Because the way to measure inflation is not correct

In plenty of bitcoin reports (here, here and here), there is a general consensus that Bitcoin is deemed a deflationary asset. However, this is not correct. It is true that there is a reduction in new supply of Bitcoin due to the halving, but this does not mean that Bitcoin is a deflationary asset.

Short answer: We talk about Bitcoin inflation as monetary inflation while we talk about FED and global economy as price inflation. These are different measures, so you cannot cross reference it that way.

Long answer

What is Monetary Inflation

Monetary inflation is the increase in money supply. Depending on the factors, this can result in price inflation, or “inflation” that you read on the news. However, as highlighted earlier, the result in price inflation is not always the case.

What is Price Inflation

Price inflation, on the other hand, is what the measure is referred to when you read the newspaper. It is also one of the mandates by central bank when it comes to adjusting the monetary policy. Price inflation is the increase in general price level of goods and services.

Thus, monetary inflation and price inflation is different. The only link between them is that we use money (affected by monetary inflation) to purchase goods and services (affected by price inflation).

Wrong Statement

The wrong statement is saying that Bitcoin is deflationary because the monetary inflation of Bitcoin (1.8%) is now lower than the FED’s targeted inflation growth of 2%. That is wrong because these are 2 different measures and you cannot compare them like this.

In fact, there is a low correlation of monetary inflation and price inflation, as seen in 2008. In 2008, we have the global financial crisis, and the FED reduced the reserve rates in hopes to boost liquidity and hence money supply. Theoretically, this can result in price inflation since there is more money available. However, we did not see price inflation in daily goods and services. Thus, there is no strict correlation between monetary inflation and price inflation.

Hence, it is wrong to say that because bitcoin’s monetary inflation is lower that the FED’s target of 2% inflation, that means bitcoin is a deflationary asset.

However, do note that there is a general consensus by economists believing that a massive increase in money supply causes hyperinflation. This is more of a tail-end situation, hence should not be taken as a general phenomenon of the relationship between money supply and price inflation.

What about Bitcoin

Firstly, Bitcoin is currently experiencing a monetary disinflation. Disinflation is a slow-down in inflation rate. Bitcoin is still increase its supply even with the halving of block rewards. The increase in supply is just less every four years, hence disinflation is the right term.

Secondly, deflation is a decrease in general price level of goods and services, the opposite of inflation. That means price inflation rates are negative. It does not mean that the change in inflation rate is negative.

Ps: looking at an asset as a hedge against the USD does not mean it is deflationary.

How to determine if Bitcoin is truly deflationary

To compare between Bitcoin’s economy and US economy, we have base them in price inflation. As prices of goods and services are not exactly priced in Bitcoins, it is tricky to measure the price inflation of Bitcoin.

Traditionally, price inflation is determined by 2 indexes, Consumer Price Index (CPI) and Personal Consumption Expenditures price index (PCE). These are similar indexes to measure price inflation, however they do have their differences.

To measure if Bitcoin is truly deflationary, we have to start calculating the CPI or PCE of a basket of goods in Bitcoin and compare it across a time variable.

I’m keen to research more on this topic to get a better quantitative measure of the price inflation rate of Bitcoin. Please contact me via LinkedIn if you have some data on this or are keen to explore this area!

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