Is the dollar a great store of value? Well, that depends. In the U.S., by definition, each dollar you hold is worth less every year due to the Federal Reserve’s mandate to maintain an inflation rate of two percent. What that means is the purchasing power of a $100 bill in five years is $90. In 10 years it’s $80, and in 50 years, in real terms, it’s worthless. So, keeping cash in a mattress or a piggy bank is not a good investment thesis.
Inflation and Dollar Devaluation
The mandate to maintain a two percent inflation rate incentivizes people to invest their cash into an instrument whose interest rate, or expected rate of return, exceeds the current inflation rate. It encourages savers to invest their cash; they can buy bonds (both government and corporate), equities or other investment products (exchange-traded funds, mutual funds, etc.). The purpose is to make a dollar invested today worth more tomorrow.
But how do people make these investments?
Typically, most people put a portion of their wages into a 401(k) program offered by their employer, and a portion will go into an investment account offered by their financial institution. The traditional financial advice is that younger people should hold a larger allocation in equities and older people should hold a larger allocation of bonds.
Sounds pretty straight-forward, right? You get paid wages, invest a portion, and if the markets continue to rise, your money invested is worth more than the rate of inflation.
Digital Currencies and Inflation
Purchasing digital currencies can help you achieve many of the same goals. They can be a medium of exchange to purchase goods and services, they are a store of value not subject the same inflationary pressures of the U.S. dollar, and they serve as a speculative investment. These are all reasons participation in digital currencies has become so popular worldwide.
How will this new asset class impact traditional investments? All things being equal, it should reduce the demand for traditional investment products offered by financial institutions and bonds issued by governments and corporations. If people take fewer of their dollars to purchase traditional investments, who will fill the gap these investors leave?
We are not at the point of seeing a significant impact in the financial markets due to people moving their assets out of traditional investment products into digital currencies. However, we have seen unprecedented wealth creation due to the rise in the value of digital currencies. The growth in value did not come out of nowhere; a lot of money has moved into digital currencies. Digital currencies have no borders, and purchases of digital currencies come from every corner of the globe. Some are buying as a means of investment, as a store of value or as a means to make cross-border transactions more efficient.
Today’s interest rates are at historic lows, geopolitical tensions are rising, and a 10-year bull market is looking fatigued. Which would you rather hold: Bitcoin, S&P 500 or a one year t-bill?
While all investments come with some risk, perhaps the riskiest move of all is to simply save your money in a bank or to invest in something with a rate of return almost sure to be less than the rate of inflation.
Digital currencies are quickly becoming a means to achieve your financial goals, whether buying goods, saving money or investing.