Price Deflation Discourage Investment?

[kiba]

http://news.ycombinator.com/item?id=1794532

I'm sorry, but this statement alone convinces me that there are important facts about economics which you do not understand. Deflation, among many other things, discourages investment. Without investment, economies stagnate. -btilly on Hacker News.

I feel cognitive dissonance. The bitcoin community's overall investment seem to be increasing not stagnating. I also know the computer industry is spending lot of money on their factories and plants while the price of computers continue to lower.

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[theymos]

The bitcoin community's overall investment seem to be increasing not stagnating.

Bad argument. 7200 BTC are created daily.

[kiba]

The bitcoin community's overall investment seem to be increasing not stagnating.

Bad argument. 7200 BTC are created daily.

Continuous price deflation?

[db]

The bitcoin supply currently inflates at a yearly rate of 62%. This is monetary inflation. (It will gradually slow down as the number of bitcoins increase and the mining rate goes down until the amount of bitcoins becomes and forever stays almost constant, neither inflating nor deflating.)

At the same time prices denominated in bitcoins are falling. This is because the demand for bitcoins grows even faster than the supply. I suppose this can be called price deflation.

When the money supply is constant prices will keep falling in step with economic growth as more and more wealth is traded using the same constant amount of money. Call it growth deflation.

Growth deflation encourages investment. It makes people want to hang on to the money and delay consumption until later when they can get more for their money. This leaves more resources available to those who can make a larger return on them by investing them than by selling them and keeping the money.

[MoonShadow]

http://news.ycombinator.com/item?id=1794532

I'm sorry, but this statement alone convinces me that there are important facts about economics which you do not understand. Deflation, among many other things, discourages investment. Without investment, economies stagnate. -btilly on Hacker News.

This statement assumes many things in order to be true.

First, that deflation is the result of a collapsing monetary base; with the assumption of a relatively stable economic base.  I.E., very little economic growth or contraction.  This is not what is happening in the Bitcoin economy, although it's largely what is happening with the US dollar and many other large Western economies.

Second, the statement assumes that retention of cash doesn't qualify as an investment.  From an investor's perspective, it would not; but from the perspective of the cash holder, it would.  As far as the overall economy is concerned, cash retention is neutral, and represents a changing 'time preference' since everyone intends to spend their money eventually. 

Generally speaking, deflation favors the saver and the consumer; who are the same people, Mr & Mrs Joe Blow Average.  Likewise, generally speaking, inflation favors the producers and the investor class, for several reasons.  The easist of which to present an example of is the producer; for he must commit cash to buy his raw materials, but by the time that the finished product is done, inflation promises that he will get at least as much out of the finished product as he put into it, whereas deflation means that it's possible that his finished product will be worth less, in nominal terms, than the original cost of the materials.  This is why nearly every fiat monetary regime operates under about a 3% APR of inflation, because a fiat monetary regime is structured by and for those who already have money, I.E. the producer and investor classes.  Hard money systems, such as a gold standard, favor the saver/consumer; putting the majority of the currency risks upon the producers.

[kiba]

creighto: Thank you for advancing my economic knowledge. That was helpful.

I already incorporated time preference and the observation that the bitcoin economy is experiencing growth deflation.

[FreeMoney]

Pretend you had a money printing press, but everyone was watching you. Maybe you would come up with some BS about how if you print some off it will help everyone?


Working hard to get my fill
Everybody wants a thrill
Payin' anything to roll the dice just one more time

Some will win, some will lose
Some were born to sing the blues
Oh, the movie never ends
It goes on and on and on and on

/believing

[hugolp]

Deflation does not stop investment.

There is empirical evidence of this, for example, the USA during the XIX century.

Its just inflationist propaganda.

[dwdollar]

Deflation does not stop investment.

There is empirical evidence of this, for example, the USA during the XIX century.

Its just inflationist propaganda.

Why observe evidence?  That's so 19th century...  

[kiba]

He proposed dollars as an explanatory mechanism for why the bitcoin economy simply doesn't implode.


I submit to you that investment in the bitcoin economy is paid for in other currencies (eg dollars), not in bitcoins. Given that, the strength of the bitcoin economy has nothing to do with the availability of money for investment. And indeed a growth in value for bitcoins should drive investment in bitcoins, which leads to what you've observed.

I don't know. The computer industry doesn't seem to be imploding. Investment in semiconductor fabrication plants are becoming more expensive why the products are in deflationary sprial.(Perhaps that is not a good example since fabrication plant investment cost are offset by inflations?)

[grondilu]

Unfortunately, there is a consensus in mainstream economists, which states that deflation is bad for economy as it discourage investments.  Bitcoin will certainly have to face critics about this. 

Fortunately, those critics are not new.  They were popular amongst people who managed to have governments abandon the gold standard.

To me, deflation and inflation are just economics phenomenae.  They are the adaptative result of an change in economics situation.  None of them is more healthy than the other.  Both allow capital and money to adjust to productivity and demand.  During gold standard, there were deflationist periods when there were big increases of wealth in the same time.

At some point, some people will ask for a change in the bitcoin protocol, in order to increase the number of bitcoins.  Hopefully, those people will just make a fork of bitcoin, and create their own currency, which would be, in my opinion, just about as crappy as present national currencies.   If I have to receive such coins on my computer, I will immediately sell them with contempt, and buy real bitcoins.

And if bitcoins were to be modified in order to allow arbitrary increase of the total amount, I will immediately sell all my bitcoins to buy gold and silver.

[theymos]

And if bitcoins were to be modified in order to allow arbitrary increase of the total amount, I will immediately sell all my bitcoins to buy gold and silver.

Bitcoin would almost certainly be forked if that happened. The fork could easily preserve all Bitcoin balances up to the change.

This situation would be great for early adopters, since you'd be able to legitimately double-spend all of your pre-fork balances.

[Gavin Andresen]

I suspect (but am far from certain) that a couple of psychological factors in the average human mind makes deflation worse than inflation.

First, we've got an irrational attachment to "free" (see the book Predictably Irrational for experiments that show this).  If money is deflating, I can just let it sit under my mattress for "free" -- and that might be more attractive to me even though I'd get a better return by investing it.  Investing ALWAYS looks like it costs something (brokerage commissions or lawyers fees or...).

And second, we've got an irrational aversion to loss and an irrational attachment to stuff that we own.  Investment means opening yourself up to the possiblity of loss AND lending out something you own; I think a little bit of inflation helps overcome that irrationality, by building in a little loss if you stick your money under your mattress.

I wonder if somebody could devise a small-scale experiment to figure out if deflation is bad for investment, and/or measure the size of the effect...

[grondilu]

And if bitcoins were to be modified in order to allow arbitrary increase of the total amount, I will immediately sell all my bitcoins to buy gold and silver.

Bitcoin would almost certainly be forked if that happened. The fork could easily preserve all Bitcoin balances up to the change.

This situation would be great for early adopters, since you'd be able to legitimately double-spend all of your pre-fork balances.

I very much doubt that a fork would include a fork of the block chain.  I think it would consist of a fork of the software, that would be launched from a brand new block chain.

[hugolp]

I suspect (but am far from certain) that a couple of psychological factors in the average human mind makes deflation worse than inflation.

First, we've got an irrational attachment to "free" (see the book Predictably Irrational for experiments that show this).  If money is deflating, I can just let it sit under my mattress for "free" -- and that might be more attractive to me even though I'd get a better return by investing it.  Investing ALWAYS looks like it costs something (brokerage commissions or lawyers fees or...).

And second, we've got an irrational aversion to loss and an irrational attachment to stuff that we own.  Investment means opening yourself up to the possiblity of loss AND lending out something you own; I think a little bit of inflation helps overcome that irrationality, by building in a little loss if you stick your money under your mattress.

I wonder if somebody could devise a small-scale experiment to figure out if deflation is bad for investment, and/or measure the size of the effect...

Give it a second though.

Could it be that humans are acting this way because we live under an inflationary system? Its known that economic situation has a big influence in human culture. For example, during crisis music tends to be happier (people wants to disconnect from reality). During the housing boom, in my country, all the advertisment was focused on making you feel like "the winner". Now, all the advertisment has shifted and is promoting the image of companionship and "street people". Its well known that monetary influence can change how people behave. Therefore it makes sense to think that a lot of the reactions of the people that you are observing is not something inherently human, but more how people is reacting and has learn to behave because of the consequences of the monetary system.

Through history monetary inflation has always led to bubbles and you can see the same kind of behaviour during the boom phase. The "winner" image. Check the roaring 20's. But the same happened centuries ago. Inflation always promotes speculation and turns the people kind of "cheaply greedy" or "stupidly greedy", it discourages savings and promotes consumption leading to a more consumerist society, and making people not being able to project for the future, more now-minded, and less self reliant. It changes people personality. And it sure is happening now. The inflationary regime its influencing people personality. It turns people stupid.

In a deflationary system, with people used to prices going down, probably would behave in a completely different way. You can see this during the USA XIX century (for example), where prices where going down and the amount of investment was going up big time.

Also, in an economic sense:

First, we've got an irrational attachment to "free" (see the book Predictably Irrational for experiments that show this).  If money is deflating, I can just let it sit under my mattress for "free" -- and that might be more attractive to me even though I'd get a better return by investing it.  Investing ALWAYS looks like it costs something (brokerage commissions or lawyers fees or...).

And second, we've got an irrational aversion to loss and an irrational attachment to stuff that we own.  Investment means opening yourself up to the possiblity of loss AND lending out something you own; I think a little bit of inflation helps overcome that irrationality, by building in a little loss if you stick your money under your mattress.

You are assuming that more investment is better. But that is not necesarily the case. Productive investment is useful, but not any kind of investment. For example, there was a lot of investment during the housing boom, but it was misguided, and a lot of it was mainly malinvestments. We would have been a lot better off if it was saved or invested on something else.

And one of the key factors that allow productive investment is the natural interest rates, because they communicate the consumer intentions to entrepreneurs. Inflation artificially lowers interest rates, thus sending the wrong signals (in this case the interest rates is not the result of consumer actions, but its influenced by inflation) fooling investors into the wrong type of projects. Therefore the increase of investment you get from inflation is not only useless but even damaging, because it promotes malinvestments.

More investment is not always good. The natural interest rates are needed to guide investors about consumer demand.

[Timo Y]

I wonder if somebody could devise a small-scale experiment to figure out if deflation is bad for investment, and/or measure the size of the effect...

Bitcoin already *is* such a small-scale experiment. Would be nice to have a control experiment, an inflationary fork of bitcoin. Let them compete and let the market decide which model is superior.

[theymos]

I very much doubt that a fork would include a fork of the block chain.  I think it would consist of a fork of the software, that would be launched from a brand new block chain.

In this case, I think the block chain would be kept for both versions. Both will perceive the other as "breaking the rules", and see themselves as the legitimate version of Bitcoin.

[db]

First, we've got an irrational attachment to "free" (see the book Predictably Irrational for experiments that show this).  If money is deflating, I can just let it sit under my mattress for "free" -- and that might be more attractive to me even though I'd get a better return by investing it.  Investing ALWAYS looks like it costs something (brokerage commissions or lawyers fees or...).

We also have an irrational preference for stuff now rather than stuff later. Even if the "free" bias pushes people to invest too much for our own good I doubt it manages to fully counteract the "now" bias pushing us to invest too little. (Hoarding deflating money is investing because someone else invests the resources that could have been consumed by spending it.)

[Anonymous]

I wonder if somebody could devise a small-scale experiment to figure out if deflation is bad for investment, and/or measure the size of the effect...

Bitcoin already *is* such a small-scale experiment. Would be nice to have a control experiment, an inflationary fork of bitcoin. Let them compete and let the market decide which model is superior.

We could call them bytecoins....they inflate at %8 more than bitcoins


I think people would save bitcoins and spend bytecoins.  

[joe]

Holders of a deflating currency are experiencing an increase in wealth just by holding the currency. The wealth is coming from users of inferior currencies, who have not yet switched over to the deflating currency, because if users of other currencies behaved rationally by using the deflating currency, then the deflating currency's price would adjust upward until deflation is no longer expected.

By using an inferior currency, those people are essentially donating wealth as an inflation tax, either to their government that is watering down the currency or to the users of superior currencies. So, they have an incentive to invest in things they might not invest in, just so they can be alleviated from the inflation tax.

So the answer is yes; price deflation discourages investment. But we must understand that it is more accurate to say that the inflation tax encourages investment, because the investment that would go on with a zero-inflation currency is the baseline.

Naturally, the next question is whether it is beneficial to coerce people to invest by penalizing them for holding the currency. The argument for this is that it provides the incentive for people to take on the risk of investment. The argument against this is that it takes away the free will of people by imposing a tax.