Ecoinometrics - How will Bitcoin be affected by the contraction of the money supply?
Bitcoin vs M2
The past few years have seen some pretty wild swings of the M2 money supply in the US.
From an unprecedented expansion after the COVID crash to the unprecedented contraction happening right now there is enough to make your head spin.
But how does the dynamic of the M2 money supply affect Bitcoin’s price action?
Maybe not as much as you might have thought.
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How will Bitcoin be affected by the contraction of the money supply?
Correction in the money supply
The M2 money supply of the US$ is the sum total of all cash or near cash instruments that form the liquid part of the US$ being part of the economy (cash, checking deposits, saving deposits, money market funds and probably soon central bank digital cash).
So M2 is the kind of liquidity that can be spent or invested with the least amount of friction.
The equivalent of M2 for Bitcoin would be the 21 million coins. A fixed supply enforced by code. For fiat currencies such as the US dollar it can be pretty much anything though. And over the years the M2 of the US$ has expanded greatly.
Checkout the chart below. You can see the year-on-year change of M2 going back to the 1960s.
If the year-on-year change of consumer prices is called inflation then we might be tempted to say the the year-on-year change of the M2 money supply be called debasement.
And that’s a pretty steep debasement. If we exclude the most recent period the average expansion rate of M2 has been around 7% with a high at 14%. The COVID crisis blew that away though. As you can see on the rightmost part of the chart the M2 changed peaked at more than 3 times the average of the past 60 years.
And like the pendulum swinging in the opposite direction we are now seeing a year-on-year contraction of the M2 money supply for the first time in the past 60 years. A cash crunch of sort.
What does that mean for Bitcoin?
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