BANKING ON BITCOIN AGAINST INFLATION

Every generation has its own asset class; might Bitcoin be the one for today?
Julio Rodriguez recalls warmly the Sunday dinners that his mother prepared when he was a child.

Rodriguez would return home from soccer practice on a Sunday afternoon to the familiar scent of his mother’s asado.
Rodriguez, the son of a college professor, recalls a comfortable childhood in what most would consider the middle class.
However, by the mid-1970s, Rodriguez, who had just started primary school, had begun to notice changes in his family.
Off cuts were utilized instead of the prime slices of asado that his mother would make on Sunday evenings.
His parents would now split a modest carafe instead of a bottle of wine.

And, while Rodgriguez was still too young to see it, the once-thriving Argentine economy was collapsing under the weight of excessive government expenditure, massive pay rises, and terrible inefficiencies all around him.
Argentina’s debt had grown to almost three-fifths of its output by the 1980s.
Buenos Aires’ attempts to control inflation by artificially pegging the peso to the dollar’s value not only failed, but also caused inflation to momentarily exceed 1,000 percent per year.
Various regimes have attempted to control inflation by imposing wage and price restrictions, reducing government expenditures, and limiting the money supply.

However, in 1982, Argentina started a costly and ultimately ill-conceived war with the United Kingdom over the Falkland Islands in an attempt to divert a disillusioned population.
As the actual value of Argentinian salaries plummeted, many Argentinians, particularly those on fixed incomes like Rodriguez’s father, resorted to gold as a safe haven.
The question today is whether investors should be seeking for inflation hedges as central bankers, particularly the US Federal Reserve, demonstrate their willingness to accept ever-increasing amounts of inflation.

Wither Wander the Dollar?

The dollar has a close inverse connection with inflation expectations in the United States over time, which derives from the fact that a weaker currency is intrinsically inflationary since it reduces the purchasing power of American consumers, investors, and debt holders.
Because a dollar borrowed by the US government today is worth significantly less when Washington ultimately (if ever) pays you back if inflation is strong, monetary and fiscal measures aimed toward a weaker greenback might greatly benefit in decreasing debt loads through this inflationary impact.
Fiscal stimulus also has the effect of weakening the medium-term outlook of a currency.

The White House is exhibiting a desire to keep writing cheques regardless of whether the US Federal Reserve can ever pay them, with the Biden administration aiming for a new US$2.2 trillion stimulus plan after recently clearing its US$1.9 trillion one.
The prospect of more U.S. deficit spending to combat the economic effects of the pandemic and fund other domestic priorities (because if you’re going to borrow money, you might as well ask for as much as you can) such as infrastructure will keep the dollar’s medium-term outlook muted, and could support gold and Bitcoin.

But Bullion or Bitcoin?

Given the lack of alternatives to gold, one would anticipate gold to rise in response to inflation fears, but it hasn’t.
Gold has underperformed despite popular optimism in a fresh wave of reflationary economic development and an unprecedented level of money printing, which is generally inflationary.
What is the reason behind this?
People will be willing to pay more for gold, which is considered as a store of value, if they are concerned about the long-term purchasing power of government-issued currencies.
However, a credible alternative to gold has emerged in the last year: Bitcoin.

As the popularity of Bitcoin has grown among investors, so has the chorus of voices praising it for acting as a check on fiat currency debasement.
The election of U.S. Vice President Joe Biden has only boosted Bitcoin’s popularity.
Fearing a dramatic left turn, more investors are banking on Bitcoin in the hopes of a free-spending Democrat-led government in the United States engendering systemic profligacy that might harm the dollar’s long-term worth.
However, aside from anecdotal evidence, there is circumstantial evidence that some of the money that would have gone into gold has instead gone into Bitcoin.

A persistent drain of cash from gold and gold-based ETFs (exchange traded funds) has paralleled bigger flows into Bitcoin since late May.
While not all of the money leaving gold has gone into Bitcoin, a substantial portion of it has.
Institutional investors, particularly family offices, are deciding to put money into Bitcoin as a hedge against a fiat currency collapse.
Because, while you hope you’ll never need a doomsday shelter, you’ll be pleased you constructed one if the zombie apocalypse occurs.
In addition, Bitcoin’s performance over the last year has shown a close correlation with bond rates, like gold did until recently.

Bitcoin has risen in tandem with bond rates, meaning that the bellwether cryptocurrency profits directly from the so-called “reflation trade,” or the notion that inflation is on the way.
The same should be true of gold, which should climb when inflation worries rise and fall when they pass.
However, it appears that the reverse is occurring.
While Bitcoin has been favorably connected with inflation worries, gold looks to be inversely correlated, with the current Bitcoin rally appearing like a move to safeguard against currency debasement through a measured transfer from gold.

The most recent stop in Bitcoin seems to coincide with a slowdown in the bond market.
Although the 10-year U.S. Treasury yield surged in late February, it has since steadied, largely going sideways, similar to Bitcoin’s recent fluctuation just below US$60,000.
So, instead of the flashy material, might Bitcoin be the “treasure” that miners should be focused on?

Definitely Maybe

At the very least, gold has inherent value as a raw element for jewelry.
The significance of Bitcoin resides in its ability to construct an alternative value system that might one day replace current governments.
However, as history has shown, incumbents do not respond well to their regimes being challenged.
The fact that central banks are racing to create their own digital currency should be telling – it’s typical to mock what’s feared before co-opting its finest features.
Central bank-issued digital currencies, on the other hand, miss the purpose of Bitcoin’s promise: certainty and value finality.

Bitcoin was cleverly constructed to lower the quantity of new Bitcoin over time — it is by design deflationary — but this will also reduce the motivation to spend Bitcoin, thereby increasing its value.
Financial asset values rise when monetary inflation rises, which is strongly tied to fiat currency debasement.
Both of these criteria favor Bitcoin.
As investors buy more Bitcoin in the hopes of seeing its price rise, monetary inflation, which drives up the price of fewer things, benefits Bitcoin.

To date, the Federal Reserve of the United States, the Bank of England, the European Central Bank, and the Bank of Japan have all raised their debt holdings to approximately US$24 trillion, accounting for nearly half of their economies’ total GDP.
The world’s four largest central banks’ stimulus has generated an excess of liquidity in global capital markets, driving up the value of everything from equities to cryptocurrencies.
Investors can expect more volatility with risk asset valuations and fiat currency debasement as long as central banks continue their strategy of adding liquidity (and because of the amount of debt they have created, they have little choice), factors that are likely to play well with Bitcoin’s narrative.

But arguably Bitcoin’s greatest strength is that it is not significantly associated with any other asset, inflation or not.
Bitcoin’s constantly reduced correlation strengthens its higher diversification potential over a range of business cycles, offering effective diversification to protect portfolio inflation risk while giving plenty of upside potential.