Why Bitcoin Is Your Best Bet Against Inflation

Angel investor Tatiana Koffman discusses decades of Federal Reserve monetary policy, and why billionaire Paul Tudor Jones once predicted that bitcoin would become a workable inflation hedge.

AccessTimeIconMar 28, 2023 at 5:38 p.m. UTC
Updated Sep 28, 2023 at 2:27 p.m. UTC
AccessTimeIconMar 28, 2023 at 5:38 p.m. UTCUpdated Sep 28, 2023 at 2:27 p.m. UTC
AccessTimeIconMar 28, 2023 at 5:38 p.m. UTCUpdated Sep 28, 2023 at 2:27 p.m. UTC

Last week, the U.S. Federal Reserve raised interest rates by 0.25% amid banking turmoil, marking the ninth increase in a year and placing rates between 4.75% and 5%. The Fed aimed to balance fighting inflation while addressing banking sector upheaval, which already had a “tightening” effect on the economy.

The decision was heavily scrutinized by investors and economists for potentially prolonging economic turmoil. Chair Jerome Powell said strong economic data justified the hike, but acknowledged tighter credit conditions could further negatively impact households, businesses and the economy.

Tatiana Koffman is an angel investor, author and creator of the weekly newsletter MythOfMoney.com, where a version of this piece published first.

Fed officials still anticipate slower growth and higher inflation, with interest rates peaking at 5.1% in 2023 before dropping to 4.3% in 2024. Further, Powell reassured the public of the banking system's resilience, with the Fed ready to deploy all necessary tools to ensure its stability, but critics weren’t convinced.

And so, the most important question remains – will these measures be effective in actually reversing inflation back to the target rate of 2%?

We do have a relatively recent historical example of the Federal Reserve successfully reversing inflation in the 1980s, but it was a bumpy road. The renowned central banker Paul Volcker is widely hailed as one of the “greatest of all time” heads of the Federal Reserve for his role in combating inflation in the early 1980s.

However, one often-overlooked policy mistake made by the Volcker Fed in 1980 resulted in a more protracted period of high inflation and necessitated even tighter monetary policy. This ultimately led to the most severe U.S. recession since World War II up to that point.

By the time Volcker assumed his position as chair of the Fed in July 1979, the central bank's credibility on inflation had been severely undermined by the flawed policies of his predecessors, Arthur Burns and G. William Miller. Inflation had soared to over 12% by October 1979. In a surprise press conference on Oct. 6, 1979, Volcker announced that the Fed would allow the benchmark federal funds rate to "fluctuate over a wider range," resulting in an increase to over 17% by April 1980.

Facing mounting pressure to roll back rate hikes, including protests by farmers and car dealers along with bipartisan political intervention, the Federal Reserve yielded. As unemployment exceeded 7% in May, the Fed chose to substantially lower the federal funds rate, even though inflation had reached a staggering 14.7% in April. This move tarnished Volcker's reputation as a champion against inflation, and throughout the remainder of 1980, inflation persisted at over 12%.

As the recession concluded in July 1980, the Federal Reserve resumed its battle against inflation and began raising the federal funds rate once more. To reassert its credibility, the Fed had to push the rate to a staggering level of nearly 20% by mid-1981. Demonstrating unwavering resolve, Volcker wielded a metaphorical baseball bat to subdue the economy and vanquish inflation. The subsequent recession, commencing in July 1981, was the most severe economic downturn of the century.

Numerous analysts and economists now hold the belief that to effectively curb inflation, the federal funds rate must exceed the rate of inflation for a sustained period. Presently, inflation hovers around 6% (as of February 2023), while the federal funds rate range stands between 4.75% and 5%. Consequently, further interest rate increases are likely on the horizon.

But what happens if the inflation fight is prolonged as it was in 1980? How do we protect ourselves from the value of our assets eroding away?

This particular concern is back on everyone’s mind due to the current instability of the American banking system. The U.S. Treasury Department and the Fed have indicated that they will “back-stop” customer deposits for regional banks where the Federal Deposit Insurance Corporation (FDIC) fails to do so, which critics say could result in another “money-printing spree” leading to further inflation.

In 2020, when the government initiated money printing in response to COVID-19, Paul Tudor Jones, the American billionaire and hedge fund investor, penned a compelling investor letter, widely regarded as the rational case for hedging one's portfolio against inflation with bitcoin.

He provides a list of inflation hedges “a host of assets that at one time or another have worked well in reflationary periods,” ranging from the most obvious such as gold to more esoteric such as foreign exchange investments like the AUD/JPY (Japanese yen/Australian dollar) foreign exchange trading pair. His full list of nine hedges, some of which you can invest in and some of which are meant to inspire ideas, include:

  1. Gold: a store of value with a 2,500-year history
  2. The yield curve: Historically a great defense against stagflation or a central bank intent on inflating. For our purposes we use long two-year notes and short 30-year bonds
  3. Nasdaq 100: The events of the last decade have shown that quantitative easing can rapidly leak into equity markets, giving stocks a boost
  4. Bitcoin: The most established cryptocurrency
  5. U.S. cyclicals (long)/U.S. defensive (short): A pure goods inflation play historically
  6. AUD/JPY forex pair: Australia is a long commodity exporter while Japan is short commodity importer
  7. TIPS (Treasury inflation-protected securities): Indexed to consumer price index (CPI) to protect against inflation
  8. GSCI (Goldman Sachs commodity index): A basket of 24 commodities that reflects underlying global economic growth in the U.S.
  9. JPMorgan’s emerging market currency index: Historically when global growth is high and inflationary pressures are building, emerging market currencies have done quite well, likely because they are also suffering from inflation

(The list was lightly edited.)

Tudor Jones then puts these nine candidates through a rigorous analysis using the following four categories:

  1. Purchasing power: How does this asset retain its value over time?
  2. Trustworthiness: How is it perceived through time and universally as a store of value?
  3. Liquidity: How quickly can the asset be monetized into a transactional currency?
  4. Portability: Can you geographically move this asset if you had to for an unforeseen reason?

His analysis leads him to identify bitcoin as the top candidate due to its ability to retain purchasing power (as the best-performing institutional asset of all time, from the perspective of bitcoin’s entire lifecycle), trustworthiness (backed by cryptography), liquidity (tradeable 24/7) and, most importantly, portability (as a peer-to-peer system, no entity can intermediate on-chain transactions).

The run on Silicon Valley Bank underscored the remarkable capabilities of digital finance, with venture capitalists effectively toppling a bank using smartphones and group chats in just a matter of hours. During periods of political turmoil such as wars, pandemics or shifts in government, the importance of digital portability cannot be overstated. After all, it's improbable that anyone would transport gold or paper bonds across borders.

Paul Tudor Jones concludes, and so will I:

“At the end of the day, the best profit-maximizing strategy is to own the fastest horse. Just own the best performer and not get wed to an intellectual side that might leave you weeping in the performance dust because you thought you were smarter than the market. If I am forced to forecast, my bet is it will be bitcoin.”

Edited by Daniel Kuhn.


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Tatiana Koffman

Tatiana Koffman is an angel investor, author and creator of the weekly newsletter MythOfMoney.com.