies increases, Bitcoin may appreciate relative to these currencies, even if its purchasing power remains the same.

The data shows that Bitcoin has begun to play a role as an inflation hedge. By observing the relationship between Bitcoin price changes and inflation changes in the past two years, it can be found that since Bitcoin was created in 2009, their correlation is improving. The current R2 is 0.3 (Since 2019). By the way, the correlation between Bitcoin and inflation is currently better than the correlation between gold and inflation.

Bitcoin and inflation: maturing into a real asset

Citi compiled an index to track unexpected inflation by measuring the difference between inflation expectations and actual results.

When the index is above 0, inflation is higher than expected, and Bitcoin has an early and close relationship with unexpected inflation. Our analysis shows that Bitcoin does respond to unexpected inflation. When the inflation data is higher than expected, Bitcoin will rise.

Bitcoin and inflation: maturing into a real asset

We realize that the relationship between Bitcoin and inflation is likely to be uncertain at this stage because the data sample size is quite small. Nevertheless, it is interesting that this relationship has been steadily improving over time, increasing the credibility of the notion that “Bitcoin is a real asset”.

Bitcoin as an asset is maturing

More and more evidence shows that Bitcoin as an asset is maturing. After the FOMC statement on June 16 expressed an unexpectedly hawkish tone, the price movement is very similar to that of gold. This highlights that Bitcoin’s behavior is in line with investors’ expectations of physical assets, which will appreciate when the U.S. dollar depreciates, and vice versa.

Bitcoin and inflation: maturing into a real asset

We are still not sure what exactly will happen to inflation in the next 5 years, but we view the increase in Bitcoin and other physical assets as a prudent measure to protect our investment portfolio from the tail risk of out-of-control inflation. Bitcoin originally had the concept of an inflation-preserving certificate, which is now proven by increasing investor participation, as evidenced by the improvement in its relationship with prices.

Source: CoinShares

Author: James Butterfill

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/bitcoin-and-inflation-maturing-into-a-real-asset/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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