What Does Persistent Inflation Mean For Bitcoin?

The temporary inflationary period has transitioned into a persistent stage, and according to certain estimates, it may take some time before the target of 2% inflation is achieved.

According to Christine Lagarde, the president of the European Central Bank, inflation has progressed to a subsequent stage. It is no longer solely influenced by supply chain disruptions or surging energy prices but is now being driven by wage increases.

The statement made by Jerome Powell, accompanied by a subtle smile, explicitly indicating that there would be no rate cuts during the current year, was initially perceived by some as an act. However, after the release of the June minutes earlier this week, the seriousness of Powell’s stance became more evident to observers.

All of the bank’s top executives that make up the Federal Reserve Banks board said that they expect more rate hikes this year. Four among them, BlackRock’s CEO Larry Fink said that they expect hikes of 25 basis points. Hence, there might be a 6% interest rate in the United States soon, higher than in the UK, but slightly lower than in Europe.

Germany has already dropped into a recession. However, Europe in general is still recording some growth. On the other hand, the Fed keeps projecting that a recession is coming in the United States later this year.

According to the latest assessments, the projected timeline now extends from the fourth quarter of this year into the first quarter of 2024. Despite the persistence of strong employment, there is a potential for further wage increases, thereby fueling inflation and subsequently influencing interest rates. As a result, there may come a point where concerns arise regarding whether the central banks have maintained control over the situation.

In the United Kingdom, a noteworthy trend has emerged where the substantial nationwide strikes demanding wage increases are being offset by a significant surge in mortgage rates, resulting in a decline in house prices. This confluence of events has created a complex dynamic within the housing market, warranting attention and consideration.

In simplified terms, the strikes, predominantly carried out by the public sector, have essentially resulted in funds being redirected from taxpayers to commercial banks, without significantly improving the overall position of the workers themselves.

With a base rate of 6%, this wealth redistribution has led to a significant surge in two-year bond rates for US Treasuries, reaching their highest levels since 2007. The impact of this redistribution is evident in the financial markets, reflecting a notable shift in interest rates and bond yields.

However, it is important to note that the economy was thriving in 2007, which differs from the current situation. Another aspect to consider is that banks tend to take on more risk when they are generating higher profits, as the increased profitability can potentially offset any potential losses.

Since commercial banks can create money through lending, while there may be tightening measures imposed by the central bank, commercial banks may adopt a more lenient approach to lending practices.

But, this is not an instant process mainly because expectations so far were that inflation would drop, rates would be slashed, and maybe also the money printer would get turned on once more.

Everything may begin to change. A Bloomberg columnist said:

“Central bankers are too fixated on 2% inflation targets.”

The columnist is not alone in that opinion with others pointing out that the target was created by an intern in the central bank of New Zealand who got it from nowhere, which is nearly similar to their fiat currency.

The question of why the inflation target is set at 2% instead of 4% has been raised by some. However, it is a challenging argument to make for a couple of reasons.

Firstly, suggesting a higher target implies a potential admission that central banks have lost control, as if they struggle to maintain the 2% target, it raises doubts about their ability to achieve a 4% target. Secondly, 2% may sound low compared to 4%, creating the perception that a higher target would be more desirable.

That might be just because we have been used to the 2% target, and if in a decade inflation is still 4%, maybe 4% might look low if it doubled to 8%.

In essence, there exists a considerable level of subjectivity and uncertainty regarding the situation. However, it is worth noting that this outcome was anticipated to some extent. While specific details may not have been outlined, Powell himself has expressed a willingness to tolerate a higher level of inflation than the 2% target “for some time,” even before the recent surge in inflation occurred.

It can be argued that central banks played a role in the inflationary situation, as they contributed to its creation. Prolonged periods of low inflation prompted a scenario where speculators benefitted more than producers, as the availability of low-cost leverage allowed capital to be leveraged with minimal costs involved

In that Context, the likes of Elon Musk when they borrow on their shares need to pay 6% interest, not zero, while a profitable business hopefully will never have to borrow at all.

Instead of a recession, such a strategy can result in an economic boom. One reason is possibly because the credit-worthy clients borrow less, so banks have to lend to the less credit-worthy customers.

Fed insists that credit remains tight for everyone without a good credit score, and that may be the case right now. However, in case the market begins taking the Fed seriously, if high inflation is here to stay, then what is good credit might change considerably.

In short blips, the market for now appears to believe that change will be for the worst. The MSCI global stock index plunged by 1.5% on July 6, its steepest drop in a year. The minutes were blamed since they suggested more hikes with some Chinese media outlets calling it a Black Thursday.

We do not believe that it is all that dramatic. It is only a temporary episode where the market goes berserk as soon as they see the Fed, and as Fed is out of view, they turn on the music once more.

At least that has been the case so far and many now wonder if all that is good or bad, well outside of China? In case the Fed plans to hike again, they are convinced that the economy is doing quite well. However, this time around they are hiking to crash to crash the economy, so it might eventually do badly, but it is yet to do badly so far and so…

Well, does the Fed have a clue about the economy? They have been projecting a recession for almost two years now, pushing back the timeline in every meeting, while Jerome Powell himself is on the record saying that he does not think there will be a recession at all.

Hence, one of them is wrong, and more crucially, they do want a recession right, at least to increase unemployment rates. But, the latter scenario is not happening. Has Fed lost control?

Is it also out of ammunition? Since at these levels does another 1% matter? Or to state it categorically, does another 20% on a 500% increase move the needle?

Fed could also hike to 15%, but they will not do that if inflation remains at 4% since that would be highly disproportionate, so we are left with these suggestions that 2% is an arbitrary target that is plucked from thin air similar to fiat money.

What does all this mean for Bitcoin? If inflation remains high then the buying power of the dollar will keep devaluing at twice the rate it should, so nobody will like holding the dollar.

Bank saving rates nonetheless will go up, taking out some funds from investments, but that may only impact bonds since those that store their funds in bank savings are the most risk-averse.

As a result, this situation implies that individuals such as grandma may have more disposable income to spend, while wages are keeping pace with the current level of inflation in the United States. However, it is important to note that surplus savings are being gradually depleted because of increased spending.

The latter observation suggests that a recession may be imminent, but it is worth noting that in the United States, consumer spending has not yet significantly tapped into credit card usage, let alone reached the point of maximum utilization.

The $1 trillion infrastructure stimulus package is anticipated to have a substantial impact on the economy. Additionally, ongoing innovations, such as the development of ChatGPT, represent further factors that can contribute to economic growth and transformation. These combined elements introduce potential avenues for progress and advancement within various sectors.

The aforementioned factors have the potential to stimulate economic growth and may contribute to some level of inflation. However, when considering a 4% inflation rate, some individuals question whether it is significant enough to warrant concern. The relatively lower rate of 4% prompts discussions about the appropriate level of attention and response required in such a scenario.

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Is It A Boom For Bitcoin?

Given its status as a fixed-limit asset and its current stage of adoption and growth, Bitcoin could potentially benefit from the aforementioned economic environment. Unlike gold, Bitcoin offers distinct advantages in terms of its digital nature and decentralized nature, making it an appealing option for investors seeking to navigate such conditions.

The “sort” being referred to potentially alludes to the pre-2008 economy. During that time, the prevailing interest rates were considered normal, coinciding with a booming economy where banks, due to their complacency, extended loans to sub-prime customers deemed “good creditworthy” at the time.

The tail-end of that period can be traced back to the late 1990s, possibly extending into the late 1980s. During that time, British Chancellor Gordon Brown decided to sell the nation’s gold reserves when prices were at their lowest. This move garnered significant attention and scrutiny within the financial landscape.

During that period, there was a prevailing belief that the economy had been effectively stabilized, leading some to assert that there would be no more boom and bust cycles.

As a result, gold was deemed less attractive as an investment option because it was perceived that the challenges and uncertainties that traditionally drove investors towards gold had been resolved. This perception raised questions about the role and attractiveness of gold in an environment where economic stability was seen as the norm.

The answer to the question is multifaceted, but at its core, gold’s limitations as an asset play a significant role. Gold lacks practical utility in everyday transactions, making it impractical for businesses and customers as a means of payment. Holding physical gold can be cumbersome and costly, with challenges in transportation and storage.

Moreover, gold is often seen as a relic of the past, with limited usefulness beyond certain scenarios such as during periods of fiat currency instability, where it offers the advantage of being outside the purview of banks and government control. Overall, while gold serves a purpose in certain contexts, its practical applications are relatively limited in comparison to other assets.

Bitcoin, in contrast, presents itself as an alternative to the traditional payment system governed by commercial banks, offering various additional functionalities. It can be utilized as collateral in decentralized finance (DeFi) platforms, enabling lending and borrowing opportunities. Bitcoin is easily held and boasts low-cost transfer capabilities.

Also, as a relatively new digital currency, it remains in the early stages of adoption, holding potential for further growth and widespread acceptance. These qualities position Bitcoin as a distinct asset with unique attributes in the evolving financial landscape.

In contrast to gold, cryptocurrencies, such as Bitcoin, have witnessed substantial innovation and may continue to do so. As a result, while gold’s relevance as a product has diminished, cryptocurrencies have emerged as a dynamic and evolving asset class.

If the new economy develops similarly to the pre-2007 period, before China attracted significant capital, it may not favor gold but rather present opportunities for Bitcoin. As economic growth entails an increase in payments, which underpin the functioning of the economy, Bitcoin’s potential to facilitate transactions could position it favorably in such a scenario.

Alternatively, an experienced banker might contend that in an inflationary environment, generating yield becomes crucial, which Bitcoin lacks.

This assertion holds true for gold, as its intrinsic value stems primarily from its limited industrial applications. Gold itself does not generate any yield. Conversely, Bitcoin offers a form of yield, albeit in a more intricate manner.

In the context of Ethereum (ETH), this scenario becomes even more explicit. Let’s consider a situation where you find yourself in South Africa and need to make a payment to someone in Kazakhstan. There are various scenarios to explore, such as the absence of a bank account or difficulties in exchanging South African currency with Kazakhstani currency, or vice versa.

Additionally, challenges may arise in accessing US dollars or utilizing US banks. In such circumstances, Bitcoin can serve as a practical solution for payment. Bitcoin’s accessibility, thanks to its widespread availability and the presence of numerous exchanges established by individuals across the globe, allows seamless transactions to take place, even in complex scenarios.

Assuming you do not possess Bitcoin initially, the process of acquiring it entails buying it, which essentially creates yield and generates new demand. Additionally, there is a network fee involved when conducting transactions. In the case of Ethereum, this network fee is burned, effectively reducing the total supply of Ethereum and acting as a form of dividend.

As a result, considering these factors and various other aspects of cryptocurrency innovation, a flourishing economy is likely to enhance Bitcoin’s utility, from our perspective. On the other hand, gold tends to be more appealing during unstable times, such as recent periods of instability, as it is often sought after as a safe-haven asset.

Both gold and Bitcoin have experienced price increases, influenced by various factors. The bank collapses in March, along with Russia and China’s adoption of gold as an alternative to the US dollar, have contributed to the rise in gold prices. Additionally, inflation concerns have played a role in driving the demand for both gold and Bitcoin.

However, if the US economy gains momentum, the relevance of Russia and China‘s impact may diminish, and the stability of banks could be restored. In such a scenario, keeping up with inflation may prove to be more manageable through alternative assets rather than relying solely on gold.

Just like Bitcoin, which sometimes correlates with stocks since there are many stock-traded crypto firms because it has a real fixed limit, and since it is useful for commerce and payments.

You may not yet buy coffee with the crypto, but sending $1,000 is still quite cheap in Bitcoin. In eth, you can use second layers where it is free.

Irrespective of whether there is inflation or not, or if the economy experiences growth or recession, cryptocurrencies possess unique characteristics that make them potentially advantageous. The digital nature of cryptocurrencies, coupled with their status as a unit of account, provides distinct advantages.

Additionally, as cryptocurrencies are still in the adoption stage, they hold the potential for further growth and acceptance. These factors suggest that cryptocurrencies may benefit from various economic circumstances and continue to evolve as a relevant asset class.