Inflation, Deflation and Bitcoin as a Store of Value

2020 has been a remarkable year in an economic context. The world observed a record decline in economic activity which was answered by record action from Western central banks.

The strong policy response by central banks has increased people’s fear of a revival of inflation just as the world witnessed it during the 1970s.

At the same time, economic commentators are warning of deflation as the world moves from one lockdown to the next and economic output is not recovering.

Whatever your expectations on the future of the US Dollar and fiat currencies in general are we will analyze the potential scenarios and the impact on the price of cryptocurrencies.

Inflation, Deflation and Bitcoin as a Store of Value

The Case for Inflation

Over the past months, central bankers across the globe were in a contest to decrease interest rates further and further.

Several currencies witnessed negative interest rates and even the US is approaching zero interest rates on an incredibly fast path.

On top of lowering interest rates, central banks have been practicing quantitative easing (QE). QE consists of buying bonds to provide liquidity for the market. The major Western central banks have included corporate bonds into their purchase programs besides the standard sovereign bond purchase programs.

As a result stock market performance has been remarkably stable during one of the most terrible recessions ever.

The price increase in all major asset classes such as stocks, precious metals, and real estate led many people to believe that we already are in the middle of inflation just the CPIs (consumer price indexes) are not showing it to us yet.

Furthermore, several fiat currencies are already in decline such as the Turkish Lira or the Brazilian Real. This means in several emerging markets inflation is already happening as of today. Bitcoin already accomplished its all-time-highs in these currencies long before it reclaimed its USD all-time-high.

The Case for Deflation

On the other hand, large parts of the economy are in crisis due to the Covid-19 pandemic. Despite increasing asset prices, salaries are decreasing. Many employees won’t receive their bonuses and variable remuneration.

On top, unemployment has soared in the Western world where almost every country was heavily affected by the pandemic. This results in lower consumption of the private sector.

Another effect of the lockdown is that spending patterns have changed since people had fewer opportunities to spend their money during the lockdowns. Furthermore saving rates are increasing because people are expecting difficult times ahead.

As long as salaries and consumption are going down it is more likely we will observe deflation rather than inflation. If prices start to decline then people might expect even further declines in the future and therefore save even more money today.

Several industries such as airlines or hospitality are affected by the pandemic. The companies which are suffering declines in sales are increasing their debt and will be less likely to invest in the coming years.

Furthermore, we will witness a wave of insolvencies in the years after the pandemic as government aids cease to support insolvent companies.

The argument of deflation theorists is that public and private debt are increasing. Too much debt eventually is deflationary and not inflationary.

The Impact of Inflation & Deflation on the Cryptocurrency Market

So far cryptocurrencies are not around for long enough to allow us to make predictions on their performance during inflationary or deflationary environments. However, we do have evidence of the price performance of gold to which Bitcoin has been often compared lately.

Gold as a store of value has performed well in both inflation and deflation environments. We know that gold performs incredibly well during inflationary times and there is a huge consensus among market observers that Bitcoin with its limited supply would also perform well in such a scenario.

Bitcoin itself has not been around during a deflation so far but we can expect a positive performance based on the experience of gold. We can assume that the purchasing power of Bitcoin will increase in a deflation scenario just as the value of Gold increased during the historic deflationary periods in the US.

While an inflationary scenario might be even better for Bitcoin a deflation does not represent a threat to the value proposition of Bitcoin.

The only scenario which is bad for Bitcoin is when fiat currencies are very stable which means we neither experience inflation nor deflation.

However, based on how much central banks are messing around with currency supply and interest rates, it is to be expected that results will be either increasing prices or eventually the burst of a bubble. Once we end up with too much debt credit expansion by banks declines and we will most likely see deflation.

Bitcoin is expected to perform well in both scenarios and therefore the cryptocurrency market represents an excellent hedge against central bank policies. Since essentially almost all cryptocurrencies are positively correlated it is very likely that the overall crypto market will follow the direction of Bitcoin.