Cryptocurrency

Will reducing US inflation from 8.3% to 2% compare to Bitcoin and Ethereum?

Inflation will be one of the most important global topics in 2022, with the US reaching 8.3% and the UK 10.1%, and countries such as Turkey see a higher figure of 79.6%. These figures are well above the 2% inflation target of major central banks.

Central banks such as the Federal Reserve, European Central Bank and Bank of England aim to keep inflation low and stable. A 2% inflation target helps everyone plan for the future. Inflation that is too high or fluctuates too often makes it difficult for businesses to set the right prices and people to plan their spending.

What is the impact of 2% inflation?

To understand the effects of inflation, we need to look at the combined effects over several years. Let’s say you have $50,000 in your savings account. With 2% inflation compounded annually over 20 years, the purchasing power would drop to just $33,648. Just sitting in the bank will effectively reduce your savings by about $17,000.

If wages increase by exactly 2% per year, this is balanced. But historically it’s not. Average UK house prices have significantly outpaced average income growth. So, since around 2000, it has become increasingly difficult for the average worker to save up to buy their own home.

house prices versus wages
Source: New Politician

Coping with inflation

Central banks are expected to eventually be able to control inflation using the tools at their disposal. We have had high inflation in the past, so it is not unreasonable to assume that similar measures will be implemented to keep inflation down in 2022, based on past successes.

Historically, the Federal Reserve has raised the Federal Funds rate above the level of CPI inflation to deal with whenever inflation exceeds 5%. The red arrows in the chart below show that this has been done by him 6 times in the last 20 years.

inflation
Source: Trading View

For most of the last 20 years, CPI inflation has averaged around the 2% target. In 2022, there is talk of a โ€œnew normal.โ€ Never before has there been such a significant divergence between the CPI and the Fed’s fund rate with inflation so much higher than interest rates.

A strategy to deal with inflation spikes similar to those currently affecting global markets is also to raise interest rates above inflation.

In the 1970s, when CPI inflation was in the double digits, then Fed Chairman Paul Volcker managed to get the Fed funds rate above 12%. But the actions of his current FED chairman, Jerome Powell, are worlds apart from those of Volcker. The chart below shows the relationship between his FED fund his rate and his CPI inflation rate since 1970. Volcker drove a change of more than 7.5% year-over-year, while Powell had the opposite effect with a change of -7.5%.

Federal Funds Effective Interest Rate Consumer Price Index for all urban consumers (Source: Federal Reserve)
Federal Funds Effective Interest Rate Consumer Price Index for all urban consumers (Source: Federal Reserve)

crypto inflation

Bitcoin can be viewed as an asset to protect against currency depreciation, but it has its own inflation. Bitcoin inflation is programmed into the protocol.Bitcoin inflation rate is currently 1.75%however, it will decrease to 0.875% in 2024 and continue to decline with each halving.

The slight difference in Bitcoin inflation rate is related to network hash power to network difficulty. If there is a change in hashrate, it will automatically adjust by increasing or decreasing network difficulty to control inflation.

Bitcoin’s inflation model aims to reduce inflation gradually over time rather than maintaining it at a set rate. Banks and other government agencies do not have to make decisions to control inflation.

Additionally, Ethereum has seen a significant shift in inflation this year.Pre-merger Ethereum Inflation Rate Roughly 2.6%This has been cut in half after the implementation of EIP-1559 in 2021.

After The Merge, issuance will drop significantly, with negative inflation likely below 0%, and ETH issuance at around 0.3%. This change stems from the 3x halving, which is done to remove the 13,000 ETH daily miner reward, leaving only 1.3,000 ETH from staking.

Lucas Outumuro of Into the Block predicted that it could go as low as -4.5% when network charges are taken into account.

Bitcoin and Ethereum were created after the 2008 recession to address problems that have plagued the traditional banking system for years. Neither protocol aims to keep inflation near his 2%. Both networks reduce inflation over time and increase the purchasing power of the underlying asset. A negative inflation rate means that holding Bitcoin or Ethereum will substantially increase in value over a long enough period of time.

Unlike holding fiat currencies that have lower purchasing power even at the central bank’s target inflation rate, Bitcoin and Ethereum are programmed to do exactly the opposite. Fiat currency inflation is slowing, but still rising globally. However, Ethereum will be upgraded in September, causing one of the biggest deflationary events in history. It will be very interesting to see how this affects speculation about the price of Ethereum.

It’s important to note that economics is not as simple as “inflation is bad and deflation is good.” In fact, deflation has many consequences that can adversely affect the economy. The goal of the 2% inflation target is to ensure that the rate of money continues at a healthy rate.

If inflation is 0% or negative, it’s wise to spend less. Holding an asset with negative inflation means it will appreciate in value over time. This trend could bring the economy to a halt as money slows down. Central banks have therefore set low inflation targets to ensure spending continues.

However, as the first example in this article showed, even 2% inflation significantly reduces 20-year savings. Ethereum and Bitcoin have low inflation and are programmed by the consensus of the global community.

There is no central bank for Bitcoin or Ethereum, so there is no Chairman to misjudge the economy. The economy is already determined and built into the code. If the goal of 2% inflation is to allow people to plan for the future, what better way than to have his next 100 years in front of him, as is the case with Bitcoin do you have?

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