Bitcoins Can Inflate Too - Stop worrying about deflation.

[JoelKatz]

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.

That's not the problem with deflation, that's the problem with *unpredictable* deflation. Yes, unpredictable anything has negative economic consequences because it makes people less likely to make arrangements that would have benefited all participants.

There's no such problem with predictable deflation.

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.

Okay, now let's run that with predictable deflation. Because of the deflation, maybe she'll need twice as many Bitcoins to pay off the loan in the future. That means that those Bitcoins also have nearly twice as much value today because she is also getting the present value of that very same future appreciation. Thus she would only need to borrow about 500 of them to buy the car instead of 1,000. Thus they'd be no more difficult to pay off in the future.

Every bit of deflationary value she paid for, she also has available to offer to the car dealer in exchange for the car. So she doesn't have to pay anything *extra*. She only has to pay back the very same value she borrowed -- the very same value she offers in exchange for the car.

[alexeft]

How can deflation be in any way predictable if its value is to be decided by the markets?

[JoelKatz]

How can deflation be in any way predictable if its value is to be decided by the markets?

Markets are quite predictable much of the time. I think you'll find near universal agreement that the more unpredictable a market is, the worse for all concerned. This gives everyone an incentive to keep markets as predictable as possible.

This is one of the reasons transactions that are technically zero sum can actually be win-win. For example, say someone has a great business idea, but it's impractical because the risk that the dollar will lose value is too high. And say someone else has a great business idea, but it's impractical because the risk that the dollar will gain value is too high. These two guys can make a deal where one pays the other if the dollar gains value and vice-versa if it loses value. Technically this is a zero-sum transaction, since each loses all and only what the other gains. But if it makes both business ideas practical, it's win-win.

[alexeft]

Markets are quite predictable much of the time.

You should be rich then! 

[JoelKatz]

Markets are quite predictable much of the time.

You should be rich then!  

To get money from someone else, you need to know something they don't. Predictable markets tend to make prosperity more fair because there's less of a luck factor, and they tend to produce more prosperity generally because less is spent avoiding risk. But to make money without having to earn it, you have to predict the market in a way that others don't.

For example, you might think that if we know that oil is going to go up in price, we can buy some now and make a profit in the future. But if we all know the price of oil will be higher in the future, the price will already be higher today than it would otherwise be to account for this. It will already be too late to exploit it. (This is what people mean when they say speculation increases the price of oil.)

Now, if you were the only one who knew ...

[justusranvier]

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.

No, it couldn't. Lending without nominal interest is never profitable because the lender could get the same benefit by just holding on to the money without the risk of default.

[JoelKatz]

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.

No, it couldn't. Lending without nominal interest is never profitable because the lender could get the same benefit by just holding on to the money without the risk of default.

Exactly. Also, the net present value of a Bitcoin next year can never be more than the value of a Bitcoin today because a Bitcoin today includes the ability to have a Bitcoin next year if you wish. It also has additional opportunity value because you can use the Bitcoin before then if you wish.

[stochastic]

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.

No, it couldn't. Lending without nominal interest is never profitable because the lender could get the same benefit by just holding on to the money without the risk of default.

Every bit of deflationary value she paid for, she also has available to offer to the car dealer in exchange for the car. So she doesn't have to pay anything *extra*. She only has to pay back the very same value she borrowed -- the very same value she offers in exchange for the car.

Disagreements with my post coming from 2 different directions.  This proves that no one really knows what will happen with borrowing of deflationary currencies.  I can only look at what has happened in the past in similar situations and make predictions.

I am pretty suspicious of utopian ideas.  The world is not going to be more happy and fair just because people have access to bitcoins.  Markets have never been predictable before, that is because its price is based on supply and demand.  One of the theories of why hyperinflation  occurred during the 1970s was due to a somewhat predictable inflation.  People knew that prices were going to increase by at least, for example 10%, so they expected to get paid 10% more the following year.  This had the effect of people having more money to buy the same amount of things which increased the inflation rate to more than 10%.

In scarce commodities, like gold, there is a predictive yet small amount of new gold put in existence, but people cannot predict the price of gold in the future.  The reason is because of the potential for supply shock that can occur with gold if the large holders of gold flood the market.  This is the unpredictable supply of gold, and what bitcoin will be like in the future when most of the bitcoins have been mined.  Demand is also not predictable, it may change over time.  If a predictable deflation of gold cannot be guaranteed, then it is very unlikely that bitcoins would have a predictable deflationary rate.

So we get back to my main point.  Bitcoins will live in coexistence with fiat currencies just like gold has done.  Also, like gold, bitcoins will be used in loans in the form of collateral to create secured loans.

[JoelKatz]

Disagreements with my post coming from 2 different directions.

I don't think I'm actually disagreeing with you. To be clear, I'm not saying that Bitcoins will experience predictable deflation. I'm saying that if that happens, it won't be a problem because it will affect everyone's assessment of the value of Bitcoins equally. I think we both agree the unpredictable deflation, like almost any significant unpredictable property of a currency, will reduce the usefulness of that currency.

[makomk]

Okay, now let's run that with predictable deflation. Because of the deflation, maybe she'll need twice as many Bitcoins to pay off the loan in the future. That means that those Bitcoins also have nearly twice as much value today because she is also getting the present value of that very same future appreciation. Thus she would only need to borrow about 500 of them to buy the car instead of 1,000. Thus they'd be no more difficult to pay off in the future.

This doesn't actually help. Think it through carefully. The company she's buying the car from has various costs - supplier costs, salary and wage costs, etc - which they have to pay from the money they get from sales. In order for them to be able to afford to sell the car for half as many Bitcoins, they'd also need to pay their suppliers and employees half as many bitcoins, and their suppliers in turn would have to pay their suppliers and employees half as many bitcoins, and so on. Most likely the same thing is happening in whatever industry our hypothetical car-buyer works in, so she ends up getting half the wages she otherwise would and her pay still decreases over time due to deflation. It's just as hard for her to pay off her loan as it is in stochastic's scenario.

[JoelKatz]

This doesn't actually help. Think it through carefully. The company she's buying the car from has various costs - supplier costs, salary and wage costs, etc - which they have to pay from the money they get from sales. In order for them to be able to afford to sell the car for half as many Bitcoins, they'd also need to pay their suppliers and employees half as many bitcoins, and their suppliers in turn would have to pay their suppliers and employees half as many bitcoins, and so on. Most likely the same thing is happening in whatever industry our hypothetical car-buyer works in, so she ends up getting half the wages she otherwise would and her pay still decreases over time due to deflation. It's just as hard for her to pay off her loan as it is in stochastic's scenario.

That's not quite correct. In this scenario, people can just hold onto money for a few years and see a huge increase in its real value. So you would expect people to have and be paid more real value.

But, in any event, in this unrealistic scenario, she probably shouldn't have the car. The economy would be so productive, doubling its value in the time of the loan, that her having the car would be unproductive unless it too doubled the value she spent for it. (In which case should could still afford it.)

Essentially, for buying a car to make sense, the value you get out of the car has to exceed the value to everyone else of you not taking that car away from people who might put it, or the resources that made it, to more productive use.

[Garika]

By definition: Bitcoins can NOT be inflated or control ed by any local government.
Local Banks only can be used for exchange BTC for local, easily inflatable currency needed for  local transactions and services in that local "newly printed paper money".
So unless the definition could be challenged - "Long live Bit Coins!"

[greenlion]

There is one glaring and immediately obvious problem with the OP.

A fixed supply has an easily mathematically-determined upper limit on total leverage given a specified minimum reserve requirement.

The current system has no such property because the un-leveraged supply is not fixed.

[pungopete468]

Bitcoin deflation != Historical deflation.

The difference is that when Bitcoin deflates it is instantaneous and world-wide (instant arbitrage opportunity). Bitcoin deflation encourages spending rather than saving because the global economy demands it, contrary to the past deflation of weighted coins, it created a position where the older coins were more valuable than the newer coins. Those coins were not likely to be spent because they were worth more than the face value of the coin.

[vtlaloc]

Bitcoin deflation != Historical deflation.

The difference is that when Bitcoin deflates it is instantaneous and world-wide (instant arbitrage opportunity). Bitcoin deflation encourages spending rather than saving because the global economy demands it, contrary to the past deflation of weighted coins, it created a position where the older coins were more valuable than the newer coins. Those coins were not likely to be spent because they were worth more than the face value of the coin.

When gold backed currencies where a "thing" no one much cared about the face value or even which country (as long as the mint was trusted) minted the damn things, indeed the face value was directly tied to weight, all anyone cared about was the gold weight. I'm not sure where you do the idea that they would deflate older coins by minting new ones with less weight and same face value, that's just daft; the gold would simply be remelted - it did not remove gold from circulation (deflation).. Your probably thinking of bullion coins being minted today with metal of value much higher than face...which is a post fiat construct, that has nothing at all to do with gold back currencies.

Bitcoin deflation would encourage spending in 2030 the same way that it does on these forums in 2014, which can be summed up in "I bought a 150k dollar pizza in 09' and we are the new wealthy elite". Any financial system with a highly deflationary currency like bitcoins would ball up and die, as no funds would ever move through the system; Inflation pushes smart money to invest in creating means of production, in to research, and building income producing properties while all that deflationary currency encourages is the building of Scroodge McDuck banks (which in the case of bitcoins you cant even swim through).

[pungopete468]

Bitcoin deflation != Historical deflation.

The difference is that when Bitcoin deflates it is instantaneous and world-wide (instant arbitrage opportunity). Bitcoin deflation encourages spending rather than saving because the global economy demands it, contrary to the past deflation of weighted coins, it created a position where the older coins were more valuable than the newer coins. Those coins were not likely to be spent because they were worth more than the face value of the coin.

When gold backed currencies where a "thing" no one much cared about the face value or even which country (as long as the mint was trusted) minted the damn things, indeed the face value was directly tied to weight. I'm not sure where you do the idea that they would deflate older coins by minting new ones with less weight and same face value, that's just daft. Your probably thinking of bullion coins being minted today with metal of value much higher than face...which is a post fiat construct, that has nothing at all to do with gold back currencies.

Bitcoin deflation would encourage spending in 2030 the same way that it does on these forums in 2014, which can be summed up in "I bought a 150k dollar pizza in 09' and we are the new wealthy elite". Any financial system with a highly deflationary currency like bitcoins would ball up and die, as no funds would ever move through the system; Inflation pushes smart money to invest in creating means of production, in to research, and building income producing properties while all that deflationary currency encourages is the building of Scroodge McDuck banks (which in the case of bitcoins you cant even swim through).

You're mistaken. You're looking at half the variables of a problem and then generating an answer...

The gold coins were debased regularly, new coins were constantly minted yet the values were decreased. People certainly cared about the face value because that was how the majority of people tendered debts; based on the face value established by the mint.

The wealthy were able to hoard coins and profit from arbitrage while the average user couldn't. The wealthy didn't care for face value because they could afford not to. Deflation was a problem because of the unfair distribution bias. Bitcoin deflation is universal affecting all other Bitcoins, essentially nullifying the deflation.

Sorry, but deflationary currency is only a negative when the value can be externally manipulated (unevenly devalued). Bitcoin will never deflate for the same reason that gold coin did... Once Bitcoin becomes deflationary, assuming it saturates the market, people hoarding Bitcoin will actually decrease the price. The price of Bitcoin will be reflected by the sum of GDP divided by the number of coins still left in circulation.

Bitcoin deflation != Historical deflation. Never before in history has something like Bitcoin been tested, and you can't introduce new variables to an equation and assume the outcome will remain constant.