As inflationary monetary economics and liquidity traps come into focus with zero percent interest rates or even negative interest rates, many are looking to Bitcoin as an inflationary hedge or a protection against inflation. Billionaire investors are lining up to compare Bitcoin to gold. That particular comparison has some nuances but the broad macro-theme of Bitcoin being a protection against an inflationary environment has broken through, especially after the recent halving.
Why is that, and what are the historical and economic reasons we might see Bitcoin act as counter-force to inflation and what does it mean to say that it has a deflationary philosophy?
It’s helpful here to define inflation and look at a few historical examples. In general, inflation is a general increase of services and goods in a country over a sustained period of time. That’s the Wikipedia definition, but it’s helpful here to understand why this might be the cause: inflation generally comes about because of a general decrease in the purchasing power of a fiat currency. It is termed hyperinflation if the decrease in purchasing power reaches a critical inflection point where the decrease in fiat currency value and increase in prices for goods and services happens in a very rapid period of time.
What might cause that decrease in fiat value? An increase in money supply, foreign investors pouring out of a particular currency, or even investors attacking a currency (what George Soros did to the Bank of England, for example). Some of these are under the direct discretion of monetary authorities, while others reflect an international flow of capital that can seldom be constrained.
As a consequence, goods like food and other essentials become more unaffordable for people, as wages tend to be more fixed or static than rapidly increasing factor prices. It also becomes much more expensive to operate any business that requires raw inputs.
Deflation is the opposite force. Here, prices decrease as fiat currency increases in value relative to different goods and services. There might be different causes for this, ranging from a controlled money supply in the form of central bank restrictions or an increase in innovation.
A stark example of this is technology-driven deflation, where for example, the consumer prices for compute power has exponentially decreased as technological innovation has fit more processing power into smaller chips — you can see this in how your cellphone contains more computing power than the rocket that sent astronauts to the moon or in how sequencing a human genome used to cost a million dollars in USD, and now costs sometimes less than a few thousand.
Inflation is usually correlated with unemployment in what’s called a Phillips Curve. Usually, increases in inflation are correlated with decreases in unemployment, since money supply is more evenly distributed and spent among the employed, who…
Read more:Bitcoin vs. Inflation