What is inflation? How to recognize inflation?
While inflation is a difficult problem that governments are still facing and solving each equation, the introduction of Bitcoin (BTC) is hailed as a hedge against the ill effects of inflation. broadcast.
Today’s article will give you a view on inflation and the value of Bitcoin as an asset to help prevent inflation, or any instability of the national monetary system.
At the same time, I will also evaluate the potential of Bitcoin as an asset to hedge against inflation (Inflation Hedge).
What is inflation?
Inflation is a phenomenon that occurs when the general price level of goods and services increases. Accordingly, the purchasing power of a currency unit will be reduced.
A simple example: Currently the price of a normal cup of coffee is in the range of 1usd – 2usd, but about 10 years ago it only cost 0.5usd. After 10 years, inflation occurs and 2usd only buys 2/3 or half a cup of coffee.
How to recognize inflation?
Inflation is an event that happens every day in our lives, and we only really feel the obvious impact of inflation over a long period of time or when the economy takes a turn.
Some ways for you to recognize inflation are as follows:
Monitor macroeconomic indicators:
- CPI (consumer price index): This is an index commonly used to calculate inflation, if this index increases, it means inflation has grown and vice versa.
- Money supply: An increase in money supply can also lead to inflation, but when monitoring this index, you also need to pay attention to compare the money supply growth rate and GDP growth rate. If the money supply grows faster than GDP, it can be a cause of inflation.
- Interest Rates: Rising interest rates can also be a sign of inflation, since inflation is a component of interest rates.
Some sources to track the above metrics:
However, all of the above indicators are indicators with high latency, due to the problem of statistics as well as the information to be collected is too great.
Therefore, we can track inflation based on observations in daily life:
- Commodity prices: You can track based on daily consumption or track prices of basic commodities at international commodity exchanges like CME.
- Scarcity: Typically during the Covid-19 pandemic, when you go to the market, you can see that goods are consumed very quickly and sometimes not enough to supply.
Causes of inflation?
There are many causes of inflation, but I will focus on the main cause of money.
Specifically, this situation often occurs when a country “prints money” faster than the rate of production of goods and services (or economic growth).
According to economist Milton Friedman:
“Inflation is a monetary phenomenon that can be created anywhere, anytime when the amount of money in an economy grows rapidly relative to the number of goods and services produced.”
In short, having “more money” in the market than an increase in the quantity of goods or services will lead to an increase in prices.
If we apply it with the Crypto mindset, it can be understood simply as follows (in this case, I will give an example with an AMM):
- Initially, when launching the project, the project will use a lot of its tokens to reward the Liquidity Provider to increase the liquidity of AMM. This will cause token inflation.
- However, if this AMM attracts a lot of trading volume, causing the Demand for tokens to increase, the price will not only not decrease but also increase ⇒ The project develops.
- On the contrary, if the transaction volume is not large (the project does not earn much profit) Demand cannot be generated ⇒ Profit cannot offset inflation ⇒ Project declines.
The outbreak of Covid-19 caused governments to pump trillions of dollars more into the economy.
In addition to the broken production chain, consumer demand has also decreased due to social distancing policies that have caused inflation.
Let’s take a look at some inflation data recently when the world witnessed the 3rd wave of Covid-19 epidemic.
US inflation has reached the crisis point of 2008 – Source: US Bureau of Labor statistics
As you can see above, the US CPI (indicating inflation) in July 2021 has surpassed the peak of 2008 – the year of the global economic crisis.
In normal times, this figure is only about 2%, under the impact of the pandemic and loosening monetary policies, even the world’s strongest fiat currency is affected.
Another example of inflation can be mentioned in Argentina, currently this country’s inflation level has reached nearly 50% (even close to 60% in 2020).
Hyperinflation in Argentina
With such a large inflation figure, if you just keep your money in the bank and don’t invest anything, your account will be “divided”.
Impact of inflation
Some of the above figures have shown the impact of inflation on your own assets. However, the current question is:
Why can the government regulate the currency without making the currency deflate?
⇒ The answer is simple, it’s about benefits and costs.
In my essay on how the Crypto market is a miniature economy.
I mentioned that the nature of the economy must depend on the increased production and consumption of goods and services, not There is a lot of money in the economy, and money is just a tool that makes it easier for us to buy and sell goods.
Therefore, the goal of economic growth must come first, and research has shown that inflation (at a reasonable rate) will bring many benefits and cost less than deflation.
Deflation is a decrease in the general price level of goods or services, which increases the value of money in the market. However, deflation can cause some negative effects as follows:
- For the manufacturing industry, the decline in commodity prices makes the revenue of companies less, leading to a loss of production motivation.
- With the financial background, the appreciation of the local currency will make more people want to keep cash rather than spend it. It is this that causes the cash flows to stagnate.
- As prices fall, job shortages and consumers hoard money in anticipation of prices falling further, this hurts the economy, fuels savings habits, and so on.
Therefore most countries do not want their currencies to deflate.
Thus, it can be concluded that the fiat currencies of countries have been, are and will always continue to depreciate over time, especially in times of crisis like the present.
Current assets to avoid inflation
In the context that Fiat money has been and will continue to depreciate like this, the demand for asset classes that can help us hedge as well as protect our assets against the “erosion” of inflation is quite high. big.
Therefore, in this section, I will base on Gold and Real Estate – the typical asset classes for Inflation Hedge – Inflation Prevention to outline the characteristics of these asset classes.
Gold & Real Estate
Some common characteristics of these two types of assets:
- Limited Supply: Both have a limited supply. Land on this earth is limited and so is gold.
- Demand increases over time: The increasing population makes the demand for land to live on increase, and the rich always want to own a lot of land in many locations. As for gold, in addition to the need for investment, there is also a need for use in production (jewelry, electronic components, …).
In addition, for real estate, besides buying and holding to wait for price increase, it is also possible to generate additional income from sublease.
It is therefore a very popular asset class due to:
- Prices increase over time.
- There are many applications (serving the essential needs of accommodation).
- In addition, it also generates income from rentals.
According to MSCI, the market size of properties managed by professional organizations in 2020 is $10,500B (9.4% growth compared to 2019 and compound interest up to 5%/year for 10 years or more) come here).
And these are just figures from the amount of assets held by professional institutions. The actual growth of this asset class depends on the region, with even more impressive growth (maybe up to 50% – 100% in the past year).
For gold, in addition to having an application in production and an investment asset, the meaning of gold also lies in payment.
As you know, with the chemical and physical properties of gold, it has been used as a means of exchange and payment since ancient times.
Along with a very long history of development, the exchange and trade using gold has become popular in all parts of the world.
In addition, the fact that the Fiat currency is always depreciating and the instability of capitalism.
I have analyzed above has made gold so far still considered a payment instrument outside the system, and also considered as a payment instrument outside the system. used in cases of severe economic crisis.
Gold also has an advantage over real estate that is: Real estate is very dependent on political stability as well as the strength of countries, while gold with its properties is less dependent.
So what about Bitcoin?
If we consider the properties of Bitcoin, we can see it as more like gold than real estate in terms of being an asset to hedge against inflation. Some common points can be found as follows:
- Limited supply.
- All outside the system of governments.
- In the current trend of more and more institutions accepting Bitcoin for payment, Bitcoin seems to have become “Digital Gold”.
However, currently for gold, too many governments and institutional investors are holding gold and policies that make it more difficult to trade gold.
Therefore, it seems that the price of gold is tending to be gradually dependent on the monetary policies of the government.
Considering gold’s performance since the Bretton Woods system, which anchored gold’s price to the dollar at $35/ounce, collapsed.
Gold price from 1971 to 2021
Over the past 50 years, the price of gold has increased by nearly 51 times, equivalent to an annual compound interest of about 8%.
When compared to the inflation rate of the USD since 1971, it seems that gold has done a very good job in being an inflation hedge.
The purchasing power of $1 from 1971 to 2021. Source: in2013dollars
The purchasing power of $1 from 1971 until now is only equivalent to $0.14 (corresponding to an average inflation rate of 4%/year).
Still smaller than the compound interest rate of 8%/year of gold.
Bitcoin is becoming more attractive in the eyes of investors
However, with the advent of Bitcoin in the context of the current economic situation, it seems that Bitcoin is becoming more attractive in the eyes of investors as a tool to hedge against inflation. :
- In the current context of governments “pumping money”, the US inflation level has surpassed 2008 – the year of the global economic crisis.
- At the same time, the ROI of gold since the beginning of the year has been about -4%, since its peak in 2011, gold has not surpassed this price.
- With the rise of Bitcoin, it seems that investors are gradually becoming more interested in this asset than gold amid volatile economies (the market cap is 12.3 times smaller than gold and it seems that the the government is still unable to control this asset class).
- Bitcoin also laid the first foundations for Blockchain technology, or DeFi developed to create a huge ecosystem like today.
Bitcoin has a number of advantages over gold, which are:
- Cannot be faked (due to Blockchain technology).
- Storing Bitcoins is less expensive than gold.
- Easily move across borders at a very low cost.
- The level of “outside the state system” is much higher than gold.
In summary, in the asset classes that help us avoid inflation, Bitcoin has many similarities with gold and is currently considered “Digital Gold” or digital gold.
While it cannot be denied that in addition to investment value, gold is superior to Bitcoin in that it is valuable in production.
But with an impressive ROI since its launch, and has created a huge Blockchain & DeFi ecosystem, Bitcoin is now gradually being chosen by many investors as a alternatives to gold in the portfolio of assets to avoid inflation.
Is the price of Bitcoin too volatile?
Many people think that the price of Bitcoin is too volatile to be an inflation hedge. However, if we look back at the price history of gold, we can see that gold has also witnessed waves of speculation as well as going into winter for a long time.
The price of gold has also witnessed a sharp decline in the past
The price of gold in 1980 saw a very strong wave of growth and speculation under the influence of inflation.
Prices then rallied, then peaked at around $850, corrected sharply as much as 65%, and entered a 28-year winter.
In 2011, we also saw a similar situation under the effects of inflation, prices then also saw a correction – 45% and went into winter until the Covid epidemic occurred.
In addition, given the history of gold’s development going back to thousands of years, it is not possible to have data on how prices have moved in the past:
- Although gold has historically been considered a common global currency, under the influence of many factors (such as manufacturing mode, measuring instruments, or degree of purity, …) gold can be values vary widely by region.
- Compared with Bitcoin, with a development history of only about 10 years, we can also see the price volatility is completely understandable.
How does the stock price change?
Another example to show you how volatile an asset class is when it is newly born is the stock of Amazon company – a giant in the global e-commerce segment.
The price of Amazon stock also fluctuated greatly in the early days
In the history of the 2000s, under a wave of speculation on technology companies, Amazon’s stock price once reached $107 and plummeted in the following years, to a bottom of only about $6 (down to about $6). ninety four%). And now, Amazon’s stock price is up to $3,200.
⇒ Therefore, it can be seen that any asset class in the early stages when the market capitalization is low, dominated by very few people and the understanding of that asset class is still low, The problem of large price fluctuations is completely understandable.
In addition, Bitcoin or gold are the same in terms of trust value:
- The belief that this is an asset with limited aggregate supply can help hedge against inflation.
- The belief that it is a common global currency when governments are in crisis causes the Fiat currency to become severely devalued (as we can see recently with the devaluation of the Afghanistan currency).
Inflation Hedge – A huge market
Bitcoin is gradually becoming an anti-inflation asset in the era of “industrial revolution 4.0”, so I will join you to find out how big the market that Bitcoin is aiming for.
Due to data problems, I will mainly take the US data and the USD for analysis (because this is the largest economy in the world at the moment, and the current and past USD is also the currency of the world. common for global trade).
According to the data I have collected, the compound annual growth rate of the US M2 money supply is 7% (from 1971 to present) and the inflation rate has an annual growth rate of 3.9%.
What is M2 money supply?
For those of you who do not understand what M2 money supply is, this is a money supply quantity including M1 money supply and a monetary standard, specifically M1 and time deposits, in which:
- The M1 money supply includes: M0 (cash) and demand deposit accounts that can be withdrawn on demand.
- Monetary benchmarks are savings deposits, money market securities, mutual funds, and other time deposits.
Every year, under the influence of the “money printing” coming from the US government, in addition to causing inflation of consumer goods, it also causes financial assets to increase in price (M2 increases more than inflation).
and cash flows at the same time increase. also look to gold as a haven asset, causing this asset to have a compound growth rate of 8.1%/year.
America has overprinted a large amount of money?
With the GDP of the US from 2010 up to now (about $15,000B – $21,000B) (data from Worldbank).
The US has overprinted an amount of money (calculated by inflation) of about $600-840 billion annually.
Not to mention that excess money also goes into many asset classes causing them to increase in value.
So the actual amount of excess money in the US market is much larger than the 4% inflation figure.
On a global scale, the amount of money that governments “print” in excess each year is much larger than that (because the US is one of the countries with low inflation globally), so the amount of money governments Annual excess printing can amount to trillions of dollars.
Along with the fact that gold and real estate have gradually become saturated with many barriers for strong growth such as large capitalization, difficult ownership, indivisible, etc., Bitcoin seems to be a great asset. Inflation hedge is attractive to many investors.
In short, inflation will be an indispensable component if the economy has growth.
This has been, is and will always happen, not only that, but it also has a particularly pronounced impact during economic crises.
Gold, real estate or many other assets have long been favored by investors for a long time as an effective tool to hedge against inflation.
However, now, with the impact of the epidemic as well as the US inflation that has peaked in 2008.
Real estate has also appeared in a bubble and lack of liquidity, and gold does not give an impressive ROI. investors will tend to shift cash flow.
In that context, Bitcoin is currently emerging and gradually being accepted by many investors as an effective inflation hedge.
With a very large Inflation Hedge market like the one I analyzed above along with the relatively small Market cap of Bitcoin, what do you think the future price of “Digital Gold” will be? Please comment below to discuss and discuss!
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