Words: 659
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 brand new dollars to buy the government bonds that funded all the new borrowing. This meant that trillions of new dollars were put into circulation to chase roughly the same amount of goods and services.
Price inflation has been the inevitable result. Monetary inflation (the creation of new money) always causes price inflation. 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 the prices for the things you want 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 price 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, then many people will sell some of their assets now while they can still get a good price. This means that 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 will they 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 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. I don’t want to 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 currently 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.
Very concise; very good summation (and on target).
I'll only add that while "Asset prices" may "always recover", that doesn't mean they can't vary a whole lot in the interim--who knows if there will or won't be a whole lot more foreign-held dollars coming home to roost, to know how they all play out in domestic prices.