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

[Grinder]

You say that an economy based on a deflating currency necessarily rejects some investments, and is thus less productive.  An economy that is neither inflating nor deflating is also rejecting some investments, those with a negative nominal return that would be possible under inflation.  And an inflating economy is smaller than one that is inflating a lot.  And so on.  Clearly, we need an infinite rate of inflation to allow the maximum possible range of economic activities.

Hyperinflation causes a lot of problems which are basically not there with a low inflation of 2-3%. With hyperinflation you are losing value extremely fast, so buying basically anything is better than holding on to them. With normal inflation the maximum loss you can get by spending more time on decisions is much lower, and you can usually get interest by putting the money in a bank. This reduces the loss or even gives a small profit. This doesn't work in hyperinflation, because the uncertainty and loss of confidence in the currency it creates means the banks can't get a good enough interest rate on their loans.

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[Roger_Murdock]

You're only looking at a single point in time though, that's the problem.  Investments are weighed in how long they take to pay off - the Return On Investment.  Your example is bad, because there IS no long term investment.  All a person is doing is assembling two parts, and then immediately selling it.  There's no overhead, no buildings to purchase and depreciate, no tools needed to manufacture these items, nothing.  So if he buys the parts for 99.5 BTC, puts them together on his kitchen counter, and resells the completed version for 100 BTC, he'll still turn a profit every time.

Now, say I want to invest in a company that creates green widgets.  I want to buy a building for 100,000 BTC, and install an assembly line for 10,000, buying 100 of the green-widget-making-machine.  My overall capital investment is then 110,000 BTC.

Assume the deflation rate is 5%.

Assume my return on investment after depreciation of my building and manufacturing equipment is 3%.

When will I recover the 110,000 BTC I invested?

I NEVER would.  I would only recover 3/5 of it, maxing out at 69,300 BTC return on my investment.

Well, my example was certainly simple, but I don't see why switching to a longer-term investment changes anything.  But sure, replace the single-use widget maker with a green circle widget-making factory that can produce X units every year for Y years.  Would someone invest the resources required to build that factory in a deflationary economy? Only if it would make a profit after factoring in deflation, and if it wouldn't make a profit after factoring in deflation, that tells me that there's an even better investment (yellow square widget factory?) where those resources should go instead. Otherwise, those resources would not be bid up to their current prices.  What am I missing?

You're concerned that it doesn't make sense to make an investment that earns a 3% return when deflation is 5%.  But why doesn't the following answer that objection?

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.  

I'd also be curious to hear what you thought of the following:

 
On the other hand, when you simply print new money and distribute it unevenly (certain people get it first), those people are able to consume real additional resources without having produced anything of value. THAT seems like something that would limit economic growth. And that's true even if you're only printing enough new money to offset the natural process of deflation and maintain "stable prices."

Thanks!

[2_Thumbs_Up]

@Thumbs - I am certain I am no expect in economics, much less those of the Austrian variety.  But while I certainly agree that resources should be allocated to the most valuable investments, are you saying that investments with a risk-adjusted return of 3% would receive no funding?  And this should be normal?

Do you think investments with a risk-adjusted return of  0.000001% should recieve funding? I'm not giving a specific rate but I am saying there exists a nominal rate that determines how high of a return your investment should generate to recieve funding. This rate is refered to as the natural rate of interest. If it is higher than 3% then yes, 3% investments shouldn't recieve funding because they would be diverting resources from higher generating investments.

Any other argument seem to imply that the optimal interest rate would be 0% since anything above this make investments with infinitesimal returns unprofitable.

Note though, that as the economy grows and the supply of capital goods increases more and more investments become viable, and thus the tendency for the natural rate of interest is to go down over time. 0% actually would be the optimal interest rate if it was caused by an infinite supply of capital goods. Since all investments could take place we wouldn't need to ration funding in this scenario.

It seems to me that, regardless of how you reallocate monies according to the valuation of various investments, it still does not answer the question of, what happens to those who choose to save instead of invest as a result of "gaining" 3% on just holding their money instead of investing it?  That's still a reduction in the overall investment pool, no matter how you divvy up the investments themselves.  Lower overall investment = lower economic activity.

They will suffer the opportunity cost of their bad decision. If someone somewhere in the economy is making a nominal profit, then the rational thing is to lend him the money you don't want to use in the near future. Yes, you gain purchasing power by simply holding the money, but the goal is to maximize it. All possible interest rates are better than 0%.

The only rational reason not to lend out your money is if you don't see a relatively risk free and effortless avenue to do so. This is currently the case in the Bitcoin economy and it was probably the case in the depression with systematic bank failures and bank runs.

In normal circumstances though, having your money at home is probably riskier than having them at an insured bank, so there really is no reason to not lend it out and get a nominal return on top of your real purchasing power return.

What if I can buy aluminum for 20 BTC and turn it into a bicycle worth 30 BTC, but my overhead is 9.5 BTC?  I'd be only make 0.5 BTC/bicycle.  Then I'd only have a 2.5% net profit margin, which would be fine in an economy neither inflating or deflating, but a bad investment in an economy deflating at a rate of 3%.

Why is this a bad investment?

If the currency is gaining purchasing power over time this means the cost of aluminium is going down, the cost of labor (overhead) is going down and the price you can charge is also going down. You won't be able to charge as much for it next year but your costs will be lower and you'll still make the same amount of profit.

It's a bad investment because of the maths I wrote out before.  I could, at maximum, only recover 83.33% (2.5/3) of my original investment if the net profit margin stayed at 2.5%.  Yes, the expenses and revenues are going down, but I would NOT make the same amount of profit.  2.5% of 19.42 is less than 2.5% of 20.00, and it would keep going down each year.  I'd only ever make back 83.33% of my original investment at that rate.

You solve this paradox by realizing the distinction between capital goods and consumption goods and see where their respective values comes from. Consumption goods get their value from their immediate consumption use. The bicycle is worth the same 30 BTC to the consumer regardless of how it's produced. Capital goods derive their value indirectly from the consumption goods that they could be used to produce. The aluminum is only worth 20 BTC as long as someone sees a profitable way to turn it into consumption goods at that price.

So if a 20 BTC aluminum price makes your business plan unprofitable, it simply means someone else is outbidding you in the competition for aluminum. Maybe someone else can produce bicycles with a smaller overhead, or makes bicycles that are considered higher quality, or makes something else entirely such as 40 BTC baseball bats. Prices ration goods to those who can use it most effectively and you are simply on the wrong side of the line here.

On the other hand, if noone could use aluminum profitably at a price of 20 BTC it would simply not cost 20 BTC.

You're only looking at a single point in time though, that's the problem.  Investments are weighed in how long they take to pay off - the Return On Investment.  Your example is bad, because there IS no long term investment.  All a person is doing is assembling two parts, and then immediately selling it.  There's no overhead, no buildings to purchase and depreciate, no tools needed to manufacture these items, nothing.  So if he buys the parts for 99.5 BTC, puts them together on his kitchen counter, and resells the completed version for 100 BTC, he'll still turn a profit every time.

Now, say I want to invest in a company that creates green widgets.  I want to buy a building for 100,000 BTC, and install an assembly line for 10,000, buying 100 of the green-widget-making-machine.  My overall capital investment is then 110,000 BTC.

Assume the deflation rate is 5%.

Assume my return on investment after depreciation of my building and manufacturing equipment is 3%.

When will I recover the 110,000 BTC I invested?

I NEVER would.  I would only recover 3/5 of it, maxing out at 69,300 BTC return on my investment.

Your calculation is backwards. Prices of capital goods are determined by the value of the consumption goods they can be turned into. If the value of the green widgets is 69.300 BTC then the building and assembly line is obviously worth less than this to you. So you won't offer 110.000 BTC for them, but say 50.000 BTC instead.

This argument goes for the builder as well. If he can only get around 50.000 BTC for the building then that's his cap for all the resources that goes into building it. So that's the amount of money that he will be willing to allocate between all his suppliers. You can continue this chain of thought all the way down to the most basic capital goods such as raw materials and labor.

It seems to me like you are making calculations with inflated prices of capital goods and deflation in consumption goods, when really no capital good can be worth more than the consumption it will ultimately satisfy.

Are we debating ideologies (Austrian theory) or actualities?   I am trying to figure out if we are dancing around this distinction?

Austrian theory only describe the consequences of different actions and policies. It makes no judgement wether those actions or policies are good or bad.

[Realpra]

Now, say I want to invest in a company that creates green widgets.  I want to buy a building for 100,000 BTC, and install an assembly line for 10,000, buying 100 of the green-widget-making-machine.  My overall capital investment is then 110,000 BTC.

Assume the deflation rate is 5%.

The world real GDP is 3.6% right now:
http://www.indexmundi.com/world/gdp_real_growth_rate.html

I think a mature Bitcoin economy would be deflating about the same on average. 5% may happen, but not sustained over longer time I think.

Assume my return on investment after depreciation of my building and manufacturing equipment is 3%.

In real terms: about 33 years to pay back the investment. (1/0.03)

Considering you are dealing with machines and buildings they will probably not last longer than 20-30 years without heavy NEW investment.

Once the 33 years were over you would only be back at square one and it would take another 33 years to double your funds.

Considering that you would either be dead of age or your machines broken down from wear and tear your investment would quite simply be a bad one in terms of helping you/the economy/the world in REAL terms.

Turning it around, if I had bought the building and equipment for $1.1M, and assumed an inflationary rate of 5%, when would I recover what I had invested?

I would recover it after just over 20 years.

Actually your products would be priced at the rate of inflation, so you should make 5% inflation + 3% = 8%.

Your investment would be "paid back" in just 12.5 years and you would make profit from there.

However you only made money from the factory as an inflation hedge and society lost valuable resources due to this inflation induced over consumption.
This is why inflation is dangerous.

So, if I had the option of investing in a green widget manufacturing facility expected to generate a 3% ROI in a 5% deflationary economy, I absolutely wouldn't do it.  If I had the same investment option in a 5% inflationary economy, I absolutely would do it.

A valid concern. Lets assume the closer to real life 3.6% deflation. As we agree deflation slows the economy a bit by killing at least bad investments so make that 3%. (while saving important natural resources mind you)

What would it take to make something viable?
Well in simple terms it would have to be better than the world average, which kind of makes sense.

After all machine/building replacement costs, running costs and other costs the investment should make about 4% at very low risk in real terms. Its slightly high I will admit that, but it can be done.

[Grinder]

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.  

Can you really not see the problem in an economy where, if you can't invest in a way that beats the average productivity, you are better off not investing (and thus not producing anything) at all?

[Realpra]

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.  

Can you really not see the problem in an economy where, if you can't invest in a way that beats the average productivity, you are better off not investing (and thus not producing anything) at all?

It's self-correcting:

1. Deflation is high at ~3%.
2. Nobody invests, but sit on their money.
3. Economy shrinks,  deflation goes down or becomes negative.
4. Everybody invests.
5. Economy shoots back to ~3%.

(A fun thing here is that investing in step 2 when your money is valuable and collecting returns when money is cheap in step 3/4 would be very profitable )

And repeat. Net world growth becomes ~1.5% or more, which I actually think is close to the average over the human race's history.

The true mystery is why anyone would spend or sell their BTC today!

[Grinder]

It's self-correcting:

You are still ignoring the fact that at any point in time, anyone who can't beat the average would be better off not investing. Your cycle would only work if nobody else was smart enough to predict point 5 after point 4, but really, it's not hard at all. Thus, those not expecting to beat the average that occurs at point 5 would not invest at point 4, but just wait and benefit from the deflation other people's investments would cause. This makes deflation a tax which the people who invest have to pay to those who don't invest, in just the same way as inflation is a tax on those who have money to those who loan money.

[2_Thumbs_Up]

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.  

Can you really not see the problem in an economy where, if you can't invest in a way that beats the average productivity, you are better off not investing (and thus not producing anything) at all?

Do you really think it's optimal that we have below average investments when the money could simply be lent to the above average investors at an interest rate somewhere between their respective returns?

[Grinder]

Do you really think it's optimal that we have below average investments when the money could simply be lent to the above average investors at an interest rate somewhere between their respective returns?

Sorry, I thought it was common knowledge. The problem with this is, it's not possible for everybody to do better than average. Also, the alternative is not to lend money to others, but to just keep them in the safe or whatever.

[Realpra]

Thus, those not expecting to beat the average that occurs at point 5 would not invest at point 4, but just wait and benefit from the deflation other people's investments would cause.

Yeah its not entirely fair, but on average the economy as a whole would be self correcting.

Some might benefit unjustly, but the economy would be less wasteful than today and would still invest in viable things.

We deflationists never said it was going to be the perfect market, just no "death spirals". Perfect money would likely be money with constant value, but there is no way to achieve that. Sure you could "move the comma" for all bitcoins, but it wouldn't do anything.

As I see it inflation is a tax on the productive while deflation is a reward to producers that then save - that saves natural resources.
Deflation can't be a tax on investors because they can simply hold their money or invest in something better.

If an investor makes a mistake in an deflationary economy and makes 2% instead of the target 3%, he is still 2% richer in real terms. Why not see deflation as a buffer?

[Grinder]

As I see it inflation is a tax on the productive while deflation is a reward to producers that then save - that saves natural resources.
Deflation can't be a tax on investors because they can simply hold their money or invest in something better.

Well, unfortunately it is, for the reasons I explained.

If an investor makes a mistake in an deflationary economy and makes 2% instead of the target 3%, he is still 2% richer in real terms. Why not see deflation as a buffer?

Because it's not. As soon as your money value is no longer in the currency, the deflation does not protect you from loss.

[2_Thumbs_Up]

Do you really think it's optimal that we have below average investments when the money could simply be lent to the above average investors at an interest rate somewhere between their respective returns?

Sorry, I thought it was common knowledge. The problem with this is, it's not possible for everybody to do better than average.

How is that even relevant to my question? Of course everyone can't be better than average. But all investments should tend towards the average. If we have a difference in profits we have a suboptimal use of capital for society. If I make 2% in my business and you make 5% I'm hogging resources that you are more capable of using. I should quit my business and lend you my capital for 3.5% instead so you can expand. We both gain. Society gains.

My edit to your edit:

Also, the alternative is not to lend money to others, but to just keep them in the safe or whatever.

So please explain why the above loan of 3.5% is impossible. If we don't know eachother it could happen through a bank that gives me a 3.4% return and charges you 3.6%. I gain since my return increases, you gain since capital is freed up for you to expand, society gains since capital is more optimally allocated, and the bank gains since it makes this optimization possible.

[Roger_Murdock]

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.  

Can you really not see the problem in an economy where, if you can't invest in a way that beats the average productivity, you are better off not investing (and thus not producing anything) at all?

Not really. If you build a green circle widget factory, those resources can no longer be used to build a yellow square widget factory.  That investment should be disincentivized by losing money.  And you're right, not everyone can do better than average.  Investors who continually make below-average investments will lose money.  But that's a good thing, because they've shown that they're not very good at allocating capital.  And they can always just save their money, which is effectively a can't-lose (low risk but relatively low reward) investment in the overall economy.  

[Grinder]

If I make 2% in my business and your make 5% I'm hogging resources that you are more capable of using. I should quit my business and lend you my capital for 3.5% instead so you can expand. We both gain. Society gains.

But then this is not the issue. I don't need your money for my 5% business, and you don't need to lend them to me to profit from the deflation my production causes. The only effect of you stopping production is that you earn slightly more, but because I did some business directly or indirectly with you, I will earn slightly less, and nobody will benefit from the production you used to have. Total production is reduced, society loses.

[2_Thumbs_Up]

If I make 2% in my business and your make 5% I'm hogging resources that you are more capable of using. I should quit my business and lend you my capital for 3.5% instead so you can expand. We both gain. Society gains.

But then this is not the issue. I don't need your money for my 5% business, and you don't need to lend them to me to profit from the deflation my production causes. The only effect of you stopping production is that you earn slightly more, but because I did some business directly or indirectly with you, I will earn slightly less, and nobody will benefit from the production you used to have. Total production is reduced, society loses.

If you are above average you should want to expand. Then you do need more capital, and capital is limited. Capital I have is capital you can't have. Resources I use are resources you can't use.

Also, I gave a response to your edit in a edit of my own. I'll put it here as well so you don't miss it.

Also, the alternative is not to lend money to others, but to just keep them in the safe or whatever.

So please explain why the above loan of 3.5% is impossible. If we don't know eachother it could happen through a bank that gives me a 3.4% return and charges you 3.6%. I gain since my return increases, you gain since capital is freed up for you to expand, society gains since capital is more optimally allocated, and the bank gains since it makes this optimization possible.

[Grinder]

If you are above average you should want to expand. Then you do need more capital, and capital is limited. Capital I have is capital you can't have. Resources I use are resources you can't use.

Microsoft is usually above average, but more money would not give nearly the same profit margin, and maybe even a loss. This is the case with mosts mature businesses.

So please explain why the above loan of 3.5% is impossible.

I don't know why you think I've said it's impossible. It's just not necessary to lend the money to anyone to get the profit, so it's better to not lending them away and that way avoid the risk of not getting them back.

[Etlase2]

I don't know why you think I've said it's impossible. It's just not necessary to lend the money to anyone to get the profit, so it's better to not lending them away and that way avoid the risk of not getting them back.

Not to mention the risk goes up year after year whereas the opposite is the case in an inflationary economy. Or otherwise the loan has to be very front-loaded, in which case there is very little benefit to taking a loan at all.

[2_Thumbs_Up]

If you are above average you should want to expand. Then you do need more capital, and capital is limited. Capital I have is capital you can't have. Resources I use are resources you can't use.

Microsoft is usually above average, but more money would not give nearly the same profit margin, and maybe even a loss. This is the case with mosts mature businesses.

It seems like you are just rationalizing now.

The money could obviously just as well be lent to a competitor to Microsoft if they won't borrow. The point still stands. Anytime we have a difference in profits between entities or sectors of the economy it constitutes a misallocation of resources. Even if one entity is unwilling to eliminate this misallocation interest rates is a tool to do so, and it should be used when possible. If you artificially lower the interest rate you destroy this tool. If the interest rate is lowered to 1% my 2% investment becomes a better option than lending to another company's 10% investement.

I don't think you even have a clear picture of what you think the interest rate should do. Is a 0% interest rate optimal since it's the only rate that allows investments with 0.000000000001% returns? What's the purpose of interest rates according to you?

So please explain why the above loan of 3.5% is impossible.

I don't know why you think I've said it's impossible. It's just not necessary to lend the money to anyone to get the profit, so it's better to not lending them away and that way avoid the risk of not getting them back.

You said it wasn't an alternative, which it certainly is. Getting an interest rate of 3.5% percent (lending) is certainly better than getting an interest rate of 0% (hoarding), regardless of how the purchasing power changes. And if someone against all odds would refuse that 3.5% interest rate on a loan he would most likely not invest his money for 2% either. So the unlikely worst case scenario stays the same while the more likely scenario means higher returns for all investors and society.

And it was certainly obvious enough that the risks of both my 2% investment and your 5% investment where equal, which would make the loan just as risky. but I'll make it even clearer for you.

If I make a 2% risk-adjusted return on my business and you make a 5% risk-adjusted return on your investment I'm hogging resources that you are more capable of using. I should quit my business and lend you my capital at a 3.5% risk-adjusted interest instead so you can expand.

[Etlase2]

You said it wasn't an alternative, which it certainly is. Getting an interest rate of 3.5% percent (lending) is certainly better than getting an interest rate of 0% (hoarding),

whoa whoa whoa, aren't we discussing real returns here? Because if deflation is assumed to be 3%, I assume interest rates are actually 0.5%. This I think was what Spike was also referring to with interest @ 2% is worse than deflation @ 3%. There is not going to be anywhere NEAR 3.5% in a 3% deflation economy. Fuck, you'd be hard pressed get that in an inflationary economy!

[2_Thumbs_Up]

You said it wasn't an alternative, which it certainly is. Getting an interest rate of 3.5% percent (lending) is certainly better than getting an interest rate of 0% (hoarding),

whoa whoa whoa, aren't we discussing real returns here? Because if deflation is assumed to be 3%, I assume interest rates are actually 0.5%. This I think was what Spike was also referring to with interest @ 2% is worse than deflation @ 3%. There is not going to be anywhere NEAR 3.5% ROIs in a 3% deflation economy. Fuck, you'd be hard pressed get that in an inflationary economy!

The choice to invest or not to invest is certainly determined by nominal rates, not real rates. It doesn't matter if you have a real positive return if you lose nominally since you always have the option to do nothing at all. So whenever I don't specifically say something else I'm talking nominally.

But you can assume whatever rates you want. 0.5% risk-adjusted returns is certainly better than 0% risk-adjusted returns as well. The principle stays the same regardless of the rate. A 0.5% interest rate would reallocate resources from sub-0.5% returning investments to above-0.5% returning investments, and make all investments tend towards the 0.5% range as competition for the higher returns increases.