If it feels like your local currencies don’t go quite as far as they used to, you aren’t imagining it. The reason is inflation, which describes the gradual rise in prices and slow decline in purchasing power of your currencies over time.
The impact of inflation may seem small in the short term, but over the course of years and decades, inflation can drastically erode the purchasing power of your savings.
Inflation occurs when prices rise, decreasing the purchasing power of your currencies. In 1990, for example, a movie ticket cost on average $3. By 2022, the average price of a movie ticket had risen to $9. If you saved a $10 bill from 1990, it would buy two fewer movie tickets in 2022 than it would have nearly three decades earlier.
Don’t think of inflation in terms of higher prices for just one item or service, however. Inflation refers to the broad increase in prices across a sector or an industry, like the automotive or energy business, and ultimately a country’s entire economy. The chief measures of U.S. inflation are the Consumer Price Index (CPI), the Producer Price Index (PPI), and the Personal Consumption Expenditures Price Index (PCE), all of which use varying measures to track the change in prices consumers pay and producers receive in industries across the whole country’s economy.
Though it can be frustrating to think about your currencies losing value, most economists consider a small amount of inflation a sign of a healthy economy. A moderate inflation rate encourages you to spend or invest your money today, rather than stuff it under your mattress and watch its value diminish.
Inflation can become a destructive force in an economy, however, when it is allowed to get out of hand and rise dramatically. Unchecked inflation can topple a country’s economy, like in 2018 when Venezuela’s inflation rate hit over 1,000,000% a month, causing the economy to collapse and forcing countless citizens to flee the country.
Some countries have experienced such high inflation rates that their money became worthless. Imagine going to the store with boxes full of money and not being able to buy anything with it because prices have gotten so high! At such high inflation rates, the economy tends to break down. The Federal Reserve and other central banks of countries seek to control inflation by influencing interest rates. When inflation is too high, the Federal Reserve typically raises interest rates to slow the economy and bring inflation down. When inflation is too low, the Federal Reserve typically lowers interest rates to stimulate the economy and move inflation higher.
According to the U.S. DEPARTMENT OF LABOR released in January, worker pay increased about 4% in one year, the fastest rate in two decades. This led to a predictable alarm that the U.S. is facing a “wage-price spiral,” in which higher wages push up prices, which lead to demands for still-higher wages, and so forth. But the wage-price spiral is a false and antiquated economic idea that refuses to die and keeps generating bad policies.
Wages don’t spiral up during inflation, they spiral down as higher prices eat away paychecks. The dollar amounts on paychecks will rise, but not fast enough for their real value to outpace inflation. The recent stories of wage increases came not long after the government announced prices increased 7% in the past year.
The reason real wages are dropping is simple. Wages are what economists call “sticky,” meaning they don’t change as fast as other prices do. When inflation comes along, gasoline stations can switch their price signs in an hour and restaurants can adjust their menus in a day, but most employees get a salary bump only once a year. Some unions renegotiate their salaries only every five years.
Most of the people who are reading this article got a raise last year or switched jobs to get one You’re one of the many Americans who saw their paychecks get bigger. Unfortunately, unless your wages or salary grew much higher than the national average of 4.5 percent last year, inflation likely canceled it out. That means that while you might be making more money, you can buy less stuff with it.
For now, inflation is again at a 40-year high. That figure takes into account a whole basket of goods and services, so it will affect people differently based on what they purchase, but as a whole, price increases outpaced typical wage growth. Price hikes were especially high for things like fuel, food, and rent and grew even faster than that average. Inflation is only expected to get worse as gas prices rise significantly due to Russia’s war in Ukraine.
To put it another way, if Deeksha made $10 an hour in 2021 and worked 40 hours a week every week of the year, you would have earned $20,800. For the purposes of this thought experiment, let’s assume you paid no taxes or Social Security and purchased literally nothing else. That means your total wages would have been enough to purchase a new vehicle outright at the end of December 2020, when they cost $20,000 on average.
Now, let’s say you got a 5 percent raise to $10.5 an hour in 2022. If you worked the same amount and again, with no taxes, Social Security, or purchases at the end of the year, you would have earned $21,840 but no longer would be able to afford a new vehicle, which now costs $24,000. You made more money, but that money was worthless.
“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens” – John Maynard Keynes
Is Bitcoin a hedge against inflation?
Wages are paid in local fiat currencies (dollars, euro, yen, rupee) savings and checking accounts hold fiat currencies, and stocks and bonds are all valued in fiat currencies. Therefore, most income and assets are prone to inflation.
1. Bitcoin isn’t tied to one currency or economy
Bitcoin isn’t tied to a particular currency or economy. It also isn’t controlled by a small group of companies or stakeholders. Rather, it is an international asset class that reflects global demand.
In times of high U.S. inflation, investors must take on more risk to offset the decline in existing asset values. For example, a 3% dividend yield may normally supplement income in retirement. But if inflation is 8.5%, it simply isn’t good enough.
2. Bitcoin has a limited supply
The supply of total Bitcoins in circulation is capped at 21 million, The 19th millionth Bitcoin (BTC) was mined on April 1st, a landmark occasion for the number one cryptocurrency. Nineteen million Bitcoin are now in circulation, with just 2 million Bitcoin yet to be minted (or mined) until roughly the year 2140.
The term ‘hedge against inflation has two connotations. In practice, the asset should rise if there is an increase in inflation. And in theory, the asset should have the qualities of an inflation-resistant asset class, the chief being it should have limited supply. After all, traditional fiat currencies are considered susceptible because they have limitless supply, meaning their purchasing power goes down over time as more units chase the same amount of goods.
Crypto investors point out that unlike dollars or any other fiat currency, Bitcoin’s supply is capped at 21 million, and nearly 19 million of them have been mined so far. So, it is unlikely to be devalued or manipulated by any government or central bank due to additional money printing. The fact that there is only a finite supply of tokens should theoretically help Bitcoin retain its value over time.
3. Bitcoin is an easily transferable store of value
Bitcoin is durable, easily interchangeable, secure, and scarce. But unlike gold, Bitcoin is also portable, transferable, and arguably more decentralized. Gold supply is mostly controlled by sovereign nations like the U.S., China, Germany, and other European countries. Theoretically, anyone in the world can store and easily protect their Bitcoin much easier than gold.
Bitcoin provides a better means of exchange in countries prone to hyperinflation and political turmoil. Bitcoin could be one of the better options outside of equities because it sidesteps many of the political and economic risks associated with the U.S. stock market. In this vein, Bitcoin and other cryptocurrencies are one of the most practical and simple ways for people across the world to diversify away from purely traditionally generated revenue, income, and assets.
Bitcoin is a store of tomorrow’s value. Choose your hedge against inflation wisely before inflation erodes the value of your money.
