Bitcoin is a Zero-Sum Game - Long-term interest bearing instruments viable?

[Melbustus]

Interesting argument, I'll have to take that into consideration.  I'm no economist by any means, but it just makes sense to me that the optimal economy would be one in which the money supply does not affect the decision to spend or save (or take on debt).

But would an economy in which the money supply dynamics are fully defined and well known with perfect information for all participants affect someone's willingness to invest negatively? Wouldn't the known money supply dynamic just become the backdrop on which people still evaluate whether they can put capital and labor together to yield more than the sum of those costs?

Sure, savings would grow purchasing power over time, but investing would bring in profits that also grow purchasing power over time... Doesn't this even out?

It seems to me that the key is perfect money supply information. People are exceptionally conditioned to a generally inflating (at variable rates) money supply right now, so if we get brief periods of deflation (or deflation expectations), of course people hoard because they know the supply is just going to inflate again soon. But again, if the supply dynamics are perfectly well known to everyone, it should just come back to sound business decisions without any of the macro-forecasting shenanigans that pervert investment incentives.

Bitcoin is the first feasible monetary system ever proposed that credibly offers perfect information to all participants. That changes (purifies) the calculus quite a bit.

Let's continue with the maths then.

Say I am looking at a potential investment in a company that has a 95% chance of succeeding, and if it does succeed, it'll grow my investment at an average rate of 7% per year, but if it doesn't succeed, then I lose everything.  I might value that investment as a potential 2% growth on my money.

Now, say that I know that prices are dropping at a rate of 3% per year (purchasing price increasing, due to deflation in the monetary supply).

Why would I invest in said business with my money to make 2% per year, when I could just keep the money in my pocket and make a certain 3% per year?

I can know everything about the specifics of the money supply, but that wouldn't change the fact that 3% > 2%, and thus saving instead of investing is the wiser business decision.

The question I cannot answer is whether the expected 7% return would have been greater in the inflationary economy vs in the deflationary economy.  If that is the case, then perhaps my argument would be nullified.

Your fixed investment is gaining nominal value, but that nominal money that your investment is earning is also gaining purchasing power. In your example, you're comparing nominal percentage growth for the investment scenario with purchasing power growth in the non-investment scenario. The investment scenario needs to also include purchasing power growth in order to compare...

I think the math gets complicated (and probably has to include assumptions about investment distribution details, etc), hence my textual assertion rather than some simple calcs...

[edited for clarity]

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[2_Thumbs_Up]

Interesting argument, I'll have to take that into consideration.  I'm no economist by any means, but it just makes sense to me that the optimal economy would be one in which the money supply does not affect the decision to spend or save (or take on debt).

But would an economy in which the money supply dynamics are fully defined and well known with perfect information for all participants affect someone's willingness to invest negatively? Wouldn't the known money supply dynamic just become the backdrop on which people still evaluate whether they can put capital and labor together to yield more than the sum of those costs?

Sure, savings would grow purchasing power over time, but investing would bring in profits that also grow purchasing power over time... Doesn't this even out?

It seems to me that the key is perfect money supply information. People are exceptionally conditioned to a generally inflating (at variable rates) money supply right now, so if we get brief periods of deflation (or deflation expectations), of course people hoard because they know the supply is just going to inflate again soon. But again, if the supply dynamics are perfectly well known to everyone, it should just come back to sound business decisions without any of the macro-forecasting shenanigans that pervert investment incentives.

Bitcoin is the first feasible monetary system ever proposed that credibly offers perfect information to all participants. That changes (purifies) the calculus quite a bit.

Let's continue with the maths then.

Say I am looking at a potential investment in a company that has a 95% chance of succeeding, and if it does succeed, it'll grow my investment at an average rate of 7% per year, but if it doesn't succeed, then I lose everything.  I might value that investment as a potential 2% growth on my money.

Now, say that I know that prices are dropping at a rate of 3% per year (purchasing price increasing, due to deflation in the monetary supply).

Why would I invest in said business with my money to make 2% per year, when I could just keep the money in my pocket and make a certain 3% per year?

I can know everything about the specifics of the money supply, but that wouldn't change the fact that 3% > 2%, and thus saving instead of investing is the wiser business decision.

The question I cannot answer is whether the expected 7% return would have been greater in the inflationary economy vs in the deflationary economy.  If that is the case, then perhaps my argument would be nullified.

But again, the question is why prices even drop in the first place? It's because we have economic growth (same money supply chasing more stuff), so obviously someone is making a profit.

Higher deflation implies higher economic growth, which implies there are lots of people actually capable of making profits in the current economy. If you can't make a profit because of deflation, it's because someone else is doing a better job than you. If they weren't, there wouldn't be any deflation to stop you.

[Adrian-x]

The question I cannot answer is whether the expected 7% return would have been greater in the inflationary economy vs in the deflationary economy.  If that is the case, then perhaps my argument would be nullified.

The argument has been answered.

Capital will only have value if the economy is shrinking while there is capacity to grow.
If the Economy is stable or rescaling capital will bear no interest.
  
As the value of Bitcoin goes up your purchasing power increases, or if the economy grows, price deflation is experienced.
As a result there should be little demand for interest bearing loans in BTC while the economy grows.
The increase in value offsets the need for interest.  

In today's economy interest is real money to the person paying it, but it is new money being created for the bank or the person loaning it. The interest paid ads to the web, of inflation.

In your scenario there is little room for growth as the economy is growing. When there is inflation, (economy shrinking in a fixed money supply) lending money out with interest is encouraged this will stabilise the economy.

An inflationary - economy shrinking  - scenario also provides incentives to entrepreneurs to seek the loans to take advantage of increasing prices.  Fixed money supply allows the market to manage the economy.

[ffe]

In a properly functioning market, interest comes from future profits, and that's healthy. The fact that there is a limit to the number of bitcoins doesn't mean this dynamic doesn't work.

1) I loan you 10 btc for your business. Terms are you pay back 11 btc in a year.
2) You start your business, and earn back enough to pay the loan.
3) You pay the loan off, and all is well.

There is no requirement for the money supply to be perpetually increasing for this to work.

But there is a requirement that the money not be worth a lot more in the future. "Terms are you pay back 11 btc in a year." would never be acceptable to a borrower if bitcoin is increasing 20% a year in value. The borrower would have to make a 30% return just  to break even.

On the other hand "Terms are you pay back 9 btc in a year." would be unacceptable to a lender, even if 9 btc in a year is 10% more than 10 btc today. Fact is, the lender knows he can keep his coins and do better.

Loans would never happen and capital would be miss allocated. In general the holder of a lot of bitcoin is not necessarily the generator of great investment ideas.

By the way. "Savings is good" is only true when savings are invested. Holding on to non-productive bitcoin is hoarding, and is not saving directed to investment in the bitcoin world. There are few things more useless to the economy than a man hoarding 100,000 bitcoins.

[2_Thumbs_Up]

In a properly functioning market, interest comes from future profits, and that's healthy. The fact that there is a limit to the number of bitcoins doesn't mean this dynamic doesn't work.

1) I loan you 10 btc for your business. Terms are you pay back 11 btc in a year.
2) You start your business, and earn back enough to pay the loan.
3) You pay the loan off, and all is well.

There is no requirement for the money supply to be perpetually increasing for this to work.

But there is a requirement that the money not be worth a lot more in the future. "Terms are you pay back 11 btc in a year." would never be acceptable to a borrower if bitcoin is increasing 20% a year in value. The borrower would have to make a 30% return just  to break even.

Yes. And if you want to invest in a car factory there is a requirement that cars are not worth 99% less in a year. You can't just make up scenarios with crazy premises without regard to how likely they are or what they imply. An economy in equilibrium with a constant money supply that increases 20% in value on a yearly basis over the long run implies that we have a 20% increase in goods and services every year. That is an extremely good scenario.

[ffe]

In a properly functioning market, interest comes from future profits, and that's healthy. The fact that there is a limit to the number of bitcoins doesn't mean this dynamic doesn't work.

1) I loan you 10 btc for your business. Terms are you pay back 11 btc in a year.
2) You start your business, and earn back enough to pay the loan.
3) You pay the loan off, and all is well.

There is no requirement for the money supply to be perpetually increasing for this to work.

But there is a requirement that the money not be worth a lot more in the future. "Terms are you pay back 11 btc in a year." would never be acceptable to a borrower if bitcoin is increasing 20% a year in value. The borrower would have to make a 30% return just  to break even.

Yes. And if you want to invest in a car factory there is a requirement that cars are not worth 99% less in a year. You can't just make up scenarios with crazy premises without regard to how likely they are or what they imply. An economy in equilibrium with a constant money supply that increases 20% in value on a yearly basis over the long run implies that we have a 20% increase in goods and services every year. That is an extremely good scenario.

We aren't in equilibrium. We never will get to an equilibrium with bitcoin as the only nominal money for valuing contracts. The premises I gave are reasonable today and for the foreseeable future. For the foreseeable future most contracts will never be valued in bitcoin for the reasons I gave.

[Adrian-x]

Loans would never happen and capital would be miss allocated. In general the holder of a lot of bitcoin is not necessarily the generator of great investment ideas.

Re read the post above the post from witch I extracted your quote.
In a fixed currency system, when the economy is shrinking (inflation) there is an economic incentive to loan money, when the economy is growing (deflation) there is no economic incentive to loan money.
This ensures the appropriate allocation of capital.    

[Dalkore]

I am glad to read all these responses.  With this information, it will allow us to analysis business propositions in a more astute manner.   People who are trying to offer gains in only Bitcoins on an ongoing basis that are not based on another currency to fix the value should be scrutinized much harder for the fact we are dealing in a fixed asset. 

[Adrian-x]

@ Dalkore
To date the only investments I have see value in, in the Bitcoin economy, are a mining investment.
And even then the rate of return is dismal compared to investing in GPU's for an old PC and running it yourself.

Keep in mind the money supply is not yet fixed so even though there is money inflation, the economy is growing so there is price deflation (meaning Bitcoin increasing in value)

[evoorhees]

  Over time if someone is getting interest "rent", it has to come from somewhere and as evoorhees correctly said, Bitcoin is a limit asset.

In a properly functioning market, interest comes from future profits, and that's healthy. The fact that there is a limit to the number of bitcoins doesn't mean this dynamic doesn't work.

1) I loan you 10 btc for your business. Terms are you pay back 11 btc in a year.
2) You start your business, and earn back enough to pay the loan.
3) You pay the loan off, and all is well.

There is no requirement for the money supply to be perpetually increasing for this to work.

Yes and where did these profits come from? (agreeing with you).    The extra 1 BTC you earned by getting my to see value in your service and price.   

You forget the element of time.  Imagine I owe a debt of 100 bitcoins, but there are only 50 bitcoins in the whole world. Can I pay off that debt? Yes. I just have to produce, earn bitcoins, and pay off over time. Each single coin can pay off n amount of coin debt over time.  Money moves around, it circulates.

[evoorhees]

But there is a requirement that the money not be worth a lot more in the future. "Terms are you pay back 11 btc in a year." would never be acceptable to a borrower if bitcoin is increasing 20% a year in value. The borrower would have to make a 30% return just  to break even.

If a mutually-agreed interest rate cannot be determined, then a loan will not happen. That's okay. Debt is not a prerequisite for growth and development (sometimes it can help, when used wisely, but it is not a prerequisite).

There are few things more useless to the economy than a man hoarding 100,000 bitcoins.

You are ignoring all the work that man did to acquire those coins. You're looking only at a slice of time and saying he is being a bad economic participant. Plug time into the equation, and you discover the benefit he created happened in the past, and that must be factored into your equation of whether he is "useless". His holding of 100,000 BTC represents the amount of production he provided to the world in the days prior. You should thank him, not scorn him.

And indeed, if he starts spending it, it will drive up prices, making goods more scarce and more difficult (costly) for others to acquire.

So in fact, rather than being "useless to the economy," the thrifty, productive saver will go to his grave having produced more for humanity than he consumed, and he should be respected for that. Many people could learn a lesson from his life.  

[dissipate]

By the way, there is one kind of inflation that is harmless according austrian theory that could eliminate all price deflation. That would be a completely even distribution of the newly created money. We could let the money supply double at the end of every year, as long as the newly created money is distributed proportionally according to how much money you currently have (the value of each bitcoin adress is simply doubled). All this would cause is that prices would instantly double as well (and lending contracts would start compensate for this). No one would lose or gain any purchasing power.

In fact, someone could even create an inflationary bitcoin client without even forking the block chain. Just change the unit of representation in the UI at the end of each year, without changing the underlying code. So at the 1 of January every year, everyone's balance doubles. Thinking about it, this would actually be a really good idea to shut the inflationists up. Just give them their inflation client, where they can pick their own rate of inflation.

That is the same as moving the decimal place. That does absolutely nothing except for perhaps arcane psychological effects.

[Adrian-x]

So in fact, rather than being "useless to the economy," the thrifty, productive saver will go to his grave having produced more for humanity than he consumed, and he should be respected for that...

+1

[dissipate]

Interesting argument, I'll have to take that into consideration.  I'm no economist by any means, but it just makes sense to me that the optimal economy would be one in which the money supply does not affect the decision to spend or save (or take on debt).

But would an economy in which the money supply dynamics are fully defined and well known with perfect information for all participants affect someone's willingness to invest negatively? Wouldn't the known money supply dynamic just become the backdrop on which people still evaluate whether they can put capital and labor together to yield more than the sum of those costs?

Sure, savings would grow purchasing power over time, but investing would bring in profits that also grow purchasing power over time... Doesn't this even out?

It seems to me that the key is perfect money supply information. People are exceptionally conditioned to a generally inflating (at variable rates) money supply right now, so if we get brief periods of deflation (or deflation expectations), of course people hoard because they know the supply is just going to inflate again soon. But again, if the supply dynamics are perfectly well known to everyone, it should just come back to sound business decisions without any of the macro-forecasting shenanigans that pervert investment incentives.

Bitcoin is the first feasible monetary system ever proposed that credibly offers perfect information to all participants. That changes (purifies) the calculus quite a bit.

Let's continue with the maths then.

Say I am looking at a potential investment in a company that has a 95% chance of succeeding, and if it does succeed, it'll grow my investment at an average rate of 7% per year, but if it doesn't succeed, then I lose everything.  I might value that investment as a potential 2% growth on my money.

Now, say that I know that prices are dropping at a rate of 3% per year (purchasing price increasing, due to deflation in the monetary supply).

Why would I invest in said business with my money to make 2% per year, when I could just keep the money in my pocket and make a certain 3% per year?

I can know everything about the specifics of the money supply, but that wouldn't change the fact that 3% > 2%, and thus saving instead of investing is the wiser business decision.

The question I cannot answer is whether the expected 7% return would have been greater in the inflationary economy vs in the deflationary economy.  If that is the case, then perhaps my argument would be nullified.

HuH? A business making 2% a year is fine, because that would be 2% a year in a currency that is appreciating in value 3% a year. I invest 100 BTC and I make 2 BTC the first year. Let's say the interest doesn't compound so I make 2 BTC again the next year. That 2 BTC will be worth 3% more than the 2 BTC I made the year before. I don't see the problem.

[justusranvier]

So in fact, rather than being "useless to the economy," the thrifty, productive saver will go to his grave having produced more for humanity than he consumed, and he should be respected for that. Many people could learn a lesson from his life.

The people who oppose savings will never respect that man, because they want to dictate who benefits from his deferred consumption instead of letting him decide based on who he freely chooses to trade with.

[Adrian-x]

So in fact, rather than being "useless to the economy," the thrifty, productive saver will go to his grave having produced more for humanity than he consumed, and he should be respected for that. Many people could learn a lesson from his life.

The people who oppose savings will never respect that man, because they want to dictate who benefits from his deferred consumption instead of letting him decide based on who he freely chooses to trade with.

If he dies with his brain wallet, benefit goes to everyone.

[SgtSpike]

Interesting argument, I'll have to take that into consideration.  I'm no economist by any means, but it just makes sense to me that the optimal economy would be one in which the money supply does not affect the decision to spend or save (or take on debt).

But would an economy in which the money supply dynamics are fully defined and well known with perfect information for all participants affect someone's willingness to invest negatively? Wouldn't the known money supply dynamic just become the backdrop on which people still evaluate whether they can put capital and labor together to yield more than the sum of those costs?

Sure, savings would grow purchasing power over time, but investing would bring in profits that also grow purchasing power over time... Doesn't this even out?

It seems to me that the key is perfect money supply information. People are exceptionally conditioned to a generally inflating (at variable rates) money supply right now, so if we get brief periods of deflation (or deflation expectations), of course people hoard because they know the supply is just going to inflate again soon. But again, if the supply dynamics are perfectly well known to everyone, it should just come back to sound business decisions without any of the macro-forecasting shenanigans that pervert investment incentives.

Bitcoin is the first feasible monetary system ever proposed that credibly offers perfect information to all participants. That changes (purifies) the calculus quite a bit.

Let's continue with the maths then.

Say I am looking at a potential investment in a company that has a 95% chance of succeeding, and if it does succeed, it'll grow my investment at an average rate of 7% per year, but if it doesn't succeed, then I lose everything.  I might value that investment as a potential 2% growth on my money.

Now, say that I know that prices are dropping at a rate of 3% per year (purchasing price increasing, due to deflation in the monetary supply).

Why would I invest in said business with my money to make 2% per year, when I could just keep the money in my pocket and make a certain 3% per year?

I can know everything about the specifics of the money supply, but that wouldn't change the fact that 3% > 2%, and thus saving instead of investing is the wiser business decision.

The question I cannot answer is whether the expected 7% return would have been greater in the inflationary economy vs in the deflationary economy.  If that is the case, then perhaps my argument would be nullified.

HuH? A business making 2% a year is fine, because that would be 2% a year in a currency that is appreciating in value 3% a year. I invest 100 BTC and I make 2 BTC the first year. Let's say the interest doesn't compound so I make 2 BTC again the next year. That 2 BTC will be worth 3% more than the 2 BTC I made the year before. I don't see the problem.

That's only true if the company itself is also growing its productivity at a rate of 3%/year.

For example, assume the company sells 10,000 widgets in year 1 at 1 BTC each, thus generating 10,000 BTC in revenues, and assume my payout of that is 2 BTC.  The next year, assume that the same company sells the same 10,000 widgets in year 2, but this time, because the purchasing power of BTC went up, buyers are only willing to pay 0.97 BTC per widget (i.e., 3% less than they did the year before, due to the 3% rise in purchasing power).  Now, the company only generates 9,700 BTC in revenues, and my payout is reduced to 1.94 BTC.

If the company sold 10,300 widgets (an increase of 3%), then they could "keep up" with the deflation and still meet the requisite 10,000 BTC in revenues.

Of course, this is a very simplistic example with many factors left out, but it should give you an idea of what I mean...

[Adrian-x]

....Of course, this is a very simplistic example with many factors left out, but it should give you an idea of what I mean...

Yes you are correct, but keep in mind there will be no deflation if there is no increase in production.  so it looks like a Zero-Sum Game - investment is still only viable if there is inflation - a shrinking in the economy.

[Dalkore]

  Over time if someone is getting interest "rent", it has to come from somewhere and as evoorhees correctly said, Bitcoin is a limit asset.

In a properly functioning market, interest comes from future profits, and that's healthy. The fact that there is a limit to the number of bitcoins doesn't mean this dynamic doesn't work.

1) I loan you 10 btc for your business. Terms are you pay back 11 btc in a year.
2) You start your business, and earn back enough to pay the loan.
3) You pay the loan off, and all is well.

There is no requirement for the money supply to be perpetually increasing for this to work.

Yes and where did these profits come from? (agreeing with you).    The extra 1 BTC you earned by getting my to see value in your service and price.   

You forget the element of time.  Imagine I owe a debt of 100 bitcoins, but there are only 50 bitcoins in the whole world. Can I pay off that debt? Yes. I just have to produce, earn bitcoins, and pay off over time. Each single coin can pay off n amount of coin debt over time.  Money moves around, it circulates.

This is true.   The other factor to keep in our thoughts the that Bitcoins are similar to gold in this regard, they are both wealth reserve assets.  Bitcoins being even more so because you can find more gold in the ground but not more BTC.  

This makes it well suited as a stateless savings vehicle which lends itself to more saving (hoarding) that you would see other instruments like currencies which have inflation baked in so you need to put the money to work or have its value eroded over time.  

[Adrian-x]

...
If you believe that wealth and prosperity result from consumption, you will hate Bitcoin. If, on the other hand, you believe that wealth and prosperity result from production, you will love Bitcoin.

Many will argue, "but you can't have production without consumption" and this is nonsense. I can go produce things without there being a buyer. Yet, I cannot consume things without there being a seller. Consumption is the effect - the result of - production, though unfortunately we live in a world in which people have come to believe the opposite.

@evoorhees
Is it paradoxical that the value of the Bitcoin economy is created by the consumption of Bitcoins?