WHAT DOES 'INFLATION' REALLY MEAN? (And is Bitcoin really an inflation hedge?)

I think it's essential to know what we actually mean when we say "inflation."


When most people use the term, they mean CPI inflation, or simply put: how much the prices of things are going up. So 9.1% CPI inflation (the "official" number this month in the US) means that on average prices have gone up 9.1% from the same time last year (and yes, that's a lot, it's much higher than normal, and the real number is probably much higher than 9.1%).


But another, perhaps more accurate, definition of inflation is this: an expansion of the supply of money.


New money (new dollars, euros, pesos, etc) are created through a convoluted system of debt and credit, by central banks and other financial institutions. The supply of money is greater, therefore we can say it has been inflated (like a balloon). An inevitable consequence of this inflation of the amount of money in the system is that the purchasing power of every unit of that money decreases. Hence, monetary inflation leads to price inflation. Things cost more and more, not necessarily because they are more desirable or scarce, but because the money is worth less and less.


So is Bitcoin a good inflation hedge? Well, let's think it through, having now defined inflation as an expansion of the money supply (sometimes referred to, somewhat inaccurately, as 'money printing'):


When COVID hit, the Federal Reserve's response was a massive expansion of the money supply. Several trillion dollars of new liquidity were injected into the US economy through stimulus checks, subsidies for businesses, etc. If you bought Bitcoin around the time that this monetary expansion (inflation) was kicking into high gear (Spring or Summer of 2020) you could have bought at somewhere between 5 and 10 thousand dollars per coin.


This meant that over the next year or so your purchasing power would have increased 5 to 10X, as Bitcoin's price ran up to over 60K per coin (twice). Even now, after the massive drawdown in all the markets, you'd still be up 2X or more on your Bitcoin holdings. In that sense, I think Bitcoin is one of the best inflation hedges. If you buy it when the money supply is being expanded (inflated), you can hedge yourself quite nicely against the inevitable CPI inflation (prices going up) that eventually follows as a consequence of there being more money in the system.


As an addendum, I think it's also important to understand that CPI inflation isn't only caused by monetary expansion (as much as we bitcoiners like to oversimplify things in this way). It seems pretty clear that price increases are caused by a whole slew of complex factors that include supply chain disruptions, energy scarcity, etc. Monetary inflation is definitely a cause, but it isn't the only one. And we're experiencing a bit of a perfect storm for CPI inflation at the moment, because we're seeing the consequences of massive monetary supply expansion (inflation, in the way I mean it) plus all the other factors in a unique confluence. Interesting times indeed.


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