Don’t buy Bitcoin to speculate on hyperinflation
It is potentially a good hedge against that but that doesn’t make it a good investment now
One of the claims from Bitcoin maximalists is that Bitcoin will be a hedge against inflation. Right at the moment, with inflation as high as it has been in forty years and Bitcoin and other cryptocurrencies crashing in value, that claim is not holding up. As Paul Krugman wrote this week in his NYT newsletter while this could all be a coincidence, given the way monetary policy is handled these days, the idea that Bitcoin’s value would decline at the same time as inflation rises was entirely predictable. Put simply, inflation causes central banks to tighten monetary policy. This raises the interest rates on holding riskless assets such as fiat currency and bonds and so people shift their portfolio towards them and away from riskier assets like stocks and cryptocurrencies. I said something similar on CNBC the other day.
As Krugman points out:
The key point to understand is that while the dollar is indeed a fiat currency — that is, the authorities can issue more dollars at will, without the need to back those additional dollars with some kind of collateral — America isn’t Venezuela or the Weimar Republic, a nation that prints money to pay the government’s bills. Our money supply is a policy tool used by the Federal Reserve to help keep prices fairly stable — actually, rising around 2 percent a year — while avoiding recessions.
But I do wonder if Krugman is putting up a strawman argument against Bitcoin maximalists. When I listen to the most enthusiastic talk, sure there is a belief that even the US government will start printing money with abandon, but the real inflation hedge they are talking about is a hedge against hyperinflation.
Hyperinflation doesn’t happen very often and it has been confined to countries whose governments have had needs to spend a lot of money and so have been tempted to just print a little bit more that then spirals into printing a lot more and before you know it people are carrying around wads of cash in a wheelbarrow just to buy bread. In terms of foreign exchange, those currencies become worthless in buying other currencies. It is a bad situation.
Could hyperinflations still arise? Why not. There may often be some even where a government knows they are going to debase the currency by printing money but the short-term benefits are so large (to them) that they do it. There are two questions then: (1) if you hold Bitcoin when that happens will you be free of the consequences of hyperinflation and (2) is it worth buying Bitcoin now to speculate on hyperinflation?
Will Bitcoin preserve your savings?
Inflation is considered to be hyper when prices rise over 50% per month. That puts our current inflation, around 8% or so per year, in perspective. Hyperinflations are a different ball game.
Imagine that Alice puts her savings in Bitcoin and Bob keeps his saving in HYP (that is, fiat currency that can just be printed). In normal times, imagine that the BTC-HYP exchange rate is pretty stable. (Yes, I know, BTC is hardly that stable but we are going to have to abstract away from that complication here). Thus, when Alice and Bob go down to their local Starbucks, they can get a latte for the equivalent of 5 HYP. Bob hands over the HYP while Alice uses a fancy wallet to convert BTC to HYP that Starbucks accepts.
Suddenly there is hyperinflation in HYP. The HYP price of a latte rises to 7.5 HYP in just a month. The purchasing power of Bob’s savings has just plummeted while Alice still can get a latte for 5 BTC because the exchange rate between HYP and BTC has now changed. You can buy more HYP with Bitcoin.
As the hyperinflation continues, as it is want to do, Alice is fine but Bob is poorer. Well, maybe. Bob’s wages are likely rising too (albiet in HYP) which means that while his savings have a problem, his income doesn’t have the same issue. Nonetheless, the point here is that if you had known a hyperinflation was coming, it would have been better to have had your savings in BTC than HYP.
During the hyperinflation, the value of BTC (in HYP terms) is rising but if the hyperinflation is contained to one country (as it has pretty much every time in the past), then the value of BTC in other currencies will not be changing. Alice is actually not richer at all as a result of her ‘wise’ investment. That’s what a hedge is about. It preserves but does not enrich.
What did Alice ‘pay’ for this hedge? Arguably, nothing. If Bitcoin is working as intended and involves zero transaction costs and high convenience, then, at least compared with holding HYP, there is no cost. But Bob didn’t likely just hold HYP but, instead, held HYP-denominated assets. If this was just interest-bearing savings, Bob did earn interest which, had there been no hyperinflation, would have been valuable. Bob may have also invested in the local stock market. In the short-run, that is likely bad news for Bob. But, in the long-run, hyperinflations are usually ‘resolved’ and a new local currency takes shape — or alternatively another currency rolls in. The shares Bob holds will then return to their previous value and so, at least in the long-run, Bob’s wealth hasn’t necessarily suffered. Interestingly, that would have been the same for Alice.
Thus, holding BTC is a hedge but against relatively short-run pain. Yes, it is true that some hyperinflations can last many years (as was the case with Brazil in the 1970s and 1980s) but others last about 12 to 18 months (as was the case more recently with Zimbabwe).
The point here is that any asset that is not HYP (or HYP-adjacent) will be a good hedge against HYP hyperinflation. The advantage, therefore, that BTC has is solely in terms of its transactional efficiency during the period of hyperinflation. Does it allow you to operate in an economy where the local currency has been debased better than other things?
Arguably, it may. Compared to gold or USD, in many countries where there is a hyperinflation risk, BTC is somewhat easier to acquire and hold securely. The main issue with BTC is that it is currently not a great store of value compared with USD. But, in the future, you cannot deny there is potential there.
Will hyperinflation drive Bitcoin value?
The above argument suggests that if, somewhere, a hyperinflation were imminent, then there would be an increased demand for BTC prior to that hyperinflation occurring (afterwards it is too late). Thus, people using Bitcoin as a hedge will pay a price for that privilege. The only way to ‘profit’ is to have (i) special insight that a hyperinflation is about to occur and (ii) to have that insight before the population in question and (iii) then make sure the population understands it is coming prior to it actually occurring. That last step is important because it is of no use to you to know a hyperinflation is coming if there isn’t an opportunity for others to demand it as a hedge.
If you think steps (i)-(iii) are a stretch, you would be right. Lots of things have to fall in place. A hyperinflation is a calamity that is bad for many and really hard to profit from. That goes for Bitcoin speculators too.
Thus, the point here is that you can accept and believe that holding Bitcoin is a good hedge against hyperinflation. But to buy it today to speculate on some future hyperinflation is a strategy that requires many things to fall into place. Put simply, it is a terrible ‘investment thesis.’