A popular narrative argues the massive stimulus programs from the Federal Reserve, launched to counter a coronavirus-induced recession, could hyperinflate the economy and fuel a major rally in bitcoin.
However, that bullish theory, which suggests the cryptocurrency would be viewed as a hedge asset in dire economic times, has been dealt a blow by recent data from the U.S. central bank.
The data suggests inflation is likely to remain absent for some time and, in fact, the probability of the U.S. economy slipping into deflation is rising.
There's now a 78.6% chance of deflationary pressure for the U.S – the highest since 2008, according to St. Louis Fed's deflation risk monitor. As tweeted by Ritvik Carvalho, a financial data correspondent at Reuters, the Fed's favored inflation measure (below right) – the core personal consumption expenditure – has also declined to an eight-year low of 1%.
Inflation refers to a sustained increase in the general price level of goods and services. Its opposite, deflation is characterized by a general decline in prices for goods and services, and is typically accompanied by a rise in unemployment.
Since the beginning of the coronavirus crisis in early March the Fed has injected an unprecedented amount of liquidity into the system to help the economy absorb shocks arising from the virus outbreak and ensure financial market stability. Its balance sheet size has expanded by over $3 trillion over the past 3.5 months.
Crypto analysts are convinced that the massive money injections would boost inflation and bode well for bitcoin. That's in part based on the cryptocurrency’s reducing pace of supply, which drops by 50% every four years via a process called the "halving."
“As we’ve closely monitored the market in the wake of recent economic policy decisions, we’ve seen that the crypto asset class is not only resilient, but that interest is surging as the monetary stimulus has caused investors to look to $BTC as a potential hedge against inflation,” Grayscale Investments, one of the leading digital asset management companies, recently tweeted. (Grayscale is a unit of CoinDesk parent Digital Currency Group.)
Legendary fund manager Paul Tudor Jones also recently disclosed a small bitcoin position to help protect against a rise in inflation.
But with the Fed data and market-based measures of long-term inflation expectations also suggesting a low chance of a rise in inflation over the next five years, the odds of bitcoin witnessing an inflation-driven bull market look weak.
So if the U.S. is, in fact, facing deflation, what does it mean for bitcoin?
Some observers suggest the cryptocurrency would appreciate in a deflationary environment – if its adoption as a medium of exchange rises, as discussed in April. This is because deflation boosts the purchasing power of the monetary unit. For this reason, the U.S. dollar tends to appreciate during deflationary bouts.
There's also evidence institutional participation in the bitcoin market is increasing. As a result, some of the increasing money supply may find its way into the bitcoin market. In that case, the cryptocurrency could rise in the long term despite low inflation or deflation.
In the shorter term, the scenario for bitcoin is looking somewhat uncertain. At press time, bitcoin is changing hands just over $9,200, according to CoinDesk’s Bitcoin Price Index. The cryptocurrency has spent the better part of the last two months trading a narrow range and may be facing losses after failing multiple times recently to leapfrog the important $10,000 hurdle.
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