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Author Topic: Deflation and Bitcoin, the last word on this forum  (Read 128441 times)
netrin
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September 06, 2011, 06:21:13 PM
 #221

Say we have 5% annual deflation.

A 0% interest loan in a 5% deflationary economy is equivalent to a 7% loan in a modern fiat 'stable' 2% inflationary economy. The difference is that members of the inflationary economy are encouraged compelled to spend, whereas a deflationary economy encourages savings. That is not to say that people will save 100% nor spend 100% in either environment, but during great inflationary times, spending becomes rampant (velocity) until the economy loses all value.

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September 06, 2011, 06:29:31 PM
 #222

spending becomes rampant (velocity) until the economy loses all value.

How does more spending make the economy lose all value? You do know how GDP is measured right?
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September 06, 2011, 06:41:18 PM
 #223

How does more spending make the economy lose all value? You do know how GDP is measured right?

You do know what causes hyperinflation right?

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September 06, 2011, 06:52:00 PM
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Way to avoid the question. Hyperinflation does not translate into more spending, quite the contrary, it translates into people fleeing the currency en masse. My question still stands.
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September 06, 2011, 06:56:36 PM
 #225

If an economy is consuming (but not producing/investing/saving). When governments monetize their debt from over spending, people start to calculate inflation into their prices, incomes, and buy and hoard goods for fear they will be more expensive tomorrow. The spending and printing are both feedback into the same loop. 2% inflation targets are assumed to be 'happy mediums' between deflationary and inflationary spirals.

Hyperinflation does not translate into more spending, quite the contrary, it translates into people fleeing the currency en masse.

Hyperinflation does indeed translate into more spending! Yes, if people can flee physically or monetarily, they will, but the majority do not for quite sometime. When everyone does, the currency is no longer hyperinflating, it is dead.

But, I agree, I have mixed cause and effect (though, the effect feeds back as a cause, hence hyper-). If spending is matched by production, then this is legitimate growth. If on the other hand, spending is leveraged, the economy is owned externally.

Overspending on a national level is another way of saying "fleeing the currency en masse", also known as a trade deficit.

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September 06, 2011, 07:16:06 PM
 #226

Deflation does not discourage investment.

This is a myth perpetuated by holders of Bitcoin.

An the idea that inflation encourages prudent investment is also a myth.  If sitting on cash is the wisest investment choice that can be made, then there is either something wrong with the investors' information or the economy in question.  Either way, where is it written that (any) investment is better (from any perspective) than no investment?  It's certainly true that wise investors will not perfer to stay in a cash position when inflation is rotting away the purchasing power of that cash, even at a mild 2% APR; but it is not true that the investments that said investors will choose are better for the economy.  Even under the best conditions, those investments are better for the investor.  There is no evidence that an economy in 2% deflation is worse off than an economy with 2% inflation, but much that says the beneficiaries of those conditions are much more likely to be closely tied to the central bank in the latter situation.

All of this is inmaterial to Bitcoin, which isn't deflationary, and cannot be deflationary until well beyond any of our predictable life expectancies have long since passed.  Bitcoin is presently inflating at about 40% APR, and is a many year before it's ready for a true economy.  Bitcoin's present value is reflective of the present speculators' collective view of it's future value.  There is no significant bitcoin economy to speak of.  There won't be until Bitcoin's inflation rate is below the inflation rates of nations that might wish to take it up.  Many third world nation's currencies still inflate at rates well beyond the 'ideal' target of 2% per year, even the stable and functioning ones.  If you live in a nation that is inflating it's currency at 9% (I suspect that China is close to this number, but the official rate is about 5%) then when Bitcoin breaks that number, the local online economy is going to begin to prefer Bitcoin (or it's successor) once it crosses that rate.  If only 1% of the online trades that occur in China are in Bitcoin, it's trade demand will be high enough that it's record value of $30+ dollars per would easily be justified.  The price presently implies that the collective wisdom of the speculators believes that the odds of this level of success in the future is less than 25%.  I would tend to agree with this sentiment.  Whoever is here that doesn't believe that Bitcoin is an extremely risky venture, shouldn't really be here.

On a side note, the effective APR for Greek bonds shot to just over 80% for a time today.  That says that the good money thinks that the odds of Greece paying back it's bills in the future are much lower than the odds that Bitcoin succeeds to grow an economy large enough to justify a trade value of $30 per share.

"The powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent meetings and conferences. The apex of the systems was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world's central banks which were themselves private corporations. Each central bank...sought to dominate its government by its ability to control Treasury loans, to manipulate foreign exchanges, to influence the level of economic activity in the country, and to influence cooperative politicians by subsequent economic rewards in the business world."

- Carroll Quigley, CFR member, mentor to Bill Clinton, from 'Tragedy And Hope'
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September 06, 2011, 08:06:11 PM
 #227

And the idea that inflation encourages prudent investment is also a myth.

Thank you! Inflation encourages invest and spending out of fear. A losing project is a safer investment as long as it is losing less than the inflation rate. But in a deflationary economy, only a remarkable project is investment worthy. Does this mean less investment? Yes. Does it mean less value or growth? No.

My point with hyperinflation is to note that between the wars, during the Weimar Deutsches Reich (a period I have studied from my armchair), the German citizens were spending their daily incomes in entirety, and while the stock market performed remarkably well (when priced in marks) for several years, the entire economy was destroyed, priced in gold, pounds, or dollars.

While the economy of the war losers is an extreme example, it is also my personal observation that countries with highest inflation rates are poorest. Japan is the only significantly deflationary economy I've visited and it seemed to function fairly well in comparison.

All of this is inmaterial to Bitcoin, which isn't deflationary, and cannot be deflationary until well beyond any of our predictable life expectancies have long since passed.

Monetarily no, but price deflation is possible whenever demand outperforms supply. Bitcoin is not just another value storage currency, it is a superior value exchange protocol. It brilliantly answers the question to which gold suffers: "but how do you spend it?"

If it's inherent value is fully realized, but it turns out that deflation is a problem, then any nation could fork, mine, and then require taxes are paid in its own sovereign bit-eque-coin.

Gold has been appreciating 50% this and roughly 20% each of the last ten years. Why has anyone invested in the stock market this past decade? Oh, that's right, some companies still innovate and make a profit.

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September 06, 2011, 10:12:26 PM
 #228


While the economy of the war losers is an extreme example, it is also my personal observation that countries with highest inflation rates are poorest. Japan is the only significantly deflationary economy I've visited and it seemed to function fairly well in comparison.


Yes, but I don't think that Japan is a good example to hold up.  Their government is in debt to 180% of their annual GDP.  They are actively trying to devalue the Yen, in order to encourage exports.  So is basicly everybody else, but only the Chinese do it well.  The stability of Japan is, I think, largely a byproduct of their culture; and one I don't think will survive their demographic peak in the near future.  I can't predict how it will end, but I give high odds that their social cohesion is going to be tested as their aging population is increasingly dependent upon a (relatively) shrinking working age population.  The same can be said for the United States and Europe, but Japan will certainly get there first, even if the US is more likely than Japan to end up in a class war as a result.
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All of this is inmaterial to Bitcoin, which isn't deflationary, and cannot be deflationary until well beyond any of our predictable life expectancies have long since passed.

Monetarily no, but price deflation is possible whenever demand outperforms supply.


True, but price deflation (and price inflation) are largely a reflection of the currency's perceptions at the time, not it's fundamentals.  Said another way, the aggregate value of a currency (within a working economy, not speculation as in the present case of Bitcoin) is, in large part, a result of the confidence of the user base of the currency's "usefulness" to themselves in the future.  Since the present and future supply of Bitcoin is a known variable, only an increase in the demand can result in price deflation of goods as priced in Bitcoin.  This also means that a greater number of people have confidence that they can spend Bitcoin in the future; which in turn means that it's impossible for the 'deflationary spiral' theory to apply to Bitcoin.  For if a 'deflationary spiral' were to occur in the Bitcoin economy (whenever that were to materialize) this would result in a drag in it's own perception of usefulness, and thus limit it's value.  It's a self limiting factor, so long as the economy at large has an alternative to the currency in question, which in this case is the local currencies that Bitcoin stands to replace.  Thus the deflationary spiral is impossible as applied to any alternative currency.

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Bitcoin is not just another value storage currency, it is a superior value exchange protocol. It brilliantly answers the question to which gold suffers: "but how do you spend it?"

I'm not sure that I agree with you here.  Not entirely.  Trading in Bitcoin is quite easy, but aquiring bitcoin in order to trade is not easy.  Using credit cards for online shopping is still easier, the privacy concerns notwithstanding.  I agree that there is a great potential for Bitcoin to dominate as a superior exchange currency, but that remains to be seen.  It is no more difficult for me to trade my metal for dollars and then go buy a new washing machine than it is for me to trade my dollars for BTC to buy books online.

Quote

Gold has been appreciating 50% this and roughly 20% each of the last ten years. Why has anyone invested in the stock market this past decade? Oh, that's right, some companies still innovate and make a profit.

Gold has been on a record tear for the past decade, but I wonder (without checking) if a purchase of Apple stock in 2000 would have outperformed gold oever teh same time frame.

"The powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole. This system was to be controlled in a feudalist fashion by the central banks of the world acting in concert, by secret agreements arrived at in frequent meetings and conferences. The apex of the systems was to be the Bank for International Settlements in Basel, Switzerland, a private bank owned and controlled by the world's central banks which were themselves private corporations. Each central bank...sought to dominate its government by its ability to control Treasury loans, to manipulate foreign exchanges, to influence the level of economic activity in the country, and to influence cooperative politicians by subsequent economic rewards in the business world."

- Carroll Quigley, CFR member, mentor to Bill Clinton, from 'Tragedy And Hope'
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September 07, 2011, 12:11:50 AM
 #229

I believe the Japanese economic adventure has been a prelude to the global economy, not any one nation.

... For if a 'deflationary spiral' were to occur in the Bitcoin economy (whenever that were to materialize) this would result in a drag in it's own perception of usefulness, and thus limit it's value.  It's a self limiting factor, so long as the economy at large has an alternative to the currency in question, which in this case is the local currencies that Bitcoin stands to replace.  Thus the deflationary spiral is impossible as applied to any alternative currency.

But now we're talking about a new (or ancient) economic model, where not one but multiple competing currencies exist in any given economy. I suppose in such a brave new world, a fiat currency distributed by a central bank could be expected to maintain price stability, both theory and in practice. Otherwise, it would lose market share. I could imagine a bitcoin-like currency with a single central miner signing key, with instantaneous transaction verification.

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Bitcoin is not just another value storage currency, it is a (potentially) superior value exchange protocol. It (potentially) brilliantly answers the question to which gold suffers: "but how do you spend it?"

AAPL dropped from $35 to $10 in 2000 and was pretty stagnant until 2004 and climbed to what I believe will be its peak this year at $400 for a ten year 40-fold return. Gold hovered around $280 for several years before 2002 and climbed to $1900, for less than 7-fold return. Bitcoin did not exist in 2000 until 2009 and was priced at $0.06 in 2010 and is $6 today, for a 100-fold return, in only one year.


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September 07, 2011, 12:15:25 AM
 #230

Hyperinflation does indeed translate into more spending! Yes, if people can flee physically or monetarily, they will, but the majority do not for quite sometime. When everyone does, the currency is no longer hyperinflating, it is dead.

So then the currency died because everyone escaped from it, not because there was more trading going on as you claim.

An the idea that inflation encourages prudent investment is also a myth.

I agree with this. I've never claimed that it encourages prudent investment, only more of it. Some of them will succeed, some will fail. What's important is that there is a real chance of success for everyone. My argument is that under deflation the chance of success is near 0% so most people will choose to hold the currency instead. See my SkepsiDyne example for the rationale.

But in a deflationary economy, only a remarkable project is investment worthy. Does this mean less investment? Yes. Does it mean less value or growth? No.

It does mean less growth, negative growth, because less investment directly means less jobs and more saving, thus less potential customers and revenue for the successful companies. It is a vicious cycle. The companies who were barely successful will end up failing from reduced margins and that will mean even less potential customers for the companies who are very successful. Eventually there will be none left.
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September 07, 2011, 12:30:04 AM
 #231

Hyperinflation does indeed translate into more spending! Yes, if people can flee physically or monetarily, they will, but the majority do not for quite sometime. When everyone does, the currency is no longer hyperinflating, it is dead.
So then the currency died because everyone escaped from it, not because there was more trading going on as you claim.

Overspending is both the cause and symptom of hyperinflation. Let me quote myself, if I may:

during great inflationary times, spending becomes rampant (velocity) until the economy loses all value.


I've never claimed that it encourages prudent investment, only more of it. Some of them will succeed, some will fail. What's important is that there is a real chance of success for everyone. My argument is that under deflation the chance of success is near 0% so most people will choose to hold the currency instead. See my SkepsiDyne example for the rationale.

But in a deflationary economy, only a remarkable project is investment worthy. Does this mean less investment? Yes. Does it mean less value or growth? No.

It does mean less growth, negative growth, because less investment directly means less jobs and more saving, thus less potential customers and revenue for the successful companies. It is a vicious cycle. The companies who were barely successful will end up failing from reduced margins and that will mean even less potential customers for the companies who are very successful. Eventually there will be none left.

Are you claiming that many companies that are only successful because they lose less than the inflation rate is superior to fewer companies that are actually creating value irrespective of the inflation rate? Just curious, do you believe that arbitrary government spending on select large projects, financed through tax or debt, helps the economy as a whole? Do you believe that War as a whole boosts an economy because it eliminates unemployment? Do you believe inflation is necessarily inversely related to unemployment thus making stagflation impossible? Do you believe that electronics companies are bad for the economy because their product prices deflate 50% annually?

The problem with the SkepsiDyne example above is that the books are recorded in multiple currencies with volatile conversion. If a single currency was used/possible or stable inflation/deflation rates priced in, there would be no issue.

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September 07, 2011, 01:14:35 AM
 #232

Overspending is both the cause and symptom of hyperinflation

No, lack of supply is the cause of inflation. Spending can remain at the same levels while supply goes down.

Are you claiming that many companies that are only successful because they lose less than the inflation rate is superior to fewer companies that are actually creating value irrespective of the inflation rate?

No, I'm claiming that having some companies is superior to having no companies.

Just curious, do you believe that government spending on select large projects, financed through tax or debt, helps the economy as a whole?

No, because they are not successful by themselves, they require constant government funding to avoid bankruptcy.

Do you believe that War as a whole boosts an economy because it eliminates unemployment?

No, because it doesn't really eliminate unemployment. If the money used for war were just given back as tax cuts it would have the same effect on employment. Also any war related jobs are gone once the war is over.

Do you believe inflation is necessarily inversely related to unemployment thus making stagflation impossible?

No, I believe spending is necessarily inversely related to unemployment.

Do you believe that electronics companies are bad for the economy because their product prices deflate 50% annually?

No, I don't believe they are bad. No idea why people keep using the electronics argument as they are still operating in a inflationary macroeconomic environment. The incentive to spend your money now hasn't gone anywhere.
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September 07, 2011, 02:34:15 AM
 #233

At least we agree on most points, just argue with an as yet untested axiom. As I understand it, from the assertion that deflation reduces or eliminates spending, you conclude that companies make little or no profit, and thus can not hire nor retain employees.

I assert that 0% inflation is ideal, that a slight negative inflation is superior to slight positive inflation, and that any extreme is detrimental to the economy. Deflation only reduces but does not eliminate spending and limits investment to projects that create real value. In a flat or deflationary environment, consumers will purchase goods that they need and want, not for fear of value loss. Savers will invest in projects that serve their principals or can be expected to outperform the inherent deflation.

While it is true that many companies that might have been successful would not start, but many more companies that would not have been particularly successful in either environment but would have wasted capital in the inflationary environment would not start in the deflationary environment. It seems Darwinian to me. An inflationary environment reduces the quality of the gene pool. Just as a hyperinflationary environment would reward the worst companies and consumers, a hyperdeflationary environment would kill off the whole population. But a slight and stable deflation would produce vibrant creative destruction, companies fit to survive, and individuals with savings for a rainy day.


Do you believe that electronics companies are bad for the economy because their product prices deflate 50% annually?

No, I don't believe they are bad. No idea why people keep using the electronics argument as they are still operating in a inflationary macroeconomic environment. The incentive to spend your money now hasn't gone anywhere.

I was concerned that you confused depression and credit contraction after the collapse of an inflationary period with a stable deflationary environment. The incentive to spend your money on goods you need will never go away. We are discussing the function of an individual's conflict between value stored in currency versus the price of goods that he wants. For a particular good, there is no difference between price inflation due to the good becoming more valuable or because the currency becomes less valuable (or deflation, less, more). Granted, there are other competing products (if I like vanilla just as much as chocolate, I will purchase the cheapest), but at some point a consumer will purchase a given product at a particular price despite the expected change in value or price. The question is how much does the change inhibit or persuade the consumption?

I believe Keynes and Monetarist agree that the velocity of money increases directly and proportionally as a function of price inflation in the long run (and here and now given stable rates). I see no reason not to extrapolate that backwards and linearly into deflation.

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September 07, 2011, 06:45:38 AM
 #234

Say we have 5% annual deflation.

A 0% interest loan in a 5% deflationary economy is equivalent to a 7% loan in a modern fiat 'stable' 2% inflationary economy.

Exactly. You could also say "A 0% interest loan in a 5% deflationary economy is equivalent to a 5% loan with an ideal 0% inflation currency".
Note that I don't advocate for inflation.
But Why would you lend at 0% interest with the deflationary currency?
The loan is just not made. That's what I claim in my example about deflation discouraging investments. I prefer to not discuss if deflation discourages spending or not. But what's wrong with my example?

EDIT:

Savers will invest in projects that serve their principals or can be expected to outperform the inherent deflation.

While it is true that many companies that might have been successful would not start, but many more companies that would not have been particularly successful in either environment but would have wasted capital in the inflationary environment would not start in the deflationary environment. It seems Darwinian to me. An inflationary environment reduces the quality of the gene pool.

I agree with you more than I thought. But I don't agree with your claim that inflation allows unprofitable companies to be profitable. It depends on how the inflation is created. If it is created by loaning money into existence and monetizing debt, then, yes, it also lowers interest rates. But inflation per se rises nominal interest rates having no effect in real interest rates. An investment with 5% inflation will be just as profitable as the same investment with 0% inflation, but the lender will receive 5% in concept of inflation premium.

In the end I advocate for modest deflation plus demurrage.

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September 07, 2011, 08:56:00 AM
 #235

The last word will never end.

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September 07, 2011, 12:14:06 PM
 #236

But Why would you lend at 0% interest with the deflationary currency?
An institution would not, nor would the population be compelled to invest for fear of losing purchasing power. An inflationary environment forces a rational actor to chose best of two evils if no better alternative is available. Whereas in a deflationary environment, doing nothing is a rational action if no better options are available.

In an inflationary environment, one has less incentive to invest in his neighbor with no terms, puts a bigger premium on generosity. The only loans are institutional (banks) rather than interpersonal in the community. In fact, in an inflationary environment, few people even have savings to lend. In a deflationary environment people would require fewer loans and would have an easier time obtaining them from neighbors if they did require/desire a loan.

But I don't agree with your claim that inflation allows unprofitable companies to be profitable.

In Real terms (inflation adjusted), yes. A company only needs to beat the inflation rate, but it does not need to create purchasing power. This is obvious in a hyperinflating economy, but less obvious in 2% inflation.

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September 07, 2011, 01:05:34 PM
 #237

Whereas in a deflationary environment, doing nothing is a rational action if no better options are available.

Exactly, deflation can lower interest rates but not below zero. The real interest must be positive, so real investments must compete with deflationary money.

But I don't agree with your claim that inflation allows unprofitable companies to be profitable.

In Real terms (inflation adjusted), yes. A company only needs to beat the inflation rate, but it does not need to create purchasing power. This is obvious in a hyperinflating economy, but less obvious in 2% inflation.

No, with inflation interest rates becomes higher because the lender must decide between lend or acquire real capital (that is going to rise in price) himself. With the current system the money lent does not need to be saved first and that's what lower interest rates (real loanable funds compete with the new funds created by the central bank and lent cheaper), but not the inflation itself. If the inflation were "natural" (more gold mined for a gold-money economy), the lenders would just ask for the inflation premium to be added to the real interest (that would still be the average real capital return).

With deflation, when the real interest rate is lower than the deflation, the nominal interest should be negative (which cannot happen) for the real investment to be as profitable as the loan. Nominal interest must be always positive with everlasting money. Only the ones with the money can invest here, borrowers can compete with them, and still they would be better if they just keep their deflating money.


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September 07, 2011, 02:35:54 PM
 #238

Why are you stuck on interest rates? Until a company pays off its creditors, it has not been proven successful. A company that beats the inflation rate is successful in nominal terms, but has not necessarily profited in real terms (increase purchasing power). Inflation creates the incentive to invest in companies that are not profitable in real terms because doing so is better than doing nothing. While this creates jobs in the near term, it is detrimental to real growth. Inflation is a major contributor to the business cycle - bubbles and contraction.

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September 07, 2011, 03:25:25 PM
 #239

Why are you stuck on interest rates?
Because real interest rates determine how successful a company needs to be in relation to the principal that funded it.

Until a company pays off its creditors, it has not been proven successful. A company that beats the inflation rate is successful in nominal terms, but has not necessarily profited in real terms (increase purchasing power).

So if the lender knows the inflation rate, he should (and will if he can) ask the real interest rate plus the inflation rate.
With deflation, he's not going to ask the the real interest rate less the deflation rate, he will get at least the lower of the two. If real capital yields go below the deflation rate, no lending at all would happen. Nothing. Lenders would just prefer to keep earning from deflation rather than investing in any real capital, even if it is profitable in real terms.
In this case there's no real investment out there that outperforms hoarding, so rational investors should not lend.
But when the deflation rate is lower than the capital yields, the problem is still there:
Some business that are profitable in real terms will turn out to be insolvent in a deflationary scenario, because financial costs are in nominal terms and your income and collateral are being devalued nominally.

Inflation creates the incentive to invest in companies that are not profitable in real terms because doing so is better than doing nothing. While this creates jobs in the near term, it is detrimental to real growth. Inflation is a major contributor to the business cycle - bubbles and contraction.

You're talking about keynesian inflation, I just want to talk about deflation. I'm not advocating inflation. I'm just pointing out the problems with deflation.
I also disagree with the way you relate all the problems we have today with inflation. A bitcoin-like currency with an exponentially growing base but with miners receiving the inflation instead of commercial banks and governments in form of debt would have very different effects on its economy.
But again, I'm not advocating inflation, just warning about deflation.

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September 08, 2011, 08:09:23 PM
 #240

"If you think deflation is just the devil, then fine, don't use bitcoin"


Hey I like the devil!

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