The U.S. CPI Is On the Corner. How Does the Index Impact the Crypto Market?

2022-07-19, 07:13

[TL; DR]
· The consumer price index (CPI) measures changes in the average aggregate price levels of an economy.

· The consumer basket comprises the basic goods and other essential products the urban dwellers of a country use.

· The major categories of a CPI include food, energy, housing, healthcare and transportation.

· Soon after the United States announced an increase in May’s CPI the prices of most cryptocurrencies fell.

Introduction

There are fundamental issues which affect prices of cryptocurrencies and confidence in the market. Among the fundamentals are economic issues such as inflation, interest rates and income levels. Since these are macroeconomic variables the market cannot control but rather react to them. Governments use consumer price index to measure inflation, a critical determinant of market performance. In June , the crypto market tumbled following the increase in the United States consumer price index. This article discusses the impact of inflation on the cryptocurrency market.

What is the Consumer Price Index?

The consumer price index (CPI) is a metric for measuring the aggregate price level of a country. In other words, it measures the average change of prices in an economy. The index reflects the increase or decrease of the purchasing power of the consumers. If the average price falls below the previous level there is deflation and if it rises above it there is inflation. The government measures the price change for a period such as one month or yearly.

The consumer basket and weights

The CPI measures the price changes of a basket of goods and services. This basket represents the major products which urban households use. For example, in the United States over 200 categories of goods and services constitute the consumer basket. The consumer basket has the basic commodities and other essential products such as water charges, auto registration fees, vehicle tolls, accomodation and clothing, among others. The major categories include Food, Energy, Housing, Health care, Transportation and Other expenses.

The items that compose the consumer basket are weighted. The value of each category is a certain percentage of the total. The following is an example of the weights: “Food 13.4%, Energy 8.3%, Other Commodities, 21.5%, Housing 32.5%, Health care 6.9%, Transportation 5.7% and other expenses 11.7%.” In this case, the weights constitute 100% which should always be the situation.

What makes this calculation remarkable and reliable is that there is a base year. Therefore, the current prices are compared to those of the base year. Having said these, let's discuss the importance of the CPI?

The importance of CPI

As a recap, the consumer price index is a measurement of inflation and deflation. Inflation means the general increase in the price of goods and services within an economy while deflation is the general decrease in the aggregate prices of products. As a result, the CPI is a good pointer of the performance of an economy. Both the government and private investors use the CPI to make decisions on policy issues.
The CPI is useful when establishing cost of living adjustments on wages and salaries in a country. Employers adjust employee earnings based on the monthly, quarter yearly or annual CPI figure.

Governments use the CPI as a basis for crafting economic policies. For example, the government can introduce policy measures to reduce inflation. If the CPI is high most governments increase interest rates to make borrowing expensive, thus tightening the country‘s monetary supply.

Limitations of CPI

The consumer price index has some limitations you should know. The major drawbacks arise from the collection of information and the composition of the consumer basket. From time to time the government includes new products in the consumer basket. In this case, the CPI does not reflect the new products as they were not part of the original basket. Second, the CPI does not take into account changes in the quality of the products. For instance, if the producers improved the quality of bread, the CPI does not account for the improvement in the taste and nutritional value. It only deals with the price change.

Also, the CPI does not reflect the expenditure and preferences of the population’s subgroups. As an example, the consumer basket reflects the lifestyle of urban dwellers and not people in rural areas. Therefore, the population samples used in collecting the data do not represent the various sections of the population.

Effects of CPI on the crypto market

For a long time crypto experts believed that cryptocurrencies hedge against inflation. However, recent developments have shown that inflation negatively affects the crypto market. In fact, the recent increase in the CPI in the United States led to sharp decrease in prices of many cryptocurrencies in June. As a fact, in early June the United States announced that the CPI had increased by 8.6% on a year-over-year basis and by 1% on a monthly basis for May.. Commenting on this, The Bureau of Labor Statistics said that there were price increases on many essential commodities such as fuel, shelter and food. For example, the energy index rose by 3.9% on the month-to-month basis. Notably, there was a 12% yearly increase in the price of electricity which would have resulted in an increase in the cost of mining cryptocurrencies such as BTC.

The crypto market statistics shows that the increase in the CPI affected most cryptocurrencies. For example, there was a massive sell-off of cryptocurrencies within the first half of June 2022. By 13 June the total crypto market capitalization fell from over $1 trillion to about 977 billion. According to CoinMarketCap, some cryptocurrencies lost up to 17% within that period.

Let’s focus on price movements of major cryptocurrencies within 24 hours that stretched from 12 to 13 June. The price of BTC fell by 10% within 24 hours while its dominance decreased by 0.36%. In all, the price of BTC fell by 20.86% within one week.

Within the same 24 hours, the price of ETH fell by 13% and by about 33% within 7 days. However, it maintained its second position based on market capitalization. BNB recorded a 10% price fall within 24 hours and 25% within 7 days.

The situation was similar with the other cryptocurrencies. There was an 8% fall in the price of XRP within 24 hours and 20% within one week. The prices of Cardano, Dot and TRX also fell significantly within the same period.

Conclusion

The consumer price index measures the general change in prices of goods and services in the economy. An increase in the CPI shows inflation while a decrease means there is deflation. National governments use the CPI when creating national economic policies. After the United States announced the CPI for May, there was a general fall in prices of cryptocurrencies which reduced the total crypto market capitalization.

Author: Mashell C., Gate.io Researcher
This article represents only the views of the researcher and does not constitute any investment suggestions.
Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all cases, legal action will be taken due to copyright infringement.