The Inflation/Deflation Relationship of Competitive Currency Systems

With the introduction of a Bitcoin and the possibility of large impacts on financial institutions it becomes obvious that new economic conditions are going to result. You have already read speculation on Bitcoin and inflation/deflation in a basic way but that is not what I am going to mention here (nor deflationary spirals). I am talking specifically about a new economic condition caused primarily by introducing a competing currency to the current monopolized fiat currency market that our governments oh so love.

The quantity theory of money applies economic laws of scarcity to currency. The more scarce a demanded item is, the more valuable that item becomes. If scarcity increases, value increases. If scarcity decreases, value decreases (It's obvious but should be mentioned). When applied to Keynesian-cult economics or a monetary printing philosophy its the expansion and contraction of credit. Currency provides a service, it provides a medium of exchange, unit of account and store of value. If another currency like Bitcoin is introduced that provides this service better then that currency will gain in value because demand increases. Simultaneously the currency that is less valuable will decrease in value because it is less demanded. The introduction of competition in currency creates an inflation/deflation relationship between the two. If we are talking about fiat currency competition than the better currency would hypothetically inflate less.

What happens when Bitcoin grows in popularity? What happens when a critical mass is reached and awareness gets out? If consumers look at the two currencies for their merits, Bitcoin or another crypto-currency will win. Fiat currency does have government backing and a history and consumers have a psychological attachment (most consumers) but Bitcoin out competes in other areas. When Bitcoin grows in popularity the price will shoot up because demand will shoot up. This will cause high deflation for Bitcoin. Simultaneously consumers will dump their dollars into the market, replacing them with Bitcoin and their demand for currency with Bitcoin. Fiat currency supplies will increase and inflation will increase.

What happens? More consumers see that if they get a dollar today it wont be worth as much tomorrow but if they get a Bitcoin today it will be worth more tomorrow. More consumers will purchase Bitcoin, demand will increase, value will increase and more will get rid of their dollars, demand will decrease and value will decrease. This inflation/deflation relationship will result from competing currency. The result = the best currency wins.