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There are two common perceptions amongst investors in late 2021. Firstly, inflation may be on the rise. Secondly, cryptocurrencies like Bitcoin could offer a useful hedge as the value of fiat currencies falls. Are these two assumptions true? In this article, our investment team at Bure Valley Group offers some answers.
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Is inflation rising?
For a long time now, central banks in both the US and UK (the Bank of England; or BoE) have had an inflation target of 2%. This target has largely been met in recent years, which has helped central banks keep interest rates low. This, in turn, has resulted in many attractive mortgage deals for homeowners (e.g. under 2%) but poor interest rates on regular cash savings accounts, where savers struggle even to keep up with inflation.
In 2021, however, inflation has been rising in both the US and UK. The latter has reported a 3.1% rise in prices over the last 12 months, and the BoE projects that this could rise to 4% by the end of the year. US inflation appears to be riding even higher at 5.3%; the highest points in 13 years. Many reasons have been attributed to this. One notable, likely factor is that pent-up demand during the COVID-19 pandemic has finally been released as lockdowns have lifted in the US and USA – resulting in a shortgages and bottlenecks in goods and energy.
Central banks appear to be at pains to emphasise that the current inflation rise is “transitory” and that prices should start settling back down in 2022. However, many economists believe that the rise could be longer-lasting. At present, the USA is more indebted than at any point in its history; something which could eventually result in a “deflationary bust”. Rising inflation can help alleviate the pressure of this indebtedness. There is also the factor that baby boomers are now retiring in large numbers, and organisations are struggling to find Generation Z workers to replace them. Unemployment benefits and minimum wages have also risen. Taken together, these are likely to drive higher persistent inflation.
Is cryptocurrency a “safe haven” against inflation?
Given these pressures in the US and UK economies, it is little wonder that investors worry about what the implications could be for their portfolio strategy. One concern is that fiat currency (e.g. the US dollar) will fall in purchasing power as central banks continue to print more money. After all, a series of trillion-dollar stimulus packages have been introduced by the Federal Reserve since the Spring of 2020 (“helicopter drops” of money, as famously described by Ben Bernanke).
Cryptocurrencies like Bitcoin, however, are often believed to be highly resistant to inflation since there is no “central bank” able to issue more cryptocurrency (therefore, driving down the value of each unit). Indeed, Bitcoin has risen in value more quickly than the US dollar has lost value. The former rose from virtually nothing to over $20,000 by 2010, whilst $1 in 2010 would be the same as $1.26 today.
Cryptocurrencies typically have a fixed “supply” which is known to all investors. New crypto “creations” are foreknown and will taper off. Bitcoin will only ever have 21m units, for example. This means that cryptocurrencies cannot be directly manipulated by central banks printing more money, or increasing money supply. However, cryptocurrencies do also experience inflation. As more Bitcoin is mined, for instance, its inflation rate should also decrease. This does not matter too much to most investors, however, provided the purchasing power of the cryptocurrency keeps rising in relation to the fiat currency it is compared to (e.g. the US dollar).
At this point, it is important to note some important caveats. Firstly, not all cryptocurrencies are designed the same as Bitcoin. Stablecoins, for example, are often pinned to fiat currencies like the US dollar. This means that your stablecoin investment could be impacted by inflation much like if you held it in US dollars, instead. Secondly, cryptocurrency is not always a “safe haven” during uncertain times. When COVID-19 first hit stock markets in the US and UK in 2020, for instance, Bitcoin fell sharply along with equities. Where cryptocurrency can be a useful hedge, however, is against assets with a similar or higher risk profile to its own. If you want to include cryptocurrency investments in your portfolio, therefore, make sure they are not present for the wrong reasons. Precious metals, for instance, are traditionally seen as a potential hedge against stock market volatility. Cryptocurrencies can be a good way to diversify a portfolio and expose it to potential higher returns compared to equities (albeit, with higher volatility).
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