Could Cryptocurrencies Hedge Against Inflation,
the US Dollar, or the Federal Deficit

Cryptocurrencies may conceivably serve as a hedge against inflation since, in contrast the U.S. dollar or other traditional ”fiat”14 currencies, bitcoin and other legitimate cryptocurrencies:

  • Can’t legally be deflated, since they have a limited money supply built into their code.
  • Have intrinsic value, since they enable the digitization of trade, through block chain technology.

Cryptocurrency And The Rising U.S. National Deficit

By definition, the value of an authentic cryptocurrency can’t be legally inflated because it can’t be diluted (devalued) by an individual or entity.

In contrast, when government spending in a country such as the United States exceeds tax revenues, the government typically meets spending obligations by printing more money and/or borrowing more money (issuing government bonds). Printing money risks inflation, by virtue of currency dilution. Alternatively, borrowing money by issuing bonds also poses risks. As the owner of a home mortgage knows, borrowing money requires paying interest to lenders, which for the U.S. government, means incurring more debt just to pay back the interest, not to mention the principal.

Higher debt can depress the value of the dollar, because a weaker currency can make it cheaper for a government to repay debt [previous sentence needs clarification]. A weaker dollar in turn, devalues all dollar-denominated assets compared to assets held in other currencies. Further, large lenders (Treasury bond buyers) such as China and Japan may someday demand higher interest rates if the U.S. credit rating falls, which would signal a greater risk of a U.S. loan default.

As a former IMF official has warned about the United States: “Living with high debt is living dangerously. When government debt is large, a rise in interest rates causes total borrowing costs, and thus the deficit to increase substantially. As larger deficits are financed, the debt also swells. Investors worried about possible default or a spike in inflation will demand even higher interest rates, creating a vicious circle."

In contrast to the dollar (or to dollar-denominated assets), the value of a cryptocurrency is not pegged to the U.S. dollar or to U.S. borrowing. A cryptocurrency could thus conceivably retain value independent of the rising national debt or a falling dollar.

14 Fiat money. “Paper money or coins of little or no intrinsic value in themselves and not convertible into gold or silver, but made legal tender by fiat (order) of the government. Fiat money is an intrinsically worthless object, such as paper money, that is deemed to be money by law.” Financial Times Lexicon, http://lexicon.ft.com/Term?term=fiat-money