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Author Topic: Krugman makes some good points  (Read 6963 times)
lonelyminer (Peter Šurda)
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March 24, 2013, 12:49:47 PM
 #41

I don't think that argument is relevant.  Surda is basically saying that "yes, this money is horrible at circulating but you can circulate other things instead of money so this money should not be expected to circulate well."

That's like if I walked into a room and saw somebody driving a tiny finishing tack with a sledge hammer and offered them a small finishing tack hammer and they told me "the sledge hammer doesn't drive finishing tacks well but there are other things that do it well so I'm going to keep using the sledge hammer!" and went back to using the sledge hammer to drive the tiny finishing tack.

TLDR; if people do not want to spend, increasing the money supply can trick them into spending but can't "fix the economy".

I think you misinterpreted my argument. My argument is that people's consumption/savings ratio is not determined by the changes in the money supply, but by their time preference, and that people can react differently than described in the keynesian model. At best, the changes in the money supply can distort information about the relationship between scarcity of resources and demand for consumption, and cause people to make decisions that appear are nominally correct but really aren't. In the absence of the distortion (i.e. if the changes in the money supply fail to trick people, there is no insider information and no Cantillon effect), people compensate by postponing consumption using a different liquid asset. This does not require that the choice of the dominant medium of exchange (money) changes. People would still use the inflating money to trade, but will reduce their cash balances in preference to, say, gold. So the price level will rise, but consumption/savings ratio will remain, only the composition of liquid asset holdings will change.

Conversely, if the price level is falling, people will compensate by increasing their cash (and credit holdings in the same unit), and reduce the holding of liquid assets that aren't denominated in the same unit, e.g. commodities such as gold, or foreign currencies. Again, no change in the consumption/savings ratio, just the composition of liquid asset holdings restructures and the price level changes.

People do not magically turn into misers if the price level is decreasing, similarly as there is no reason for people to turn into hedonists if the price level is increasing. Rather, they might be prevented on reacting according to their preferences, for example due to the Cantillon effect, interventionism, externalisation of costs, barriers to entry in capital markets, giving preferential legal treatment to national money such as legal tender laws, capital gains taxes, sales tax on precious metals, and so on.

Please note that I did not actually use Austrian assumptions in my "liquidity portfolio" counterargument (I specifically excluded the information distortion and Cantillon effect). And Krugman wrote papers in the 70s and 80s where he analyses competition of currencies in international trade with respect to liquidity. Let me quote him:

Quote from: Krugman
The discussion in this section has concentrated on the medium-of-exchange role of international money in isolation. In fact, there is some interdependence among roles. The links which seem clear are these: if the dollar is a good store of value, the costs of making markets against the dollar are lower, thus encouraging the vehicle role.

The essence of this argument (people choose their liquid asset holding based on the price changes of liquid assets) is exactly the same as mine. Why he forgot about it after 30 years I don't know, you need to ask him.

The other two problems that I describe in my article, confusing capital with information about capital, and conflating changes in the money supply with changes in the price level should also be acceptable to non-Austrians. In particular the argument that credit deflation must end when banks establish 100% reserves is, in my opinion, so blindingly obvious that I'm baffled how people can still argue that a credit deflation "spiral" is even logically possible.
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March 24, 2013, 01:45:05 PM
 #42

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What that means is that if you measure prices in Bitcoins, they have plunged; the Bitcoin economy has in effect experienced massive deflation.

And because of that, there has been an incentive to hoard the virtual currency rather than spending it.
This is simply not true.

Imagine I want to keep 50% of my savings in USD and 50% in bitcoin. Bitcoin rises in value and suddenly my savings distribution is: 20% USD, 80% bitcoin. Now I want to spend (sell) bitcoin and hoard (buy) USD. If I have the option to pay with BTC or USD, I will pay with BTC. This can only be good for the bitcoin economy.

Saving is so strongly discouraged in the current economy that Krugman wouldn't ever consider this.
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March 24, 2013, 07:51:30 PM
 #43


Borrow 1 BTC, and pay back 1.1BTC can work over any time.


Where is that 0.1 BTC coming from?

In the fiat world, the way to make this happen is issue more and more money to pay back the previous interest, but in bitcoin world, the total number of money supply is fixed, paying back more than you borrowed simply means that interest must come from someone else's pocket  Wink

Interest is a perfectly valid way of making money with a currency!
The 0.1btc comes from the person who borrowed it, just like in the old days of banking!

Even in the old days of banking, where money is backed by gold, total amount of gold is not limited, so you can dig out some gold each year to pay the interest

In fiat system, added money supply simply means added debt, and added debt will have to be paid back later, together with their interest, it is a snowball effect

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March 24, 2013, 10:04:44 PM
 #44

I think you misinterpreted my argument.

I agree, and I'm sorry about that.  I didn't misinterpret you on purpose.  I'm not trying to be dense, but I'm still not sure that I understand your argument.  Are you saying that inflation doesn't cause people to save less?  The current situation in US retail banks seems to suggest that people do save less when interest rates are lower than inflation.

The only element of the original Krugman quote that seriously needs looking at again is the idea of lending not being possible, and with this I think he is wrong.  Mostly because he is not thinking outside the box.  You can lend bitcoins at a very low level of interest, but only if you don't want to work with a different currency as well. 

Borrow 1 BTC, and pay back 1.1BTC can work over any time.

Ironically, while a large number of bitcoiners are ranting for the end of fiat, without the exchange rate, bitcoin would be more useful. 

How we solve that problem is beyond me at this time on a Saturday!

I presented that wrong.  Krugman doesn't actually talk about lending in his short essay (it's only a few paragraphs long).  I gave my description of Krugman's argument after I gave the link to it, and threw in the credit part to show the problems I think we might see with deflation.

You are right that the nominal interest rate would be lower for a deflationary currency like BTC, but the real interest rate is what will make things more difficult.  Lets run some numbers to see how a loan would work out:

Alice loans Bob 120 BTC for 1 year at 1% simple interest to purchase a physical capital to build a widgit factory.  That means that payments will be 10.1 BTC per month for 12 months ((120 BTC * 1.01)/12 months).  Widgits currently sell for 0.10 BTC per unit.  Deflation is 5% per month.

In the first month Bob has to sell 101 widgits to make his 10.1 BTC loan payment to Alice.

In the second month deflation effects Bob's business.  Because deflation is at 5%, widgits now sell for 0.095 (0.10 BTC - (0.01 0.05))  If we round up (assume widgits are not divisible), this means that Bob has to sell 107 widgits to make his loan payment.

In each successive month Bob has to sell more widgits to make his loan payment.  This continues along these lines, every month Bob has to sell more and more widgits to make his loan payment, resulting in this table (rounded to 5 decimals):

Month | Widgit Price | Widgits Sold
10.10 BTC101
20.095 BTC107
30.09025 BTC110
40.08574 BTC118
50.08145 BTC125
60.07738 BTC131
70.07351 BTC138
80.06983 BTC145
90.06634 BTC153
100.06302 BTC161
110.05987 BTC169
120.05688 BTC178

Bear in mind, this is in addition to the iron law of wages, which drives down prices as more competition enters the market place.  Lets assume that Bob has a monopoly, though, just for the hell of it, and that widgits are in no way necessary to anybody's survival, so he's still a price taker due to the trivial nature of the product.  Lets say his widgits are something stupid like Justin Beiber albums.

If the market for Justin Beiber albums demanded exactly 150 units per month reliably, then the latest Bob could possibly operate is month 8, because even with zero overhead, Bob could not make his loan payments any more (and music fans rejoiced!).  That isn't because there is no demand for Justin Beiber albums and it isn't because Bob is a bad businessman who let his overhead run away on him.  People are willing to buy them, Bob is willing to make them, this transaction just can't take place because the financial system will not support the transactions because deflation killed the real value of Bob's business.

This is just the effect of one very short term loan on a small business.  Imagine a 30 year home mortgage.  Deflation would put everybody underwater almost immediately and keep them there for the life of the loan (assuming there is no insane housing bubble or something).  Deflation effects wages as well, so people would find their nominal income shrinking as time goes on, making it harder for them to make their mortgage payments.  If the bank came in and repossessed a home after a few years they would loose even more money.  It would be an endless cycle of loss for the banks and consumers.

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March 24, 2013, 11:02:33 PM
 #45

From the economist who wrote half the textbooks we use in the economics department at my university:

http://krugman.blogs.nytimes.com/2011/09/07/golden-cyberfetters/

Basically, he says that bitcoin is not really being used as a medium of exchange because it's deflationary.  He has a point.  If you aren't using it to buy goods and services then you are using it as a way to save your money, speculating on it.  Constant deflation stops people from using it as a medium of exchange.

Its hard to argue against this. A purely deflationary currency provides no incentive for investment or economic activity; it only causes rich people to get richer just from being rich and sit on their money. Its a great system if you have money,  but economically its..  not very smart to put it mildly. 

I think the solution to this problem is -  or could well be  ripple; or something like ripple. It allows the issuing of credit money at a rate that keeps pace with economic growth (or shrinks if the overall economy shrinks). Bitcoin could act as monetary base like gold did for fiat. Although one could question if in the longer run, if such user issued credit money becomes mainstream; if there really is a need for the monetary base in the first place.
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March 24, 2013, 11:20:23 PM
 #46

From the economist who wrote half the textbooks we use in the economics department at my university:

http://krugman.blogs.nytimes.com/2011/09/07/golden-cyberfetters/

Basically, he says that bitcoin is not really being used as a medium of exchange because it's deflationary.  He has a point.  If you aren't using it to buy goods and services then you are using it as a way to save your money, speculating on it.  Constant deflation stops people from using it as a medium of exchange.

If any currency is deflationary it makes sense to hold as much of that currency as you can for as long as you can because the value will constantly increase.  This discourages spending and encourages saving.  Even if every vendor in the world accepted bitcoin, people still would not spend their bitcoins if they can get around it by using USD or Euros Yen or L$ (Linden Dollars, AKA SecondLife currency) or something else.

On the other end of things, think about the effects on the credit market.  Interest rates take inflation into account, to ensure that the lender makes money after inflation eats some of their investment.  If a currency deflates at 5% per month then it makes sense to only loan to somebody who can make more than 5% per month on your investment (and this is compounded monthly for the life of the loan).  This is because if they don't make more than that then it makes no sense to loan the money out when you can make more money by leaving it in a savings account.  This would make it very difficult to buy houses and cars and start new ventures with credit.
Krugman fails to acknowledge the fact that money is a substitute for future goods and service, i.e. delayed consumption. A deflationary currency "rewards" those who can delay the consumption to a time significantly in the future. However, what ultimately determines the consumption decision is the need. In an inflationary environment you have an incentive to spend your money on things you don't really need, while in a deflationary environment you spend money preferably only on things you need.

Krugman is trapped in his keynesian assumption of the broken window economy, where spending money on useless stuff increases overall productivity.

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March 24, 2013, 11:25:25 PM
 #47

Krugman is an idiot, proof under your nose.


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http://www.libertariannews.org/2011/06/11/the-economics-of-bitcoin-why-mainstream-economist-lie-about-deflation/

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March 24, 2013, 11:31:30 PM
 #48

<snip>deflation is always bad</snip>

I hope I'm not alone in not buying this whole "deflation is bad" argument.  By your logic, Samsung should be broke because the SGS3 that used to retail for $800 is now available for $350.  And by the same logic, I will never buy a computer because in a month's time it will always be cheaper than buying today.

Any business that borrows money to make/sell widgets needs to do price/expense/cash flow management to decide if the venture is profitable and sustainable.  The cash flow implications of falling sale prices over time is no different to falling sales volume over time (ie. saturating the market), or any other rising input cost.

Just because a business agrees to pay back +X% over a 12 month loan when they know the price they can sell their goods at will fall by Y% per month doesn't mean they'll necessarily go broke - and if they do, it's because their outgoings are more than their incomings.  That their outgoings are falling slower than their incomings (due to deflation) doesn't make deflation bad in and of itself.  It just means they didn't do their sums.

If it costs BTCX to make a widget, then you better sell that widget for more than BTCX, inflationary, stable or deflationary environment.  If that means you can't drop the selling price of your widget as much as your competitors, then you don't deserve to be in business any more.

And as for assertions that:
A purely deflationary currency provides no incentive for investment or economic activity

Again, I don't buy it.  Deflation just raises the bar for what is deemed an acceptable return on your funds.  If you can make X% through deflation, then any investment must make >X%.  Some could argue that inflation lowers the bar too far, allowing malinvestment to consume valuable resources that would be better deployed elsewhere.

And for the person who asked
Where is that 0.1 BTC coming from?

The loan and repayment of borrowings are part of the capital stock of the currency (I may be muddling my words here).  Interest payments comes from the flow of money through the system.  The amount of money in the system hasn't changed - what changes is the distribution.

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March 25, 2013, 12:39:04 AM
 #49

I think you misinterpreted my argument.

I agree, and I'm sorry about that.  I didn't misinterpret you on purpose.  I'm not trying to be dense, but I'm still not sure that I understand your argument.  Are you saying that inflation doesn't cause people to save less?  The current situation in US retail banks seems to suggest that people do save less when interest rates are lower than inflation.

The only element of the original Krugman quote that seriously needs looking at again is the idea of lending not being possible, and with this I think he is wrong.  Mostly because he is not thinking outside the box.  You can lend bitcoins at a very low level of interest, but only if you don't want to work with a different currency as well. 

Borrow 1 BTC, and pay back 1.1BTC can work over any time.

Ironically, while a large number of bitcoiners are ranting for the end of fiat, without the exchange rate, bitcoin would be more useful. 

How we solve that problem is beyond me at this time on a Saturday!

I presented that wrong.  Krugman doesn't actually talk about lending in his short essay (it's only a few paragraphs long).  I gave my description of Krugman's argument after I gave the link to it, and threw in the credit part to show the problems I think we might see with deflation.

You are right that the nominal interest rate would be lower for a deflationary currency like BTC, but the real interest rate is what will make things more difficult.  Lets run some numbers to see how a loan would work out:

Alice loans Bob 120 BTC for 1 year at 1% simple interest to purchase a physical capital to build a widgit factory.  That means that payments will be 10.1 BTC per month for 12 months ((120 BTC * 1.01)/12 months).  Widgits currently sell for 0.10 BTC per unit.  Deflation is 5% per month.

In the first month Bob has to sell 101 widgits to make his 10.1 BTC loan payment to Alice.

In the second month deflation effects Bob's business.  Because deflation is at 5%, widgits now sell for 0.095 (0.10 BTC - (0.01 0.05))  If we round up (assume widgits are not divisible), this means that Bob has to sell 107 widgits to make his loan payment.

In each successive month Bob has to sell more widgits to make his loan payment.  This continues along these lines, every month Bob has to sell more and more widgits to make his loan payment, resulting in this table (rounded to 5 decimals):

Month | Widgit Price | Widgits Sold
10.10 BTC101
20.095 BTC107
30.09025 BTC110
40.08574 BTC118
50.08145 BTC125
60.07738 BTC131
70.07351 BTC138
80.06983 BTC145
90.06634 BTC153
100.06302 BTC161
110.05987 BTC169
120.05688 BTC178

Bear in mind, this is in addition to the iron law of wages, which drives down prices as more competition enters the market place.  Lets assume that Bob has a monopoly, though, just for the hell of it, and that widgits are in no way necessary to anybody's survival, so he's still a price taker due to the trivial nature of the product.  Lets say his widgits are something stupid like Justin Beiber albums.

If the market for Justin Beiber albums demanded exactly 150 units per month reliably, then the latest Bob could possibly operate is month 8, because even with zero overhead, Bob could not make his loan payments any more (and music fans rejoiced!).  That isn't because there is no demand for Justin Beiber albums and it isn't because Bob is a bad businessman who let his overhead run away on him.  People are willing to buy them, Bob is willing to make them, this transaction just can't take place because the financial system will not support the transactions because deflation killed the real value of Bob's business.

This is just the effect of one very short term loan on a small business.  Imagine a 30 year home mortgage.  Deflation would put everybody underwater almost immediately and keep them there for the life of the loan (assuming there is no insane housing bubble or something).  Deflation effects wages as well, so people would find their nominal income shrinking as time goes on, making it harder for them to make their mortgage payments.  If the bank came in and repossessed a home after a few years they would loose even more money.  It would be an endless cycle of loss for the banks and consumers.


I appreciate your work but I could write out this exact same example with inflation at %3 and loans at 8%, or whatever spread you want. All deflation does is change the starting point.
Ex: bank needs a 5% profit margin, deflation is running at -3% so they lend at +2%. Pick any spread you want, the math doesn't change.
Ex: deflation is at -10% and banks need a 7% profit margin on an x years loan, so they loan at -3%.
Ex: inflation is at 7% and banks need a 4% profit margin on an x years loan so they loan at 11%. Etc


Same with home loans,etc...



Inflation in currency encourages people to spend it before it loses value. Deflation encourages savings. Savings is what ultimately makes people more productive and wealthier over the long term. Economic activity for the sake of activity is not a good thing, i.e. war isn't helpful and broken windows dont increase wealth. Inflation leads to chronically overworked people with stagnating or even decreasing real wealth. In other words, pretty much what we have right now with Krugman, Bernanke and the fed.

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March 25, 2013, 01:12:55 AM
 #50

If everyone *knows* that the money supply will increase a certain way (at a decreasing rate), then this information will be factored into the price of Bitcoin. It is not a surprise to anyone. If the rate of inflation would cause the price of Bitcoin to increase, it would increase instantly at the beginning, and not gradually over time. Therefore, you can not expect the price of Bitcoin to inevitably increase.

The price of Bitcoin is increasing because it is becoming more popular, not because the number of Bitcoins in existence is increasing at an ever-slowing rate.

Do not waste your time debating whether Bitcoin can work. It does work.

"Early adopters will profit" is not a sufficient condition to classify something as a pyramid or Ponzi scheme. If it was, Apple and Microsoft stock are Ponzi schemes.

There is no such thing as "market manipulation." There is only buying and selling.
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March 25, 2013, 01:23:28 AM
 #51

Just found this excellent article on twitter that explains Krugmans errors very clearly:

http://www.libertariannews.org/2011/06/11/the-economics-of-bitcoin-why-mainstream-economist-lie-about-deflation/

"Krugman’s argument that people would be less willing to spend and borrow, and this would lead to unemployment, is as ridiculous as saying that because computers keep getting better and cheaper into the future, people would be less willing to spend money on a computer today because they could simply wait and buy an even better/cheaper computer in the future.  That is obviously not how people think.  People have needs and desires that have to be met, and they will purchase things as soon as their desire for the product is larger than their desire for future earnings on savings."
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March 25, 2013, 01:32:06 AM
 #52

Just found this excellent article on twitter that explains Krugmans errors very clearly:

http://www.libertariannews.org/2011/06/11/the-economics-of-bitcoin-why-mainstream-economist-lie-about-deflation/

"Krugman’s argument that people would be less willing to spend and borrow, and this would lead to unemployment, is as ridiculous as saying that because computers keep getting better and cheaper into the future, people would be less willing to spend money on a computer today because they could simply wait and buy an even better/cheaper computer in the future.  That is obviously not how people think.  People have needs and desires that have to be met, and they will purchase things as soon as their desire for the product is larger than their desire for future earnings on savings."


This.  And as was mentioned here

As I wrote shortly after Krugman's piece came out. The main reason that deflation is not - and won't be - a problem is that bitcoin is not debt-based (interest bearing) - unlike nearly all fiat systems.

See this post for details:
http://seekingalpha.com/instablog/530678-minorman/214527-paul-krugman-s-take-on-bitcoin

It's hard to emphasise this point strongly enough, especially since most people don't get it.  In our world of fiat currency, money is created out of nothing, based on little more than the existence of debt.  And given those conditions, deflation can certainly be a concern.  But under a currency that operates to different rules (eg. physically backed, or fixed supply) the conclusion that deflation is bad is erroneous.


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March 25, 2013, 01:58:50 AM
 #53

I don't have in depth knowledge about Economics, so I'll try to give practical examples. Please point out where I'm wrong; I'm prepared to do some recommended reading. Smiley

Let's assume I'm a Cypriot who lost trust to the banking system and decided to preserve my wealth in Bitcoin. I don't see any reason why I wouldn't spend the BTC for my needs, since I would be doing it if it was sitting as EUR anyway (or not, in the same manner). I always could have stored the value in deflationary vehicles in my control, but I didn't, because it wasn't liquid enough. Well, with Bitcoin, I can both store it in a deflationary vehicle and spend. It's both better than EUR in a bank or gold under my pillow. Granted, my BTC stash will decrease over time, but my overall wealth will still increase. Just as I won't lock my EUR in a good investment while depriving my children of a good education, I won't try to preserve my coin stash at the expense of their benefit.

Another personal example is, a few years ago, I bought land from an old guy. I was pretty sure that it would appreciate in time, and I'm sure he thought the same. He sold it to me anyway, because he wanted to expand his business. If he is successful now, he might have made more money than he lost to appreciation. If he isn't, tough luck; but it is a fact that he made that decision. Since Bitcoin is more liquid, to spend coins to make more coins is an easier decision IMHO.

In turn, all my family combined probably do not hold as much land as our forefathers did. Still, we are much wealthier than they were. Of course, if they did hold the land, it would be worth a lot more than all of ours combined. But at what cost? It's almost impossible to imagine.

All in all, I could understand the argument more easily if there were no deflationary vehicles one can invest in. But there already are. At this point, I'm pretty sure I'm missing something. Instead of investing in gold and keeping some EUR to spend, I can keep it all in Bitcoin. If I chose to invest in something other than gold, then I would do the same with Bitcoin. Should I not?

The only mechanism I can think of is, if investing in deflationary vehicles are made accessible only to a minority of the population. Bitcoin breaks this condition almost perfectly, therefore will result in market failure.
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March 25, 2013, 04:03:42 AM
 #54

All the people who say Bitcoin stinks because it must inevitably increase in value - do you think they do the logical thing that their belief points to and put their money in Bitcoin?

Do not waste your time debating whether Bitcoin can work. It does work.

"Early adopters will profit" is not a sufficient condition to classify something as a pyramid or Ponzi scheme. If it was, Apple and Microsoft stock are Ponzi schemes.

There is no such thing as "market manipulation." There is only buying and selling.
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March 25, 2013, 08:29:16 AM
 #55

Keynesianism is a dying religion, with Krugman as the high priest. Spending driven by currency inflation is not helpful to humans, it results in a bunch of economic "activity" that can only be described as wasteful. Buying unneeded consumer goods from someone so they can turn around and buy unneeded consumer goods from someone else just results in overworked people with decreased real wealth.

Saving is a good thing and is what creates real wealth, ie increases personal productivity per unit of time. A deflationary currency like Bitcoin will help create a society with less economic "activity" in terms of frivolous spending and more real wealth in terms of productive capacity and freedom to spend your time in ways you enjoy.

Austrian economics >>> Keynesian economics  


 

I couldn't agree more!
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March 25, 2013, 08:49:52 AM
 #56

A purely deflationary currency provides no incentive for investment or economic activity

I'd like to point out, that this might actually be a positive aspect. Right now the worlds monetary system is geared towards infinite growth. This strikes me as not very smart since last time I checked, we were living on a planet with finite resources. A deflationary (not sure, this technically applies to Bitcoin. Bitcoin does have inflation, but it's small, controlled, predictable and finite) currency might act as a catalyst for change in the way we think about the economy and lead us from a growth oriented to a sustainability oriented model. I don't see it as a threat to general prosperity if people stop spending currency like it's hot potatoes and going into debt in order to fuel consumption - on the contrary. A currency increasing in value over time encourages saving - delayed consumption, as in "lets' not strip the planet bare to the bones right now to have 5 ipads and 4 cars each but let's leave something for later generations". Just my two Satoshis.

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March 25, 2013, 09:00:58 AM
 #57

I hope I'm not alone in not buying this whole "deflation is bad" argument.  By your logic, Samsung should be broke because the SGS3 that used to retail for $800 is now available for $350.  And by the same logic, I will never buy a computer because in a month's time it will always be cheaper than buying today.

Thats not currency deflation. Cellphones and computers actually are getting cheaper to produce. Its called an increased productivity and if that is what is causing the price deflation; then there is nothing wrong with that, on the contrary. We had the same during the industrial revolution; we got massive increases in productivity causing price deflation. But also causing more production of actual physical wealth because we produced more goods more efficiently. As a society we actually got richer and the increased purchasing power of our money was just a reflection of that. But you cant reverse that. Making money more scarce doesnt cause an increase in productivity or production, let alone wealth- anymore more than printing more money can make everyone rich.
lonelyminer (Peter Šurda)
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March 25, 2013, 09:01:28 AM
 #58

I agree, and I'm sorry about that.  I didn't misinterpret you on purpose.  I'm not trying to be dense, but I'm still not sure that I understand your argument.
No problem.

Are you saying that inflation doesn't cause people to save less?  The current situation in US retail banks seems to suggest that people do save less when interest rates are lower than inflation.
We need to be careful to differentiate between changes in prices and expectations of these changes. If the expectations are mostly accurate, the direction of the change is irrelevant. The only reason why people might consume more during an inflation is if they are tricked, i.e. if they think the prices will rise slower than they really will.

You are right that the nominal interest rate would be lower for a deflationary currency like BTC, but the real interest rate is what will make things more difficult.
There are several issues here too. First of all, the price of the capital goods is derived from the price of the consumer goods. Unless there is friction in price adjustments then, it's impossible for the unit of account to have a negative nominal interest rate. The real interest rate can't be negative even irrespective of that, as that would mean that people value the same good in the future more than they value it in the present, and that contradicts the axiom of human action.

Of course, a negative nominal interest rate can hypothetically occur with something that is not a unit of account. But this is not as big a problem as mainstream economists assume. I did a simulation and presented the results at the London Bitcoin Conference 2012. In my simulation, a merchant with a 6% real markup and a turnover/stock ratio of 6 was able to have a positive nominal RoI using a deflationary currency that is not unit of account even at a 50% deflation (i.e. the prices in that currency halve within a year). Even income taxes did not revert the positive RoI (of course that depends on the details of the tax rules, but I took those that according to my research should be applied to Bitcoin in Europe).

In fact, because the prices dropped, after a year the simulated merchant would be able to double his stock, i.e. he saved enough capital to be able to expand his business. This is a hint that a deflationary currency edit: falling price level is highly beneficial for consumers, as it increases the amount of goods available to them. And if you don't believe the simulations, just look at consumer electronics.
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March 25, 2013, 09:06:52 AM
 #59

A purely deflationary currency provides no incentive for investment or economic activity

I'd like to point out, that this might actually be a positive aspect. Right now the worlds monetary system is geared towards infinite growth. This strikes me as not very smart since last time I checked, we were living on a planet with finite resources. A deflationary (not sure, this technically applies to Bitcoin. Bitcoin does have inflation, but it's small, controlled, predictable and finite) currency might act as a catalyst for change in the way we think about the economy and lead us from a growth oriented to a sustainability oriented model. I don't see it as a threat to general prosperity if people stop spending currency like it's hot potatoes and going into debt in order to fuel consumption - on the contrary. A currency increasing in value over time encourages saving - delayed consumption, as in "lets' not strip the planet bare to the bones right now to have 5 ipads and 4 cars each but let's leave something for later generations". Just my two Satoshis.

Exactly! In an expanding world (resources and people) infinite value helps you exploit nature and grow population as fast as possible. But now finite is on the table, and decreasing population. Only gold and bitcoins work in that environment.

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March 25, 2013, 09:07:32 AM
 #60

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What that means is that if you measure prices in Bitcoins, they have plunged; the Bitcoin economy has in effect experienced massive deflation.

And because of that, there has been an incentive to hoard the virtual currency rather than spending it.
This is simply not true.

Imagine I want to keep 50% of my savings in USD and 50% in bitcoin. Bitcoin rises in value and suddenly my savings distribution is: 20% USD, 80% bitcoin. Now I want to spend (sell) bitcoin and hoard (buy) USD. If I have the option to pay with BTC or USD, I will pay with BTC. This can only be good for the bitcoin economy.

Saving is so strongly discouraged in the current economy that Krugman wouldn't ever consider this.


+1 Smiley  

Yeah, your coin is now worth a whole lot more goods than when you traded for it.  And people think this will discourage spending your coin?  That's like saying that lower prices discourages shoppers.
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