Beware of the deflation monster!!!1 (not really..)

[hazek]

I see it everywhere, people are terribly confused when it comes to correctly understanding the concept which we named deflation and it's counter concept which we named inflation.

In layman's words:

What is (monetary)deflation: Deflation is a decrease of the total supply of a currency.
What is (monetary)inflation: It's an increase of the total supply of a currency.

What deflation is not: An appreciating price of a currency. The appreciation in price is merely the symptom of either a lower supply of currency(monetary deflation) and/or higher demand for currency(hoarding, saving ect.).
What inflation is not: A depreciating price of a currency. That is merely the symptom of either higher supply of currency(monetary inflation) and/or lower demand for currency(increased spending trend).


Which applies to Bitcoin:

Bitcoin is currently experiencing INFLATION by 50 new BTC approx. every 10min and will continue to experience this inflation which will exponentially decrease until the total limit of almost 21mio Bitcoins are generated. After that Bitcoin will experience neither inflation nor deflation. (well not entirely true since a few Bitcoins are going to get lost so technically there will be slight deflation)

What applies to the price of Bitcoin: They are obviously appreciating because the demand is growing faster then the inflating supply. What will likely happen in the future? Well if we assume the demand isn't going to stop growing and we know the supply is, the prices of Bitcoins is going to appreciate in perpetuity. BUT as I clarified this is not deflation, it's a function of supply and demand where the supply is constant and the demand is growing.

Also a mistake is to confuse constant appreciation in price of a currency(Bitcoin) with a deflationary spiral of debt based fiat currency(dollar). While in the former we will always have the same number of Bitcoins with only their prices changing, in the later example should it come to a deflationary spiral, it's usually caused by massive liquidation of debt which because of the fractional server banking literally makes a big chunk of the existing monetary supply suddenly and unexpectedly disappear. This can never happen with Bitcoins, since fractional reserve banking isn't possible unless we start using receipts for Bitcoins instead of actual Bitcoins.




Now can everyone learn this please and stop posting all the nonsense??(feel free to sticky!)

[Anders]

What is (monetary)inflation: It's an increase of the total supply of a currency.

I'm a total amateur when it comes to economy but I looked up the meaning of inflation:

"A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services." -- http://www.answers.com/topic/inflation#ixzz1NhgA1LT6

So if the amount of currency increases, and the amount of available goods and services too increases at the same pace, then there is no inflation.

[hazek]

NO! Inflation simply means an increased supply of a currency. It has nothing to do with prices. I mean ffs haven't you read my OP?! You even quoted the relevant part...

And please stop listening to definitions you get from the establishment. Go to mises.org and learn.

[billyjoeallen]

NO! Inflation simply means an increased supply of a currency. It has nothing to do with prices. I mean ffs haven't you read my OP?! You even quoted the relevant part...

And please stop listening to definitions you get from the establishment. Go to mises.org and learn.

Not every Austrian is in agreement with your definition. Mike (Mish) Shedlock defines it as the supply of money AND credit, with certain qualifications.  The supply of BTC credit is almost non-existant right now, which is bad because BTC credit is what allows puts (short sales) on the exchanges, something needed to keep the market from plunging when there are no bids. (when the shorts cover)

http://globaleconomicanalysis.blogspot.com/

[zef]

There is actually a lot of disagreement over how inflation is defined.  I think mainstream economists don't consider it strictly to be an increase in the money supply, but rather a general rise in prices, which could or could not be caused by said increase in money supply.  I agree with OP that it only makes sense to define it in terms of money supply, but don't be surprised(or upset) when people get the terminology confused.

[benjamindees]

Personally, I don't think monetary inflation is a reasonable metric at all.  It's a second-order effect which has been given more importance than it deserves.  Price inflation tells us much more about the actual state of the economy than the total number of dollars, which is almost completely arbitrary, given the amount of credit, fractional reserves, derivatives, quantitative easing, etc.  The important thing to pay attention to is the price of basic goods and commodities.  When milk and bread and gasoline go up 30%, that's real inflation.  When people are buying hot dogs and hamburger instead of pork chops and steak, that's inflation.  When central banks start tampering with basic measures of prices and when they stop reporting measures of the money supply, everyone should expect lots of pain to follow.  On the other hand, when goods and commodities are consistently becoming more abundant, and prices are falling, that's a reasonably good indicator of a functional economy.  And if a so-called 'deflationary' currency ever takes hold in a significant way, I think what we will find is that we do have a fundamentally sound economy;  it's just one that has been hampered for far too long by narrow-minded, despotic idealogues.

[Anders]

NO! Inflation simply means an increased supply of a currency. It has nothing to do with prices. I mean ffs haven't you read my OP?! You even quoted the relevant part...

And please stop listening to definitions you get from the establishment. Go to mises.org and learn.

Ok, I don't know much about economy but I would say it also depends on what the definition of currency is.

[cloud9]

Thanks hazek, this is definitely the most basic, simplest, sensible, easily understood explanation for inflation/deflation that I've seen in a long time.

Inflation - Available money gets inflated
Deflation - Available money gets deflated

With no regards to goods and services traded with the money at all.

I always thought that % Change in Inflation (or Deflation if negative) = % Change in Money Supply - %Change in Goods or Services

[hazek]

Let me just add one more thing.

It is completely irrelevant what some of you believe what inflation/deflation are. They are what they are regardless of your belief (that you learned from someone else). And wishing them to be as you want them to be will not make them so.

The great Greek philosophers Socrates saw values as guides to excellence in thinking and action. In this context, values are standards which we strive to achieve. Values are practical habits that enable us as individuals to live, be successful and achieve happiness.

To be useful, values must be consciously held and be consistent (non-contradictory). Many people have conflicting values which prevent them from acting with clarity and self-confidence.

So please learn value nr.1:
1. Reality (Fact-Based)
What is, is. If we want to be better, we must act within the context of reality (the facts). People often make serious mistakes by making decisions based on what they "wish was so," or based on theories which are disconnected from reality. The foundation for quality decision making is a careful understanding of the facts.

There is a fundamental difference between the laws of nature (reality), which are immutable, and the man made. The law of gravity is the law of gravity. The existence of the law of gravity does not mean man can not create an airplane. However, an airplane must be created within the context of the law of gravity.


So please, learn the facts of inflation/deflation.

[Soros Shorts]

Personally, I don't think monetary inflation is a reasonable metric at all.  It's a second-order effect which has been given more importance than it deserves.  Price inflation tells us much more about the actual state of the economy than the total number of dollars ...

Conceptually that may seem to make sense, but what would you quote the prices of your goods in .... US dollars? That would make "price inflation" a third-order effect because the prices that you are measuring are now dependent on the money supply of the base currency (USD) as well as a whole bunch of other things such as the price of oil, market manipulation, government regulation, etc.).

[benjamindees]

No one is in need of any philosophy lectures.  You want to define inflation as strictly "monetary inflation".  Good for you.

In reality, however, there are such things as price inflation, wage inflation, along with monetary inflation.  Saying "all inflation is monetary inflation" might make a neat argument, but it doesn't tell you anything interesting, especially if that which you consider "money" really, well, isn't.

Because in reality, there is absolutely no way to measure the total money supply, even in a hypothetical "Bitcoin economy".  Money is made up of a lot of things besides just the official currency.  Businesses extend each other credit.  They barter.  They invest in liquid assets.  There are black markets.  There are currency exchanges.  There is a gift economy.  There are layers of derivative assets from stocks and bonds to rental agreements.  Even in a Bitcoin economy, which attempts to capture these arrangements by offering pseudo-anonymity, they will exist.  How much of the "Bitcoin economy" do you think is made up of MTGoxUSD?  And even if you could measure all these different forms of money, good luck valuing them in relation to each other.

Now, with regard to Bitcoin, let's go ahead and see what the facts are telling us.  You want to argue that the Bitcoin money supply is inflating.  And it is.  But the fact is that Bitcoin prices are deflating.  So monetary inflation isn't making prices go up, as it logically should.  Why?  Well, that's easy.  Merchants don't price their goods and services in Bitcoins;  they price them in dollars or pounds, and convert on the fly.  Miners don't spend the Bitcoins they create;  they "cash out" into some other currency.  Early adopters aren't using their Bitcoin fortunes to invest in productive capital;  they invest in mining more Bitcoins.  The value of Bitcoins is driven by speculation and hoarding.  So Bitcoin monetary inflation means nothing if no one actually uses Bitcoins as money.  The same is true for US and Zimbabwe Dollars and Monopoly money for that matter.

Your assertion that Bitcoins are undergoing inflation is based on the theory that Bitcoins constitute money.  And it only has value in so far as that theory is correct.  Using a single metric to determine the validity of this claim while ignoring all others is, quite frankly, naive.

[hazek]

I don't understand how you can miss the one point I tried my best to make as clear as possible.

Inflation has nothing to do with prices. Nothing.

[benjamindees]

Inflation has nothing to do with prices. Nothing.

Then we might as well be arguing about inflation of the Monopoly money supply.

[cloud9]

Hazek, I agree with you that there are only a 50BTC / 10minute Bitcoin units inflation built into the Bitcoin algorithm.  I agree that sharp increase in demand for goods / services / other are causing an increase in BTC price / (goods, service, other)     - because supply is fairly fixed. I agree that attributing this sharp increase in demand for goods / services being called BTC deflation is not correct.  However, with

A = %Change in BTC    =   very small value
B = %Change in (goods, services, other exchanged for BTC)     =   progressively larger value

The systems,
C = %Inflation/Deflation = A - B

with Systemic Deflation if C is negative, which is the case for a large value of B and a small value of A.

The above simplification of Inflation/Deflation assumes a constant BTC velocity - otherwise this would also had to be factored in as D.

http://en.wikipedia.org/wiki/Equation_of_exchange

Deflation however, rewards savings (automatically without interest rates applied) - which is not necesseraly bad for an economy - because it rewards early savers and bring about scarcity in BTC supply which causes more deflation - but ultimately you can not eat, drink, or use BTC for anything other than digital bookkeeping (like gold is for physical bookkeeping) - so at some stage you will be required to do an exchange - and the system will find this balance point.  Deflation will also come down when the value B above stabilises and the novelty wears off at some time in the distant / not so distant future.

[hazek]

I really don't understand what you have such a big problem with for to be able to better explain it to you.

Inflation or deflation is used to describe the change in the supply of a currency. If the supply grows, the value of each unit decreases, if it falls the value of each unit increases.

Value in this case is not necessarily equal to the price. The price is always the function of supply and demand, where inflation or deflation is only used to describe the supply end of that equation.

And please do not confuse credit with supply because in a commodity currency such as Bitcoin is, fractional reserve banking is not possible. So lending cannot affect the supply of money. Also do not confuse the volatility with the supply.

I don't know what else to tell you.

[hazek]

Nice explanation cloud9.

Deflation will also come down when the value B above stabilizes and the novelty wears off at some time in the distant / not so distant future.

One minor thing though. Don't call it deflation but rather at least price deflation or price appreciation.

You know:
A superior man, in regard to what he does not know, shows a cautious reserve. If names be not correct, language is not in accordance with the truth of things. If language be not in accordance with the truth of things, affairs cannot be carried on to success. When affairs cannot be carried on to success, proprieties and music do not flourish. When proprieties and music do not flourish, punishments will not be properly awarded. When punishments are not properly awarded, the people do not know how to move hand or foot. Therefore a superior man considers it necessary that the names he uses may be spoken appropriately, and also that what he speaks may be carried out appropriately. What the superior man requires is just that in his words there may be nothing incorrect.

– Confucius

[cloud9]

Will do so hazek.

[Anders]

Inflation or deflation is used to describe the change in the supply of a currency. If the supply grows, the value of each unit decreases, if it falls the value of each unit increases.

Isn't that a too simplistic view? What was the total value of cell phones in the world 1000 years ago? What I'm trying to say that there is also the creation of new kinds of products that never have existed before.

[abyssobenthonic]

Much like "liberalism", "inflation" (and its antonym, "deflation") had their meanings change during a particularly unpleasant period of human history (viz. the first three quarters or so of the 20th century).  Probably best to accept that the definitions have moved on and stake out new terminology for the former definitions (e.g. "libertarianism"/"market liberalism", "debasement"/"monetary inflation", and /"monetary deflation").

[abyssobenthonic]

http://forum.bitcoin.org/index.php?topic=10552.0

Have you read the thread?