In the wake of negative headlines about the global financial stability, investors are looking for a safe haven to protect themselves against inflation. The crypto market has experienced a remarkable surge in March 2023, with Bitcoin climbing by 19.81% and reaching a value of USD 28,426.29. In this article, we will discuss how investing in cryptocurrencies like Bitcoin can offer protection against inflation.
Inflationary Pressures: An Uncontained Crisis
A wave of supply and demand peaks suggests that inflationary pressures are on the rise, and central banks are unable to control it with interest rates. Investors are looking for alternatives to traditional monetary assets like savings deposits or bonds to diversify their portfolios. A significant drop on the demand side and decline in corporate profits are required to bring inflation under control, but it may not be enough.
How will inflation develop?
What will happen if market participants realise that structural inflationary pressures are much stronger than previously expected and the bond market could force a rise in nominal interest rates? A recalibration of interest rates may be a potential consequence. Who will suffer? Hard to say. But at some point, market participants will start to question not only the stability of the financial system, but also the financial stability of governments. Because there is still a lot to come. To name a few examples: Labour shortages, climate change and limited raw materials.
The global economy has experienced an enormous demographic boost with the baby boomer generation. Yet, they are now retiring. In Japan, as well as in most Western countries, this trend has been observed for years. China's population also showed a decline last year for the first time in decades. We had an abundance of labour, soon we will face a shortage. This will drive the wage spiral upwards.
The costs associated with climate change are underestimated. There are basically only two ways to deal with them: De-escalate or face the consequences. To mitigate the effects of climate change, a shift away from fossil fuels is necessary. This will potentially lead to strong increases in energy prices in the transition phase, as the supply of renewable energies only grows slowly and the demand increases more rapidly. The second way is not to try to defuse climate change at all, but to bear the resulting consequences. However, this will lead to more extreme weather events, hurricanes and destruction. No matter how you spin it, coping with climate change will cost big time.
Shortage of resources
The issue of commodities is closely linked to the issue of climate change. Many tend to assume that Russia's attack on Ukraine has driven up commodity prices. But the Ukraine war has merely intensified an already existing trend. Energy already is a scarce commodity and metals are arguably going to be the most important sector in the near future. To ensure the electric transformation, we would need to move from a world built on fossil fuels to one based on metals: Lithium, cobalt, copper, etc. But it takes years from the discovery of a resource to production, which again could drive up prices.
If income remains the same, there is only one thing left to do: consumption would have to decrease to be able meet these challenges.
What can governments do to control inflation?
Governments could keep interest rates low by asking investors to buy government bonds, as seen in the US and the UK after World War II. Meanwhile, inflation would be allowed to remain at a tolerable level of 4 to 5%, so that nominal growth is significantly higher than interest rates, which can lead to a reduction in debt. However, inflation acts like a tax, and people who hold their wealth in monetary assets will find that a considerable part of it was just an illusion.
How can investors protect their wealth against inflation?
Here, too, the rule applies: diversify, diversify, diversify! Investors should diversify their investment pot and risk by investing in alternative assets like short-dated government bonds, defensive shares, gold, and digital assets. Cryptocurrencies like Bitcoin offer the advantage of being built on a decentralized financial system. Bitcoin has a limited supply, and its value increases as the demand increases, making it a good investment option.
Investing in cryptocurrencies like Bitcoin, Ethereum or Ripple can potentially provide protection against inflation. Governments can take steps to control inflation, but it comes at a cost. Investors should therefore diversify their portfolio and invest in alternative assets to protect their wealth.
What are your tips for continuing to invest despite inflation and hopefully realising profits?