my argument against the so called deflation problem

[grondilu]

A typical economically oriented argument against bitcoin is the "bitcoin will eventually create a deflationary spiral" one.

According to this argument, bitcoin will fail because it lacks a way to inject new money into the system in order to suit economic growth.

I think most of bitcoin adepts answer this argument by defending the concept of deflation, explaining that it is really not so bad after all.  It's especially common amongst former goldbugs as myself.

However, there is a much simpler argument, that doesn't even have to defend the idea of a deflation-friendly economy.

In a keynesian nightmare, people would start to hoard bitcoins in such an extent that bitcoins become rare in circulation and thus prices start to fall.  Then people are even more inclined to hoard bitcoins, and that is the very deflationary spiral.   In such a situation, the lack of money in circulation will create a demand for money.  The failure of bitcoins to serve the economy will become more and more apparent and people will just start to want an other currency.   To put it simply, they will just create an other block chain.   Bitcoin is a tool to create money.  It can be started as soon as a social/economic consensus requires it.

On the opposite, if the bitcoins do their job and allow trades to occur correctly, there is no need for a new currency and nobody will be willing to put any effort into a new block chain.

Between those two situations some equilibrium has to be found by the market.  It can be observed by looking at the prices of the main cryptocurrency compared to other challenging cryptocurrencies.

Bitcoin doesn't prevent from creating more money than what is written in the software.  It prevents from creating more bitcoins.  Mind the difference.   Basically monetary injection/destruction is possible with cryptocurrencies.  It's just that it obeys social consensus and individual economic freedom, and NOT central bureaucratic forced planification.

[FooDSt4mP]

planification

+1 wordsmithing

Although, google suggests you could just be French.  In that case, -1 translation.

[Vandroiy]

Most people do not really want more Bitcoin incarnations. That defies the purpose of keeping them rare and stable. Concurring Bitcoin block chains would hold many problems.

I don't see how hoarding would go into some extreme though. Right now, while the market size isn't determined, well, speculation has that gambling charm. But later? There might be better investments than just holding Bitcoins. Also, few people want to sit on their money forever. Hoarding could become a very boring thing.

The deflation criticism is more of the kind that people expect overall economic strength to be away from the optimum because of deflation -- which would be bad indeed. But a total failure scenario? Mmh... I don't think so.

[grondilu]

Most people do not really want more Bitcoin incarnations. That defies the purpose of keeping them rare and stable. Concurring Bitcoin block chains would hold many problems.

Can't avoid it anyway.  So we'll just have to deal with it.

And no, it does not defy the purpose of keeping bitconis rare and stable.  The "original" bitcoin will stay rare and stable.  But they will be other cryptocurrencies.  I don't think it will be a problem though.

Prices between different cryptocurrencies will be a matter of social consensus and economic desire for new, "fresh" money.  I don't think it will be a problem for the whole cryptocurrency concept.  It won't be much different from the time when most currencies in the world were private.

I don't see how hoarding would go into some extreme though. Right now, while the market size isn't determined, well, speculation has that gambling charm. But later? There might be better investments than just holding Bitcoins. Also, few people want to sit on their money forever. Hoarding could become a very boring thing.

Agreed.   There is no point having a lot of money if you die before spending it.

[kiba]

How many gazillion of thread that must be created on deflation and bitcoin?

[FooDSt4mP]

How many gazillion of thread that must be created on deflation and bitcoin?

7 gazillion

[evoorhees]

First of all, there is no deflation of Bitcoins as they are always increasing in quantity (but at a diminishing rate). Bitcoins will always be inflating asymptotically, thus no deflation.

Second of all, even though the number of goods and actors in the market will increase relative to the number of Bitcoins, there is no reason to assume this phenomenon is a problem. So what if we live in a world in which prices tend to fall slowly over time as opposed to rising over time? There is this funny fear amongst people that if prices tended to fall people would horde money in perpetuity - but this is an economic myth. People will only "horde" money until that point at which the value they obtain from purchasing real goods outweighs the value of having the money. Hording is, in all cases, limited by the human need for consumption in the present.

Electronics are a great example. We all live in a world where computer prices fall by great amounts each year for any given level of processing power. We all know that if we wait another 3 months there will be a better processor available, or we can get the same processor at a lower price. And yet, how many of us wait in perpetuity to get the better computer in the future?  This example highlights the absurdity of the deflation argument. Falling prices does not create a positive feedback loop of doom. It DOES, however, encourage a higher level of savings than does an inflationary environment, and this is a benefit, not a problem.

So long as the quantity of money is relatively stable and relatively predictable, prices will adjust to the supply of money over time and the market will function relatively smoothly.

Krugman and Bernanke would disagree with everything I just said, btw.

[cindylove]

A typical economically oriented argument against bitcoin is the "bitcoin will eventually create a deflationary spiral" one.

According to this argument, bitcoin will fail because it lacks a way to inject new money into the system in order to suit economic growth.

I think most of bitcoin adepts answer this argument by defending the concept of deflation, explaining that it is really not so bad after all.  It's especially common amongst former goldbugs as myself.

However, there is a much simpler argument, that doesn't even have to defend the idea of a deflation-friendly economy.

In a keynesian nightmare, people would start to hoard bitcoins in such an extent that bitcoins become rare in circulation and thus prices start to fall.  Then people are even more inclined to hoard bitcoins, and that is the very deflationary spiral.   In such a situation, the lack of money in circulation will create a demand for money.  The failure of bitcoins to serve the economy will become more and more apparent and people will just start to want an other currency.   To put it simply, they will just create an other block chain.   Bitcoin is a tool to create money.  It can be started as soon as a social/economic consensus requires it.

On the opposite, if the bitcoins do their job and allow trades to occur correctly, there is no need for a new currency and nobody will be willing to put any effort into a new block chain.

Between those two situations some equilibrium has to be found by the market.  It can be observed by looking at the prices of the main cryptocurrency compared to other challenging cryptocurrencies.

Bitcoin doesn't prevent from creating more money than what is written in the software.  It prevents from creating more bitcoins.  Mind the difference.   Basically monetary injection/destruction is possible with cryptocurrencies.  It's just that it obeys social consensus and individual economic freedom, and NOT central bureaucratic forced planification.

I agree. I was thinking the same thing the other day. The fallacy with the Keynesian argumentation is that they assume a sole legal tender is being used as currency. In that case deflation could be bad. But when currencies be it fiat, commodity or digital are allowed to freely compete then when a shortage in say bitcoins arises then businesses facing rising costs of borrowing in BTC will switch to say chinese yuan (forget about the USD & Euro they are toast) and demand will reduce for BTC. This will eventually lead to an optimal equilibrium. I strongly suspect that what the free market will show as the optimal will be low deflation instead of low inflation that Keynesian advocate.

[bitcoinBull]

The main distinction to make is that deflation/inflation/stagflation etc. are Macroeconomic concerns, on the scale of national economies and national currencies.

Bitcoin is still a micro-sized economy, so it is dominated by Microeconomic principles like supply and demand.

All the worry about deflation or inflation might be relevant if the discussion is about the theoretical ability of bitcoin to replace one of the global currencies, like the dollar or the euro, or if we're imagining a global economy based on bitcoin.

The confusion is from conflating two different fields: the macroeconomic and the microeconomic.  This is how people get the (wrong) idea that bitcoin is undergoing a deflationary spiral and therefore doomed: by applying macroeconomics to something which is not a macroeconomy.

The exponentially increasing value of bitcoin is because demand is growing faster than the supply.  This is a microeconomic principle, and an entirely different phenomenon from deflation.


grondilu is right.  Bitcoin is just one of the many kinds of money.  Macroeconomic worries about deflation, etc concern a theoretical world where bitcoin is the only money, an unrealistic assumption which results in tiresome and endless academic discussion.

No time to waste on these confused and irrelevant worries.  Bitcoin will keep moving right along.. and quickly.
 

[cindylove]

First of all, there is no deflation of Bitcoins as they are always increasing in quantity (but at a diminishing rate). Bitcoins will always be inflating asymptotically, thus no deflation.

Second of all, even though the number of goods and actors in the market will increase relative to the number of Bitcoins, there is no reason to assume this phenomenon is a problem. So what if we live in a world in which prices tend to fall slowly over time as opposed to rising over time? There is this funny fear amongst people that if prices tended to fall people would horde money in perpetuity - but this is an economic myth. People will only "horde" money until that point at which the value they obtain from purchasing real goods outweighs the value of having the money. Hording is, in all cases, limited by the human need for consumption in the present.

Electronics are a great example. We all live in a world where computer prices fall by great amounts each year for any given level of processing power. We all know that if we wait another 3 months there will be a better processor available, or we can get the same processor at a lower price. And yet, how many of us wait in perpetuity to get the better computer in the future?  This example highlights the absurdity of the deflation argument. Falling prices does not create a positive feedback loop of doom. It DOES, however, encourage a higher level of savings than does an inflationary environment, and this is a benefit, not a problem.

So long as the quantity of money is relatively stable and relatively predictable, prices will adjust to the supply of money over time and the market will function relatively smoothly.

Krugman and Bernanke would disagree with everything I just said, btw.

Awesome argument

+1

[abyssobenthonic]

I strongly suspect that what the free market will show as the optimal will be low deflation instead of low inflation that Keynesian advocate.

I strongly suspect (and Hayek would appear to have agreed) that the optimum is zero long-term net inflation as opposed to low deflation or low inflation.  Of the block chain currencies, I suspect that a currency with a minimum block reward (I suspect around 1 or 2 coins per block to maintain the spendable (i.e. a private key known to someone and thus having a price in something else that will result in exchange) supply at 20-ish million coins) offers the best chance to achieve this with long-term stable demand.  Perpetually low deflation is almost certainly superior to perpetually low inflation, however.

Comparisons of block chain currencies with a known block reward for any (past, present, or future) given block in the chain and stable time per block* with commodity currencies like gold fall are not totally reliable due to the issue of supply elasticity.  The supply of such a block chain currency has basically zero long run elasticity in that there's no way, long term, to increase the rate of production (increasing coin value can short-term increase the production by adding hash power, but eventually there's a point where there isn't enough computer/electrical power to keep outrunning difficulty).  Fiat currencies are generally quite (if somewhat unpredictably) elastic as monetary goods go and commodity currencies are rather more elastic than such block chain currencies (at some gold value, it becomes profitable to try mining on other planets/asteroids/etc. or even to devise methods of nuclear alchemy; there is no BTC value that makes producing coins profitable when production becomes impossible).  Accordingly, if there's a reliable increase in BTC value over time (which is to say deflation), which means that supply's long run rate of increase is lower than that of demand, then that increase in value can be expected to continue for an arbitrarily long time due to a general lack of negative feedback (this is basically what happens as something becomes monetized).

If a positive correlation exists between the number of spendable coins over a given time period and the number of spendable coins that become unspendable over that period, then the supply of spendable coins will be decreasing (negative rate of increase): if demand is stable then supply will increase more slowly than demand.  I suspect that there is such a correlation (though it's impossible to empirically know how many coins are unspendable or which are merely not being spent... any attempt to try to adjust the block reward to directly compensate for changes in spendable supply is thus impossible), probably with about the same order of magnitude as 0.5% per annum (remember that a mature bitcoin will probably see somewhere around 1.5% of holders dying each year, barring people living to be multiple hundreds of years old).

Reasonably perpetual mild deflation isn't terrible.  The high degree of subdivision allowed for (and little to no practical need for bitbills) makes the "OMG! A carrot will cost .000000004 BTC!" objection meaningless.  The issue arises when holding (or "saving" or "hoarding": the three terms are exactly equivalent... lending is not saving...) has a predictably positive return.  The optimal outcome in that case is to delay an exchange until the last moment before you couldn't bear to not have the exchanged item.  Having to pay a fee (it can be reasonably expected that most miners will essentially stop including free transactions in their blocks when the block reward is zero) in addition to giving up the expected appreciation increases the incentive to delay.  The probability of blocks without transactions (and thus without fees) increases and the price the network pays for hashing power decreases.  The decreased price pushes out miners for whom the new price is less than the cost of a given hashrate and thus decreases the hashrate and difficulty (with the time between blocks increasing until the difficulty adjusts).  Slower confirmation of transactions and increased chance of double-spends then decreases the utility of the block chain for trading with untrusted parties and tilts demand for use of the block chain more to long-term holdings and larger transactions between fewer parties with higher levels of mutual trust.  The primary trade involving BTC then becomes exchange into day-to-day media of exchange currencies that are appreciating less quickly in value but offer their users cheaper transaction processing and/or less fear of fraud.  At various intervals, significant balances in the day-to-day currency are exchanged for BTC (probably at fairly predictable spot rates most of the time).

A currency with a reasonably perpetual mild inflation isn't likely to gain traction as a day-to-day currency: actually decreasing value will need to deliver dramatic advantages over the mildly deflationary currency in transaction processing and credibility and I'm not sure it's possible for any currency (at least any block chain currency) to deliver that sort of advantage over BTC (a currency backed by large amounts of physical force may be able to deliver that, given things like the Rule of Law etc.).  The decreasing value will generally mean that what constitutes a significant balance above which it is unwise to keep funds in that currency will be rather low: this in turn means a lot of trading into the savings currency which increases transaction costs.  Mild inflation of the engineered variety is also generally self-accelerating.

A zero long-run inflation/deflation currency (which can be accomplished with a currency in which its value stays (or is perceived to stay...) in a trading range), on the other hand is one that can gain such traction, IMO.  A constant block reward with a reasonably predictable (largely due to coherent debasement curves in both currencies, though this assumes stable demand in both) exchange rate should ensure that the hashing capacity is there for credibility (if the exchange rate is that 1 coin buys 0.05 BTC, but you're guaranteed 2 coins (0.10 BTC) even if there's no transactions or you accept free transactions then you're better off mining for the other coins unless you can expect to earn 0.10 BTC in transaction fees) and also that miners that are willing to forego transaction fees (e.g. to allow for micropayments to work) aren't mining at a loss.

*: as far as I know nearly every proposed block chain currency has that trait ([Mervyn]KingCoin sets the reward to be a percentage of all coins mined ([theoretically] the Bank of England is legally obligated to keep the annual increase in consumer prices to a range (IIRC, the current range is 1-3%)), BitCoin has the reward asymptotically tend to zero before rounding to zero, TimeCoin has a constant reward, etc.)

[kjj]

Deflation is never a problem.  Even when it is quite severe.

I'm pretty sure Keynes never drank alcohol.  If he had, he would have known better than to blame the hangover for the previous night's binge.

[markm]

abyssobenthonic, I agree with much, most, maybe even all of your post.

It seemed clear to me that bitcoin was aiming more toward being a savings/reserve currency than toward being one's day to day microtransactions currency. That was much of my motivation for coming up with BitNickels (NKL) for my trading IRC-bots to use for small transactions.

I like your point about the likely lower amount of processor power thrown at whatever the microtransaction blockchain of the day happens to be causing the amount of value any one person ought to leave in that currency to be relatively low{|er}. If true, it should hopefully be another thing helping BitNickels to act like pocket change, being converted {|back} into bitcoins as soon as enough have been accumulated to make the cost of doing so less than the perceived risk or inconvenience or whatever of leaving your funds in such "pocket change".

The reserve/savings currenc{y|ies} can gradually increase in fees even maybe as they come more and more to be used only for massive nation to nation transfer/balancing of national debts / trade deficits rather than by businesses and individuals.

As the supply of BitNickels becomes too small to support their continued use as pocket change, BitPennies can be introduced, and so on as each type of coin becomes too large for practical use as a microtransaction unit.

I think that once one gets over the hangup of insisting there be only one global blockchain used for currency throughout the universe all alone without others present, a lot of the perceived or imagined FUD-inducing 'problems" might kind of evapourate.

-MarkM-

[Vladimir]

There is another argument against the so called deflation problem: http://video.google.com/videoplay?docid=-2550156453790090544#

It is 47 minutes long but it is the best ever explanation of how money work in modern world.

[sirius]

"That [deflation] is considered very destructive in today's economies, mostly because when it occurs, it is unexpected," says Roberts. But he thinks that won't apply in an economy where deflation is expected. "In a Bitcoin world, everyone would anticipate that, and they know what they got paid would buy more then than it would now." - Russ Roberts, professor of economics at George Mason University. http://www.technologyreview.com/computing/37619/page1/

[cookmonster]

Deflation is simple math in a growing economy.  Bitcoin says it is built to create a stable economy.   Really it is built to create an extremely stagnant economy.   It would be better if their were an algorithm for controlled growth over time.  I am for Bitcoin.  BUT As value and population increase in an economy and you don't grow the money supply, deflation is inevitable.   Everyday central banks are attempting to not only protect against inflation but deflation as well.   Here is an example......

Say there are 2 people in an economy.  1 guy grows corn and likes to have his shoes shined and on person shines shoes and needs corn to survive and there is only 1 BC to exchange.   Each day they will exchange the 1 BC as value is rendered for it.   But if the corn grower grows 10x and the Shoe shine boy grows by 10x and there is still 1 BC the average exchange will be 10 cents oh and some people may starve to death.   This is a very simple example that can be expanded upon.     Lets say I am a baker and I buy my inputs and I even stock up to have a months supply but when I go to sell my bread the price of bread has gone down to where it cost me more to buy the inputs than I could sell it for.   Soon I would stop backing bread.   

Bottom line as an economy grows from value being created with demand the BCs need to be there.   Even gold grows..... or is "mined" and is added to the money supply.   I love love to see smart industrious hard working people add value and keeping the currency stagnant will stop that.   There will not be an incentive to do it and there will be wars. This is not a viable currency until this is taken into effect.   Many on Wall Street have stated that the Fed should be replaced with an algorithm.   There has been open discussion on this. 

The value in BCs is:
-It can't be stopped.
-It can be very transparent.

Just make the growth transparent and allow the miners to continue to mine based on a very open algorithm.   The algorithm would need to be perfected over time but it would be very transparent in doing this. 

[grondilu]

The value in BCs is:
-It can't be stopped.
-It can be very transparent.

Just make the growth transparent and allow the miners to continue to mine based on a very open algorithm.   The algorithm would need to be perfected over time but it would be very transparent in doing this. 

You totally missed my point but whatever.  I'll just translate it in simple words and apply it to answer your post:


Just do it man.  Just chose your algorithm, find a name for your currency and start using it.   Please do it already so we can have peace and spread the world about it.   But please don't mind if I stick to bitcoins, ok?

[kiba]

Deflation is simple math in a growing economy.  Bitcoin says it is built to create a stable economy.   Really it is built to create an extremely stagnant economy.   It would be better if their were an algorithm for controlled growth over time.  I am for Bitcoin.  BUT As value and population increase in an economy and you don't grow the money supply, deflation is inevitable.   Everyday central banks are attempting to not only protect against inflation but deflation as well.   Here is an example......

A deflationary growth economy is by definition isn't stagnant. Here, in the bitcoin economy, we have deflation but it isn't stagnant at all.

[FreeMoney]

Deflation is simple math in a growing economy.  Bitcoin says it is built to create a stable economy.   Really it is built to create an extremely stagnant economy.   It would be better if their were an algorithm for controlled growth over time.  I am for Bitcoin.  BUT As value and population increase in an economy and you don't grow the money supply, deflation is inevitable.   Everyday central banks are attempting to not only protect against inflation but deflation as well.   Here is an example......

Say there are 2 people in an economy.  1 guy grows corn and likes to have his shoes shined and on person shines shoes and needs corn to survive and there is only 1 BC to exchange.   Each day they will exchange the 1 BC as value is rendered for it.   But if the corn grower grows 10x and the Shoe shine boy grows by 10x and there is still 1 BC the average exchange will be 10 cents oh and some people may starve to death.   This is a very simple example that can be expanded upon.     Lets say I am a baker and I buy my inputs and I even stock up to have a months supply but when I go to sell my bread the price of bread has gone down to where it cost me more to buy the inputs than I could sell it for.   Soon I would stop backing bread.   

Bottom line as an economy grows from value being created with demand the BCs need to be there.   Even gold grows..... or is "mined" and is added to the money supply.   I love love to see smart industrious hard working people add value and keeping the currency stagnant will stop that.   There will not be an incentive to do it and there will be wars. This is not a viable currency until this is taken into effect.   Many on Wall Street have stated that the Fed should be replaced with an algorithm.   There has been open discussion on this. 

The value in BCs is:
-It can't be stopped.
-It can be very transparent.

Just make the growth transparent and allow the miners to continue to mine based on a very open algorithm.   The algorithm would need to be perfected over time but it would be very transparent in doing this. 

Oh man, where were you a year ago? You could have saved us so much trouble.

I for one don't want to starve to death, I'm done with Bitcoin.

[kjj]

Lets say I am a baker and I buy my inputs and I even stock up to have a months supply but when I go to sell my bread the price of bread has gone down to where it cost me more to buy the inputs than I could sell it for.   Soon I would stop backing bread.

Erm...

Did the price of everything else fall too?  Or was it just bread?

If it was just bread, that is the market telling you to stop baking.  If it was everything else too, you are just fine.