Deflation and Bitcoin, the last word on this forum

[MoonShadow]

Change is price is neither a symptom nor a cause of inflation/deflation.  It'd the definition of both.  Increase in price = inflation.  Decrease in price = deflation.  That's the definition of these two concepts, regardless of context.  When prices of goods denominated in BTC fall (i.e. it takes fewer BTCs to buy something) deflation occurs. 

Correct. This is the textbook definition of inflation.

Not all textbooks are created equal.

http://austrianeconomics.wikia.com/wiki/Inflation

[thomiel]

Not investing has two big benefit for hoarders: No risk to lose the invested money. No work involved to care about how the money is used.

Right, but that works the same whether the currency inflates or deflates.

Wrong, if you expect that your tresure keeps growing in value, there is no point in investing it and use it like state currencies are being used. This is of course only true till the bubble bursts. If this happens, acceptance of bitcoin will be hurt badly. An inflation mechanism (something beyond the regular ever decreasing mining rate) could help buffer the effect.

The whole amount of gold reserves on earth is 100.000 tons. It would have the volume of a ~20x20x20m cube. That's all, with rather negligable additions to it, compared to world economy. This is the model bitcoin tries to emulate. Only that bitcoin is yet a ~10x10x10m cube and people are still in a gold rush.

But I start to repeat myself. If I didn't make my point by now, I won't be able to explain better in the future.

[serchanto]

The argument that deflation is bad because it disincentivizes investment is like arguing that theft is good because it motivates people to work harder to feed themselves.

Amen to that, but Bitcoin isn't deflationary.  It is very inflationary at present, and will taper off to a very stable amount.  The only reason so many people believe it to be deflationary is because the Bitcoin economy is growing as such a greater pace than the monetary base.

As more people assign value to bitcoin (recognize it as something worth having) it will have no other choice but to deflate.  Imagine that 100 people thought BTC is something worth having and they had 21M of it to go around.  Now imagine that 7 billion people find it worth having with the same 21M of bitcoins to go around.  Wouldn't you agree that BTC would be worth a lot more in the second case?  This is what will happen as more and more people get involved.

That's not deflation, that's the law of supply and demand.  Inflation and deflation are economic terms that directly describe the increase or decrease of the monetary base, respectively.

I would disagree with this definition.   Deflation is the reduction of the general level of prices in an economy, it has nothing to do with the base of BTC, just how much things cost in BTC.  So, if the base stays the same (21M BTC) and a widget goes down in price from 1BTC to 0.1BTC because more people find value in BTC, we have deflation.

Changes in the general prices are symtoms, not the causes, of deflation and inflation.  In the case of Bitcoin's high inflation rate, that symtom is overwelmed by other factors.  Words have specific meanings within certain contexts, and withing the context of Economics deflation and inflation only have meaning at all in relation to the decrease and increase in the monetary base.  There is no other way to define them with any useful precision.

Change is price is neither a symptom nor a cause of inflation/deflation.  It'd the definition of both.  Increase in price = inflation.  Decrease in price = deflation.  That's the definition of these two concepts, regardless of context.  When prices of goods denominated in BTC fall (i.e. it takes fewer BTCs to buy something) deflation occurs. 

<sigh>

Please take some time and read an Economics textbook.  The definition that the news media presents is not the Economic definition.

Thank you for your advise, the truth is I've read many textbooks on economics and have considerable life experience in this area myself, so my knowledge is not purely academic.  The definition I provide is accepted by many economists, including those leaning towards Austrian school's perspective (I am one of them) and has nothing to do with what media presents (which I try to stay away from).  Nonetheless, can you please point me to an Economics textbook or a published paper that defines inflation/deflation as an increase/decrease in the money supply?  I'd be curious to check it out (a link to a wiki would not be considered a credible source).

What you seem to be saying, if I understand correctly - "inflation/deflation is an increase/decrease in the money supply" is really putting two observations into one and creating a causal link between the two, namely, 1)  traditional money supply increases (governments print money) and 2) prices rise.  Your definition is simply a jump to a conclusion that inflation (rise in prices) is caused by increase in money supply and lumps them together.  This happens often, however, one does not fully cause the other.  The prices in a given currency are not determined only by its supply, but also by how much people value it (demand).  Supply and demand cause increase/decrease in prices in a free market.  It's possible to have a scenario where there is a DECREASING supply of currency and INCREASING prices denominated in that currency.  That would be the case if people lost faith in that currency.  Government may stop introducing new money supply all together and prices would still increase because people don't value the currency and don't believe in its future.  It is also conceivable to imagine a scenario where currency supply is INCREASING and the prices are DECREASING none the less.  We don't have to go far for a case study - this is exactly what's happening to bitcoin right now and will continue in the future if the number of people finding it valuable continues to increase faster than BTC's supply.

[MoonShadow]

Thank you for your advise, the truth is I've read many textbooks on economics and have considerable life experience in this area myself, so my knowledge is not purely academic.  The definition I provide is accepted by many economists, including those leaning towards Austrian school's perspective (I am one of them) and has nothing to do with what media presents (which I try to stay away from).  Nonetheless, can you please point me to an Economics textbook or a published paper that defines inflation/deflation as an increase/decrease in the money supply?  I'd be curious to check it out (a link to a wiki would not be considered a credible source).

Maybe later.

What you seem to be saying, if I understand correctly - "inflation/deflation is an increase/decrease in the money supply" is really putting two observations into one and creating a causal link between the two, namely, 1)  traditional money supply increases (governments print money) and 2) prices rise.  Your definition is simply a jump to a conclusion that inflation (rise in prices) is caused by increase in money supply and lumps them together. 

I didn't say any such thing.  Are you confusing me with someone else, or do you have a reading comprehension issue?

[serchanto]

I didn't say any such thing.  Are you confusing me with someone else, or do you have a reading comprehension issue?

I see.  Well then you explain to me how you arrived from the classical definition of inflation/deflation being change in prices to your "inflation/deflation is an increase/decrease in the money supply"?

[MoonShadow]

I didn't say any such thing.  Are you confusing me with someone else, or do you have a reading comprehension issue?

I see.  Well then you explain to me how you arrived from the classical definition of inflation/deflation being change in prices to your "inflation/deflation is an increase/decrease in the money supply"?

I didn't.  The classical definition of inflation/deflation has never been a change in the general price level.  As I have already said, and changes in the general price level could be a symptom of inflation or deflation; but it is, itself, not either.  Inflation/deflation can be considered the absolute change in the monetary base, or alternatively, the change in the monetary base relative to the size of the economy that it represents.  Either definition is valid, but both are fundamentally dependent upon a determination of the size of the monetary base.  The changes in the general price levels are always and effect, never a cause.

If you have been taught otherwise by any formal Economics instructor, you need to ask for your money back.

[serchanto]

I didn't.  The classical definition of inflation/deflation has never been a change in the general price level.  As I have already said, and changes in the general price level could be a symptom of inflation or deflation; but it is, itself, not either.  Inflation/deflation can be considered the absolute change in the monetary base, or alternatively, the change in the monetary base relative to the size of the economy that it represents.  Either definition is valid, but both are fundamentally dependent upon a determination of the size of the monetary base.  The changes in the general price levels are always and effect, never a cause.

And as I have already asked:  sources please.

If you have been taught otherwise by any formal Economics instructor, you need to ask for your money back.

Why don't you let me decide what I need?

[Babylon]

monetary inflation is an increase in the money supply.  From that point of view Bitcoin is inflationary for quite some time.

price inflation is an increase in prices and can be caused by monetary inflation.

Deflation is the opposite of this, it can be either a shrinking monetary supply or shrinking prices,  bitcoin will be deflationary at a certain point, in monetary terms, because bitcoins do get lost and there will be less created than are being lost.  Bitcoin is deflationary in price terms, over any sort of long term scale currently, because the bitcoin economy has grown MUCH faster than the supply of bitcoins.

[serchanto]

Bitcoin is deflationary in price terms, over any sort of long term scale currently, because the bitcoin economy has grown MUCH faster than the supply of bitcoins.

Agreed.

[cunicula]

And as I have already asked:  sources please.

Could we amend the request to sources first published within the last 30 years?

Otherwise, they will dig up something "classical".

[MoonShadow]

I didn't.  The classical definition of inflation/deflation has never been a change in the general price level.  As I have already said, and changes in the general price level could be a symptom of inflation or deflation; but it is, itself, not either.  Inflation/deflation can be considered the absolute change in the monetary base, or alternatively, the change in the monetary base relative to the size of the economy that it represents.  Either definition is valid, but both are fundamentally dependent upon a determination of the size of the monetary base.  The changes in the general price levels are always and effect, never a cause.

And as I have already asked:  sources please.

Okay, I'll post this again, since some people seem unable to either do some research of their own, or even read the older posts.

http://austrianeconomics.wikia.com/wiki/Inflation

Among the Economics texts that use this definition....

Economics in One Lesson, by Henry Hazlitt
http://www.lfb.org/product_info.php?products_id=38

The Road to Serfdom, by F.A. Hayek
http://www.lfb.org/product_info.php?products_id=49

The Law, by Fredric Bastiat, I think also uses this definition implicitly, but it's not really an economics text, per se.
http://www.lfb.org/product_info.php?products_id=96

Capitalism & Freedom, by Milton Friedman
http://www.lfb.org/product_info.php?products_id=103

Applied Economics: Thinking Beyond Stage One, by Thomas Sowell probably uses this definition either explicitily or implicitly, although I haven't read this one.
http://www.lfb.org/product_info.php?products_id=300

Whatever Happened to Penny Candy by Rich Maybury of Chaostan.com fame, but that is a children's textbook.
http://www.amazon.com/Whatever-Happened-Explanation-Economics-Investments/dp/0942617525

Other's can provide more, I'm sure.

If you have been taught otherwise by any formal Economics instructor, you need to ask for your money back.

Why don't you let me decide what I need?

Because you seem to be incapable of independent thought, so I thought I might help out.

[netrin]

Wikipedia claims that the gentlemen below state in their glossaries that...

In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.

Abel, Andrew; Bernanke, Ben (2005). Macroeconomics (5th ed.). Pearson

Barro, Robert J. (1997). Macroeconomics. Cambridge, Mass: MIT Press. p. 895. ISBN 0-262-02436-5

Blanchard, Olivier (2000). Macroeconomics (2nd ed.). Englewood Cliffs, N.J: Prentice Hall. ISBN 013013306x

Burda, Michael C.; Wyplosz, Charles (1997). Macroeconomics: a European text. Oxford [Oxfordshire]: Oxford University Press. ISBN 0-19-877468-0

[netrin]

"Inflation is always and everywhere a monetary phenomenon." - Friedman, Milton. A Monetary History of the United States 1867-1960 (1963).


Perhaps some econ guru can clear something up for me. In 2008 the supply of dollars M0 most certainly went way up. However at the same time (in some cases before) the price in dollars of hard commodities such as silver, platinum, and crude oil (not gold) dropped significantly. That seems counter intuitive to me and contradicts the seemingly obvious idea that monetary inflation generally effects price inflation.

[netrin]

Please pardon my triple replies.. just some background references.

monetary inflation is an increase in the money supply.  From that point of view Bitcoin is inflationary for quite some time.

price inflation is an increase in prices and can be caused by monetary inflation.

Michael F. Bryan, On the Origin and Evolution of the Word "Inflation",
http://www.clevelandfed.org/research/Commentary/1997/1015.pdf

[MoonShadow]

"Inflation is always and everywhere a monetary phenomenon." - Friedman, Milton. A Monetary History of the United States 1867-1960 (1963).


Perhaps some econ guru can clear something up for me. In 2008 the supply of dollars M0 most certainly went way up. However at the same time (in some cases before) the price in dollars of hard commodities such as silver, platinum, and crude oil (not gold) dropped significantly. That seems counter intuitive to me and contradicts the seemingly obvious idea that monetary inflation generally effects price inflation.

During that same time period that M0 was rising, consumer credit was collapsing.  Particularly with regard to housing loans.  Mortgage defaults (or any credit default, really) is deflationary.  As the market value of homes across American tanked, much of the monetary base ceased to exist, because much of the monetary base is digits these days, and not just paper.  As homeowners filed for bankruptcy, and got it, the digits that depended upon those debts simply ceased to exist; and so the real monetary base (could be M1, M-Prime, the Austrian Money metric; choose one, they all have faults) still contracted.

[netrin]

Thanks MoonShadow, I have to take your word for it (and it makes sense), but I can't see much from graphs. I'm looking at st. Louis fed and m0, m1, m2, all look more or less the same except for scale (well m0 sky rockets in 2008 while the others increase as always).

Now I have to wrap my head around what happens to imaginary credit backed by defaulted imaginary credit. Why not just write the loss off the books? Why doesn't the entire economy collapse after just one default? Do the banks just get fined when they drop less than 10% reserve? The bail out just put them in the legal boundaries, precisely creating the monetary inflation the reserve laws are meant to prevent?

If what you say is correct, then the Fed did prevent price deflation (in one sector). The money supply growth remains stable. What's the problem?

[MoonShadow]

Thanks MoonShadow, I have to take your word for it (and it makes sense), but I can't see much from graphs. I'm looking at st. Louis fed and m0, m1, m2, all look more or less the same except for scale (well m0 sky rockets in 2008 while the others increase as always).

Now I have to wrap my head around what happens to imaginary credit backed by defaulted imaginary credit. Why not just write the loss off the books?

The minimum reserve requirements of the bank in question could be breeched.

Why doesn't the entire economy collapse after just one default?

Well, it's not really quite so fragile.  It's all a fiction, really; so it just becomes a greater fiction, but all the while someone is making money even when that money is disappearing.  The fiction begets a real world effect.

 Do the banks just get fined when they drop less than 10% reserve?

Under normal times, such a bank would be put on probation of sorts, and given a time period to raise the reserve requirements.  If they failed they would be seized on behalf of the FDIC and sold to a more capitalized bank.  In the present times, we are running out of more capitalized banks.

The bail out just put them in the legal boundaries, precisely creating the monetary inflation the reserve laws are meant to prevent?

Sort of, but the apparent inflation creeps into the greater economy at a lag of around 14 to 18 months.  So the banks have some time to make full use of that new money before the markets respond.  Stock & bond markets tend to react much faster than the rest of the economy, though.

If what you say is correct, then the Fed did prevent price deflation (in one sector). The money supply growth remains stable. What's the problem?

The problem is that it's a balancing act, and one that always has victims.  Also, keep in mind that although the banks didn't fail due to bad loans, they made those bad loans and in the end of it all those banks not only ended up with the money (which must be paid with taxation, thus a transfer of wealth from the middle class to the banker class) they also ended up with the properties.  Literally getting their cake and eating it too.

[serchanto]

Because you seem to be incapable of independent thought, so I thought I might help out.

My "incapacity" for independent thought should give you no concern to "help me out".  If you are a fan of laissez faire you should have no difficulties comprehending this.  I'm not interested in your immature insults and complexes so keep them to yourself, only provide facts por favor.

As far as the actual topic is concerned, I'm inclined to agree with Babylon's post, there may be more than one definition of inflation/deflation (monetary and price), I didn't think of this.  It is very curious what will happen to bitcoin in light of "price" deflation, all other things being equal.  Will it slow down trade as people hoard it in hopes of inevitable appreciation?  Thoughts on this?

[serchanto]

"Inflation is always and everywhere a monetary phenomenon." - Friedman, Milton. A Monetary History of the United States 1867-1960 (1963).


Perhaps some econ guru can clear something up for me. In 2008 the supply of dollars M0 most certainly went way up. However at the same time (in some cases before) the price in dollars of hard commodities such as silver, platinum, and crude oil (not gold) dropped significantly. That seems counter intuitive to me and contradicts the seemingly obvious idea that monetary inflation generally effects price inflation.

I'm no guru, but here are my thoughts on this - price inflation (notice the word "price" before inflation) depends on supply of a particular currency, true, but it also depends on the demand for that currency.  Namely, people's demand for USD must be greater than supply still.  No matter what some may think about the US economy, people seem to still value US dollar more than other currencies (rightfully or not so much).  Creditors are unwilling to lend money because they aren't sure they'll get it back (due to bankruptcies and defaults), this reduces the amount of USD floating around in the free market.  As bad as USA's situation is, people still tend to trust USD more than other currencies.  This, too, reduces the amount of USD in the free market as people are willing to hold it more than other currencies.  As far as commodities are concerned, I'm not sure they've been dropping in price.  Gold, silver, platinum and other metals (precious and not so much) have all been increasing in USD denominated price.

Also, a lot of people have lost a lot of "value" in their homes as US housing market has "price" deflated.  That is also a lot of USD taken out of the circulation as people have stopped being able to take out HELOCs and spend them.

Last, but not least, USD still serves as the sole backing of many currencies around the world, most of those that were part of Bretton Woods and then some.  This may be one of the reason why it has so much credibility despite US governments monetary actions.

[netrin]

Thanks Serchanto,

Just a comment on 2008 prices.

"Inflation is always and everywhere a monetary phenomenon." - Friedman, Milton (1963).

As far as commodities are concerned, I'm not sure they've been dropping in price.  Gold, silver, platinum and other metals (precious and not so much) have all been increasing in USD denominated price.

 * I invite you to look at Palladium $570 March 2008 $200 by the end of the year.
 * Platinum $2 250 in March below $800 in November 2008.
 * Rhodium $10 000 July 2008, $1 000 in November of the same year.
 * Silver $20 to $9 and Gold dropped from $1 000 to $700 in 2008 (though that's normal volatility).
 * Crude oil from $130 to $30
 * Wheat $1 250 to well below $800 (my numbers run out during the fall) in 2008