It’s a popular misconception that inflation is inherently bad. Sure, it has a bad history1, but inflation is just an instrument that requires tending to and is a good indicator of growth when managed well. Our ability to implement policies designed to influence inflation is one of the superior elements of fiat currency and deserving of more nuanced consideration than the crypto community is willing to give it2.
Crypto cheerleaders have made inflation a primary target in rationalizing their own means of existence, but in doing so they misunderstand the relationship between the inflation rate and the money supply. Their argument goes like this: The Fed prints money3 and expands the monetary supply, so your dollar is then diluted proportionately. It’s a textbook definition, to be clear, and it could be applicable if all that new money circulated through consumer markets, but most of it won’t get that far.
Inflation is a measure of PCE4, which tracks the prices of household goods and services. If prices are going up, it’s inflation. If they’re dropping, it’s deflation. The healthiest way for prices to go up is if it’s in response to a spike in demand. Prices will eventually reach parity when production meets demand, and the cost of reaching this equilibrium is some inflation. This is good5.
What’s bad is when people are pulling money out of the economy and putting it into cryptocurrency6. Cryptocurrency is not currency. It does not transact like currency. If you had paid $6 for a sandwich using Bitcoin on March 12th 2020, then you spent the current equivalency of about $487. If you’d just spent cash then you’d just be out about $6. That’s why Bitcoin can’t operate as currency.
The Myth of a Stable Coin
And it never will operate as a stable currency because a decentralized system can’t effectively reign itself in. The problem is that markets are naturally selfish and behave as if they exist in a vacuum8. The logical fallacy at the heart of the fabled wisdom of markets is the assumption that as more people believe in crypto, crypto must then have value. So many people can’t just be wrong, right? But if enough people are suddenly shaken in their faith, crypto prices invariably go through manic swings. Nothing short of universal acceptance will insulate Bitcoin from that kind of volatility, which prevents it from realistically coexisting with more stable currencies in regulated markets9.
About 1,500 Bitcoins are lost daily, meaning fewer than 14 million coins will ever circulate. Given that the supply caps at 21 million, should that not increase the value of everyone’s remaining coins by half to account for the contraction? Considering many Bitcoin enthusiasts view it as a hedge against inflation, and they equate all new money being printed as inflationary, the inverse should ring true as it applies to their own instrument and it should be exposed to the peculiar effects of deflation, of which its decentralized system would be unable to control10.
For a lot of Bitcoin enthusiasts, though, it doesn’t matter if Bitcoin ever stabilizes and becomes adopted currency. They view it as a commodity to eat into gold’s market share as a viable hedge against the dollar. But why would it ever replace gold?11 Or silver, or platinum, or palladium for that matter? Precious metals have intrinsic value. Bitcoin doesn’t.
What Bitcoin has that gold doesn’t, however, is blockchain. As an encryption/authorization protocol, blockchain is an impressive idea. As a transaction processing system, it’s a logistical nightmare. The average transaction right now takes approximately ten minutes to clear, and you’re encouraged to sweeten the pot by paying a fee to move things along12. Say what you will about bank fees, at least debit transactions are practically instantaneous and don’t require bribes. That’s how a modern currency needs to operate.
Growth
Again, it always comes down to growth. Bitcoin looks sexy because it’s been on a huge bull run, but investors aren’t bullish on Bitcoin because it’s a practical instrument. Institutional investors are buying in because they see a market full of true believers that will sooner go broke than let their dream die, which provides them a floor in the event of a price correction. They realize that buying in validates it13, which brings even more people into the market, which raises the value and everyone makes money, so even more then jump on the bandwagon, etc. It’s a classic bubble14.
But we’re currently experiencing a dual bubble with the stock market as well, and the policies laid out at the Federal Reserve are largely to blame. Analysts point to the Fed’s commitment to low interest rates for the foreseeable future as reason to believe that we’re in no imminent danger of this bubble popping anytime soon, so the financial wizards are insisting that everyone get while the getting is good. And they’re probably right until interest rates need to go back up15, but what then?
In 2020, the Fed made two notable commitments: to keep interest rates near zero and to institute a purchasing program to stabilize the financial markets. Their balance sheet expanded by more than $3 trillion for the year and the money supply grew dramatically. Economists braced for spikes in inflation and investors hedged against a weakening dollar by buying up gold and Bitcoin. But that rising tide of inflation never came and the central bank can’t even make their target of 2%16.
The obvious problems here are that the Fed’s programs are disproportionately propping up investment markets and not the consumer markets that drive inflation, and companies are pessimistically hoarding cash instead of investing in growth17. Cheap lending and low bond yields emboldened investors into riskier bets, and with no sign of the Fed reversing their policy any time soon, there’s no real concern that the good times in the stock market are coming to an end. So, what’s the problem?
A Modest Proposal
The Fed’s playbook is a tired approach to trickle-down economics. In their model, cheap lending and additional support to the debt markets is supposed to make borrowing more attractive, but there’s that darn issue of wild near-term uncertainty that’s preventing potential borrowers from connecting with willing lenders18. Sure, it benefits some credit-worthy borrowers who can afford to buy up assets to store wealth, but that money isn’t exactly pouring into small- and mid-level businesses that are looking to remain afloat and are vital to controlling unemployment figures.
My suggestion19 is that we try a bubble-up approach and redirect those funds to be cash infusions into households instead. Not a debt-financed stimulus approach that digs the deficit deeper, but a money-financed fiscal policy in which the Fed, under authorization from Congress, simply prints and distributes money to households to jump-start inflation20. Using the same eligibility requirements as the CARES Act checks, distribute each person a $500 check each month for nine months, followed by a sundown period for the final three months of the year that halves the amount each time until it expires21. It’s not providing enough for households to live on22, but it’s enough to encourage spending.
That’s the carrot. The stick would be that the Fed would need to couple it with an incrementally rising interest rate to manage the surge in inflation. Raise the target on inflation to 2.5% and commit to a quarterly hike in the fed rate between 25 and 50 basis points for a full year23. This should siphon out some of the speculative bloat from investment markets to distribute back into consumer markets ahead of inflationary price adjustments. The equities market will have its reckoning with a correction, but underlying financials for value companies should help mitigate against a hard crash as stimulus-fueled boosts show up on earnings reports. The idea isn’t to pop the bubble, just to let out some of the hot air24.
Of course, this would require everyone25 to accept that inflation isn’t always evil, and trust that the Fed, Congress, and the Biden administration could effectively coordinate such a radical agenda while communicating the plan clearly to a country that is so bitterly divided that they just looted their own Capitol. So, none of that is feasible. Instead, we’re all just left waiting for the day where we don’t need to wear masks and can finally get outdoors to dump some of that $16 trillion in cash that U.S. households are currently sitting on26 into markets that are unprepared to handle the surge in demand. When that inflation bomb goes off, will The Fed have any tools left to handle it27?
Note: The author last took an economics course during his senior year in high school. It lasted a single semester and he did not receive credit for completion.
1. There are plenty of people around that remember double-digit inflation during the 70’s and 80’s that will tell you that inflation is bad.
2. Look no further than the insurrection at the Capitol on Wednesday for confirmation that we live in a post-nuance society. Like the good vs. evil worldview of political extremism, the crypto faithful indulge in a hyperbolic valuation on their belief system. Because they believe it has value, it must therefore be invaluable.
3. “Money printer go BRRR” was a popular meme. They’re all such clever boys.
4. Or CPI if you nasty
5. To be clear, there are other roads to inflation that are far worse. For example, a plummeting valuation of the underlying currency can lead people to panic, especially as it shows up in import markets.
6. The entire crypto market cap just exceeded $1T
7. .00126 BTC = $6 on 12-Mar-2020, and $47.90 on 7-Jan-2021
8. Which is why we have regulations.
9. Let’s be clear: regulations aren’t inherently evil either. The anarcho-libertarian ethos behind cryptocurrency is silly paranoid tripe that bases its core philosophy around incomplete definitions of basic economics, and they’d have you think that regulations are just another way that governments rob you of your freedoms, though a great many of our regulations exist to prevent crooks from running amok. If you want to know who the crooks are in a deregulated market, first look at who’s winning.
10. Their democratized system hasn’t worked great for them so far. After all, it led to Bitcoin Cash.
11. The beauty of gold is that we use it for a lot of things, both practical and ornamental. Bitcoin is just a number we can look at in secret digital wallets that are prone to scams and hacks.
12. Remember being stuck in line at the grocery store behind someone writing a check? How many checks could one write in ten minutes?
13. Each week some famous investor says or does something to validate Bitcoin, and a dozen or more articles suddenly pop up with clickbait headlines to throw gasoline on the fire.
14. Tulips. That’s not hyperbole either. In both cases, you’re seeing people dramatically overprice a market based on unreasonable assumptions about future value. Aesthetically speaking, tulips are much prettier than some gaudy amalgamation of gold and the U.S. dollar as an icon. Yuk.
15. Which they will, provided the Fed can ever figure out inflation.
16. The annual inflation rate for the U.S. is 1.2%. Doing your darndest to spur inflation and still sliding in the wrong direction probably means that you need a different approach.
17. More than $2T in cash held at U.S. nonfinancial companies, a record high
18. A firm may have access to cheap cash, but many are waiting to see demand pick up before they commit to investing. Meanwhile, the consumers whose demand would spur those investments are struggling with high unemployment and depressed wages because firms aren’t investing in employment
19. No one asked
20. Which would probably send Bitcoin’s market cap past $1T
21. $4950/person over the course of the year, distributed at a time of (hopefully) rising inflation to dilute its purchasing power throughout the program and help gradually phase it out. Considering approximately 153M people receiving stimulus checks, that’s $757.35B in new money that fuels new life into our most damaged markets and spurs investments in growth. For comparison, that’s about how much the Fed committed to their quantitative easing program last year.
22. Though this program could work alongside any additional support that Congress might see fit to contribute on top of that, using their traditional debt-financed approach.
23. Reevaluating the position after a full year with an ideal two-year goal of a 2-3% interest rate alongside 2% inflation
24. Lest we forget, higher inflation benefits borrowers in the long-term, which mitigates against the sting of paying a higher interest rate; while lenders are more eager to lend at the higher rates. It’s a rare win-win.
25. Citizens of a post-nuance society; See footnote 2
26. Unsurprisingly, a record
27. Perhaps you should approach a novel problem with a more novel solution, whatever it may be. This can’t be fixed by QE just because it worked a decade ago for an entirely different issue.