What is asset price inflation, and how does it affect bitcoin?
Most people think of inflation in the context of goods and services increasing in price. However, the price of assets such as stocks, bonds, real estate, precious metals, bitcoin, art, and other asset classes can also experience inflation.
Want to know how asset price inflation can be a catalyst that drives the price of bitcoin past $2 Million per coin? Keep reading till the end! (or skip down to: How Bitcoin Is Affected, where I make a bull case for bitcoin)
Asset Price Inflation
Asset price inflation is largely disregarded – people don’t realize that it is a problem. This is because as the price of assets go up, investors think they have made a good investment. Their asset is appreciating in value. Great. Right?
Not always! Asset price appreciation is only a good thing, if the asset is also experiencing a net gain in purchasing power, or inflation adjusted value.
In the past 10 years, bitcoin has returned a mind-boggling CAGR (compounded annual growth rate) of ~200%. Rest assured, these gains are outpacing inflation, as well as every other asset class on earth!
Two hundred precent is crazy, but it is also a nominal gain – which means that this number is not inflation adjusted. A portion of the gains are due to asset price inflation, and don’t represent a real gain in purchasing power.
Nominal Gains vs Real Gains
Let’s look at the example of real estate. If you own a $400,000 home and it appreciates by 40% nominally over the course of 5 years, this seems like a win. But what if the cost of goods and services increased by 20% over the same time period? This seems like less of a win.
What if you take into account that you paid $70,000 in interest over that five year period. A lot more of your gains just got wiped out.
However, this is not a clear-cut example. To fully determine the success of this investment, you also have to consider the utility that the home provided, the alternate cost of renting, and the opportunity cost of missing out on other investments.
My point here is that you cannot look at nominal gains by themselves. Asset price appreciation by itself is a poor metric and must be put into context.
Housing Market Asset Inflation
Over the past century, the real estate market in the US slowly appreciated, just enough to steadily outpace inflation. However, around the year 2000, things began escalating quickly. Housing market gains inflected upwards, and started beating inflation by a lot.
When a century long trend gets turned on its head, there’s always a reason. In my opinion, the cause was excessive deficit spending, and monetary expansion, which led to asset price inflation in the housing market.
Excess capital and liquidity in an economy tends to get absorbed by the most dominate asset classes. The dominate asset classes are usually just the preferred assets of the wealthy: real estate, and equities (stock market).
Inflation and Deflation
Technological deflation drives prices down. Demographics can also be a huge force of deflation (or inflation). It makes a big difference if an economy has the largest cohort of its population in their peak productivity of working years vs. old and retired.
If an economy has inflationary pressure from deficit spending and monetary expansion, these forces of inflation and deflation counteract each other.
Central banks and governments have control over the inflationary pressure (money printer), so there usually ends up being more inflation than deflation.
The Federal Reserve’s target is to achieve 2% inflation and full employment. In the highly complicated and convoluted fiat system, trying hit a 2% inflation tarted is near impossible. It’s an imperfect science, and there are too many factors they cannot control.
To learn more, I highly recommend reading The Fiat Standard by Saifedan Ammous.
If the Fed succeeds and inflation wins out, the working class is robbed of purchasing power gains from technological deflation. Those gains get redistributed into asset classes largely controlled by the rich.
Looking at how monetary expansion works can help to explain how it affects asset price inflation.
In a simplified explanation, as more and more money is pumped into the economy, some is absorbed by the stock market, some is absorbed by the real estate market, some is absorbed by other asset classes, and the rest leaked into inflation.
Asset Price Valuation
Stocks are relatively easy to appraise based on a company’s profitability – this metric is called the price to earnings ratio or P/E. Throughout the 20th century, the S&P 500 was typically valued with a P/E ratios around 10 to 15 depending on the type of stock.
As the economy went through business cycles of expansion and recession, the P/E ratios would peaked around 20, bottomed around 6, and then returned to trade near 10-15.
Starting in the late 90’s, valuations in the stock market got senseless. During the dot com bubble, the 2008 financial crisis, and most recently in 2021, P/E ratios reached peaks of 40+, 100+ and 35+ respectively.
If an average company in the stock market maintained the exact same profitability from 1980 through 2001, the total value of their stock would have increase by over 600%. This made no sense, and was clearly unsustainable.
There was a steady 100 year pattern in the stock market, and then out of nowhere, massive outliers started appearing. This does not seem random. Only functional market changes can create such drastic outliers.
If a company was worth $1 million in 1980, and it didn’t become any more profitable, why was it worth $6 million in 2001?
The answer: asset price inflation.
Asset price inflation has two main components which force prices higher: inflation and speculation.
- Inflation: Inflation makes money worth less, so asset prices must rise to accommodate value retention.
2. Speculation: Excess capital in an economy must go somewhere. It tends to go to the most dominate assets that are most likely to continue going up in value.
How Bitcoin Is Affected
Here’s where things get interesting. Asset price inflation is a catalyst that has the potential to drive the price of bitcoin drastically higher.
Many different asset classes have become speculative asset bubbles. This is true for the housing market, the stock market, art, collectables, luxury items, and cryptocurrencies.
All of these asset classes have largely decoupled from their utility value, and they have become vehicles for storing excess speculative capital. This happens out of necessity because capital needs somewhere to reside – and the 21st century economy is flush with excess capital.
A Bull Case For Bitcoin
Excess capital in the economy is absorbed disproportionally by the most attractive assets. Currently, extra money in the economy is largely consolidated between stocks, and real estate.
As bitcoin continues to appreciate in price, and gains adoption & utility, it becomes an increasingly attractive place to store excess capital.
In the words of Michael Saylor, “Bitcoin is the apex property of the human race.”
If Michael Saylor is correct (I think he is), excess speculative capital stored in other asset classes will start bleeding into bitcoin – and bitcoin is perfectly capable of absorbing any and all capital.
In 2021, Bitcoin’s market cap is currently less than $1 Trillion. Let’s look at some other asset classes that are likely to contribute excess speculative capital to bitcoin’s market cap in the future:
Gold: $11 Trillion
Stock Markets: $90 Trillion
Real Estate: $280 Trillion
If bitcoin was to absorb even 1% of the capital stored these three asset classes, the price of bitcoin would 4X to approximately, $250,000 per bitcoin.
If bitcoin were to absorb 10% of these assets, the price would exceed $2 million per coin.
In a scenario where bitcoin becomes extremely dominate, the world’s money supplies, and national treasury reserves would also be susceptible to being absorbed into bitcoins market cap.
In this scenario, bitcoin would functionally become money, and it would no longer make sense to denominate in dollars.
If something close to this scenario plays out, any amount of bitcoin acquired in the near future will gain drastically more purchasing power over time (orders of magnitude).
Bitcoin favors early adopters in a huge way. To learn more about this concept, check out my article: Why Bitcoin Favors Early Adopters.
How To Get Started With Bitcoin
To learn more about the fundamentals of bitcoin, and how it works, I recommend getting started here:
Learn All The Basics About Bitcoin: What Problems Does it Solve? Why is it Special?
Thanks for reading! Please leave any comments or questions down below.