29. Has Bitcoin Failed as an Inflation Hedge?
- What has changed in Money Supply growth
- Why this current inflation may be both temporary and worrisome
- Is it too early to dismiss Bitcoin as a long term inflation hedge
- What drives the current market price of Bitcoin
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Howdy. It's Alex, welcome back to prosperous. So we've had the question for a while, uh, coming over and over if Bitcoin has failed as a hedge against inflation. And I think it's a fair question, particularly, if you look at what the performance of Bitcoin has been recently, certainly since inflation has come in. Uh, the performance of Bitcoin has been quite horrendous. So what I thought I'd do is just try to essentially answer two quick questions. First this, to discuss Bitcoin in the context of inflation, as well as other instruments that you can do to combat inflation, and then look at this concept of hybridization and money supply. So the first thing is we've talked about. In kind of great detail, how Bitcoin is a new technology that its only value is in its adoption as a network. And so very much like any other Fiat asset or any other asset in which the value of the asset is not connected to some operational utilities. So again, kind of a currency, just like any, you know, pretty much anything else or commodity. Think gold and we'll talk about gold in a second. The idea is that the more people believe that it has value, the more it has value. Now, of course, this can be used, you know, to create all kinds of instruments that, you know, nonsensical, uh, and we could have a whole discussion about social NFTs and other things like this. But the idea here is to try to understand the idea that Bitcoin has. Two equilibrium positions, one in which it did gets rejected for whatever reason, uh, by the community as being a store value or having any value. And I think a lot of people believe that that it has no value. It doesn't make any sense. It is, you know, not tied to anything. Compared, for example, to the us dollar, which is backed by military metaphors that people use and another equivalent position in which you have a set, however, big of believers or believers is, is, is probably the wrong word, but people who have adopted it network participants who see in. Logic of how it was constructed in its decentralized nature in its extremely, you know, simple nature. And I'd admit that I'm one of them to some extent, believe that there is another equality position in which people who want to have permissionless trustless, permanent record of ownership of a scarce asset. Can subsist in a community in which Bitcoin has value to each other. We've talked about before, you know, you may not like an Andor painting, but it has value to whomever believes it has value, right? And in that case, it could represent an asset which has value and can get transacted and has a sense and meaning and value and utility to 1% of the planet, 10% of the planet, or a hundred percent of the planet. And again, there'll be an equilibrium position over time. And of course zero, which is where some flaw comes in. So I'm perfectly willing to accept and, and, and, and believe that there could be, even after 13 years, 15 years now, a flaw in the design, there could be a reveal as to the identity of the original creator that could. Put the whole thing in distributees, there could be a number of different things that could happen, like a particular actor taking, uh, a significant portion of the available Bitcoin out there. And therefore polluting if you want the belief in the decentralized nature, not of the protocol itself, but of who holds it. Right. So imagine if, for example, Saudi Arabia owned 20% of all the Bitcoin out there, then perhaps it would be viewed as something which is not as decentralized and not as good of, of a univers. A store of wealth, perhaps simply because one actor has, you know, so much of. The thing, which I think is interesting on this graph. And again, this is easier on YouTube than, than on the podcast. And we'll put a link to the video in case anybody wants to watch it is to look at the growth in network addresses, which is on the screen right now. Right. And so to describe it basically, and, and again, this is glass node and it's relatively trustworthy as a source of information, but again, you have a log. Scale for the price, which I think is fair, but you don't have a log scale for the adoption, which doesn't make a whole lot of sense, but still having said all that, what you can see is that the network adoption has not fallen down to a level of irrelevance, right? The. If you look at the number of addresses and you look at activity, this is one metric without many others that you can look at. And if you look at the activity amount, transact, uh, the number of nodes, people accumulating it, and there's all kinds of different groups of people out there. What you see is you see somewhat of a vibrant network or at least one, which has not a. Collapsed. Right. If you were to look at MySpace, if you were to look at other networks out there that have been, uh, used, and that have falled in low usage, you would see materially lower numbers in terms of activity and active addresses and so on. And so, and what you see here, what you see in this part of graph on the right. And again, I'll describe it is that, you know, we're pretty much at the levels that we wear it in 2020 to 2021. And we're above the peak of where we wear. The peak of the last cycle, right. You know, reasonably consistently, even now after this quote, crypto winter. So, you know, you've seen network activity go down by, you know, somewhat of a substantial amount, but it's still only relatively 10 to 15% of the total activity. This is nowhere near to say a 50% or 80% something that you would see when somebody is abandoning a network. This is not a network that's being abandoned. Right. So what's interesting about that is that it doesn't give you the vibes of something, which. Has arguably fallen and complete disuse and even in the narrative out there and so on, so forth, understandably Peter shifts of the world and the rest of the people who have never believed in it will continue to never believe in it. But those who do, which again, back to the Andy world metaphor only needs to be a sufficiently large, albeit still very small minority of people still believe in it and still kind of use. To put that into a perspective. See that inflation had been within a range and over the last 30 years, the average inflation, including owners rent, which basically means also including real estate, which has had, you know, quite a run in the expense of real estate, which is a very large part of. Wallet has been around 5% for going on 30 years, uh, 35 years, right up and down target rate on the federal reserve was 2% X housing. Uh, but you know, we have lived with inflation for quite a long time, certainly as a result of COVID and transfer payments on so forth, that's exploded. And we are where we are. In this situation. And so looking at the situation for the last year, let's say since inflation's become more of a topic, then certainly you can look at Bitcoin and tell yourself that that has not helped you in any possible. and I think that's a fair point, but I think the question that we need to ask ourselves is going forward, what are the assets that you can comfortably put yourself into in terms of transferring generational wealth through time? Right? So if you had a certain amount of assets and you wanted to go out and, and get them to move around time from now into the future, where would you go? Right. And we're not gonna go through bonds, but I think, you know, certainly the last. You know, 15 years quantitative using after the grief financial crisis, the general path of interest rates have shown that bond have basically come to a point where there are very, very low rates in terms of your ability to get a return out of them. Well below inflation, while bonds themselves over the last 15, years've done very well again, because they went from a high interest rate environment or a relatively high interest rate environment to a lower one. Right. Wealth is accumulated into a bond portfolio. But again, the question is what to do going forward. We are in a bizarre inflation moment and there's a lot of questions as to whether it's gonna get fixed or not. But I think it's worth looking at whether it gets fixed or who doesn't get fixed, what the impact is likely to be of either staying at high inflation levels or coming back down to a normalized level. Either way, what matters for bonds for example, is a relative level of interest rates, which is still fairly low, which means that it Eli stays where it is, or it goes up, which again is not particularly good for the safest part of what has been, uh, the portfolio for. You know, 10 to 15 to 20 years, the idea that bonds was, uh, you know, where you kind of took the least amount of risk is, is definitely a narrative as everybody I think now has come to the conclusion as something which is a little bit tenuous. What's interesting to look at is if you look at M two, the money supply and also the impact of the federal reserve, and this is in the us putting money into the system. Sure. Look at this in Europe, it looked more or less the same, but certainly, you know, kind of a steady increase. Over time and then quite a substantial one. If you were to look at it on percentage basis, you know, you would kind of see the same thing that what we said before in inflation, which is that you kind of see a 5% growth steady up until 2008 and up until COVID. Right. A steady state, 5% increase in money, supply steady at the same time that you have a 5% in, you know, rise in inflation. So kind of balances out a little bit. If you really look long term in that way, again, since COVID, you've had quite a substantial amount of liquidity put into the system because of, you know, a number of different reasons that we've discussed before. If you look at it on a log basis, right. Which I think is a little bit more presentative then you can see how steady it was until COVID. So if you look at 1990, let's say in this case, 1998, but if you go back again further out, uh, you'll see pretty much the same, a little bit of acceleration still. Uh, uh, certainly an acceleration after 2008. Which is around here, right. Then a very single increase after COVID. So let's put COVID aside. Cause I think that that definitely has some impact. And the question is, you know, once you digest that you go back trend to, to form. But what's interesting is that if you pair it to the S and P index, and if you look at just the behavior of equities against the money supply, what you see is that, you know, money supply in this particular case. And again, you can play with. The origins are. So if you go back back to the 1990s and the beginning of the 1990s, then the S and P certainly has exceeded money supply. But more interestingly, if you looked and starting in the two thousands, you do see that money supply vastly exceeded the return in the S and P. So what does that tell you with. It kind of tells you that the S and P follows, and in this case actually kind of lags the amount of money that's been put into the system throughout. I'm not saying that it supports valuation as much as it's. And, and again, remember this whole concept of, of, of having had a, an explosive growth in the valuation of equities. And again, equities is an interest. Piece, because you're looking at companies and because you're looking at index the most successful companies, because again, you weed out the bad companies outta the S and P on a routine basis. You're looking at their ability to stay up with inflation, with money supply, with, uh, forgetting for the moment, you know, technology. We'll talk about that in, in a second. Basically, what you see is that, well, you know, money supply has grown quite substantially, right? And this points to you again, to this concept that a dollar is not really what a dollar was. So $10 of earnings, a $50 stock, a hundred dollars bill, whatever it is, you know, five years ago, 10 years ago, 20 years ago is just a meaningfully different purchasing power instruments over time. And that there is this slow bleed in the last 20 years. Significant amount of money supply coming out. It's very important to understand money supply and the concept of productivity gains and the concept of living standards. And, and we'll get to that. We come to Bitcoin in a second, but still you, you do see government, if you want reflect the priorities of the population and through the election process and so on, so forth. And we have had. Kind of a desire to cut taxes and a desire to have additional social services throughout the Western world that has created the only choice that governments has, have had to do in order to be able to accomplish both of these goals, which is running large deficits in financing them through quantitative reason. And, you know, Worst example of that is Japan. But again, through, you know, throughout the European and American systems, you see quite liberal monetary policy. Okay. All this is very interesting, but let's now go back and, and look at what your alternatives are. So let's look at, for example, the market cap of gold through time. And again, in this particular case, if you look at today's reserves or you assume that those reserves kind of existed before, which is not true because reserves have increased. Just for fun. You look at graph of gold, uh, over, over time. And, and this is market value of gold, right? And again, some estimate that about 85% of the market value of gold is a premium over its 15% industrial value, which means that if you only looked at gold for the purpose of using it in a industrial way, obviously the price of goal would be significantly lower. And in this case, The estimate is, you know, 85% of the value of gold is this kind of premium to the industrial value, which is an important point to make when you're comparing it to currencies and to, uh, crypto generally. So there, what you see is that starting in 2008, right, starting at the great financial crisis, you see a very significant. Increase in the price of gold, which means that it was being used more and more as a hedge asset against financial conditions, inflation problems, whatever you wanna call it, because it has capacity to be an asset that people understand that people feel have a fixed supply and be a hedge against financial assets of, of all different. Types, historically, it's been an assets that you go to in inflationary times and also in financial disruptive times because it has this hard money aspect. So again, you know, if you're looking at times in the nineties and before then, you know, you're in the. Two to 3 trillion in total market cap. And again, this is a hack number it's relevant over time. Uh, it could be off, but this is relatively indicative of what's changed. Now you see this massive run up between 2004, let's say in 2012, right? During those times before, during, and after the financial crisis where you see gold being seen as a safe Harbor for general transfer of wealth through time, let's get into. And you see this achieving all the way up to about $12 trillion, uh, in, uh, 2012 and then slumping through the economic development and, and, and success of the 2000 tens. And as you come back into COVID, as you get to 20, 20 and 20 19 20 20, you see it rise back to the 12 to 14 trillion size. Now what's fascinating about this is how bad things are. Right. Gold in the last two years has been. Right. Um, and what that tells you if anything, and this is, you know, trying, let's look at since the beginning of COVID we're talking about something in which the, you know, total market cap of gold has been somewhat. And to be fair, you know, Bitcoin has. Lost quite a lot of value in the last year, but again, gold has not been the knee jerk reaction asset that people go to in order to try to, uh, hedge inflation, you know, a number of different reasons. And, and, and certainly if you were to look at the market cap of crypto and so on, so forth, there's probably a lot of money that's gone into that. And other things since then, The point there is, well, we don't have an answer yet as to whether, uh, other instruments than gold and certainly, you know, real estate and some of the traditional hard assets that people go to in inflationary times and in, uh, you know, financial stress times are the ones that are going to succeed in. Short term, there's a lot of discussion as to whether we're in an energy and commodity squeeze at this point. What's interesting is whether if you change your, um, Your point of view or your horizon to instead of one or two or three years to 5, 10, 20, 30 years. The question becomes where do you want to be invested in order to transfer this, this wealth over time? Right. And, um, gold is old is one that at least in the short term has not been discounted by. Users by network participants by investors, by people as the one to tap for the next leg. Uh, um, you know, for, you know, for, for a number of reasons in the face of massive monetary expansion, the money supply and printing of money has been so substantial in these two years. And you've seen, you know, kind of nothing coming out of gold. Now think this concept of hyper colonization. And specifically kind of how does Bitcoin work with inflation? And what's the main argument there? It's a, a fairly interesting argument because in 1971, we UN pegged from gold, which basically meant that you can go out and print as much money as you wanted. Let let's not forget that while it is true that a dollar is not worth what a dollar was then. And so on. So forth, there's been enormous technology change, enormous social change, enormous. Um, productivity changes in the last, uh, 50 years that themselves are difficult to fit into this model. So the argument is that, um, a lot of the benefits out of this. Uh, uh, accommodating money supply over the last 40 50 years since say 1971. Let's say before COVID let's COVID I think is, is, is, is another topic, but the argument has been that a lot of the capacity to finance venture capital new. Technologies new markets, emerging markets, and other pillars on the planet has been facilitated by loose monetary policy because it allows, let's say more risk in the system at a time of accelerating productivity, uh, and therefore risk capital and capital in the system is actually quite useful. In some ways it's not an entirely bad argument, but let's contrast this with this concept of super hard money. Stering eco economics and. And specifically, you know, kind of 21 million Bitcoin hyper ization. This is where it becomes a little bit more, more diff, more difficult. And I think. The argument is, for example, if you were to go back to 1971 and you were to not just not go off the gold standard, but actually lock into a certain standard, imagine Bitcoin existed at a time or that the money supply was forced to be fixed. What would've been the impact on the last 50 years of growth of having money, which is absolutely. Absolutely fixed. It's uh, you know, to me, it's unclear. I think some, some people would argue it would've made for balanced budgets. It would've made for, uh, you know, perfect allocation of scarce resources. But again, scarce resources is not necessarily what, what a system needs in, in, in order to grow. Put another way Bitcoin or fixed supply monetary supply tells you, or allows you to look at a fixed pie that now you're competing with other actors, other companies, and are producers and you know, other. Uh, holders of wealth for, um, and compare that to say a steady two to 5% increase of the pie. Well, I should say the monetary pie, right? So you, you have this economic pie, which is out there, which is driven by productivity, technology, change, living standard increases, all these things that are happening out there. The, you know, as, as Elon Musk, I guess would say the restructuring of atoms in a more. Valuable way for humans, right. Uh, and then you've got money, which is supposed to kind of keep track of it. And you've got a choice there. Right? You keep that, um, uh, uh, uh, uh, finance that, that, um, Uh, total amount of mono, uh, you know, monetary pie, which is meant to reflect or value or somewhat be used to transact the true actual economic pie. Right. Uh, is it better if it's fixed or is it better if it is in managed? Chaos. Right. And for sure, what governments, what elections, what history, what the politics of the last 50 years has shown is that we prefer a chaotic inflationary system because there's been no, no way to control it right. To a fixed. Parody system where basically what we say is that there's a fixed amount of value, monetary value out there against which productivity, a growing economy, a growing, living standards, more development technology change is now getting valued. And so the only way that it works in a hyper colonization, Uh, sense in, let's say if you were to actually believe that now a hundred percent of the network is gonna be Bitcoin, not 1%, not 10%, but a hundred percent that every single actor around is going to use Bitcoin for transactions at scale, not now at scale. Then the problem that you have is that you're forced to live with forced deflation, right? The price of everything has to go down in order to account for the fact let's hope that life continues that. Living standards increase that productivity increases that technology brings new avenues, new beliefs, new, new, uh, new avenues of productivity and wealth. And now you still only have 21 million Bitcoin at scale to, uh, to represent it. And, and that's a difficult that, that is really just a massive change. It means that for example, salaries go down structurally always because your money is worth more, every of a certain pie, which, you know, if the economic pie is growing, but the financial pie, which is measuring it, which is, uh, allowing you to transact in it is fixed. Then you have structural deflation, uh, with every passing year, right? It's an attractive concept, which is very difficult and would require, you know, monumental change in people's views, right? People are used to, for example, uh, this 2% or 5% or X percent increase every year, they're used to having a bonus. They're used to having a number of different things, uh, and they live with this con you know, this chaos that we've lived through inflation. Do is to make sure that you earn a little bit more than what your costs are going up every year. Assuming that, you know, you have an average basket, uh, uh, and, and, and the problem of course, over the last two years is that that basket has completely changed and the expectations are not completely. And totally all over the place. Uh, both for everyone, you not for, obviously for consumers, but also for producers and people holding inventory in stock and all these kind of things. These decisions are now subject to massive uncertainty and uncertainty is not a good thing when it comes to economic output. So I think we, you know, we need to digest that. So the point here is. and I guess this is more opinion than anything else. I think, you know, the concept of hyper colonization, having Bitcoin as the only asset I think is one, which is very, very far away, um, perhaps, um, something to, you know, kind of maybe fight for, for those who, who believe in it. But I think for where we are right now, I don't think anything that's happened in the last year, ha two years has invalidated. The core premise that if you were to try to design a currency or an asset that some minority of the market wanted to use in order to measure each other's wealth transfer each other's wealth, um, Transact in a decentralized fashion and be entirely, uh, transparent about it. It would be difficult to find an asset, uh, um, You know, kind of better, uh, uh, uh, structured wi than Bitcoin. It's not perfect. It, you know, has a lot of uncertainty as to a number of different things, but in terms of something that people can understand, people can can use. And again, when it comes to say, you know, five, 10, you know, percent of your portfolio try to use as a hedge on how to understand how to maintain your piece of the overall economic pie through some instrument. Right over time. I don't think anything has, uh, has gotten really invalidated, uh, uh, except for the price. Right. And the price again is, you know, we've all due respect and, and, and deserves respect to people like George Soros and reflexivity and other logic. Yes. Price does have an impact on price for sure. You know, in this case, price is a lagging indicator. Uh, a price will settle at utility, right? And again, if people through the lightning network, if people through remittances, if people through, uh, uh, assignment of wealth and, and, and put portfolio positions, Uh, create a demand in this particular network. And again, the network addresses and the activity seems to under, uh, underscore this, this, this, um, it, it remains one of the few new avenues of, um, participating in, in network, um, for. At least for now some sense of, um, store of wealth, extremely volatile, complete, you know, the, the market and the liquidity of this market is, is still complete in, in its infancy. But the arguments, you know, still has not changed, right. Uh, um, certainly people who bought it high have seen significant amount of wealth destroyed and it may be years until. It naturally, uh, uh, you know, kind of gravitates back to a possible. Positive, uh, positions. But if you want, when it comes back to the, you know, to the real use of it and what it was designed for and what the network does, nothing's changed, uh, only the price. Um, and so, you know, without being a fanboy and without thinking about it, since we try to think of likely outcomes out there, right. Uh, I, you know, and, and we'll end on this. If you believe that continued productivity will exist, the technology will continue to change markets to create opportunities, to create, um, uh, uh, increase in living standards. Then, um, the. Securities the instruments, the assets that facilitate or otherwise get, have more network adoption. So for example, think of it. Apple investing in apple is just a proxy for what is a network adoption of the apple ecosystem, the ability of that it has to, you know, sell, uh, products and so on, so forth. So again, you know, these, these kind of adoption measures, um, Nothing has really changed in that way. Uh, uh, uh, long term. Now that doesn't mean. That this is, you know, that one should buy it or, or otherwise. But I think to answer the initial question, which is, has entirely failed as a method of managing inflation, I think it has. Um, I, I think the last year is not data that provides any answer to, to this. I think that's the only way to look at assets. Like this is an extremely long term. You have to look at them. Decades and like decades, you can't manage them as a hedge fund manager in order to get monthly returns. I mean, you can, but you, you, at that level, it's an enormously risky exercise. I think the only way to, you know, to try to fit Bitcoin into the financial logic. Um, is to, to, to, to understand what is the likelihood of this equilibrium position coming into the future at some point. And, and I think that the, the situation has not changed and I think I'll leave it at that. Thanks for listening.