The Relationship between Bitcoin (BTC) and the Money Supply

The money supply appears to be the determining factor for the level of major global stock indices. The influence of the money supply on the stock market

We largely know, with significant consistency, the close relationship between the S&P 500 and the level of the money supply. We also know the fairly high long-term correlation between the S&P 500 price and that of bitcoin. Therefore, it is likely to assume the existence of a close link between the money supply on the one hand, and the price of bitcoin on the other. In this paper, we will focus on describing the nature of the relationship between bitcoin (BTC) and the money supply for the United States.

The link between the S&P 500 and the money supply

Major stock indices like the S&P 500 are largely determined by macroeconomic variables. Indeed, the S&P 500 alone represents nearly 80% of the US stock market capitalization. This mass effect allows, independently of individual values, to judge global economic dynamics. Thus, many economists have long observed a close relationship between the amount of money (M2) and the S&P 500 for the United States.

Indeed, an econometric study between 2014 and 2024 shows the existence of a correlation and determination of over 90%, even 95%. The link between the money supply and the S&P 500 is not only considerable, but it is also particularly determining. The graph below shows the S&P 500 price (black curve) and the level of the model based on the money supply and cyclical phenomena. The correspondence between the two curves is extremely strong. This strongly suggests that the S&P 500 is largely determined by the money supply, as well as the bullish or bearish excesses surrounding monetary expectations.

How to explain this phenomenon?

The relationship between the money supply and the S&P 500 can be explained in the short term and the long term. In the short term, a decline in rates can encourage an increase in the growth of the money supply. This first shock leads to an increase in liquidity in the money market, which mechanically favors stocks. In the long term, this relationship can only be valid if the increase in the money supply translates into an increase in companies’ results and/or economic growth.

Therefore, we can assume that the increase in the money supply leads to an increase in agents’ wealth (assets and liabilities). There is a wealth effect in the sense of Milton Friedman, meaning that the anticipated increase in agents’ wealth leads to an increase in growth. Ultimately, company results and stock values increase in the long term. The relationship between the money supply and the S&P 500 is viable.

The causes identified by Milton Friedman

The relationship between stock indices and the money supply has been identified for many decades in the world of finance and economics. In the 1980s, Milton Friedman advanced some elements of explanation for this empirical relationship.

“The inverse relationship between stock prices and monetary velocity (or the direct relationship between stock prices and the level of real money balances per unit of income) can be rationalized in three different ways:

Money Supply (M2) and Bitcoin (BTC)

The presence of a significant correlation between the S&P 500 and the bitcoin (BTC) price leads us to consider an influence of the money supply on bitcoin. A simple linear study allows us to identify, between 2015 and 2024, a determination of nearly 72%. That is, more than 70% of the variability in the bitcoin price is explained by the money supply. The graph below shows the level of the money supply and the level of the S&P 500. We can see quite clearly, from the adjustment presented here, that bitcoin’s major highs are more or less framed by the money supply.

However, it may happen that the bitcoin price temporarily exceeds the level suggested by the money supply. This was the case in early 2024, before the correction in March and April 2024. Therefore, exceeding the level suggested by the money supply indicates that markets are optimistic about the future growth rate of the money supply.

Bitcoin and money supply: the model

The econometric estimation of the relationship between the money supply and bitcoin allows us to construct a theoretical model. Indeed, such a model allows us to compare the bitcoin price with the level of the money supply. However, the bitcoin price is significantly more volatile than the money supply. As a result, bitcoin experiences cycles of bullish and bearish excesses around the level of the money supply. To improve the model, we thus correct the initial equation for this cyclical phenomenon. Finally, we obtain the following graph.

The graph above thus shows the bitcoin price with the corrected model based on the money supply. The significant symmetry between the two curves suggests that the bitcoin price has two major determinants:

We thus note that the coefficient of determination for such a simple