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

[SgtSpike]

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?

Because 5% > 3%. If you are earning a sum of 2% in a currency that increases in value by 3%, you reap the benefits of both.

In a way, yes. But you're missing out on what that investment could have been making had you just held on to the money.  I'll do some maths.

I have 200 BTC to invest.  I have the option of holding on to it and gaining 3% in value each year, or the option of investing in another company and making 2% per year.

So, first year:
Holding: 200 BTC = 206 BTC (effective purchasing power compared to initial investment)
Investing: 4 BTC dividend

Second year:
Holding: 206 BTC = 212.18 BTC
Investing: 4 BTC dividend + 0.12 BTC effective purchasing power increase on prior balance + 4 BTC prior balance = 8.12 BTC

Third year:
Holding: 218.55 BTC
Investing: 4 BTC dividend + 0.24 BTC effective purchasing power increase on prior balance + 8.12 BTC prior balance = 12.36 BTC

So, you see how it never "catches up" compared to just holding the money?  Or, maybe it eventually will LONG into the future, as long as the dividends are saved and you let the purchasing power continuously compound on itself.

Now, if you don't like seeing the purchasing power increase in BTC (because your BTC balance doesn't increase, just the purchasing power of your BTC balance increases), then I'll format it differently to what would actually happen:

First year:
Holding: 200 BTC
Investing: 3.88 BTC

Second year:
Holding: 200 BTC
Investing: 3.88 BTC prior balance + 3.77 BTC new dividend = 7.65 BTC

Third year:
Holding: 200 BTC
Investing: 7.65 BTC prior balance + 3.66 BTC new dividend = 11.31 BTC

And the investment dividends would keep decreasing (the investment wouldn't make more money just because the purchasing power of the currency used increases), making it a LONG time before that 200 BTC was ever recovered.  Actually, doing a quick calculation, you'd never recover more than 133.33 BTC, making it a bad investment vs the 3%.  Which, I suppose that makes sense, given that 200 BTC * 2% / 3% = 133.33 BTC.

[Dalkore]

Very interesting.  I actually have a business I have been holding off launching because of the exchange rate fluctuations and at this point it has been more profitable to just sit on my reserves then expose myself to the exchange risks.   Nice points Sgt. Spike.

[Etlase2]

The malady of investing in Bitcoin is compounded by the fact that investing lowers the price of money. If more money is available, interest rates go down (and likely exchange rates), at least in a free market that isn't dominated by a central authority's funds. I have a thread sitting in this forum with 1 anecdotal reply and zero discussion on what Austrians actually think of this situation. Apparently head-in-sand bitcoinomics is much more comforting.

[SgtSpike]

The malady of investing in Bitcoin is compounded by the fact that investing lowers the price of money. If more money is available, interest rates go down (and likely exchange rates), at least in a free market that isn't dominated by a central authority's funds. I have a thread sitting in this forum with 1 anecdotal reply and zero discussion on what Austrians actually think of this situation. Apparently head-in-sand bitcoinomics is much more comforting.

Right, I agree.

I think where many people disagree is what the appropriate amount of investment is.  Obviously, investment based on inflation (at least the rate of inflation in the US) is bad, as it encourages too much debt.  When that debt-based bubble pops, it wrecks all kinds of havoc.  But I think investment based on deflation is bad as well - too few investments will be made, and not enough innovation or production to "keep up" in a global economy.  Sure, we'd still survive, but we wouldn't be as productive or innovative as we could be, and the economy would not be optimized because of it.  Lower monetary velocity and lower paychecks for, well, everyone would ultimately be the end result.

That said, I think Bitcoin (and thus, a deflationary currency) could still be the lesser of the two evils.  And since a perfectly stable currency is still impossible to create, perhaps the best solution to be found for now.

[Etlase2]

But inflation is an effect, not a cause. I mentioned somewhere else that it isn't very fair to compare bitcoin to fiat because bitcoin is free market and fiat is not. Fiat encourages too much debt as a matter of policy--new money goes to banks, and inexplicably governments take on debt. A free market currency with an unfixed supply would do no such thing. You are aware, Spike, that I've spent a lot of time trying to figure out how to do that.

[Roger_Murdock]

You have to keep in mind that the Bitcoin economy exists alongside (and is positively dwarfed by) the "regular" fiat-based economy.  If your concern is that a deflationary currency will result in "too little" investment, it doesn't seem fair to point to the relative lack of Bitcoin loans for investment as evidence to support your argument.  The purchasing power of bitcoins has increased enormously in the last four years.  And I expect that trend to continue because I expect (hope) that the currency will be massively successful.  That long-term increase in purchasing power has also coincided with very high volatility.  This is all to be expected.  Naturally bitcoins were worth essentially nothing when the system was new and untested.  And naturally they'll be worth a huge amount if and when Bitcoin becomes massively successful.  That implies some "growing pains" (although I haven't personally found the experience to be too painful).  So of course people are reluctant to borrow bitcoins for investment purposes.  Of course it makes more sense to borrow fiat and buy bitcoins if you're trying to raise capital for a new business that requires a bitcoin bankroll.  (The principal reason for borrowing BTC over fiat that I can see is if you want to short bitcoins.)  Again, the regular inflationary economy is the dominant economic force, and it's still encouraging too much investment and consumption.  Bitcoin is currently acting as a (still very tiny) safety valve that's encouraging some actual SAVINGS to partially offset the fiat economy's destructive tendencies.  I don't know about you, but I'm excited as hell about the deferred purchasing power I'm holding in my bitcoin wallet.  But if and when bitcoin becomes the dominant currency, it won't need to operate as a "safety valve" anymore.  The volatility and deflation (in terms of purchasing power) will be much slower and more predictable.  The real question is whether THAT economy will encourage the "correct" level of investment / savings.  I think it might.  But I don't have an economics degree. (I do, however, dabble in bitcoinomics.)

[justusranvier]

The real question is whether THAT economy will encourage the "correct" level of investment / savings.

The correct level of investment is the level which people choose in the absence of coercion.

[Roger_Murdock]

The real question is whether THAT economy will encourage the "correct" level of investment / savings.

The correct level of investment is the level which people choose in the absence of coercion.

No argument here. And I believe that in the absence of coercion people would choose a deflationary currency.  But it's still useful to show why that doesn't lead to "too little" investment from a market efficiency perspective.

[justusranvier]

But it's still useful to show why that doesn't lead to "too little" investment from a market efficiency perspective.

It's not possible to do that due to the economic calculation problem among other reasons.

"Efficient" can't stand alone as an adjective here. It must be defined with regards to a goal. If the goal is anything other than a free market then it's likely Bitcoin isn't the most efficient tool. It's probably not the most efficient system if the goal is a centrally-planned economy that efficiently funnels wealth to the central planners and their cronies.

This is why arguing about economic efficiency is a tar pit. Two people who don't agree on the destination will argue in circles forever about how to get there.

[Roger_Murdock]

But it's still useful to show why that doesn't lead to "too little" investment from a market efficiency perspective.

It's not possible to do that due to the economic calculation problem among other reasons.

"Efficient" can't stand alone as an adjective here. It must be defined with regards to a goal. If the goal is anything other than a free market then it's likely Bitcoin isn't the most efficient tool. It's probably not the most efficient system if the goal is a centrally-planned economy that efficiently funnels wealth to the central planners and their cronies.

This is why arguing about economic efficiency is a tar pit. Two people who don't agree on the destination will argue in circles forever about how to get there.

Really? I get that people have to agree on definitions, and that sometimes what you really have is a normative disagreement over goals. But I'm not sure that we have that problem here (although I'm honestly not sure). It sounds like some people think that a deflationary currency limits the economy's ability to grow. I think that's wrong, and that it actually maximizes long-term growth.

[szuetam]

But it's still useful to show why that doesn't lead to "too little" investment from a market efficiency perspective.

It's not possible to do that due to the economic calculation problem among other reasons.

"Efficient" can't stand alone as an adjective here. It must be defined with regards to a goal. If the goal is anything other than a free market then it's likely Bitcoin isn't the most efficient tool. It's probably not the most efficient system if the goal is a centrally-planned economy that efficiently funnels wealth to the central planners and their cronies.

This is why arguing about economic efficiency is a tar pit. Two people who don't agree on the destination will argue in circles forever about how to get there.

Really? I get that people have to agree on definitions, and that sometimes what you really have is a normative disagreement over goals. But I'm not sure that we have that problem here (although I'm honestly not sure). It sounds like some people think that a deflationary currency limits the economy's ability to grow. I think that's wrong, and that it actually maximizes long-term growth.

But why, could you explain?
I believe it, in my opinion it is caused by long term stabilization by not forcing people to spend money.

[SgtSpike]

The real question is whether THAT economy will encourage the "correct" level of investment / savings.

The correct level of investment is the level which people choose in the absence of coercion.

Yes, but a deflationary currency biases the users' choices.

Let's take it to the extreme.  Say that bitcoin deflates at a rate of 50%/year.  Now say that someone wants a loan.  Who is going to loan to them?  Anyone?  What would the interest rate of said loan be?  Why?

Similarly, say that USD inflates at a rate of 100%/year.  Now answer the same questions above.

Does that help you understand my position on this?  I completely agree, the correct level of investment is the level which people choose in the absence of coercion.  But currency inflation/deflation is also a form of coercion, in that it biases the users' decisions.

[Roger_Murdock]

Let's take it to the extreme.  Say that bitcoin deflates at a rate of 50%/year.  Now say that someone wants a loan.  Who is going to loan to them?  Anyone?  What would the interest rate of said loan be?  Why?

Ok, but now we're talking about the scenario where Bitcoin has become the dominant currency and is no longer acting as a "safety valve" to encourage savings. (BTW, did that analogy / explanation make sense?) If and when we get to that point, it's extremely unlikely that Bitcoin will still be experiencing that level of price deflation.  But if it did, that tells me the economy is growing extremely fast.  There MUST be some individual businesses and investments that are growing at an above-average rate.  It will still make sense to lend them money.  Here's a thought experiment I came up with a while back:

Imagine that it's Jan. 1, 2020, and you're an investor in an economy where the currency is deflating 10% a year.  You're considering making an investment in a programmable widget-maker.  The widget-maker costs 100 BTC (naturally everyone uses Bitcoins in 2020).  To simplify things, assume that the widget maker is disposable and can only be used once, after which it has zero value.  Also assume that all you have to do to use the widget maker is to input two choices, e.g. color and shape, and then wait exactly one year.  Let's say that you know that you can make a green circle widget that will be worth 105 BTC in present 2020 BTC.  So it sounds like a smart (and wealth-creating) investment, right? Except there's a problem. You also know that when you can actually sell the widget on Jan. 1, 2021, it will only sell for 94.5 BTC as a result of deflation. So you're better off just sitting on your 100 BTC, and you certainly won't borrow money to make the investment.  Is that a bad result for society? I don't think so.  First, it should be noted that if the widget maker were only capable of making green circle widgets, it wouldn't sell for 100 BTC because no one would pay that much (everyone else would make the same calculation you did). In that case, the price would be adjusted downwards until it made economic sense.  But if it DOES sell for 100 BTC, what does that tell us? It tells us that there's someone else (who's presumably also aware of deflation) who knows that they can make, e.g., a yellow square widget worth at least 111.11 BTC in 2020 BTC (meaning it will sell for at least 100 BTC in 2021).  So there's no problem.  The asset goes to its most productive user and doesn't just sit on a shelf.

More generally, what does a 10% deflation rate tell us assuming a constant money supply?  I'm perhaps oversimplifying, but basically it tells us that the economy is growing at around 11.11% a year (with 10% deflation, the purchasing power of every BTC increases 11.11% each year).  So you now have the same amount of money chasing more goods.  If the economy is growing that rapidly, that tells you that there must be lots of investment opportunities with a return of at least 11.11%.  Basically, that's the number to beat.  If you're looking at an investment opportunity with a measly 5% return, deflation is telling you not to waste your time because there are higher and better uses of that capital.  

Krugman makes it sound like it's a bad thing that "just sitting on cash becomes an investment with a positive real yield." But I don't think that it is. And again, the only reason that sitting on cash can produce a positive real yield for some people is that many other people AREN'T just sitting on their cash.  There MUST be even higher-return investments occurring.  And it seems to me that "just sitting on cash" SHOULD return a positive real yield.  Deferring consumption is not something people typically like to do.  And people who do make that sacrifice ARE providing something of value to society by doing so.  By sitting on their cash, that cash is temporarily not competing with other cash for goods and services, thus keeping prices low for everyone else, including investors.

Now let's look at an inflation scenario.  Assume that it's Jan. 1, 2000 and the inflation rate is 10% (you're stuck using inflationary U.S. fiat because Bitcoin hasn't been invented). You're looking at a widget maker that costs 100 USD, but this widget maker is not programmable.  It only makes orange triangle widgets and once again, it takes a year to do so.  But these orange triangle widgets can only be sold for 95 bucks (in 2000 dollars).  But that means that on Jan. 1, 2001, when you can actually sell the widget, you'll be able to get $104.50 for it.  So buying the widget maker with your 100 bucks makes more sense than just sitting on the cash despite the fact that it's a wealth-destroying investment.  That seems bad.  Basically, it seems like inflation causes people to treat cash like a hot potato which will sometimes lead to economically-wasteful transactions.

[szuetam]

Imagine that it's Jan. 1, 2020, and you're an investor in an economy where the currency is deflating 10% a year.  You're considering making an investment in a programmable widget-maker.  The widget-maker costs 100 BTC (naturally everyone uses Bitcoins in 2020).  To simplify things, assume that the widget maker is disposable and can only be used once, after which it has zero value.  Also assume that all you have to do to use the widget maker is to input two choices, e.g. color and shape, and then wait exactly one year.  Let's say that you know that you can make a green circle widget that will be worth 105 BTC in present 2020 BTC.  So it sounds like a smart (and wealth-creating) investment, right? Except there's a problem. You also know that when you can actually sell the widget on Jan. 1, 2021, it will only sell for 94.5 BTC as a result of deflation. So you're better off just sitting on your 100 BTC, and you certainly won't borrow money to make the investment.  Is that a bad result for society? I don't think so.  First, it should be noted that if the widget maker were only capable of making green circle widgets, it wouldn't sell for 100 BTC because no one would pay that much (everyone else would make the same calculation you did). In that case, the price would be adjusted downwards until it made economic sense.  But if it DOES sell for 100 BTC, what does that tell us? It tells us that there's someone else (who's presumably also aware of deflation) who knows that they can make, e.g., a yellow square widget worth at least 111.11 BTC in 2020 BTC (meaning it will sell for at least 100 BTC in 2021).  So there's no problem.  The asset goes to its most productive user and doesn't just sit on a shelf.

More generally, what does a 10% deflation rate tell us assuming a constant money supply?  I'm perhaps oversimplifying, but basically it tells us that the economy is growing at around 11.11% a year (with 10% deflation, the purchasing power of every BTC increases 11.11% each year).  So you now have the same amount of money chasing more goods.  If the economy is growing that rapidly, that tells you that there must be lots of investment opportunities with a return of at least 11.11%.  Basically, that's the number to beat.  If you're looking at an investment opportunity with a measly 5% return, deflation is telling you not to waste your time because there are higher and better uses of that capital.  

Krugman makes it sound like it's a bad thing that "just sitting on cash becomes an investment with a positive real yield." But I don't think that it is. And again, the only reason that sitting on cash can produce a positive real yield for some people is that many other people AREN'T just sitting on their cash.  There MUST be even higher-return investments occurring.  And it seems to me that "just sitting on cash" SHOULD return a positive real yield.  Deferring consumption is not something people typically like to do.  And people who do make that sacrifice ARE providing something of value to society by doing so.  By sitting on their cash, that cash is temporarily not competing with other cash for goods and services, thus keeping prices low for everyone else, including investors.

Now let's look at an inflation scenario.  Assume that it's Jan. 1, 2000 and the inflation rate is 10% (you're stuck using inflationary U.S. fiat because Bitcoin hasn't been invented). You're looking at a widget maker that costs 100 USD, but this widget maker is not programmable.  It only makes orange triangle widgets and once again, it takes a year to do so.  But these orange triangle widgets can only be sold for 95 bucks (in 2000 dollars).  But that means that on Jan. 1, 2001, when you can actually sell the widget, you'll be able to get $104.50 for it.  So buying the widget maker with your 100 bucks makes more sense than just sitting on the cash despite the fact that it's a wealth-destroying investment.  That seems bad.  Basically, it seems like inflation causes people to treat cash like a hot potato which will sometimes lead to economically-wasteful transactions.

Wow!
It's great explanation of what I was thinking even before I had touched with BTC or even before it was created.

I have only one thing to add.

Technology is making things easier and simpler so price should show that.
Producing single loaf of bread is much cheaper now than 10 years ago, but wait a moment why price is increasing?
Do you understand what I mean?

[kjj]

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?

Because 5% > 3%. If you are earning a sum of 2% in a currency that increases in value by 3%, you reap the benefits of both.

In a way, yes. But you're missing out on what that investment could have been making had you just held on to the money.  I'll do some maths.

Nope.  You need better maths. 

If you have X units of something, and their value is increasing by 3% per year, if you don't invest, then after three years you will have a value of X*1.03³.  However, if you do invest at 2%, after three years, you will have X*1.02³ units, each worth 1.03³, for a total value of X*1.02³*1.03³.

In the investment case, you'll end up with a value of 1.159611, but if you had simply held them, you'd have a value of 1.092727.

[bitcoinbear]

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?

Because 5% > 3%. If you are earning a sum of 2% in a currency that increases in value by 3%, you reap the benefits of both.

In a way, yes. But you're missing out on what that investment could have been making had you just held on to the money.  I'll do some maths.

Nope.  You need better maths. 

If you have X units of something, and their value is increasing by 3% per year, if you don't invest, then after three years you will have a value of X*1.03³.  However, if you do invest at 2%, after three years, you will have X*1.02³ units, each worth 1.03³, for a total value of X*1.02³*1.03³.

In the investment case, you'll end up with a value of 1.159611, but if you had simply held them, you'd have a value of 1.092727.

The big question here is wether the investment goes up in value or not. Say you loan btc out at 2%, then your math is correct, the investment income is added onto the btc value increase. But if the investment is in a physical good then the currency gain is not added into the investment gain. Whoever came up withthe scenario needs to be a bit more specific.

I know this is a slightly different situation than investing in a company, but consider the following: You have the opportunity to invest in gold using your bitcoins. Let's say you did some analysis and decided the price of bitcoins (in dollars) would go up 3%, and the price of gold (in dollars) would go up 2%. If you invest your bitcoins in gold, after a year the value in bitcoins would have gone down, since bitcoins were rising faster than gold.

The big problem with all this analysis is that the market will react. If the price of bitcoins is going to rise in the future that will get priced in, the more sure people are the price will rise then the faster it wil jump now. I just don't think we will ever have a steady, large deflation; there will always be some risk to holding onto the coins hoping the price will go up,  and so at some point even with deflation there will still be a higher net present value for investing than just holding the coins.

[SgtSpike]

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?

Because 5% > 3%. If you are earning a sum of 2% in a currency that increases in value by 3%, you reap the benefits of both.

In a way, yes. But you're missing out on what that investment could have been making had you just held on to the money.  I'll do some maths.

Nope.  You need better maths. 

If you have X units of something, and their value is increasing by 3% per year, if you don't invest, then after three years you will have a value of X*1.03³.  However, if you do invest at 2%, after three years, you will have X*1.02³ units, each worth 1.03³, for a total value of X*1.02³*1.03³.

In the investment case, you'll end up with a value of 1.159611, but if you had simply held them, you'd have a value of 1.092727.

Ah, I was afraid I wasn't explaining it well enough.

To put it simply, the investment value does NOT rise with the 3% purchasing power increase.

If I buy a building for 10,000 BTC, and deflation hits at a rate of 3%/year, then my building is only worth 9,700 BTC the next year (and maybe the rental income was the 2%, so I'd have 9,900 BTC instead).  If I had held that BTC instead, I'd still have 10,000 BTC.

I cannot think of an investment that would also gain value along with value gains of the currency itself.  If you can think of one, please enlighten me.

[Dalkore]

The malady of investing in Bitcoin is compounded by the fact that investing lowers the price of money. If more money is available, interest rates go down (and likely exchange rates), at least in a free market that isn't dominated by a central authority's funds. I have a thread sitting in this forum with 1 anecdotal reply and zero discussion on what Austrians actually think of this situation. Apparently head-in-sand bitcoinomics is much more comforting.

Actually investing by purchase in a fixed asset, increases its value based on the fact you have limited the supply if you intend to hold the asset as savings.

[bitcoinbear]

I cannot think of an investment that would also gain value along with value gains of the currency itself.  If you can think of one, please enlighten me.

I just gave you an example in the post above. Give a loan, get back a larger amount of currency at the end of the loan.

[kjj]

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?

Because 5% > 3%. If you are earning a sum of 2% in a currency that increases in value by 3%, you reap the benefits of both.

In a way, yes. But you're missing out on what that investment could have been making had you just held on to the money.  I'll do some maths.

Nope.  You need better maths. 

If you have X units of something, and their value is increasing by 3% per year, if you don't invest, then after three years you will have a value of X*1.03³.  However, if you do invest at 2%, after three years, you will have X*1.02³ units, each worth 1.03³, for a total value of X*1.02³*1.03³.

In the investment case, you'll end up with a value of 1.159611, but if you had simply held them, you'd have a value of 1.092727.

Ah, I was afraid I wasn't explaining it well enough.

To put it simply, the investment value does NOT rise with the 3% purchasing power increase.

If I buy a building for 10,000 BTC, and deflation hits at a rate of 3%/year, then my building is only worth 9,700 BTC the next year (and maybe the rental income was the 2%, so I'd have 9,900 BTC instead).  If I had held that BTC instead, I'd still have 10,000 BTC.

I cannot think of an investment that would also gain value along with value gains of the currency itself.  If you can think of one, please enlighten me.

Ahh, ok.  You are saying that you'd end up with X*1.02³*0.97³, which is of course lower.  And no one would do that.

But that seems to be a straw man.  The numbers 2% and 3% aren't dictated by the market, you just made them up.  Saying that 2% < 3% is hardly controversial.  What you need to do is show that the market causes x% to be necessarily less than y%, where x% is the market rate of return on investments (beta) and y% is the rate of deflation.

No one would make the purchase that you are using as an example.  They would either purchase things with a yield higher than the deflation rate, or they would make loans where they get interest in addition to the return of the principle.  Or they would do nothing.