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11/01/2024

Bitcoin and the Consumer Price Index (CPI): A Complex Relationship

Bitcoin launched in 2009 in the aftermath of the financial crisis and has had almost no exposure to macroeconomic stress tests. This stands in sharp contrast to gold, which has a long track record spanning centuries and vastly different political systems. That said, gold's supply is only assumed to be finite, making its scarcity less reliable. New gold deposits are discovered regularly, whereas Bitcoin's scarcity is mathematically defined and predictable, capped at 21 million BTC. But does that actually make Bitcoin a better inflation hedge than gold?

Bitcoin and the Consumer Price Index (CPI): A Complex Relationship

Bitcoin launched in 2009 in the aftermath of the financial crisis and has had almost no exposure to macroeconomic stress tests. This stands in sharp contrast to gold, which has a long track record spanning centuries and vastly different political systems.

That said, gold's supply is only assumed to be finite, making its scarcity less reliable. New gold deposits are discovered regularly, whereas Bitcoin's scarcity is mathematically defined and predictable, capped at 21 million BTC. But does that actually make Bitcoin a better inflation hedge than gold?

How Does CPI Affect Bitcoin's Price?

On any given day, Bitcoin (BTC) prices can move up or down from the opening price on the day a CPI report drops, regardless of which direction inflation is heading. For example, when the CPI report showed inflation falling from 8.5% to 8.3% (year-over-year) from March to April 2022, Bitcoin's price fell 11%.

On the flip side, after the CPI report showed inflation dropping from 8.2% to 7.7% (year-over-year) from September to October 2022, Bitcoin's price climbed 9.68%.

In May 2024, when the CPI report showed a modest decline from 3.5% to 3.4% (year-over-year), BTC's price rose 7.02% the following day. Notably, when the March 2022 report showed inflation rising from 7.5% to 7.9%, Bitcoin's price actually dropped 6.37%.

In other words, the assumed logic behind the relationship between Bitcoin's price and CPI announcements simply doesn't hold up in the data. This makes sense when you look at monthly BTC price changes in the context of the broader forces that carry more weight.

Does Bitcoin Rise or Fall with Inflation?

In March 2022, the Fed kicked off a rate-hiking cycle to rein in inflation. Given that monthly CPI reports are released with a lag, January 2022 serves as the natural starting point for comparing against monthly Bitcoin prices, for two reasons:

  • Rate hikes slow the economy because borrowing becomes more expensive.
  • The move itself framed inflation as an urgent problem in the public eye — which would reinforce the narrative of Bitcoin as an inflation hedge.

From this data, it's clear that the Fed's rate-hiking cycle — as a tool to shrink its balance sheet — had a greater (suppressive) impact on Bitcoin's price than CPI data alone. In fact, Bitcoin's price has tended to rise when CPI data trends down. This makes sense when you consider the following:

  • Bitcoin is viewed as a speculative asset and a hedge against currency debasement. This perception stems from Bitcoin's limited use in the broader economy (under 2%) compared to the dollar's ubiquity.
  • Conversely, before the Fed started hiking rates — when money was "cheap" — Bitcoin was more likely to attract capital flows as a higher-risk investment.
  • However, as the Fed kept raising rates to fight inflation, Bitcoin's increasingly constrained supply offset that pressure. As of October 2024, following the fourth halving in April 2024, 94.13% of Bitcoin's total supply had been issued, with an inflation rate of just 0.84%.
  • There's a case to be made that Bitcoin is not just an inflation hedge but a central bank hedge. This was on full display during the U.S. regional banking crisis, when Bitcoin surged 9.5%.

In short, the impact of CPI announcements on Bitcoin's price is diluted when set against the underlying tokenomics of Bitcoin. Most critically, a USD inflation rate higher than BTC's inflation rate has been baked into the central bank's playbook. That's why even as CPI data trends lower, it can't obscure the reality that the USD will keep losing purchasing power while Bitcoin's inflation rate will fall further after the fifth halving in March 2028.

On the other side of the coin, it's highly unlikely that the federal government will cut spending to a degree that leads the Fed to stop monetizing its ever-growing debt. In the near term, Fed rate cuts are far more likely to reopen capital flows into Bitcoin — regardless of where CPI trends.

Why Do Inflation Reports Affect Bitcoin's Price?

Inflation is a slippery concept, broadly understood as the rise in the price of goods and services, typically measured by government agencies. In the U.S., that responsibility falls to the Bureau of Labor Statistics (BLS) through the Consumer Price Index (CPI).

But at a deeper level, inflation is best understood as a byproduct of the central banking system. Specifically, when the Federal Reserve ("the Fed") monetizes debt to fund government spending, the central bank expands its securities portfolio — and the resulting growth in money supply manifests as inflation.

After decades of steadily increasing monetization, the most extreme episode occurred in 2020. The Fed's balance sheet ballooned from $4.2 trillion at the start of the year to $7.2 trillion by year's end. Inflation (CPI) then arrived as a lagging effect the following year, peaking at 9.1% (year-over-year) in June 2022 — the highest reading since 1981.

Put differently, the Fed has been systematically debasing the USD through continuous monetary expansion. Even Fed Chair Jerome Powell couldn't explain why the standard inflation target (the rate at which the USD loses value) is set at 2% and not some other figure.

This implies the following:

  • The USD is a manipulated asset with built-in, ongoing value erosion.
  • Bitcoin is an immutable asset whose value is secured through decentralization and inherent scarcity.

In theory, this would mean Bitcoin's price should rise when CPI reports come in higher and fall when they come in lower. But as we've seen above, that's not actually how it plays out.