By Michael Schmid in Bitcoin — Nov 17, 2021

Inflation Hedging

Inflation is not going away and our financial system is broken and flawed. In my opinion not having Bitcoin today is an actual risk.

Disclaimer
None of this is financial advice. I believe that our school systems do not teach us properly about saving for the future, especially in a high inflation environment. Please use the information you find here just as one step in your journey of saving and investing for the future.

Most Important:
Always use your critical thinking skills. Try to think about who profits from the current existing system and if the people behind the current system have an interest in telling us how the system really works or not.

TL;DR:
Inflation is not going away and our financial system is broken and flawed. Buy a property with a mortgage if you have the possibility and put the rest of your savings in Bitcoin or as much as you feel comfortable with. In my opinion not having Bitcoin today is an actual risk.

Inflation and your savings

There are many different types of savings available to us, most people have either a savings account at a bank, or a pension account, or probably both.

Pension accounts provide you with a return of around 3% to 8% depending on the type, how much risk you take and many other factors. Savings in developed countries accounts are way worse, they give you 1% if you are lucky. In developing countries they might give you higher rates, but rarely above 8%. Source

Now let’s look at inflation. We’re told that an inflation rate of 2% is a good driver for the economy (I don’t agree, and that’s a topic for another day, let’s just use this as an example). This 2% inflation means that if you were able to buy a car for $20’000 at the beginning of the year, you will need to pay $20’400 in the next year for the exact same car.

If you subtract inflation from your savings yield, you can see that your savings yield needs to be higher than inflation or your money would be worth less. If inflation is higher than the interest earned on your savings, your savings are slowly melting away

And yes you would still have more money in number terms in your pension than when you started, but that money can buy you way less than when you started. The important factor is not the amount of money, it’s what you can afford with that money.

With 2% inflation your pension account therefore makes 1% - 6% yield, which is not epic, but a pretty safe investment.

The are four problems though:

Inflation is rising fast and this increase doesn’t seem to be transitory and will most probably continue on for many months and maybe years to come.
Inflation is measured in the rate of change. If you have 6 months of 5% inflation, we would need 6 months of -1% inflation (deflation) in order to be on the same trajectory as 12 months of 2% inflation. If we just go back to 2% inflation after 6 months of 5% inflation, we have done 18% (6 x 3%) “damage” to our savings that we don’t get back (the actual math is more complex than this, but you get the point)
Inflation is very very hard to measure, as for every person it’s completely different. If you own a car and drive it every day, you care about fuel prices much more than if you don’t have a car.
Governments change how inflation is measured every couple of years. If we would use the same inflation measurement system that originally was created in 1981 we would have today an inflation rate of 15%.

All this together basically means that inflation is higher than your savings yield and therefore your money will be worth much less when you actually need it in the future.

Long story short, we need to find savings options that produce a yield which will be consistently and predictably higher than inflation. This is called an inflation hedge. Before I list things that provide higher yield and why they are a good hedge. I think it’s worth understanding a bit more about our financial system, for three reasons:

The more you understand about how the system actually works, the better decisions you will be able to make.
Our school system doesn’t really teach us much about our financial system, why this is, we can only speculate. But nonetheless it’s important to understand how stuff works.
I believe that the current system is fundamentally flawed and high inflation rates are just the beginning of a much bigger change coming at us.

If you don’t have time to read all of this (really you should take time for this), just skip to the Bitcoin part of this.

First: Debt Cycles and how Credit works

You probably have heard about cycles in the market, do you know what drives them? It’s credit. Credit allows us to live above our means and pull money forward that we don’t have yet. But credit has to be paid back and this means there is a time where we have to live below our normal standard. This generates a cycle for individual people. If all people are on the same cycle it creates a market cycle. And then there is a short term and a long term cycle, many believe we are close to a correction in the long term cycle.

If you like to learn more about dept cycles, watch this:

It’s a lot of information in a short amount of time, so I suggest you watch this video at least twice to truly understand it. If you don't have time right now, no problem, but I strongly suggest you come back and watch it.

Second: Fiat Money is eventually going to die

We believe that money has existed since humans started to trade with each other. While this is true, the money that we use today has only existed since 1971 (when the US shifted from the gold standard), yes this is only 50 years. Plus any other Fiat money in the past has died before.

Until 1971 humans have mostly used money that was supported by some kind of precious metal (gold, silver) or some other rare physical objects (salt, shells, rocks, etc.). The actual bills and coins that we used were just a proxy for actual gold. At any time you could exchange your bills into gold from your bank. Gold was chosen because it’s physical properties make it never change into something else, plus it’s very hard and expensive to dig more gold out of the ground, which means there is only around 2% new gold found every year.

In 1971 the US government decided to stop this gold standard and create Fiat money: Money that can be printed at will by the government and is not backed by anything physical anymore and just the trust of the people into the government.

To learn more about this topic, watch this video:

Some parts of the video are a bit overhyped, it focuses a bit too much on Gold for my taste and the continuous mentioning of the “ponzi-scheme” is a bit overdone. But the video does a good job of explaining the situation of Fiat money and why it is eventually going to die.

If you want to learn even more about the history of money, different types of money that humans used throughout history, how the world wars are connected to money and how every other fiat currency so far always died, read this book:

and if you want to learn even more, read also The Fiat Standard.

If you don’t have time to read a whole book, get a free trial on Blinkist and get the summary of “The Bitcoin Standard” it’s 16 minutes and worth every minute.

If you want to learn even more, read this book about how the Weimar Republic hyper-inflated their currency, you will find a lot of similarities to today's situation.

Third: Fractional reserve banking is poison

Deposit your money to the bank. It's safe there and you can get it any time back.

This is what we are told about banks, unfortunately it’s a lie.

Fractional reserve banking allows banks to take the money that is deposited and lend it to somebody else without you telling about it, these other people then put the money into another bank and can lend it again, and again and again. Basically they are creating new money out of thin air and if many people at the same time would pull their money from the bank, the bank would collapse within days, yes the Government maybe bails out the bank and shortly prints more money, but a bank collapse could cause more people to pull their money and cause a huge collapse of the financial system as we know it. Something that happened multiple times in the past.

Watch these three videos to learn how fractional reserve banking exactly works and how we probably all thought that our banks work by a full reserve banking system:

And now the kicker:

In the videos above the reserve for the banks is at 10%, meaning that they could maximum give out 90% of what they have.

Now guess the reserve ratio today.

Yep you are correct, it’s 0.00%

This means that banks can not only lend out every dollar they receive from somebody else, it means they don’t even need money from anybody in order to lend more money out. So if you go to the bank and ask for a loan of 10k, they basically go to the database that holds the amount of your checking account and just increase it by 10k and that’s it. No money from somebody else, no reserve needed.

This maybe all sound scary, but it actually held up quite well

If you understand points 1 to 3 you might be worried even more about the future and see a doomsday scenario in front of your eyes.

But let’s see the fact straight: Our economies went through multiple crashes or hard times in the last 50 years and every time they recovered quite fast. So we can’t really blame the people that believe in this system and are defending it, as it has worked quite well so far. Also most people that lived for a long time on a gold standard before 1971 are all dead now, so there are not many people that could remind us how the system worked before.

There is though no immediate need to change your complete savings strategy just right now, there is still enough time to adapt. Keep in mind we are talking about long term savings here.

Hedge 1: Buy a House with a Mortgage

This might sound strange initially, but a mortgage is a bet against the fiat system. Let me explain:

If you buy a house worth 300’000 USD and get a Mortgage for 250’000 USD for 30 years on it (the remaining 50k you paid by yourself, which is the “down payment”, also called “deposit” in some countries), the fiat will inflate by minimum 2% every year, so your house is worth 540,000 USD at the end of the 30 years just for inflation. Not because the house is worth more, it’s just because the piece (USD) that we measure the price of the house has inflated away. (This is an important point to understand, just because something goes up in money value, it doesn’t mean it’s worth more, it can also be that the money gets worth less)

Now the interesting part: Your Mortgage will always be for 250’000 USD and the interest rate is also measured against the 250’000 USD, your mortgage interest will not be adapted for inflation. So technically it becomes easier and easier to pay for the mortgage as the money you have to pay for it is less worth and should be easier for you to reach.

Plus it’s possible to refinance your property with a new mortgage. Again this sounds initially strange, but can be beneficial:

Let’s assume that after 5 years you paid down 50’000 USD of the 250’000 mortgage and owe now 200’000 USD. Your house based purely on inflation is now worth 330’000 USD. If you refinance the house you now need a mortgage for just 60% (200k / 330k) of the worth of the house, while before you had a 83% (250k / 300k) mortgage on the house. Many mortgage companies will give you better rates and conditions for a lower mortgage percentage and so over time you can reduce the interest rate even more. Or you can take some more money as cash out, so you could refinance again with 250’000 USD on the 330’000 USD house worth, this is still a reduction to 75% and you get 50’000 USD cash to be used for anything you want (house improvements that increase the value of the house even more are a good choice for example)

Now a couple of caveats:

This system assumes that you have a low interest rate on your mortgage. If you pay 20% in interest, you will have a very hard time to pay down the principal of the mortgage and inflation is probably not high enough for this calculation to work.
But in today’s world where mortgage rates are at 3%-5% and high inflation this will work.
This system assumes that you actually can pay the interest in your current financial situation. You cannot depend on inflation magically making the house worth more, we’re talking about multiple years here. If you can’t afford the interest don’t do this.
For these calculations to work it is assumed that you somehow make more money in the future than you make today. In a normal situation where employers increase your salary for inflation and you also will level up and increase your salary, this should be no problem. In some situations though this might not work out, so be careful here.
This system assumes that you have a fixed rate for the whole length of the mortgage. There are some mortgage systems out there that lock the rate in for 5 years but then adjust the rate every year. This is extremely dangerous and if the rates go up (which they probably will) you could very easily be in a situation where you cannot afford the mortgage anymore and default on your mortgage and loose everything.
The worth of your house is not just defined by inflation and the price of the house can go down for a multitude of reasons. So research the property and the surroundings of the property well!

All of this sounds maybe too good to be true, and as somebody that is a recent house owner I have to tell you that it is.

Unfortunately though not everybody has the possibility to buy a house: You maybe don’t have the possibility for a down payment on a house (you can use your pension fund in some cases, plus there are incentives for first time house buyers in many countries) or you just live somewhere where there is no property available or they are too expensive for your situation.

Don’t worry, there are other hedges coming up, with the best at last.

Hedge 2: Buy Gold

Gold has been used as money and store of value for thousands of years. The chance that gold is also used in the future is quite high. And looking in the long term, gold has done an overall good job in increasing in value over a long period of time.

If anything drastically should happen to our financial system many people will want to protect their wealth and gold will be a choice of many people, making it more valuable.

So having some gold is probably a safe way to invest your savings.

Unfortunately there are some caveats here as well:

The entities that run the fiat financial system (the central banks) are also some of the biggest Gold holders in the world. Which means they can control the Gold price by buying or selling Gold in big quantities. Of course they can’t do this forever as at one point their Gold reserves are depleted, but until then they have quite a big control over the Gold price.
Central Banks self report how much Gold they have, nobody really knows if what they report is really correct. There is no higher instance that could verify if the Gold reserves are all correctly reported.
Gold is heavy and hard to transport. So even if you buy Gold you might not actually get the Gold physically, which means in case of disaster you still are depending on an intermediary company that gives you access to the Gold. If that company doesn’t like you, or the government that the company is in doesn’t like you, you may lose access to the Gold all together.
In the last years we humans have roughly increased the supply of above gold by 2% every year. This doesn’t mean though that this will continue the same way. It’s possible that we invent a new technology that would allow us to mine much faster or even produce Gold from another material. This would be devastating for the Gold price if we suddenly have 20% more Gold from one year to the next.

So overall Gold might be a hedge against inflation, but on a closer look it might not be the best out there as Gold is still controlled in big parts by the current fiat system.

Hedge 3: Buy Bitcoin

I won’t have time and space to explain in full why I believe that Bitcoin is a great inflation hedge and why it has a great possibility to become the future world store of value and even a unit of account replacing fiat money.

So I will look at it from a purely inflation hedge point of view, there are a couple of reasons that it’s a huge mistake not to have bitcoin, even if it’s just 10 Dollars:

Bitcoin is the only asset we know today that has a truly limited supply. There will only ever be 21 Million Bitcoins. And from simple supply and demand that we learned in school, if the supply is limited and demand is steady, prices will go up. One of the big reasons that we have high inflation today, is that the central banks have printed trillions of dollars and injected it into the market which causes demand for goods to go up and therefore increase their prices, hence inflation. This cannot happen with Bitcoin as nobody can manipulate the supply.
Bitcoin is controlled by nobody, no single person, organization or government can mess with it. As soon as somebody has control over a monetary system (like central banks have over the fiat system) there will be greed slowly creeping into the thinking of the people in charge and they will take decisions that profit themselves and their peers, even if they maybe don’t realize. This cannot happen with bitcoin as the creator of Bitcoin Satoshi Nakamoto does not exist anymore and the bitcoin protocol is controlled by more than 10’000 computers spread around the world.
Bitcoin is truly decentralized and nobody can take away your coins. With the current financial system we rely on somebody controlling our money and investments, if that organization goes bankrupt you possibly lost all your money, if a government doesn’t like you anymore they can just take all your money away. With Bitcoin that’s impossible, as you control the coins with your private key and as long as you keep the private key for yourself, nobody can take away the money, no matter in which country you are. You can even create a system that needs multiple private keys to access the bitcoin (called multisig), so you are safe from break ins or hacking attacks.
Bitcoin is fully digital and open source, while for some people this is probably freaky and they would rather invest into something they can touch, I would 100x put my money into something that is digital and open source than a bank or another company. With Bitcoin you can verify yourself at any time that the money you have is still in your control, with banks and even with Gold this is very hard, in some cases even impossible. There is a German saying “Vertrauen ist gut, Kontrolle ist besser” (“Trust is good, control is better”), and especially with hard earned savings I would rather have a system that I can control any time and bitcoin gives me that.
There is no minimum on Bitcoin, many people think they need to have 1 Bitcoin, which is currently around 60’000 USD, this is wrong. One Bitcoin can be divided into 100’000’000 Sats (Satoshis), so you can buy just 1 Dollar worth of Bitcoin, which is currently 1’500 Sats.
There is no restriction on what you can do with your Bitcoin. With a pension account you are limited to access your savings, there are some specific cases where you can access it, but they are very limited. So if you really need the savings you might not be able to use them. With Bitcoin that’s not possible to happen, it’s your decision what you do with the Bitcoin at any time. This of course also means that there are no guardrails for you and if you want you could use all your savings and give it to scammers on the internet, so please use your critical thinking skills any time you do something with your savings.
We are still very early with the adoption of Bitcoin. There are estimations that only around 100 Mio people own Bitcoin, now compare this to the amount of people in the world and you can see that we are just scratching 2% of all people that have Bitcoin. While inflation is affecting everybody on a global scale and everybody has to find an inflation hedge at one point.

I hope this explains to you why it is a mistake to not have any bitcoin in the current inflation situation. I’m not talking about all your savings, but just one to three percent of your savings allocated to bitcoin can protect you from sustained inflation over the next few years. And if one percent is too much for your taste, just try 1 USD or 10 USD or 100 USD (whatever you feel comfortable with) and see how Bitcoin works and how it feels. I can say from personal experience that it is extremely freeing being in full control of your savings without anybody else being able to take it away.

Now we have not talked about the future price of Bitcoin, because honestly in terms of inflation hedge it does not really matter that much, because it’s almost a crime not to have Bitcoin: In order to be a good inflation hedge, Bitcoin has to provide a return of around 10% per year. Since the beginning Bitcoin has done a minimum 300% return over any two year time period and in some cases even 2000% return over one year. So it passes the test of 10% return per year easily.

Of course there is also the possibility that Bitcoin does another 2000% over the next few years and some people (including me) believe that the current 60’000 USD Bitcoin will be a rounding error in a couple of years as we will hit a minimum 1 Mio USD Bitcoin or even 100 Mio USD Bitcoin. But this again is a topic for another post, right now it’s about inflation hedging and so far I’ve not met anybody that does not believe that Bitcoin is a bad inflation hedge, just for the fact that it has a limited supply and is not controlled by any government.

If you like to learn more about Bitcoin, here a couple of very good sources to learn more:

Podcast of two hours covering everything Bitcoin and our financial system from A-Z.

Another podcast with Preston Pysh a very good thinker and communicator in the Bitcoin space.

Covering the history of Fiat money, how Bitcoin came to be, almost a must read.

Conclusion

We’re in a strange world and nobody really knows what is going to happen in the near and long term. I know one thing though:

Not owning even a little bit of Bitcoin could be one of the worst decisions in your life if you like your savings.

If you are ready, head over to https://www.buybitcoinworldwide.com/ where you can learn everything on how to buy Bitcoin (select your country and payment type on top and go through the whole page), and of course you can also reach out to me and I’m happy to help.