Out of all the reasons to be bullish on Bitcoin, claims that it is an inflation hedge is the most puzzling one I have encountered. The argument usually makes a case that bitcoin is similar to digital gold (which we largely agree with), and traditional wisdom has it that gold is an inflation hedge.
That gold has been tossed around as an inflation hedge flies in the face of contradicting data. Historically gold has had a weak and unreliable relationship to realized inflation as measured by the CPI. The relationship even in the 70s and early 80s where gold was viewed as a reliable inflation hedge was weak and has become weaker since. The full sample correlation of gold returns to the change in CPI is less than 10% and a rolling correlation shows that it is fairly unstable. It is a piece of traditional wisdom that is simply false, yet it is still being propagated as true despite decades of evidence to the contrary.
Source: FRED, Interactive Brokers
You know what is an actual inflation hedge? Inflation derivatives! Breakeven Inflation Swaps. Treasury Inflation-Protected Securities. Turns out, you can actually trade inflation directly! Shocking, I know.
Inflation derivatives are usually OTC instruments that require ISDA agreements in place and are not the easiest instrument to trade. So it is understandable if retail investors need to look to assets they can trade such as listed commodities, equities, or real estate to protect their wealth. Even then, the best inflation hedge available to retail investors is usually fixed-rate nominal debt. In other words, if you are a homeowner with a fixed rate mortgage at nominal rates below the prevailing inflation rate, you actually have a fairly great hedge in place that is benefiting from the higher inflation. This is especially true for US homeowners given the prevalence of 30-year mortgages with fixed rates that were as low as 4% in the beginning of this year.
To make things worse, assets without cash flow such as non-dividend paying stocks, gold, digital assets, etc. are more likely to be hurt by persistently high inflation given that it makes rate hikes more likely. Since the entirety of the value of assets without interim cash flows is in the terminal value, any steepening or rise across the yield curve would increase discount rates, i.e. lowering net present value. This is one of the primary reasons why they have performed so poorly in 2022 as the central banks have acted quite aggressively in tightening of their monetary policy to address inflation.
Bitcoin is a store of value similar to digital gold, but for the same reasons that gold isn’t an inflation hedge, neither is bitcoin. Trading them for inflation protection makes little sense, even more so when there are pure inflation instruments available to institutional entities and superior ones to the average retail investor.
This article was originally published on Firinne Capital during my time as Head of Research.