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On Tuesday I wrote about inflationary pressure on the Dollar and how that will positively impact hard assets like Bitcoin. In order to get a clearer picture of this it’s important to define exactly what inflation/deflation is and when we’re likely to see it.
Inflation and deflation are simple concepts that everyone should understand but their widespread use to generate buzz has left them misunderstood. Unfortunately the FUD created by the media’s use of these words means most people simply think of them as “bad” or worse — just something for economists to kick around.
Inflation and deflation are not objectively good or bad, but they both play a critical role in a modern economy. Inflationary or deflationary economic climates drive important things like monetary policy, spending habits, and investing. So what exactly is deflation and inflation?
Inflation simply means that the prices of goods and services are rising.
Simplistically this means that the purchasing power of a currency is going down. Under inflation a candy bar may cost $1.00 today and $1.10 tomorrow.
What does inflation do to an economy? Inflation stimulates spending. If prices are going to be higher in the future it makes sense to purchase goods and services today. If that new 50" TV you want is going to cost more next year why not just get it this year? Additionally, inflation spurs investment. If $100 left in the bank (assuming 0% interest) this year will only purchase $90 worth of goods and services next year then leaving your money in the bank is a money losing proposition. Who wants to lose money? Nobody does, so people invest.
If you can invest your money in stocks and generate a return in excess of inflation you are not only making money, you are also avoiding losing money to inflation. This is part of the reason retirement investment accounts are so popular.
Is inflation normal? Yes! Whether it is good or bad is a topic of intense discussion but in the US it is normal. The Federal Reserve targets an average inflation rate of 2%. The idea behind this policy is to encourage people to buy goods and services and to invest based on the logic explained above.
Examples of inflationary assets are major currencies such as the United States Dollar and the Euro.
Deflation simply means that the prices of good and services are falling.
Simplistically this means that the purchasing power of a currency is going up. Under deflation a candy bar may cost $1.00 today and $0.90 tomorrow.
What does deflation do to an economy? Deflation stimulates saving. If prices are going to be lower in the future it makes sense to wait and purchase goods and services tomorrow. If that new roof for your house is going to be cheaper next year it is more prudent to wait and purchase the roof in the future (assuming your old roof isn’t leaking). Additionally, deflation discourages investment. If $100 left in the bank (again assuming 0% interest) this year will purchase $110 in goods and services next year then leaving your money in the bank is a money making proposition. You are essentially making money at zero risk. Who wants to take on excess risk? Nobody.
People are generally risk averse so instead of investing in a risky stock market they choose the safer savings account. It’s easy to see that deflation is generally harmful to an economy. People are incentivized to save and spend money in the future vs. spending money today.
Is deflation normal? Not really. Again whether it is good or bad is a topic of discussion but generally in US history deflation is uncommon. The Federal Reserve tries its hardest to avoid deflation for the reasons listed above. It’s hard to grow Gross Domestic Product (GDP) during a deflationary climate — a knock-on effect from the Fed’s mandate. By targeting a 2% inflation rate the Fed will use all the tools in its monetary policy toolbox to avoid a negative inflation rate (deflation).
Examples of deflationary assets are typically hallmarked by scarcity – things like Bitcoin and gold.
The Impact of COVID
COVID-19 has had an unprecedented economic effect. Unemployment claims are so bad they’re distorting historical graphs. Global travel is at a stand still. Companies are struggling with remote working capabilities. Revenue across many industries has dried up almost overnight. The jury is still out on whether these impacts are temporary (1–3 quarters) or will be long lasting (several years). So what does all of this mean for inflation and deflation?
The short answer is that it is unclear.
The case for inflation rests largely on the record amount of spending the US government has been doing to stem the economic damage of COVID. The trillions of dollars spent so far by the US government has been largely broken down into two categories: Fiscal Stimulus and Money Printing. Fiscal Stimulus largely means money that will flow into the real economy (think the everyday economy you interact with). The stimulus checks and Payroll Protection Program (PPP) fall under this category. Money Printing is money that flows into the banking system as new bank reserves. This money never leaves the banking system and thus its inflationary impacts are limited.
The biggest risk for inflation lies in Fiscal Stimulus. These onetime programs are necessary to the wellbeing of people across the country but should these programs be renewed or become staples of policy there will certainly be upward pressure on prices as more money enters the real economy.
The case for deflation is largely defined by reduced economic activity. COVID shutdowns coupled with layoffs and quarantines have crippled demand across many industries. As demand falls prices will follow in the near term until supply can adjust.
What’s the most likely scenario? It will probably be a combination of both deflation and inflation. In the near term we will certainly see deflation. The prices of goods and services will go down as vendors try to stimulate sales in a climate where people are thinking twice about spending their dollars. In the longer term we will likely see inflation as the impacts of global quantitative easing are uncovered. It’s possible future inflation will stay near the targeted 2% rate but there also exists the possibility of inflation beyond 2%, a situation that could have dire consequences for the global monetary system but would be beneficial for hard assets like Bitcoin.
That’s it for this week, have a great weekend and I’ll talk to everyone on Tuesday.
MicroStrategy plans to raise $400 million to buy more bitcoin – US software firm MicroStrategy plans to raise $400 million through convertible bonds to buy more bitcoin, the company announced Tuesday. Proceeds from the debt sale will be invested in bitcoin if they aren't required for general corporate needs, the statement said. (via BI)
S&P Dow Jones Indices to launch cryptocurrency indexes in 2021 – S&P Dow Jones Indices, a division of financial data provider S&P Global Inc, said on Thursday that it will launch cryptocurrency indices in 2021, making it the latest major finance company to enter the nascent asset class.
The Portfolio Rundown
Bitcoin is trading sideways in the $18k-19k region, downward moves have been quickly filled but upward progress is stagnant. CME futures volume is up suggesting the pressure is coming from shorts. In the near-term we’ll see one of the following:
Significant leg down, will likely shake out shorts and set up a run past $20k
Key support levels @ $16k then $13k
A sharp move upward with shorts racing to cover
Upside is likely mid $20k
BTC dominance is currently sitting at ~62% which means the door is open for altcoins, at the peak of the ‘17/’18 mania BTC dominance fell to 34% as altcoin prices ballooned. Capital may bypass Bitcoin and flow to other alts from traders looking for volatility. Very bullish on ETH, LINK, and ADA. Recently it feels like the window to accumulate “cheap” alts is closing.
Nothing in this email is intended to serve as financial advice. Do your own research.
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