Making Sense of Consumer Price Index (CPI) – And Its Correlation to Crypto Investments
If you are active in the financial space, chances are, you have come across news on the “CPI report” released yesterday by the US Bureau of Labor Statistics. It says the Consumer Price Index (CPI) of the country for the 12 months rose to its highest level in the last 42 years. The all items index increased 7.5% in the past year, while the CPI of All Urban Consumers (CPI-U) is up by 0.6% in January alone.
The higher inflation rate sounds like good news for the crypto community. It’s what the data from the previous two months suggests. On November 10, when the CPI report came out, Bitcoin gained a new high of $68,688.
On December 10, the crypto market responded similarly to the CPI report and gained more than $1000 in an hour.
But, yesterday, when the CPI report was released, Bitcoin fell as much as $1000 in less than five minutes before reclaiming the $45000 mark. Shortly thereafter, it dropped to $42851 and is still struggling to reach its resistance level of $44,000.
This tells us, like all assets, cryptocurrencies are also unpredictable and don’t always react in a particular pattern.
But, doesn’t this raise a question: if Bitcoin is really a good hedge against inflation? If so, why didn’t it jump upward on the release of a concerning CPI report? More importantly, what is CPI, and how/why does it affects the crypto market?
CPI – What is It for Beginners or Non-Economists?
The US Bureau of Labor Statistics explains CPI as “The Consumer Price Index (CPI) measures the change in prices paid by consumers for goods and services. The CPI reflects spending patterns for each of two population groups: all urban consumers and urban wage earners and clerical workers.”
There is a whole big para we left. Essentially, what it means is:
CPI is a study that understands the price change of multiple commodities to calculate inflation. In order to measure the CPI, the US BIS put various economists in charge of collecting the change in price of most goods and services used by consumers. These experts survey households for a fixed list of items, including food, apparel, electronics, etc, which helps the government calculate inflation.
To illustrate this: Let’s say, an apple that used to cost $1 on January 12th is now $1.5 on February 11th. So, the surveyor will calculate the price change over a period of one month to understand the inflation along with the buying pattern of consumers and their behavior.
An important point to understand here is: higher the CPI, costlier the goods and services.
The recent report of CPI by US BIS shows a 7.5% increase in the period of 12 months ending January. It simply means, an Apple is going to cost 7.5% more than what it was 12 months ago.
It all boils down to the fact that the purchasing power of USD is reducing, which is not a hidden fact if we look at the below chart from FRED:
Clearly, one US dollar in 1913 held the same purchasing power to about $28 today. Simply put, an apple that would cost $1 in 1913 is going to cost you $28 in February 2022. That’s an increase of $27 over the century, and the recent report suggests that it’s going to inflate even more in the near future.
So what if the dollar is losing its value and the inflation is increasing?
Undoubtedly, inflation – to a certain extent – is good for the economy. But, the January CPI report is alarming because it’s above the threshold level – which economists believe to be between 2-4%. Although the 7.5% rate can still be worked up, the problem arises when hyperinflation kicks in.
A classic example of that would be Venezuela. The country has an annual inflation rate of 472% as of January 2022. 1 USD is equivalent to 446,352.98 Venezuelan Bolívares. The local currency has little-to-no purchasing power. A loaf of bread might cost you 1000 Bolivares.
While most countries have low CPI rates compared to hyperinflationary economies like Venezuela and Zimbabwe, it’s essential for daily consumers to preserve the value of their currency because one cannot always be sure of a healthy economy. Besides, the current CPI report suggests the inflation rate is getting out of control.
So, how do you protect your money against sometimes-unavoidable economic phenomena like inflation?
By exchanging cash for relative assets!
But, Are Cryptocurrencies a Good Hedge Against Inflation?
Commodities, stocks and other traditional financial instruments are considered good investments throughout history. But, how does cryptocurrencies with a volatile history of a decade make up for inflation-immune assets?
To find this, let’s look at the most-favored assets from both the traditional market and cryptocurrency market – Gold and Bitcoin.
Comparatively, Bitcoin is volatile. The price of 1 BTC can change dramatically within a short period. However, if/when tracked across a decade against preferred investment instruments, Bitcoin has indeed made profits for those who held it for a long time and has proved over its 12-year history that it is a better inflation hedge than Gold or S&P 500 Stock Index.
How Bitcoin derives its value and why people are comparing it to “digital gold” makes up for another topic. But, the data shows that the asset has done exceptionally well in the past, especially on days when inflation-related reports are published. In tumultuous times like today when economies are in turmoil due to the long-lasting pandemic, the cryptocurrency can help a portfolio survive inflation ravages.
However, at the same time, Bitcoin has a short history of only 12-years, which is considerably a short period to conclude if an asset is a good investment instrument that hedges against inflation.Nonetheless, it’s certain that rising CPI rates in the US are driving up the crypto investing activities around the world.