Bitcoins Can Inflate Too - Stop worrying about deflation.

[Hyena]

One of my teachers during the course of software economics pretty much started the course with comparing inflation and deflation. And he told the classical explanation of why deflation is a bad thing (also mentioning Japan at some point during the last century), then came to a conclusion that even if inflation is a bad thing deflation is even worse and then asked the class if anyone thought it's not all bad. Obviously I was the only one raising my hand and telling him that it's not that simple and deflation can still be good. The guy then told me I'd be stupid if I bought gas knowing that it would be cheaper tomorrow and completely ignored me saying "If I need something today I won't be waiting for tomorrow". The argument ended with the lecturer asking me if I now think deflation is bad and me answering "this topic needs a lecture of its own".

A couple of days ago I sent him this article of someone explaining why deflation isn't all bad. I also told him that next time when explaining deflation and inflation he might want to consider taking a rather neutral stand on that topic.

[hgmichna]

A sudden bout of deflation is bad, because most of the economy would grind to a halt.

But a gentle course into a slight and stable deflation is an entirely different matter.

[Hyena]

Yes, we have 4 types:
hyper inflation - bad
hyper deflation - worse
inflation - evil
deflation - fair enough

The dudes saying deflation is bad always describe "hyper deflation" without saying the word "hyper".

[kokojie]

21 million bitcoins is way too low for a whole world economy to use

That would be true if there were only 21 million bitcoins, but that's not the actual limit. There will be 21000000.00000000 bitcoins. That's plenty for a world economy.

Most of those decimal numbers can't be used, they worth almost nothing, if they worth something more than a penny, then it's a problem: we will pay more than pennys for every transaction.
Conclusion: stills small for a whole world economy.

Transaction fee can be easily changed, I can send a transaction right now with 0 fee anyway. In fact there are already discussions to modify the minimum transaction fee.

[JoelKatz]

The guy then told me I'd be stupid if I bought gas knowing that it would be cheaper tomorrow and completely ignored me saying "If I need something today I won't be waiting for tomorrow".

The better counter-argument is this: The guy trying to sell me gas also knows it will be cheaper tomorrow, so he'll do whatever he has to do to get me to buy it today.

[Richy_T]

And how about the opposite? If deflation implies currency hoarding and delaying purchases, inflation implies early purchasing and hoarding of supplies, consequently pushing the price up for everyone else.

[hgmichna]

The guy then told me I'd be stupid if I bought gas knowing that it would be cheaper tomorrow and completely ignored me saying "If I need something today I won't be waiting for tomorrow".

The better counter-argument is this: The guying trying to sell me gas also knows it will be cheaper tomorrow, so he'll do whatever he has to do to get me to buy it today.

But even so, would it really matter much if he filled his tank tomorrow, rather than today?

Can we expect that somebody prefers a pile of money to a higher standard of living? Of course not.

Prices are never stable anyway. Today we have important parts of the economy that have rapidly rising prices and are therefore inflationary, but we also already have sectors that are highly deflationary, like computers, smartphones, etc. According to the anti-deflation preachers nobody would ever buy anything like that, because next year you could buy the same thing for much less money or a much better one for the same money. According to them, this sector would perish due to lack of buyers, because everybody would always wait until tomorrow.

What happens instead in these sectors is a very good, living example for a deflationary economy. Does anybody have any problems with this? No. Do they florish? Yes, nicely.

[JoelKatz]

And how about the opposite? If deflation implies currency hoarding and delaying purchases, inflation implies early purchasing and hoarding of supplies, consequently pushing the price up for everyone else.

Right. If we have inflation, why would a gas station sell me any gas today when he knows he can sell me that same gas tomorrow for more money?

The simple fact is, whether we value gas in terms of a basket of commodities, ounces of gold, an inflationary currency, or a deflationary currency, gas is worth more to me than it is to the gas station. And so long as there's no particular reason either of values a currency *differently*, we can use that currency to trade gasoline. If we both think the currency will be worth more tomorrow, we can both take that into account and agree to exchange less currency because we'd both like to hold the currency.

The properties of the currency, so long as it is predictable and affects both parties equally, will have no effect on whether the parties are willing to trade or not.

[justusranvier]

The guy then told me I'd be stupid if I bought gas knowing that it would be cheaper tomorrow and completely ignored me saying "If I need something today I won't be waiting for tomorrow". The argument ended with the lecturer asking me if I now think deflation is bad and me answering "this topic needs a lecture of its own".

No, actually it doesn't deserve a lecture of its own. It doesn't even deserve to be elevated to the status of a serious discussion.

Somebody who says that falling princes means that nobody will buy anything is one of two things: 1) either so mentally deficient that trying to have a debate with them would be cruel, like racing somebody in leg braces, or 2) actively engaging in deception.

Either way a debate is not appropriate.

At most you might want to ask the person if people actually buy iPhones and computers, and if he knows what happens to the prices of those items over time.

[Lethn]

lol justusranvier I wouldn't bother trying to go after and change the mind of people like Hyena's teacher because I met his type lots of times during my school years, all they're interested in is teaching what's on the textbook and making grades higher even if the entire textbook is completely wrong. I'm looking forward to when people like him try to argue against Bitcoin because Bitcoin is made entirely from math and people always, always look stupid when they try to argue against math.

[justusranvier]

lol justusranvier I wouldn't bother trying to go after and change the mind of people like Hyena's teacher

I agree, which is why you don't engage in the pretence of a debate with them.

[alexeft]

The year is 2030. People revolted and threw the feds out. Everyone pays in bitcoins, woo! But all the 21 million bitcoins have being mined already.

An apple sells for 0.05 BTC. The average hourly wage is 1 bitcoin. Everyone's happy.

Someone loses their coins. The world population grows. Now the average hourly wage is only 0.9 bitcoins! People stop buying apples as much as they did before.

An apple now sells for 0.045 BTC. Everyone's happy again.

But then people realize that just by holding bitcoins and not buying, they are actually becoming richer! Plus, someone loses their wallet again, and the world population grows. Now the average hourly wage is 0.8 bitcoins from the natural deflation, and people start putting 1/4 of their wage into a coin store wallet to become richer. The apple farmer realizes less and less people are buying apples, and have to lower the price. And then people knows that if they don't buy something, they will have more buying power tomorrow.

So nearly nobody buys things. The world economy collapses. Then some corporation called the Federal Reserve comes, 'hey, here's our fiat!'.

Right?

WRONG.

This will not happen because of fractional reserve banking.

Alice deposits 1 bitcoin into the bank.
Bob deposits 10 bitcoins into the bank.
> Coins in bank: 11 bitcoins

Carpenter borrows 5 bitcoins to start up a new business.
> Coins in bank: 6 bitcoins

Don't see the problem?

Alice sees her statement with 1 bitcoin.
Bob sees his statement with 10 bitcoins.
Carpenter sees his wallet with 5 bitcoins.

Kaboom. Inflation. Fractional reserve banking will *save* us from a deflationary spiral.

Is fractional reserve banking even possible with bitcoin? When banks make loans, they create money out of thin air, which is not possible long term with bitcoin.
I mean, when the crisis time comes (which it will), who will save the "too big to fail" banks? No government can print bitcoins in order to save them.

I think deflation is the only way bitcoin can go, even with the occasional hiccup upwards that should be expected in any market.

[JoelKatz]

Is fractional reserve banking even possible with bitcoin? When banks make loans, they create money out of thin air, which is not possible long term with bitcoin.

It's quite possible. You just deposit bitcoins at a "bank" and they tell you that you have a particular bitcoin balance, just like Mt Gox does. They then don't hold that number of bitcoins but instead back their holdings with some other currency or asset.

I mean, when the crisis time comes (which it will), who will save the "too big to fail" banks? No government can print bitcoins in order to save them.

What kind of crisis are you talking about? A government wouldn't have to print bitcoins, all you have to do is reimburse depositors in any currency. If some bank holds 50,000 bitcoins for you, you have no legal basis to care whether they pay you back in bitcoins, dollars, or gold. So long as they have assets to equal the currency they hold, they can still make you whole.

I think deflation is the only way bitcoin can go, even with the occasional hiccup upwards that should be expected in any market.

If that's not what the market wants, and nobody passes any laws or uses any force, then that won't happen. Market substitutes for bitcoin will just be introduced to compensate.

[alexeft]

Is fractional reserve banking even possible with bitcoin? When banks make loans, they create money out of thin air, which is not possible long term with bitcoin.

It's quite possible. You just deposit bitcoins at a "bank" and they tell you that you have a particular bitcoin balance, just like Mt Gox does. They then don't hold that number of bitcoins but instead back their holdings with some other currency or asset.

Mt Gox is not a bank, it's an exchange. Why would I want to deposit bitcoins in a bank in the first place?

I mean, when the crisis time comes (which it will), who will save the "too big to fail" banks? No government can print bitcoins in order to save them.

What kind of crisis are you talking about? A government wouldn't have to print bitcoins, all you have to do is reimburse depositors in any currency. If some bank holds 50,000 bitcoins for you, you have no legal basis to care whether they pay you back in bitcoins, dollars, or gold. So long as they have assets to equal the currency they hold, they can still make you whole.

A crisis that an economy might suffer from time to time. I didn't know that as a depositor I could be obliged to be reimbursed in anything of value other than what the original deposit was.

I think deflation is the only way bitcoin can go, even with the occasional hiccup upwards that should be expected in any market.

If that's not what the market wants, and nobody passes any laws or uses any force, then that won't happen. Market substitutes for bitcoin will just be introduced to compensate.

You are right about this.

[JoelKatz]

Mt Gox is not a bank, it's an exchange.

Mt Gox is an exchange, but it also provides service beyond just allowing you to exchange currencies. It also serves as a wallet for many people, which is akin to a bank.

Why would I want to deposit bitcoins in a bank in the first place?

There could be a lot of reasons. One would be if you don't want to run the Bitcoin client to send Bitcoins, don't want to go through the hassle of having a paper wallet, and are concerned about security. Another would be if the bank could provide you with additional services, such as being able to exchange your bitcoins at any time without waiting an hour for confirmations.

But the reason I bring it up is to address an argument whose premises I don't agree with. If you think bitcoins are inevitably going to deflate and if you think that's going to present a problem, then the solution will be fractional reserve banking. In the event of some incredible global catastrophe, the bank can pay you back with other assets greater in value than the bitcoins they owe you. Boo hoo. If deflation is a crisis, then this miniscule "risk" is negligible if we can avert a crisis just by taking it.

If people would avoid a currency just because it had this kind of risk, nobody would use any national currencies. They have inflation risk.

A crisis that an economy might suffer from time to time. I didn't know that as a depositor I could be obliged to be reimbursed in anything of value other than what the original deposit was.

This is silly. A crisis is, by definition, a rare event. In a crisis, you might get paid in gold rather than bitcoins, but you wouldn't lose a penny. Oh, that's awful! Forget this entire economic plan because it can't give me bitcoins in the event of nuclear war. Are you serious?

[alexeft]

Why would I want to deposit bitcoins in a bank in the first place?

There could be a lot of reasons. One would be if you don't want to run the Bitcoin client to send Bitcoins, don't want to go through the hassle of having a paper wallet, and are concerned about security. Another would be if the bank could provide you with additional services, such as being able to exchange your bitcoins at any time without waiting an hour for confirmations.

Why buy more security? There already is enough! Exchange services I would buy though. But that doesn't permit fractional reserve banking, since deposits only stay with the bank for very little time.

But the reason I bring it up is to address an argument whose premises I don't agree with. If you think bitcoins are inevitably going to deflate and if you think that's going to present a problem, then the solution will be fractional reserve banking.

I think bitcoins are going to deflate but I don't think this is a problem. On the contrary, it is a valuable property to me.

A crisis that an economy might suffer from time to time. I didn't know that as a depositor I could be obliged to be reimbursed in anything of value other than what the original deposit was.

This is silly. A crisis is, by definition, a rare event. In a crisis, you might get paid in gold rather than bitcoins, but you wouldn't lose a penny. Oh, that's awful! Forget this entire economic plan because it can't give me bitcoins in the event of nuclear war. Are you serious?

All I said is I didn't know. I am living in a big crisis right now, that of Greece
Rest assured that if you had to live through something like that, you would take it more seriously than a rare event.
My former employer wished me "happy poverty" when he fired me!  

[hazek]

A sudden bout of deflation is bad, because most of the economy would grind to a halt.

But a gentle course into a slight and stable deflation is an entirely different matter.

Even this isn't true because there are some scenarios where a "sudden bout of deflation" is exactly what is needed. One or two that I can think of would be in the case of say the hurricane Katrina devastating a large region. It would be in the best interest of the people of such a region to drastically reduce their consumption and start intensive saving in order to accumulate enough capital to rebuild everything that got destroyed and it would be perfectly ok if that meant that some non life sustaining businesses went under. Same goes for a whole sector of the economy one day realizing it's bankrupt.. in order for the economy to remain healthy, the people who lost their jobs would need to drastically cut back on their consumption until they could find other employment even if that meant for the broader economy to focus on the essential businesses.


Price deflation all else being equal just means that there is less demand and there are plenty of cases where less demand is the perfectly logical course of action which will ultimately lead to people in general being better off.

[JoelKatz]

All I said is I didn't know. I am living in a big crisis right now, that of Greece
Rest assured that if you had to live through something like that, you would take it more seriously than a rare event.

My point is simply that no sane person would consider it a deal breaker if, in the event of a global economic catastrophe, one received a greater value but in a different currency. This is just worrying about the wrong thing. There is no reason to worry about runs or currency issues.

That's not to say there's nothing to worry about. For example, when the housing market collapsed, lots of mortgages went bad. Banks didn't have enough capitalization to cover the reduction in the equity in their loan portfolio. If not for the government picking up the tab, a lot of people whose money was held in a fractional reserve bank would have lost a lot of money. The real problems with fractional reserve systems are insufficient capitalization and equity collapse due to bad loans.

If you operate a fractional reserve bank, are well capitalized, not a bunch of crooks, and your loans don't go bad, it's almost impossible for your depositors to lose money. Improbable enough that it's still a very good deal.

[stochastic]

Is fractional reserve banking even possible with bitcoin? When banks make loans, they create money out of thin air, which is not possible long term with bitcoin.

It's quite possible. You just deposit bitcoins at a "bank" and they tell you that you have a particular bitcoin balance, just like Mt Gox does. They then don't hold that number of bitcoins but instead back their holdings with some other currency or asset.

I don't think there will be any kind of borrowing bitcoins in the future, especially long term loans.  There will be the use of bitcoins as collateral for a loan in fiat money, much like a gold loan. 

Lets say Alice borrows 1000 bitcoins from her Credit Union to purchase a car because she needs a car right now.  She gets a 5 year loan.  She would find that she would have an increasingly difficult time paying back that loan.

Say her job pays her in bitcoins.  As bitcoins become more scarce the value she provides to the company becomes less in terms of bitcoins so she would get a reduction in pay over time.  It is not such a big deal since all the goods around her are becoming less expensive in terms of bitcoins too.  The only problem is that loan she took.  If she got paid in fiat the same thing would theoretically happen as more fiat would purchase less bitcoins.

So she borrows 1000 bitcoins at a rate of 5% APR, and she has to make 60 payments of about 18.87 bitcoins a month for a total of 1132.27 bitcoins on the original 1000 bitcoin loan.  The problem is that bitcoins in this make believe world is deflating against other items at about 1% a year.  So the first year Alice makes 10,000 bitcoins, the 2nd year she makes 9,900, the 3rd year 9801, the 4th 9702.99, and the 5th year she makes 9605.96.  Her loan payment as a percentage of her yearly income increased over the term of her loan.  Of course, a bank could could instead charge no interest and just rely on the increase of the value of bitcoins to make a profit, but that rate of increase is volatile and unpredictable for the lender to rely on.

The problem with deflation is that it does not keep people from buying things, it keeps them from borrowing.  It does not matter if the bank holds a lot of funds, no one is going to borrow a deflationary currency because they have to pay not only the interest but also the unknown deflation rate.

What will happen instead is a type of loans in fiat from a lending institution that will use bitcoins as collateral on the loan.  If Alice wants a loan for a car she borrows $16,000 from the bank but she also gives the bank a percentage of bitcoins to the bank in collateral depending on her credit worthiness.  If she defaults she will lose her collateral, but if she fulfills her obligation on her loan she will receive her 1000 bitcoins back.

[odolvlobo]

The problem with deflation is that it does not keep people from buying things, it keeps them from borrowing.  It does not matter if the bank holds a lot of funds, no one is going to borrow a deflationary currency because they have to pay not only the interest but also the unknown deflation rate.

The problem with these arguments is that they are not realistic. Borrowing and spending are not going to completely stop because of deflation. That would only happen in the case of extreme deflation, just like saving and lending would completely stop only in the case of extreme inflation.