The news cycle is awash with supply chain problems and inflation. What had once been a niche academic concern seems to have reared itself into significant policy effects and narratives. Terms like the “Phillips Curve” and intricate cost curves on shipping have come to the fore as the world economy deals with aggressive monetary policy, unpredictable health policy, and fiscal stimulus paired with lockdowns. Is inflation “transitory” as a result of COVID-19? Or is it here to stay? What role does bitcoin have to play when it comes to inflation?
1- Inflation is more global than the American context it’s often spoken in
The US-based media often only comments on inflation when it comes to an American political context. Seldom does the rest of the world get as much attention. One American inflation might be worth two or three hyperinflations elsewhere when it comes to the media cycle.
And it isn’t just countries that are regularly cited as being profligate spenders or as hyperinflation examples such as Venezuela. Argentina, Lebanon, and Turkey are major economic powers that have been beset by life-altering inflation. This has changed the lives of many people: for example, in Argentina, long-known for its cultural love for fine cuts of beef, has seen residents report they can no longer afford beef.
It’s important to recognize that we talk about inflation, even though it has global impacts, in the anglophone media cycle, the focus on inflation is often on the American context — where it hasn’t had nearly the effect as it has had around the world. Globally, the story of policy elites and central bankers getting the narrative wrong and causing economic suffering among the people is widespread. It is only now that the American narrative is starting to catch up for this generation’s version of that discussion.
The United States has seen inflation rise recently and is a leader in terms of inflation growth between the third quarter of 2019 and the third quarter of 2021 per Pew Research. However, the world has seen large average raises in 2008 and 2011 in inflation rate: in that time period, the United States (and most developed nations) have seen low inflation numbers, the lowest among half a century from 2009 to 2014.
In the meanwhile, Lebanon has approached famine, and there is lack of access to basics such as essential medicines due to the decimation of the Lebanese pound by inflation. Countries around the world are seeing highs in inflation, leading to political action and protests such as Spanish protests for truckers against prohibitive fuel price increases — inflation is a global problem and as such, requires more of a global perspective — and has layers of context that go beyond an America-only focus.
2- Inflation has been hard to predict academically
The greatest example of stagflation in the United States, a stagnating economy with high unemployment along with punishing inflation, surprised academics as well when it first emerged in the 1970s.
The Phillips Curve, the relationship between employment wages and inflation, was first observed and fleshed out in 1958.
In general terms, economists tend to see unemployment and inflation as a tradeoff: either low inflation and high unemployment or high inflation and low unemployment. Policy prescriptions and the “dual” mandate of the Federal Reserve and most central banks follows from this: ensure the economy is performing towards maximum employment while keeping inflation within a certain stable and low band.
This analysis by the Federal Reserve talks about the different implications of the Phillips Curve when looked at different time horizons, including the trend that in the long term, high inflation seems to in turn “cause” high unemployment.
Academics however disagree on whether the Phillips Curve is dormant with the recent curve down in inflation across the developed world, whether it is dead, or whether it is actually a functional relationship. This leads to a situation where depending on the time frame you look at and the country, you might get an entirely different response.
This generation’s economists, raised in a low-inflation environment and the “need” for fiscal and monetary stimulus are gradually taking over the seats of those who were surprised (and had to reconfigure economics in its entirety) after a sustained period of high inflation and low employment.
In practice, the Federal Reserve and many other central banks, through aggressive monetary stimulus, are acting as if the Phillips Curve is dead or at the very least strongly dormant — it remains to be seen if that’s the case.
3- It’s important to decompose more “temporary” and more permanent causes of inflation
How much of the inflation being caused is because of supply chain issues that will pass away with the adjustment period to what has been incredible economic turmoil? Shipping prices for example have nearly doubled, with ships stuck in ports and shortages of workers to unload a booming line of cargo.
Yet, can we expect this to go down for exactly the “transitory” reasons often cited: that a surge of demand (especially holiday demand) from economies put back to life are driving prices and instability across the supply chain, but will soon stabilize into a “normalized” economy?
Don’t count on it though: COVID-19 has shown an incredible ability to morph into new variants — even two years or so later, the default response from policy elites seems to be unprecedented monetary and fiscal stimulus to pair with broad shutdowns, whether culturally or legally mandated (as seen in Canada and Europe).
Yet this level of analysis, which may already take us into the economic medium-term (2025 and beyond) needs to be also complemented by long-term considerations. Certain countries have seen their energy mix change radically — China, for example, became a net importer of aluminum partially after energy mandates made it prohibitive to make aluminum in domestic borders — looking beyond temporary arbitrage, this is structural change to a key manufacturing component.
There is also the idea of higher wages pushing towards higher levels of inflation, which is what the Phillips Curve is constructed around. All things equal, higher wage prices are correlated with higher inflation curves in the medium term.
Most importantly, there is a global increase in money supply: in the United States, for example, M2 money supply (a measure of how much money is in circulation, with physical cash, cash equivalents, and liquid bank deposits accounted for, with the difference in M2 and M1 largely being small-denomination longer-term savings, and savings deposits) has accelerated dramatically due to the policy response to COVID-19.
Over the long-term, a fairly robust association between the growth of money supply and inflation holds. It is this effect that bitcoin is most well-positioned to address and speaks to the longer-term time scale of the Phillips Curve: a world where policy responses that let inflation run hot eventually lead to a currency over-supply that naturally chases after fewer and fewer goods and an economy that is unresponsive to monetary stimulus — leading to stagflation — high unemployment, high inflation, and political unrest.
4- What role does bitcoin play in inflation?
Bitcoin is held up as an anti-inflation hedge. Yet, at a first glance, the research doesn’t seem to back that up. Bitcoin has recently, as a result of institutional investment, become rather pro-cyclical or aligned with broader market movements: if the market goes down, bitcoin tends to go down as well meaning that when news of inflation strikes, it’s not necessarily the case that bitcoin will perform like a pure hedge.
After all, the markets will sink if there is news that there is inflation pending or happening in the United States, as it will probably weigh on the Federal Reserve’s dual mandate, and force a change in the policy interest rate or the posture of America’s central bank. If the policy rate goes up or if there is monetary tightening, then assets will go down in price — including bitcoin.
Bitcoin’s role in hedging against inflation is more subtle than its immediate financial impact and needs to be separated according to different time scales like we decomposed the Phillips Curve.
It is a philosophical, cultural and technological story rather than a financial one. Its principles of being an internationalized currency with no domestic polity and the idea of imposing strong technical constraints on controlling the monetary supply gives it clearer line of sight to the longer-term implications of Phillips Curve research: namely that monetary policy that leads to high inflation rates in the long-term ultimately end up creating the conditions for a terrible economy that will punish savers, low-income wage earners, and anybody who denominates their worth in fiat money.
By calling attention to this, and focusing the attention of many, including retail-type investors, economic analysts and journalists on inflation, and keeping central banks accountable for the transparency they owe their peoples, bitcoin rallies people around understanding what goes into money supply and inflation, a wonkish conversation that technocrats may lean towards hiding through obscurity (as Alan Greenspan, the former Fed chairman, mastered with “fed-speak”). It also sets the conditions to have a more permanent check on long-term inflationary and money supply growth factors — directly combating a principal source of what may be long-standing and established inflation.