Deflation and Bitcoin, the last word on this forum

[MoonShadow]

Tell that to the Japanese.  Just-in-time manufacturing ate Detroit's lunch in the 1980's.  Print-on-demand & every aspect of the Internet is doing the same thing for the media industries today.

That seems to be a clear case in which the reason is an increase in efficiency. All I'm saying is that it doesn't have to be necessarily the case.
Yes 3d preinters are going to change everything but we're just talking about the effect of different monies in the economy, right?
I thought it was the monetary technology what we were discussing.

It doesn't have to be the case, but wherever the monetary base is ridgid and the credit system is limited (as in full reserve lending) there has never been a case that could be held up as an example of a deflationary period that was predominately caused by anything other than increases in productive efficiency or growth of the economy.  While I'll concede up front that doesn't mean that such events are impossible, they are most certainly possible under fractional reserve lending & fiat monetary systems unattached to a commodity base.  We are living through just such an event right now, namely the contraction of the monetary base due to the rapid fall of credit.  While the majority of the effects have thus far been mitigated by the Fed's massive increases in the monetary base (M1 or M-prime) this only works to keep prices stable while the economy is still contracting.  Once the economy actually starts to recover, there is no practical process for the Fed to recall that liquidity, and thus a future of massive price inflatin is already backed into the cake.  Flexible monetary systems resonate and do so in an unbalanced direction, always favoring inflation of the maonetary base in the long run. 

This was less possible under a gold standard with full reserve lending practices, and is actually impossible under bitcoin.  Bitcoin can 'resonate' but must, by design, do so in a balanced fashion.  There is mathmaticly no other possibility.

[MoonShadow]

Hey MoonShadow, I read Mish and want to see if I'm understanding him.  (And I don't think he says all of this; some of it is me trying to fill in the gaps.) So the Fed is printing money like crazy which has some Austrians convinced that inflation or even hyper-inflation is the real threat and just around the corner.  But what the hyper-inflationists are missing is that all this money printing is the finger in the dam trying to hold back much larger deflationary pressures caused by debt deleveraging.  But my understanding is that the deflation that's trying to occur on the debt side is the natural, opposite-and-equal-type reaction to years of inflationary policies by the Fed which printed too much money and kept interest rates too low for too long.  And my understanding is that the liquidation of all this bad debt (which will be deflationary) needs to occur for the long-term health of the economy.  (It's trying to unravel a lot of "malinvestment" which seems to be the word of the day.) My understanding is also that there are powerful interests that are terrified of this looming deflation because they stand to lose their shirt.  That would include obviously the government, the biggest debtor of all.  But that also includes the banking industry, right? Banks are huge creditors, but they're also huge borrowers, no? And in a deflationary contraction, the banks' borrowers are going to be more likely to default, making it more likely that the banks will default on their own debts.  

Doing great so far, and yes, banking defaults are themselves deflationary.  Any 'money' that they create by fractional reserve lending (it's not the multiple that is often implied, the new money is forced into creation as the loans are repaid with real cash, and the interest on loans without any bank reserves to support them become the new money.  Ultimately, though, the fed is forced to create that money due to the demand that fractional reserve banks have created.) is then destroyed when those loans go bad and teh bank defaluts.

My questions are: (1) won't it be relatively easy for the Fed to "win" the war on deflation (which again, I think is a bad result)?  Won't you at some point overpower the deflationary deleveraging that's trying to occur if you just print enough money? And don't they have every (bad) incentive to do so?

That depends upon what you consider a 'win'.  Yes, the Federal Reserve can literally create as much money as is necessary to contradict price deflation in the near term.  However, they 1) can't dictate into which sector that liquidity primarily goes into, which is why we have a succession of market bubbles.  The inflation has never been even across the entire economy at any point in history; and 2) is they take the printing too far, then they risk the destruction of the public trust in the currency, which results in the hyperinflationary death of the currency.  Since their entire world revolves around that trust, and hyperinfaltion would destroy the banking system that gives the Federal reserve it's reason for existance, the fed governors are not going to risk that unless forced into it by poltical events beyond their control.  This is why, always and everywhere in history, the hyperinfaltionary death of a fiat currency has always been triggered by a political event wuch as a war or a revolution.  Bankers know why their currencies die, and won't permit it without a fight.  That is also why the FedReserve is traditionally a politically independent entity, to insolate it's leadership from political pressures.  It's never really worked that way, but it was a good idea.

(2) Won't all this money printing become inflationary (in a price sense) at some point?  Even if (or maybe even, especially if) the house of cards topples and all this debt is forced to liquidate thereby causing deflation on the debt side, won't the economy eventually releverage when it starts growing again?  And when it does, won't it be releveraging on a much larger base?  

Yes, it will.  That is, it will if there is still enough trust in the system to prevent a hyperinflationary death.

[JoelKatz]

Is this the "predictability makes deflation impossible by perfect speculation" argument again?

If deflation is predictable, then speculation is almost always possible. (And, in fact, automatic. You don't need to do anything for it to happen. The reason there's deflation is because people already value the currency more highly.) If it's unpredictable, of course it's bad. But to say a system will definitely suffer from unpredictable deflation is self-refuting.

[jtimon]

Is this the "predictability makes deflation impossible by perfect speculation" argument again?

If deflation is predictable, then speculation is almost always possible. (And, in fact, automatic. You don't need to do anything for it to happen. The reason there's deflation is because people already value the currency more highly.) If it's unpredictable, of course it's bad. But to say a system will definitely suffer from unpredictable deflation is self-refuting.

Ok, that argument again. Someone (I think lonelyminer or maybe moonshadow) already explained to you better than me why predictable deflation is definitely possible.
I failed last time I tried, so I won't do it again.

[Roger_Murdock]

Ok, that argument again. Someone (I think lonelyminer or maybe moonshadow) already explained to you better than me why predictable deflation is definitely possible.

My understanding isn't that predictable deflation is impossible.  It's that predictable runaway deflation is impossible.   If runaway deflation were predictable, everyone would want to get in on the (relatively costless) riches to be had by simply holding currency.  Accordingly, people would bid up the price of money until equilibrium is reestablished. Yes, bidding up the price of money is itself deflationary, but that adjustment should happen very quickly and its final stopping point should be governed by fundamentals.  Of course, deflation can still continue predictably after that initial quick adjustment, but at a slower, market rate.  There will still be a reward for deferring consumption, but it'll be much smaller and again, I think that's the efficient result.

Another thought that occurs to me is you seem focused on a single positive feedback loop, i.e. hoarding --> deflation --> more hoarding --> more deflation, etc.  But that's obviously not the only game in town, because you admit that this process is self-limiting (i.e., you won't eventually be able to buy a mansion with a penny).  So there must be other feedback loops, at least some of which are negative.  

You compared deflation to a pill that makes you throw up when you've accidentally ingested poison.  You said that while throwing up is necessary in such a case that doesn't make it "good." And you conceded that the real problem in that scenario is the poison (i.e. the initial disequilibrium). That sounds reasonable.  But I think this may sum up some of the disagreement.  I think there are two types of deflation: (1) sudden unpredictable deflation caused by the market attempting to correct misallocations of capital fueled by government intervention and (2) steady relatively predictable deflation caused by sound money and a growing economy.  The poison / pill analogy seems apt for the first type of deflation but not the second.  And in a Bitcoin-based free economy, it seems like the second type is all we would see.  

[Roger_Murdock]

Thanks, MoonShadow! That was helpful.  Following up on one thing you said earlier:

Once the economy actually starts to recover, there is no practical process for the Fed to recall that liquidity, and thus a future of massive price inflation is already baked into the cake.

Is that correct? I guess I'm remembering reading stories about the "balancing act" or whatever the Fed has to walk, i.e. fighting deflation now by growing the money supply and then shrinking the money supply when the economy starts to recover.  My understanding is that they CAN shrink the money supply by using some combination of these three: (1) raising reserve requirements; (2) raising the discount rate; and (3) selling government securities. (http://www.investopedia.com/articles/08/fight-recession.asp#axzz1vgv6S4Xm)

I'm wondering if the real problem isn't that we can't have it all, i.e. a growing economy with low inflation without first suffering the painful (for some) deflationary deleveraging that's trying to occur. If the feds print enough money to trigger a "recovery" (really another bogus bubble, no?), an extremely painful inflation will kick in. But if they then put on the brakes enough to stop the inflation, they'll also stop the recovery. There's no sweet spot.  The physics don't work.  We need to back up (deflate) and change course (reallocate) by allowing all this bad debt to be liquidated.  But the Feds don't want to allow that (to protect certain parties) and so the economy will likely continue to stall for a while as they put on the gas just enough to keep us from slipping backwards but not enough to actually move forwards since the road ahead leads over a hyper-inflationary cliff. Is that basically the Japan "Lost Decade(s)" story or is there something different going on there?

So... how does this end? Also what the hell should I be doing to protect myself? And don't say investing more in Bitcoin.  I'm also trying to stay married and my wife is not completely sold on "Mario Money" as she calls it. (I know. It sounds like a compliment, but that's not how she means it.)  

[jtimon]

That seems to be a clear case in which the reason is an increase in efficiency. All I'm saying is that it doesn't have to be necessarily the case.

It doesn't have to be the case, but wherever the monetary base is ridgid and the credit system is limited (as in full reserve lending) there has never been a case that could be held up as an example of a deflationary period that was predominately caused by anything other than increases in productive efficiency or growth of the economy. 

I'm mostly interested in discussing this case: no fractional reserve lending and a gold standard.
This bring us back to my question...What happens when most capital yields get under the basic interest (time preference if you prefer)?

While I'll concede up front that doesn't mean that such events are impossible, they are most certainly possible under fractional reserve lending & fiat monetary systems unattached to a commodity base.  We are living through just such an event right now, namely the contraction of the monetary base due to the rapid fall of credit.

I would say that fractional reserve, like regular money printing can act as a patch that delays the bust and makes it much worse. Following your wave analogy, it would act like some kind of amplitude and wavelength amplificator.

While the majority of the effects have thus far been mitigated by the Fed's massive increases in the monetary base (M1 or M-prime) this only works to keep prices stable while the economy is still contracting.  Once the economy actually starts to recover, there is no practical process for the Fed to recall that liquidity, and thus a future of massive price inflatin is already backed into the cake.  Flexible monetary systems resonate and do so in an unbalanced direction, always favoring inflation of the maonetary base in the long run. 

With money-printing combined with fractional reserves gets you in a much worse disaster than only fractional reserve with a gold standard.
In summary, I think we can agree that...
keynesian base supply + FRB < gold standard + FRB < gold standard

This was less possible under a gold standard with full reserve lending practices, and is actually impossible under bitcoin.  Bitcoin can 'resonate' but must, by design, do so in a balanced fashion.  There is mathmaticly no other possibility.

Not sure I understand this point. I suspect it has to do with the supply of money provided by miners.
If you prefer, let's forget the gold standard and consider a completely fixed monetary base, ok? When no new bitcoins are going to be created (and forgetting that some of them will get lost).
A fixed monetary base and no FRB for our discussion. I still claim that there will be cycles and that deflation will destructively participate in the "ugly side of the curve".

[rdponticelli]

I just don't think that money should (or even can) perform the medium of exchange and the storage of value functions together.

Why? What's wrong with it?

I know, you're afraid of deflation, and you think that the basic interest rate encourages hoarding, and deflation, and the famous death spiral...

But thinking from the other side. If a medium of exchange isn't also a storage of value, how doesn't it encourages pure consumerism? How such a medium of exchange could end on something else than hyperinflation? Isn't the inflationary tendency of such a money even worse than what we have today?

[MoonShadow]

Thanks, MoonShadow! That was helpful.  Following up on one thing you said earlier:

Once the economy actually starts to recover, there is no practical process for the Fed to recall that liquidity, and thus a future of massive price inflation is already baked into the cake.

Is that correct? I guess I'm remembering reading stories about the "balancing act" or whatever the Fed has to walk, i.e. fighting deflation now by growing the money supply and then shrinking the money supply when the economy starts to recover.  My understanding is that they CAN shrink the money supply by using some combination of these three: (1) raising reserve requirements; (2) raising the discount rate; and (3) selling government securities. (http://www.investopedia.com/articles/08/fight-recession.asp#axzz1vgv6S4Xm)

Thereortically yes, but here's the problem with that...

1) would shove many marginal banks into insolvency.  The federal reserve exists to prevent this, they are not really going to ever do this to any degree that would really matter.

2) would do pretty much the same thing as above, so again, not going to do it to any effective degree and

3) would, for many reasons, increase the effective interest rate that the government pays to it's own banks for rollover debt financing.  Which would bankrupt the government which holds a monopoly on force within the same nation that said banks reside.  I can't really see that one happening either.

I'm wondering if the real problem isn't that we can't have it all, i.e. a growing economy with low inflation without first suffering the painful (for some) deflationary deleveraging that's trying to occur. If the feds print enough money to trigger a "recovery" (really another bogus bubble, no?), an extremely painful inflation will kick in. But if they then put on the brakes enough to stop the inflation, they'll also stop the recovery. There's no sweet spot.  The physics don't work.

Well, there is a sweet spot, it's just always moving and we don't know what it is.  And we can't know what it is except in hindsight.  That's the 'fatal conceit' that Hayak talked about.

We need to back up (deflate) and change course (reallocate) by allowing all this bad debt to be liquidated.  But the Feds don't want to allow that (to protect certain parties) and so the economy will likely continue to stall for a while as they put on the gas just enough to keep us from slipping backwards but not enough to actually move forwards since the road ahead leads over a hyper-inflationary cliff. Is that basically the Japan "Lost Decade(s)" story or is there something different going on there?

Close enough.

So... how does this end? Also what the hell should I be doing to protect myself? And don't say investing more in Bitcoin.  I'm also trying to stay married and my wife is not completely sold on "Mario Money" as she calls it. (I know. It sounds like a compliment, but that's not how she means it.)  

There are actually better 'catastrophy' investments than bitcoin.  Silver is one, to a point.  So are bullets for coo=mmon calibers even if you don't own a gun, because of the varoius commodites used in the product as well as teh practical usefullness of the item in teh worst of conditions.  Obviously this should come after a well stocked pantry & a couple of cans of kerosene.  “In the house of the wise are stores of choice food and oil, but a foolish man devours all he has.” Proverbs 21:20

[jtimon]

Ok, that argument again. Someone (I think lonelyminer or maybe moonshadow) already explained to you better than me why predictable deflation is definitely possible.

My understanding isn't that predictable deflation is impossible.  It's that predictable runaway deflation is impossible.   If runaway deflation were predictable, everyone would want to get in on the (relatively costless) riches to be had by simply holding currency.  Accordingly, people would bid up the price of money until equilibrium is reestablished. Yes, bidding up the price of money is itself deflationary, but that adjustment should happen very quickly and its final stopping point should be governed by fundamentals.  Of course, deflation can still continue predictably after that initial quick adjustment, but at a slower, market rate.  There will still be a reward for deferring consumption, but it'll be much smaller and again, I think that's the efficient result.

Another thought that occurs to me is you seem focused on a single positive feedback loop, i.e. hoarding --> deflation --> more hoarding --> more deflation, etc.

Not only that, credit contraction also acts as positive feedback for deflation.

But that's obviously not the only game in town, because you admit that this process is self-limiting (i.e., you won't eventually be able to buy a mansion with a penny).  So there must be other feedback loops, at least some of which are negative.  

I get your point, because it is unsustainable it has to get to a new equilibrium fast. I agree. But how long is fast?
It cannot be instant. But I don't know. Different contracts would have different clearing processes and dates. I fear that question doesn't have an easy answer.
If you don't interfere and labor prices can be adjusted too
Surely much faster than the formation of the imbalance.

You compared deflation to a pill that makes you throw up when you've accidentally ingested poison.  You said that while throwing up is necessary in such a case that doesn't make it "good." And you conceded that the real problem in that scenario is the poison (i.e. the initial disequilibrium). That sounds reasonable.  But I think this may sum up some of the disagreement.  I think there are two types of deflation: (1) sudden unpredictable deflation caused by the market attempting to correct misallocations of capital fueled by government intervention

Yes, it can be produced with money printing and fractional reserve. But the very structure of money could require periodical adjustment too.
Incidentaly is growth what triggers deflation in this case, but the problem is the artificial limit that the basic interest imposes on growth.
If the capital yields generally fall under the basic interest, savers are less incentived to loan and prefer to just hoard and enjoy the free advange over uncertainty that having your savings liquid has. There will be a fast movement from savings lent to savings hoarded, which creates deflation, destroys credit and leads you to a new stable equilibrium. [ The keynesian approach is to inject fictional savings before that happens through money creation at a lower interest rate. But eventually you will reach that new minimum and the solution would be lower it again until you reach zero. But you didn't really wanted to sustain prices, you wanted the real savings not to be hoarded. You haven't solved your problem and you have created new and worse imbalances. ]
In the new price equilibrium, capital yields are over the basic interest again and everything can go back to normal. The inherent imbalance in money is that it artifically prevents capital yields from dropping to zero, which is their natural tendency. That's what deflation clears in this case instead of the bad investments created by the artificial expansion of monetary base/credit in other cases. It throws capital yields high so that they can try to approach zero again.

and (2) steady relatively predictable deflation caused by sound money and a growing economy.  The poison / pill analogy seems apt for the first type of deflation but not the second.  And in a Bitcoin-based free economy, it seems like the second type is all we would see.  

The drop in prices caused by growth is not "a general drop in prices". The efficiency of a given production process increases and as a result, we can produce the same thing with less resources or produce more for the same. The price of the product needs to be changed. I'm prefectly ok with that. That's prosperity. The problem is only the deflation that is caused by a monetary phenomenon. Only when it comes to resolve an imbalance.
I would say that we mainly disagree in

1) If in the process of resolving the imbalances the deflation can cause additional collateral destruction.
2) The posible causes deflation. Apart from the fractional reserve and the money-printing credit and base expansions I claim that capital-money produces cycles that get cleared with deflation too.

[Roger_Murdock]

jtimon, apologies for my ignorance on this, but could you explain what is meant by "basic interest" and this statement:

The inherent imbalance in money is that it artifically prevents capital yields from dropping to zero, which is their natural tendency.

Does that just mean that the market interest rate will never drop to 0% (or do you mean something different by "capital yields")? And why is that the natural tendency? I guess my understanding is that the interest rate is the "price of money." Why would the price of money  (or any other scarce, useful thing) drop to zero?

You also say:

I would say that we mainly disagree in

1) If in the process of resolving the imbalances the deflation can cause additional collateral destruction.
2) The posible causes deflation. Apart from the fractional reserve and the money-printing credit and base expansions I claim that capital-money produces cycles that get cleared with deflation too.

So you're saying that the business cycle which will include periods of corrective but unnecessarily destructive deflation is baked into the pie of an inelastic currency? Is that right? But assuming that's true, is there anything we can do about it?  We've tried a fiat system that relies on the intelligence and benevolence of top men to sort of twist the dials and smooth things out.  That hasn't worked very well.

[jtimon]

Good questions. Straight to the points.

I just don't think that money should (or even can) perform the medium of exchange and the storage of value functions together.

Why? What's wrong with it?

The price of savings shouldn't influence the price of money. When the price of savings is too low (for non-perishable money), the financial market creates deflation that also affects commerce. If people can save the medium of exchange directly:

1) The economy cannot reach its optimal state of prosperity, namely zero average profits AND 0% average capital yields.

2) Periodic cycles are produced as a result of the previous point

3) Things in the future cannot be valued more than things in the present. Society becomes biased for the short-term thinking.

I know, you're afraid of deflation, and you think that the basic interest rate encourages hoarding, and deflation, and the famous death spiral...

Basic interest concerns me more than deflation. One is the disease an another a periodical symptom.
But the price we pay for the basic interest is much higher than the destruction that deflation can cause from time to time.

But thinking from the other side. If a medium of exchange isn't also a storage of value, how doesn't it encourages pure consumerism?

The fact that you can't block the medium of exchange doesn't push you to consume. You can buy things you're going to need in the future in advance, lend your money, pay your taxes in advance, invest...
Also, it's a common misconception that low interests lead to short-term thinking. In fact is actually the opposite.
The austrian school tell us that we humans think short-term by nature and as a result, the basic interest, liquidity premium, the time-preference factor of the gross interest or however you want to call it appears.
But while it's true that I prefer to directly hold an ounce of gold from the beginning, rather than wait until next week for you to pay me back, I may prefer an apple you give me next week over an apple today.
If the time preference went from the people to money and not the other way around, it could happen that people preferred things in the future and the basic interest were negative. If we didn't prefer any of the two overall but some people preferences were compensated with others in the opposite direction, that rate would be zero.
With this image Bernard Lietaer exemplifies the time preference that money causes over us:
http://www.wuala.com/jtimon/temp/what%20do%20we%20invest%20in.png
Ask if you have doubts about that tree metaphor.

How such a medium of exchange could end on something else than hyperinflation? Isn't the inflationary tendency of such a money even worse than what we have today?

You can have demurrage and a fixed monetary base. You would expect prices to drop independently by improvements in production processes but not a perpetual and general rise in prices as a result of the demurrage. You can have lower and free floating interests without creating inflation.

[jtimon]

jtimon, apologies for my ignorance on this, but could you explain what is meant by "basic interest" and this statement:

The inherent imbalance in money is that it artifically prevents capital yields from dropping to zero, which is their natural tendency.

No worries. I'm using this definition:

nominal interest = real interest + inflation premium = basic interest + risk premium + inflation premium

I use basic all the time so that people don't think I want to suppress interest altogether or fix the price of savings.

Does that just mean that the market interest rate will never drop to 0% (or do you mean something different by "capital yields")?

Yes.
Capital yields is like the "interest on real capital". Or like "the profits on real capital".

And why is that the natural tendency? I guess my understanding is that the interest rate is the "price of money." Why would the price of money  (or any other scarce, useful thing) drop to zero?

Just like profits tend to zero by competition capital yields should do the same, because different capitals of the same type (for example, houses) compete with each other for the revenues. And the "price of savings" are naturally coupled with capital yields.
I use "price of savings" to separate it from "price of money", which I think is more useful in the inflation/deflation context.
This way you can study the demands and offers of money (as medium of exchange) and savings (transporting value into the future) separately.

So you're saying that the business cycle which will include periods of corrective but unnecessarily destructive deflation is baked into the pie of an inelastic currency? Is that right?

Yes. It also has to be non-perishable so that money holders can enjoy for free the "liquidity insurance" which constitutes a positive externality for them that we all end up paying in several ways.

But assuming that's true, is there anything we can do about it?  

Scarce money (cash) can be charged with a demurrage fee so that it is still good for exchange but can't be useful as a storage of value and people prefer to lend or invest themselves rather than hoarding.

We've tried a fiat system that relies on the intelligence and benevolence of top men to sort of twist the dials and smooth things out.  That hasn't worked very well.

Yes, they have miserably failed as Gesell predicted.
He said that paper money without demurrage is doomed to failure, but now I don't even want his flexible supply with demurrage. If basic interest was the real problem there should be no need for an elastic supply, the demurrage should suffice. Unlike Gesell, I don't want an elastic supply, only demurrage to suppress the basic interest. The Austrian school have really changed my mind in this respect

[Roger_Murdock]

Ok, let's switch from the disease to your proposed cure.  How would this demurrage work? Who collects it? How? What do they DO with the demurrage fees? And (perhaps most importantly) how is the "appropriate" demurrage price determined?  And how is it really any different from an inflationary money supply? Doesn't it necessarily rely on the supposed intelligence and benevolence of a centralized authority (and thus won't it fail for the same reason as the Federal Reserve system)?

[jtimon]

Ok, let's switch from the disease to your proposed cure.  How would this demurrage work?

Like a negative interest on cash.
http://en.wikipedia.org/wiki/Demurrage_(currency)

Who collects it?

The issuing authority. For Gesell's free-money, the state. For local currencies like the later prohibited Wörgl miracle, to the city. In the modern chiemgauer I think it goes to non profits, but there's more regio currencies in germany.
In the case of freicoin, it goes to miners.

How?

With paper money is typically implemented through stamps that you need to stick to the bills for them to continue being valid.
For freicoin, you just change the way you look at balances. When you want to know the balance of a given address you look at the amount that is written in the chain, the block number in which it appears and substract the demurrage fee per block.
That money gets destroyed. Miners count on a perpetual constant reward but eventually the new money created equals the money destroyed by demurrage and the monetary base gets stable (morestable than bitcoin's because you also recycle lost wallets with this). That's why I say that the fees go to miners.

What do they DO with the demurrage fees?

Public institutions: take it as a tax.
Miners: take it for the security service they provide. They will be able to provide more security with less transaction fees so in certain way it also goes back to the users in the form of lower tx fees. This would also solve the "transaction fee tragedy of the commons" if it happens to occur with bitcoin when there's no other reward for miners.

And (perhaps most importantly) how is the "appropriate" demurrage price determined?

That's the hard one. Ideally you want to equal the basic interest with the demurrage rate, but what's the natural basic interest?
Gesell estimated it around 4% or 5% based on historic data, but have other improvements in commerce lowered that figure?
I guess the best solution would be to have different currencies with different demurrage rates and let the market decide.
Borrowers will prefer high demurrage rates to lower their borrowing costs but lenders won't accept less than 0% interest.

And how is it really any different from an inflationary money supply?

Yes the wey they affect interest is different. The inflation is added to the inflation premium of the gross interest so you don't really lower interests.
Let's compare freicoin with expocoin/inflatacoin bouth at 5% demurrage/inflation.
Let's say we have some real capital (say a house) with zero risk that yields y% anually and costs 10000.
You're a lender with 10000...

10000 inflatacoins
You ask me borrower at least y + 5 % or you just buy the house.

10000 freicoins
You just ask me for y% because the house is not expected to rise in price 5% anually.

Doesn't it necessarily rely on the supposed intelligence and benevolence of a centralized authority (and thus won't it fail for the same reason as the Federal Reserve system)?

That's only necessary if you want an elastic supply. Anyway, a central bank issuing money with demurrage would have much more control over the price of money because V would be not only greater (which means a smaller increase or decrease in the base will affect more and faster) but much more predictable. Current central banks just can't control the price of money even if they were benevolent.
But the power of a free-money central bank could also be abused.

[MoonShadow]

Demurrage can't work in a bitcoin-like cryptocurrency without breaking something.  I've looked pretty deep into this before, and wish I were proven wrong.  So far, it just adds too much complexity or it fails to encourage the desirable activities such as deliberate consolidation of inputs.  One thing that could be done is to add a new rule to the minimum fee structure that adds a relative increase in the minimum fee after a year or so, in such a way that long term savings accounts end up paying for their past security eventually; but that's not really demurrage and doesn't contribute much to consolidation of the blockchain nor does in contribute anything to the running security.

[Foxpup]

One thing that could be done is to add a new rule to the minimum fee structure that adds a relative increase in the minimum fee after a year or so, in such a way that long term savings accounts end up paying for their past security eventually; but that's not really demurrage and doesn't contribute much to consolidation of the blockchain nor does in contribute anything to the running security.

There are no rules to the minimum fee structure - miners and nodes are free to enforce whatever fees they want. Ultimately the market will decide what fee structure is best for Bitcoin, which is the way it should be.

[MoonShadow]

One thing that could be done is to add a new rule to the minimum fee structure that adds a relative increase in the minimum fee after a year or so, in such a way that long term savings accounts end up paying for their past security eventually; but that's not really demurrage and doesn't contribute much to consolidation of the blockchain nor does in contribute anything to the running security.

There are no rules to the minimum fee structure - miners and nodes are free to enforce whatever fees they want. Ultimately the market will decide what fee structure is best for Bitcoin, which is the way it should be.

There are rules to the minimum fee structure and miners and nodes are free to enforce whatever fees that they want.

[jtimon]

Demurrage can't work in a bitcoin-like cryptocurrency without breaking something.  I've looked pretty deep into this before, and wish I were proven wrong. 

Does this means that you would be ok with a government issued currency with a fixed monetary base and demurrage? What could be the problems?
For the bitcoin like currency...please, tell me what would be broken.

So far, it just adds too much complexity or it fails to encourage the desirable activities such as deliberate consolidation of inputs. 

I think it adds little complexity. It just replaces the generation equation with a constant and changes the way balances are interpreted.
How is worse than bitcoin consolidating inputs?
With a minimum absolute demurrage fee per account you're in fact penalizing people who hold their money in many addresses.
Also demurrage destroys old accounts. I think it is better than bitcoin at consolidating inputs unless you mean something else.
By consolidating inputs you mean basically saving miner's storage in their database, right?

One thing that could be done is to add a new rule to the minimum fee structure that adds a relative increase in the minimum fee after a year or so, in such a way that long term savings accounts end up paying for their past security eventually; but that's not really demurrage and doesn't contribute much to consolidation of the blockchain nor does in contribute anything to the running security.

I think demurrage + constant reward for miners solves the "transaction fees tragedy of the commons" potential problem.

But besides those technical byproduct advantages what's more relevant to this thread is that demurrage enables a free savings market with lower interest rates and paying no manipulation/inflationary costs. I want to preserve that credit = debit equation that keynesians and fractional reserve banking destroy through the creation of fictional savings. But I also think interest could be lower if hoarding the medium of exchange was discouraged. And if the time preference interest rate is allowed to drop to 0% (which would mean society doesn't value more the present than the future), hopefully the cycles will disappear (also removing central and commercial banks counterfeiting privileges, of course).
Please, anyone tell me how demurrage could affect the financial market negatively.
Is there any paper on the subject?

[Sant001]

It is true that price deflation encourages hoarding. But that's why merchants will have to accept other currencies to keep on selling.
That currency competition will decrease the value of bitcoin as a medium of exchange, decreasing demand, decreasing deflation.
Since bitcoin is not the only currency on earth, deflation can't kill it.  

Well said. Although let's hope one of these other competing currencies aren't bitcoin v2.0 with speculation and deflation proof features.