Understanding Inflation, Compound Interest and Bitcoin as a Hedge
Inflation isn’t just an abstract economic concept or a force of nature, it quietly erodes your purchasing power, diminishing your savings over time. But where exactly does inflation come from, and how can you protect yourself?
Let’s break it down clearly:
What Causes Inflation, Really?
Inflation is commonly described as rising prices, but that’s just the symptom, not the cause. Inflation doesn't happen 'naturally' either, it is mostly manufactured. The real drivers behind inflation are:
Monetary Expansion: When central banks print more money or increase credit, more currency chases the same amount of goods, causing prices to rise.
Supply Shocks: Events like pandemics or geopolitical conflicts disrupt supply chains, reducing availability and pushing up prices.
Demand-Pull Inflation: When demand for goods and services exceeds supply, prices naturally rise.
Of these factors, monetary expansion is the most persistent and influential long-term driver. It’s also the one most within government control.
Why 2% Inflation Is Considered “Healthy”
Economists and central banks around the world treat 2% annual inflation like a golden rule. It is often said that 2% inflation is 'healthy' for an economy.
Let's look at why that is said:
It’s just enough to encourage people to spend and invest instead of hoarding cash.
If prices are expected to rise slightly over time, people are less likely to delay buying a car, a house, or launching a business.
Moderate inflation also gives employers room to raise wages nominally, even if real wages stay flat.
That’s the theory - and it's not wrong. But here’s the truth that is often not mentioned.
The real reason governments prefer inflation is because it makes their debt cheaper over time.
With 2% annual inflation, a trillion euros in debt becomes significantly easier to pay back over the decades, because the value of that debt diminishes in real terms. It’s a quiet, politically palatable way to default on obligations without ever calling it that.
You pay higher prices. The governments reduce their debt. Quietly.
The Compound Effect of 2% Inflation
Even low inflation compounds. Here's how 2% plays out over time:
Year 1: €100 → worth €98 by year-end
Year 5: €100 → worth €90.39
Year 10: €100 → worth €81.71
That’s nearly a 20% loss of purchasing power in just a decade, while being called 'stable'.
Now imagine your savings sitting in a bank account earning 0.01% interest. You’re slowly bleeding value, whether you notice it or not. The numbers don't change on your account, but your purchasing power, i.e. your ability to buy goods and services with it, declines over time.
That’s the power of compound interest, but working against you.
Why You Can't Afford a House: Inflation in Action
Inflation is also one of the main reasons why you can't easily afford a house nowadays. Imagine you've saved diligently, planning to buy a house for €300,000. With inflation at 5%, the cost of the same property rises significantly each year.
After just five years, that house would cost around €382,884, an increase of almost €83,000. Meanwhile, your savings, if sitting in a typical low-interest savings account, barely grow. The gap between what you have and what you need widens rapidly, making homeownership feel increasingly out of reach for most people who earn a regular income.
How Compound Interest Can Work For You
The antidote and the good news? You can make compound interest work in your favor and grow your wealth faster than inflation eats it away. Here’s how it works:
If you invest €10,000 with a 7% annual return, in 10 years you have roughly €20,000.
Over 20 years, it grows to approximately €40,000.
Over 30 years, you end up with over €80,000.
Your money doesn’t grow linearly, it accelerates dramatically over time. Notice how the money almost doubles every 10 years? That is the rule of 72 I discussed in my last article (72 / 7 = 10.28, i.e. it takes ca. 10 years to double your investment at a 7% annual interest rate). But that does not magically happen, you have to take action and put your money to work in an investment account.
Why Bitcoin Stands Out as an Inflation Hedge
So, why Bitcoin? If you're reading this blog regularly, you'll know that I am a big fan of Bitcoin and here's why from an inflation perspective:
Limited Supply: Bitcoin’s total supply is capped at 21 million coins. Unlike fiat currency, no authority can print more at will.
Decentralization: Bitcoin operates independently of governments or central banks, insulating it from inflationary monetary policies.
Historical Performance: Over the long term, Bitcoin has significantly outperformed traditional inflation hedges like gold.
Institutions and governments are increasingly recognizing Bitcoin’s role as a legitimate hedge against inflation, highlighted by recent institutional adoption and the US plans for a Strategic Bitcoin Reserve.
Putting It All Together
Now what, you might ask. Inflation isn't going anywhere, it’s built into the modern financial system. But by understanding its true origins and harnessing the compound effect in your favor, you can still build lasting wealth. If you take action and use your money. The only way to do this is by investing it in appreciating assets, i.e. assets that grow in value over time, ideally faster than inflation.
This is true for stocks and ETFs. And Bitcoin offers an alternative route: a hard, digital asset mostly immune to monetary manipulation and dilution. Its fixed supply, global adoption and decentralization make it an ideal long-term hedge.
Final Thought
Inflation might be inevitable, but losing to it is not. Compound interest and Bitcoin offer powerful tools to defend and grow your wealth over time. The only thing you have to do is start taking it seriously.
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