As economies across the globe start to re-open, oil, lumber, and copper have seen sharp price increases. While it remains to be seen how much of this is related to supply chain issues versus permanent price increases, people are becoming increasingly worried about inflation. In addition to commodities, asset prices are also rising, with real estate, stocks, and Bitcoin near all time highs. What are the implications of these rising prices, and does Bitcoin provide a solution?
Is Inflation Good or Bad?
Most mainstream economists claim that inflation is not only necessary but a net good for society. Here’s the argument in a nutshell: inflationary policies are intended to drive the cost of living up by 2% per year. By driving prices up, people and firms are incentivized to reduce their savings by spending more money today than they would have spent otherwise. Because people and firms are spending more money, economic activity increases, pushing GDP up and driving unemployment down. While this may make sense in theory, these potential benefits must be compared with the negative consequences of inflation.
The flip side of incentivizing people and companies to spend money is that they are discouraged from saving money. While economists looking to maximize short-term metrics view a lack of savings as a positive thing, the everyday person or small business may have a much more negative experience in the long-run.
Let’s explore further using a farmer as an example. The farmer offers up his blood, sweat, and tears to earn money for his family. By 1971, he saves up $30,000 - enough to purchase a house at the time. In 2021, the buying power of his labor is down 85%. Fifty years ago, these earnings could buy a nice house; today, these same earnings can’t even purchase a new car. Of course, the value of farming did not decrease by 85% over 50 years. Rather, the inflationary policies slowly depleted the fruits of his labor. Each time new money was created, the purchasing power of the farmer’s earnings were depleted and given to whichever person, company, or government was lucky enough to receive the newly created money. If the farmer wanted to avoid losing his purchasing power, his only alternative was to take on a new risk by investing his earnings in something other than dollars. In other words, inflationary policies provide the farmer with two options: (1) lose purchasing power over time, or (2) take on risks that he otherwise wouldn’t need to.
If money is a battery to store the fruits of our labor, the current inflationary policies represent a minimum 2% annual loss of power each year for those living in the US. Other statistics such as the Chapwood Index put the annual dilution at closer to 10% in the US, while less developed countries regularly see value leakage in excess of 20% per year. Because local currencies such as the US dollar have proven to be a poor way to store value over time, many have sought alternative ways to store the monetary output of their labor.
Bitcoin Fixes This
Historically, gold has been the premier way to store value. While trillions of dollars can easily be created with a few keystrokes, gold is extremely difficult to mine. That being said, even gold has an approximate 1.5% annual supply increase, and there is no guarantee that this leakage rate won’t spike in the future.
With the creation and subsequent growth of Bitcoin, people across the globe now have another option which offers less value depletion than gold and more certainty regarding the future supply. Bitcoin improves on gold’s assumed limited supply by providing a form of money where the supply is pre-programmed, auditable, and unchangeable. Every four years, the new incoming supply of Bitcoin is sliced in half. At the time of writing, the new annual increase in supply of Bitcoin is just under 2% (very similar to gold). In 2024, the annual inflation rate will drop below 1%, and then below 0.5% in 2028. This pattern of ever-decreasing supply will continue until the inflation rate reaches zero, approximately 120 years from now. In the graph below, we can see how the farmer’s earnings are diluted over time based on the varying inflation rates of dollars (USD), gold, and Bitcoin.
The implications of Bitcoin’s pre-programmed issuance rate cannot be understated. In the earlier example, the monetary output of the farmer’s labor is subject to central authorities that ultimately decide how much to devalue the farmer’s earnings. By switching to gold, the farmer could partially limit his value leakage, but he would still be diluted about 1.5% per year. With Bitcoin, the farmer can store the fruits of his labor in an upgraded monetary battery with an ever-decreasing amount of leakage. For the first time in human history, people across the world can simply store the value of their labor in a form of money that is not subject to unpredictable swings in inflation. Each day that Bitcoin continues to work as designed, it marches forward toward its ultimate destination as the ultimate tool to avoid the negative consequences of inflation.