In-depth analysis - Why Bitcoin cannot be "anti-inflation"?

The market is like a mountain. It is profound and mysterious, and there are always things you can't imagine happening. You must respect the market.

Inflation has become the most serious problem since the beginning of the year. For those in East Asia, you may not feel inflation directly. But for those in the United States and Europe, inflation is not a number, but a bill that keeps rising day by day.

This article will briefly discuss the inflation problem in recent decades, and explain why Bitcoin has performed poorly recently from the causes to the results. This article will mainly cite US inflation data in terms of economics, because the United States is still the world's largest market and the largest economy. The US economic performance has a far-reaching impact on the world.

Since Bitcoin was born from the global economic recession that evolved from the US subprime mortgage crisis, Bitcoin has always been considered a rebel against modern currency. From the "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks" left by Satoshi Nakamoto in the Bitcoin Genesis area, Bitcoin represented a group of rebels who distrusted the modern financial system in 2009 and accused the Federal Reserve of indulging Wall Street.

Although I am not one of the earliest holders of Bitcoin or other cryptocurrencies, some articles on Bitcoin in the past show that early Bitcoin was seen as a counterattack against the central bank. It was unfair to the Federal Reserve for allowing Wall Street to "cut leeks", and it was also dissatisfied with the central bank's unrestrained printing of money. Early supporters of Bitcoin advocated: "Dollar is printed from the air, and one day it will become waste paper, but there will always be only 21 million Bitcoins." Many people regard Bitcoin as a tool to fight inflation. However, under this epidemic, we have seen almost "deflation" during the epidemic. On the contrary, after the epidemic, even if interest rates are raised from the beginning of 2022, serious inflation has begun to occur.

(U.S. CPI over the past six years, from Bloomberg)

As can be seen from the above figure, the epidemic began to appear in the United States in late February, and a large-scale outbreak began in March, causing a sharp drop in stocks and currencies at the time, namely the famous "312" incident. At that time, the US CPI index continued to plummet. Observing past or long-term data, the US CPI has been hovering around 2% in the past decade.

In fact, the US Federal Reserve has always set a 2% annual CPI growth target, and a 4% unemployment rate as a balance to ensure that the economy does not overheat or decline. The reasons for this will be discussed later, but in general, the Federal Reserve has successfully controlled the CPI within expectations for the past decade, basically staying around 2%.

But what does this have to do with Bitcoin’s anti-inflationary properties? This will take a long time to explain. If you don’t have the patience, you can jump directly to the section “Is Bitcoin a Risky Asset?”

What is inflation?

First of all, we need to understand what inflation is. In short, inflation means that goods are more expensive. There are only two reasons for this, namely "insufficient supply" or "excessive demand". The demand side and the supply side are the only two factors that affect inflation. These two factors basically appear at the same time, but the proportions vary in different situations. For example, the main reason for the hyperinflation in the United States in the 1970s and 1980s was the increase in oil prices caused by the reduction in production in oil-producing countries, which led to an increase in the cost of all goods. At that time, the monetary school advocated by Milton Friedman in economics was still in its infancy, so the Federal Reserve had no idea how to deal with this situation. Instead, it went against the trend and cut interest rates. In the end, Paul Volcker, the chairman of the Federal Reserve, finally forced down the inflation of more than 10% at the time.

However, after 2008, the Federal Reserve released a large amount of money, and even learned from Japan's "quantitative easing" (hereinafter referred to as QE), printing a large amount of money, but it did not cause inflation in the United States. It can even be said that inflation has not been a concern for people in the past decade. Doesn't this contradict the early supporters of Bitcoin who accused the Federal Reserve of excessive printing of money, which will lead to inflation? Bitcoin advocates all accuse the excessive printing of money of making the US dollar worthless, but the facts show that prices have not risen much.

Why has there been almost no inflation in the past decade?

This needs to be understood from a macroeconomic perspective. The U.S. dollar is indeed more than before, but what has been suppressing inflation is that supply has increased more than demand. Since the Industrial Revolution, especially after the invention of the Internet, a large number of technologies have rapidly improved human productivity. In the past, dozens of workers were required to manufacture a car, but now a machine is used to automatically produce it in Tesla's factory. Tesla's factory in Shanghai can produce 50,000 cars a month, but it has fewer workers than any other car factory.

Especially since China became the world's factory, cheap labor and land, combined with Western machine tools and other technologies, have produced a large number of products. As long as there are enough raw materials, these products can be said to be endless. An endless supply of products is put into the market, so that everyone with money has something to buy, thus successfully neutralizing inflation. Even if everyone's purchasing power increases, there are always endless products in society that make you take out your wallet to consume. How can prices rise under such circumstances?

If someone doesn't understand, let me give you an example. An iPhone now costs about $1,000, which seems very expensive. But think back to 1973, when the price of a mobile phone started at $2,000, and $2,000 at the time would be about $13,000 today, which would allow you to buy 13 iPhones13. Do you think prices are really that expensive?

Let's change the concept. If you were asked to be a landlord in the Ming Dynasty 500 years ago, with a huge fortune, or stay in the modern world and continue to be a wage earner, would you be willing to go back? I believe that many people would not go back after serious consideration. After all, even if you were rich 500 years ago, the goods on the market could not meet your needs. After seeing modern technology, except that our houses are much smaller and we can't have three or five wives (or maybe), our quality of life is ten thousand times higher than 500 years ago. We don't need to burn firewood to cook, and we don't need a carriage to travel far. We can know what is happening thousands of miles away by simply opening a computer.

Under such economic globalization, inflation has almost become history. That is why Bitcoin supporters have been slapped in the face, because the Federal Reserve can indeed continue to print money without causing inflation - provided there is enough supply of goods.

But after the outbreak of the epidemic, problems arose. In the early stages of the epidemic, due to the lockdown in various places, even though the Federal Reserve printed money to ease the economy, people had no place to spend the money, which led to inflation approaching 0%. Everyone had more money but could not meet their needs, and merchants had a lot of inventory but could not sell it to customers, resulting in oversupply. As a result, prices did not rise and some products were even reduced in price.

The current inflation problem is more of a supply-side problem. This does not mean that demand is not higher than normal. After all, everyone is trapped in the city under the epidemic. In this post-epidemic era (in fact, almost no one in Europe and the United States is discussing the epidemic anymore), people in Europe and the United States have begun to show their consumption power and desire accumulated over the past year. If nothing happens on weekdays, this is basically a good economic phenomenon, but this is obviously not the case on weekdays.

Two major problems have caused the supply side to be unable to meet people's needs in a timely manner. First, the Russian-Ukrainian war has caused a sharp increase in food and energy. Food is a necessity, and energy is also a necessity for many European and American countries. Especially in terms of transportation, rising energy prices are equivalent to a significant increase in transportation costs. This will cause a significant increase in producer costs. Of course, business people are not fools, and they will naturally transfer the costs to consumers.

Another important reason is that the supply chain of countries mainly in China has been cut off due to the epidemic. China is the world's factory and a "sponge" that has been absorbing the money printed by countries around the world without causing inflation. China not only produces goods, but also produces a lot of raw materials, industrial products, etc. For example, the supply chain of automobiles is extremely long and wide. As long as one component is not done well, the entire production will stagnate. The main problem at present is that the epidemic measures of China and the world's major economies offset each other. On the one hand, people are allowed to continue to consume, while on the other hand, the lockdown has caused production to stagnate.

Of course, wages and rents also account for a large part of inflation. The increase in rents will be explained in the next paragraph, and wages are a very important part of CPI, especially in the United States, where the service industry accounts for about 70% of the entire economy, and the most important cost of the service industry is wages. However, wages did not rise steadily but instead rose sharply. One of the decisive factors is that gasoline prices in the United States have risen sharply. Most Americans drive to work by themselves. At the same time, energy has also caused electricity bills to rise. Under unstable weather conditions, expenses are much higher than in the past. So wages are forced to rise as well. Currently, the number of employed people in the United States is close to that before the epidemic, but the unemployment rate has dropped relatively. Below the natural unemployment rate of 4%, it means that some people in the United States have withdrawn from the labor market, and this group of people may never come back. Some may retire early, and some may have no intention of working after making a fortune in financial freedom during the market boom during the epidemic. This labor contraction situation requires wages to continue to rise in order to attract workers, and CPI will increase consumer prices due to the cost increase brought by wages, which will eventually cause the two to continue to rise in a death spiral.

So where does the money printed by the Federal Reserve go?

You may be wondering, what does this have to do with the rise or fall of Bitcoin? What is the relationship between inflation and Bitcoin?

In fact, inflation or not is indeed closely related to Bitcoin, or more precisely, the medium- and long-term impact of monetary policy on Bitcoin is far greater than other factors. Short-term factors are not difficult to be manipulated by whales, after all, the depth of the market is here.

To explain the relationship between the two, I have to first explain what the Fed's money printing actually does. As mentioned above, basically a large number of goods can be manufactured at a lower cost under globalization, thus meeting people's needs. But this does not explain that people's more money will have no effect on market prices. On the contrary, the prices of some things have been rising wildly under the Fed's money printing machine.

There are three main types of consumption: goods, services, and assets. Because technology and globalization have made the productivity of goods almost endless, the price of goods has not increased much. The main cost of services comes from labor, and the wages in this area have indeed increased steadily. The most important part is assets. Assets such as real estate and stocks are not like ordinary goods that can be continuously manufactured. For example, land rights are limited, so they are scarce. These assets become another sponge to absorb excess money in the market.

The figure below shows the median home sales price in the United States. It took the United States more than 40 years from 1960 to increase the price to 200,000, but from 2005 to 2021, it doubled again in just 16 years and increased by another 200,000. However, the CPI during the same period was much lower than that in 1970-1980.

The extra money printed by the Federal Reserve was absorbed by assets, causing a surge in the market value of real estate and global stocks. Next, it is the final chapter to discuss what impact this situation will have on Bitcoin.

Is Bitcoin a risky asset?

The rise in assets is absorbing the extra money printed by the Federal Reserve.

All kinds of assets are purchased by asset owners using the excess money printed by the Federal Reserve, pushing up prices to an incredible level.

But this is like after playing the Monopoly game for three hours, our generation suddenly wants to play, and all the land has been bought by the players who entered the game first, and no matter how hard we work, we are just paying rent to others. Maybe if we are lucky, we can use the "Chance Card" and "Welfare Card" to turn things around, but the greater chance is that we have always been slaves of the capitalists.

Then one day, Satoshi Nakamoto published the Bitcoin white paper, and another new asset was formed. But gradually more and more people began to know about it. People bought it based on various beliefs and ideas and became Bitcoin holders.

Bitcoin was initially viewed as a currency, but unfortunately, it is difficult to satisfy one of the three uses of currency - "medium of exchange". (If you are interested, you can read the previous article: Bitcoin, Ethereum and Economics )

The price of Bitcoin keeps going up and down, so merchants need to take certain risks to use it as currency. Although 1BTC = 1BTC is permanent, it is difficult to use BTC as a general currency when most of the goods in the market are paid by legal currency. Although some merchants will accept BTC payment, some will convert it back to legal currency in a blink of an eye, which only increases transaction costs and is useless.

However, more and more people are accepting Bitcoin as an asset. Some Wall Street tycoons, such as Ray Dalio, also recommend people to invest in some Bitcoin, and he himself also holds Bitcoin. This is because Bitcoin has become another sponge, turning the money issued by the Federal Reserve into Bitcoin. Now many hedge funds and investors have allocated part of their funds to Bitcoin. The main reason why Bitcoin rushed to $60,000 in May and November last year is that Bitcoin is regarded as a risky asset. After all, the price of Bitcoin has always been determined by supply and demand.

At that time, the Federal Reserve cut interest rates, the government distributed cash, and there was excess liquidity in the market. Investments with stable returns became less attractive because the borrowing costs were too low, so people rushed to risky assets in pursuit of high returns. Among them, Bitcoin, as the leader of cryptocurrencies, led other cryptocurrencies to set new highs. The price of Bitcoin is actually only determined by the liquidity of the market. When there is too much cash in the market, there always needs to be a place to absorb the money. And others followed FOMO and finally pushed Bitcoin to $60,000.

When Europe, the United States and other countries lifted the blockade, people's external consumption increased, and when goods were insufficient, inflation that we had not seen for many years reappeared. In order to withdraw excess cash in the market to curb people's consumption power, the Federal Reserve began to vigorously raise interest rates and shrink its balance sheet. All of these will be directed at risky assets, which are assets pushed up by excess liquidity. At the moment when liquidity is withdrawn, various crypto assets purchased with high leverage under borrowing are sold, ushering in a wave of cryptocurrency bear market from the beginning of the year to now.

On the other hand, investors who used leverage to invest in technology and high-risk assets were forced to sell cryptocurrencies first to maintain the margin of their stock positions, which was also an important factor in accelerating this wave of decline.

Although Bitcoin is a rare currency created to oppose the Fed’s money printing, it eventually turned into a risk asset driven by excess liquidity under the Fed’s money printing. This is really ironic. Therefore, Bitcoin, which is obviously anti-inflation, eventually saw its price plummet at the time when inflation was the most serious.

And if you ask investors in the market when Bitcoin will rise back to 60,000 or even break new highs, I believe that experienced people will tell you that Bitcoin will return to its peak when the Federal Reserve starts printing money again.

However, as I mentioned in my last article, the price of Bitcoin has an upper limit, because just like real estate, the price will stagnate when it reaches a certain point, and then continue to rise after the market salary can support it. The endless means of buying a house, such as mortgages, will always allow hard-working people to afford a house. Otherwise, it will only lead to everyone not buying collectively, and the price will fall freely without support, or trigger a violent revolution to redistribute wealth.

But when the price of Bitcoin rises to a point where no one can afford it, expectations will decline. Everyone thinks that it cannot rise any higher and the return is too little to be worth buying. They will turn to other assets, such as other cryptocurrencies or stocks. At this time, the price of Bitcoin will fall freely due to the lack of buyers. It is unlikely that Bitcoin will reach 100 million yuan per piece (unless the purchasing power of 100 million US dollars in the future is far less than it is now). Otherwise, those early holders will be like old players in Monopoly, who become big winners on the chessboard because of their early purchase of Bitcoin. This is the disadvantage of the formation of scarce assets. In this case, it is not as good as real estate. After all, even if real estate is expensive, it is a rigid demand. As long as there is this demand, people will be forced to buy it, but Bitcoin is not a rigid demand. When there is no demand, the price will fall.

However, the market is like a mountain. It is profound and mysterious, and there are always things you can't imagine happening. You must respect the market.