Why are bitcoin and stock prices falling?
It’s a matter of balancing income with expense
Words: 736
By Perry Willis
Follow my logic…
The level of federal debt grew by 50% during the Trump administration. About half of that debt was monetized.
In other words, the Federal Reserve created new dollars to buy the government bonds that funded the debt.
This put trillions of new dollars into circulation to chase roughly the same amount of goods and services as existed before.
The increased dollars led to increased demand, but little or no new production. Prices had to rise to balance supply with demand, otherwise there would be shortages.
Indeed, we’ve had quite a bit of both things — shortages and price inflation, but price inflation has been the larger effect. Please grasp this key point…
Monetary inflation (the creation of new money) always causes price inflation. Monetary inflation is the cause and price inflation is the result. Perhaps you’ve noticed…
Prices are soaring everywhere
Wages are rising too, but not as fast. Wages always trail prices during inflationary periods. This means that people have less money to fund their customary levels of consumption. Something has to give.
There are four possibilities
- Reduce consumption
- Reduce saving
- Borrow money
- Sell assets
Since inflation is systemic, the response will also be systemic. In other words, because price inflation impacts everyone, everyone must respond to it by doing one or more of the four things described above. Bear down on this point…
All 330 million Americans are either reducing consumption, reducing savings, borrowing more money, or selling assets. But there are reasons to think that reduced consumption may not be the favored response. Please consider…
Price inflation incentivizes increased debt, reduced savings, and asset sales
Why forego consumption today when prices will be higher tomorrow? Why not buy things now when they’re cheaper than they will be later?
And why not borrow to fund this consumption if the dollars you receive today will be worth more than the dollars you will pay back later? Remember, you can pay back most of the loan after your wages have risen. This is a way to manage the fact that wages lag behind consumer prices during monetary inflation. But it gets worse…
Why save if the returns you receive won’t cover the cost of inflation? It makes short-term economic sense to save less and borrow more during monetary inflation.
The impact on asset prices
Those who reduce savings are doing less to bid up investment assets such as stocks and crypto. This, in turn, increases the incentive to sell assets.
If asset prices aren’t increasing, but the cost of living is rising, then many people will try to balance income and expense by selling some of their assets now while they can still get a good price. Those who are selling assets such as stocks and crypto are putting downward pressure on the prices for those assets.
Stock and crypto prices are set by marginal sales. Only a few assets are sold each day, but the prices for those sales are presumed to represent the current value of all the assets in that class. Thus, reduced savings and asset sales make it appear that all of those assets are worth less than they were before. This can cause…
Panic
When asset prices start to fall people naturally wonder how low they will go. No one likes losing money. This increases the incentive to sell now, before prices fall even further. The fear then is father to the risk. That which is falling tends to continue falling.
The Answer
I believe all of this is sufficient to explain the severe drop in bitcoin and stock prices. People are attempting to sustain their standards of living in the face of severe price inflation. They are trying to balance income with expense. This means they are saving less, borrowing more, and selling assets to maintain old patterns of consumption. All of this pushes asset prices lower.
What should you do?
Personally, I will try to think long term, and not submit to short term incentives. I am trying to respond to price inflation by reducing consumption. If I can reduce my spending by more than the amount I am currently losing to price inflation, then I will buy assets like bitcoin and stocks, because I believe both assets are presently priced below what their long-term value will be.
Inflation doesn’t last. Asset prices always recover. It makes sense to buy when others are selling.
