Interest rates in a deflationary currency

[aaaxn]

No kidding workers are being screwed, this is a mess and solving it, something has to give.  
Penalising savers through inflation (adjusting exchange rate) flies in the face of what has allowed humans to flourish,  i.e. Penalising the savers of recourses (Differed consumption of others debt in the case of fiat) for unforeseen events.

I am not convinced with " adjust it more efficiently through exchange rate of domestic currency" (ie. The invisible thief) is the most efficient option.

The net result of inflation is investing in future risk taking to maintain value. That investment = Economic growth, or stagnant growth and accelerated consumption. The net result is malinvestment.
I suspect we'd be better off taking the hit hard now and reinvesting finite recourses after the economic corection as opposed to business as usual and malinvestmenting the recourses compromising the future.  

Well compare how is USA doing with all this "stealing" and how is Spain doing. Spain has over 27% of unemployment and over 50% among youths and it is not temporary but from 3 years and still getting worse. You cannot save work potential for later, if someone is unemployed his output is lost forever.

And saving money is just saving money. It is not automatically investment and/or really saving something valuable (like bushel of wheat or something).

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[NewLiberty]

What happened in there is exactly what should happen in sound money system. People lent bank money and bank went bankrupt so lenders lost their money.

I'd agree, it is one of 2 options, I would go further and say when I have invested in something and it has gone bankrupt or delisted, I just lose my money, and so it should be for the lenders who miscalculated and lent to those states.

The new piece is that not just lenders take the loss, but also depositors, who are converted to shareholders in the failing bank.

the difference between depositor and shareholder is largely that depositor has no vote.

That and Depositors traditionally are entitled to withdraw the deposit.  Shareholders must find the greater fool and sell for what they can get.

[Adrian-x]

Well I did lend some bitcoins on coinlenders. Are they fraudsters? Or am I?

Good luck selling the IOU as money. 

To your point, great well done, there is lots of opportunity, I haven't been so lucky, not because it is wrong, just because the price of goods and services are deflating in relation to Bitcoin's value. 

Fortunately not everyone is lending there Bitcoin's out now and trusting they will be repaid when the value is $1000+. If you want to speculate and you think the future value will be $1 then (inflation in goods and services relative to Bitcoin is a good time to lend - it's up to the market to assess the risk, all the power to you, your actions are valued in the free market)

I think you may be missing my point.
I don't think we disagree on anything, other than you believe the IOU you create by lending Bitcoin's is sound money because you are a law abiding and trust worthy citizen, and I believe your IOU's are risky, and it is immoral to argue otherwise.

Or phrased in contemporary banking terms:

I don't think we disagree on anything, other than you believe money created by Banks through fractional managed reserve assets baked by debt is sound money and I believe it distorts the economy and is risky and it is immoral to argue otherwise.

[Adrian-x]

It is not automatically investment and/or really saving something valuable (like bushel of wheat or something)

You have highlighted the distortion we now have in the economy, it is about saving something of value - real money to debt money.

Wealth isn't created by overconsumption, but by deferred consumption.  Hard money's value is reflected in the state of the economy, Fiat is reflected by the optimism of central planners, or bankers. Saving hard money is risky in itself but saving fiat is just stupid.  

We should be saving something of value, but instead we are consuming it exponentially, to satisfy the return on investment in recourses extraction ripening through the entire civilisation, in order to stay solvent.

In Fiat terms investing in more efficient oil extraction, is a good investment, simply put in a dynamic situation it will lower the cost of Oil, and the profit to cover the investment will be made on the increase in volume. The input costs in other industries will benefit and they too can lower their production costs, they will make up the investment on the increase in volume. Before you know it you will take what used to be a recycled bottle and be throwing it away, because we have invested in industries that do that more efficiently, while it is progress, it is progress that is a result of malinvestment, ultimately based on avoiding a default in1971. (I am not bitter just grateful it happened now and we didn't have to keep a fractional reserve gold standard going for a few more hundred years of operation.)    

In Fiat terms saving money is deferred consumption, and collectively inflating the value away is theft.
Not so with hard money or a bushel of wheat or something.

The only option now is to invest your way out of the problem, (as saving fiat is for stupid people who want to see their money devalued) but the viable alternate is investments that are more of the same resulting in concern highlighted here: http://physics.ucsd.edu/do-the-math/2012/04/economist-meets-physicist/

The old way of doing things is broken, we need to learn to fly, and stop thinking we have launched off a cliff in the 1900 believing we are flying while just a few realise we are falling and can see the ground approaching fast, if you have better ideas or if I am missing something I would like to learn.

[aaaxn]

Well I did lend some bitcoins on coinlenders. Are they fraudsters? Or am I?

Good luck selling the IOU as money. 

I would probably be able to sell my coinlenders account with existing CDs for something like 9x% of its value, so yes it is possible. I succesfully traded mtgox codes for bitcoin or services at it face value so it isn't impossible to use bitcoin IOU as money.

Fortunately not everyone is lending there Bitcoin's out now and trusting they will be repaid when the value is $1000+. If you want to speculate and you think the future value will be $1 then (inflation in goods and services relative to Bitcoin is a good time to lend - it's up to the market to assess the risk, all the power to you, your actions are valued in the free market)

I am lending in bitcoins and will get bitcoins back so I am long bitcoin and if it falls to $1 I will loose 99% of value. $1000 would be good for me.

I think you may be missing my point.
I don't think we disagree on anything, other than you believe the IOU you create by lending Bitcoin's is sound money because you are a law abiding and trust worthy citizen, and I believe your IOU's are risky, and it is immoral to argue otherwise.

I am not thinking that IOU is sound money. It is money substitute and it affects value of other money. There is nothing wrong with it, because like anything in free market you have right to your property but don't have right to you property value. It''s up to market.

You have highlighted the distortion we now have in the economy, it is about saving something of value - real money to debt money.

Yes it is about real saving or investment. What you miss is that no matter what is money saving money is just that - saving money. If money was bitcoin or gold it would still be only saving it and not real saving or investment.

[aaaxn]

In Fiat terms investing in more efficient oil extraction, is a good investment, simply put in a dynamic situation it will lower the cost of Oil, and the profit to cover the investment will be made on the increase in volume. The input costs in other industries will benefit and they too can lower their production costs, they will make up the investment on the increase in volume. Before you know it you will take what used to be a recycled bottle and be throwing it away, because we have invested in industries that do that more efficiently, while it is progress, it is progress that is a result of malinvestment, ultimately based on avoiding a default in1971. (I am not bitter just grateful it happened now and we didn't have to keep a fractional reserve gold standard going for a few more hundred years of operation.)    

So what you are saying? Investing in more efficient oil mining wouldn't be profitable with sound money? How so? You reduce your costs per barrel so you can keep prices and earn more for every one you sell. Or you lower price a bit and get greater share of market. Same in fiat and same in sound money system.

[rovchris]

If you have a deflationary currency I am at a loss to why you would need to pay interest on a loan?

For example lets say today 1 BTC buys 1 pint of milk but as it deflates tomorrow it would 0.8 BTC for the pint of milk.(quite extreme deflation I realise  )  So therefore just by repaying the principle you have effectively earned 0.2 BTC because of the increased purchasing power.

Gold is effectively a deflationary currency as its value increases overtime - you give me 1 kilo of gold today I give it back to you in 10 years time and it is worth a great deal more so you have effectively made money.

[Adrian-x]

So what you are saying? Investing in more efficient oil mining wouldn't be profitable with sound money? How so? You reduce your costs per barrel so you can keep prices and earn more for every one you sell. Or you lower price a bit and get greater share of market. Same in fiat and same in sound money system.

It is not the same if the measure of success is measured in the units of medium of exchange.

Obviously you have a simplified model in bold for making a business case, that simplified model is what I would call the Austrian model devoid of all human action and dependant on rational facts, so I propose we base the modeling on just rational facts and ignore human action.

The investment should be considered in terms of macro economics, given the scale of the investment and the size of the market.

Starting from the premise oil production is profitable and has been profitable up until the investment was considered, then during times of inflation (shrinking economic prosperity) the investment is more viable.

that is: Save your medium of exchange and you purchasing power decreases - by the inflation rate.  The rational reaction is invest now and get a higher return, that is inflation adjusted in the future and invest before your capital lose value.

V

Starting from the premise oil production is profitable and has been profitable up until the investment was considered, then during times of deflation (increasing economic prosperity) the investment is less viable.

that is: Save your medium of exchange and you purchasing power increase - by the deflation rate.  The rational reaction is save now for a higher rate of return in purchasing power, consider the capital investment will cost less in the future so save until you get the best value when investing.

If the inflation rate is targeted at between 2 and 5% investing is preferred to saving because saving will cost you between 2 and 5%. So the rational thing to do is invest.  
The deferred investing is a free market responding to hard money, and taking risks based on market feedback, the market self regulates in the absent of  the medium of exchange manipulators. It is argued by Keynesians that deferred investment is the cause of Boom Bust cycles and can be eliminated by having constant inflation - the prevailing wisdom by which our economy is organised today.
 
I don't see much point in arguing that fact, at the end of the day if you can manipulate the economy and steel wealth from the working class, and the political elite have no motivation to change, they won't.
For the first time an alternate option is available and reason and rationality can prove themselves independently of the entrenched system of economic and political structures. And fortunately I don't have to prove anything if our system is working there is no need for a hard currency and Bitcoin will fail, if the Austrians made any sense at all then all you have to do is use Bitcoin, every possible way you can think of. And the more efficient system will win in the long-term.  

If you have a deflationary currency I am at a loss to why you would need to pay interest on a loan?

A rational market wouldn't.

This changes in times of inflation (economic activity starts to shrink low supply and high demand) then the rational market would be willing to pay interest and borrow with interest.  
Until then, save your cryptos,

[rovchris]

I was under the impression inflation is caused by an increase in the money supply (Quantitative easing for example) and as the creation of money is controlled at a sustained rate by the Bitcoin network and has a set upper limit - there should be no inflation?

[xxjs]

If you have a deflationary currency I am at a loss to why you would need to pay interest on a loan?

For example lets say today 1 BTC buys 1 pint of milk but as it deflates tomorrow it would 0.8 BTC for the pint of milk.(quite extreme deflation I realise  )  So therefore just by repaying the principle you have effectively earned 0.2 BTC because of the increased purchasing power.

Gold is effectively a deflationary currency as its value increases overtime - you give me 1 kilo of gold today I give it back to you in 10 years time and it is worth a great deal more so you have effectively made money.

Interest rate is the added price you have to pay for the pleasure of buying something now, as opposed to later when you have earned it. Inversely, it is the premium you get for postponing consumption now, and then consume it later. It is basically a time market, where prices have a time dimension in addition to the value at present. Lets call this the basic interest rate.

I practice, when loaning, you also have to pay for the expected price inflation, insurance against default and the work spent by the lender.

The current high appreciation of bitcoin is not going to last forever. When bitcoin is implemented in the world, and all coins are created, the appreciation (reduced prices of goods) will come from more users (more people in the world) and lost coins. More users could be a small percent per year, but it could also stabilize, expand faster or even start to go down. Nobody knows. In the meantime, if you need a loan, get it in fiat.

Expected appreciation will have to be subtracted from the interest rate. So, if we have a basic interest rate of 3%pa, appreciation of 2%pa, the resulting nominal interest rate would be 1%pa. Obviously, if the basic interest is lower, or appreciation is higher, the resulting nominal rate could become negative. This would stop lending, because you don't get more than just keeping the bitcoins in the mattress.

A sound business traditionally could loan say half of its capital, representing the safe part, while the owners' equity represented the risky upper part. Loaning for business is not strictly necessary, for instead of loaning, you could summon up more people, and finance your business with only equity. But this does not really solve the problem, as any entrepeneurial effort should have an expected return of the nominal interest rate plus compensation for risk and effort. This means that investing could also stop, except for the ventures with high expected return.

I am not sure if this is healty. Anyway all the low return, high risk projects would have to stop, leaving only safer, high return projects.

At least, this would stop all the malinvestments. Malinvestment today is chinese unused cities, spanish unused airports and so on. May be capital could therefore build up more, giving higher productivity. Not sure here either.

[rovchris]

Interest is charged on FIAT currencies because there is an unlimited supply of money.

Take this example - lets just say I have all 21 million bit coins - I then loan them to you at an interest rate of 1% - hey I am a generous guy.

Immediately you can see the problem - how are you going to pay back the additional 300,000 bit coins? They do not exist?

[rovchris]

Further to my last post - if you break it down into lots of people loaning other people BTC and charging interest there will be more BTC listed in loan books than there are in circulation and then we will end up in another financial crisis when someone does an audit and realises this.

[molecular]

Interest is charged on FIAT currencies because there is an unlimited supply of money.

Take this example - lets just say I have all 21 million bit coins - I then loan them to you at an interest rate of 1% - hey I am a generous guy.

Immediately you can see the problem - how are you going to pay back the additional 300,000 bit coins? They do not exist?

That's only a problem if everyone tries to pay back their debt. Also: you're forgetting the fact that some borrowers default.

It's not a problem.

[molecular]

I was under the impression inflation is caused by an increase in the money supply (Quantitative easing for example) and as the creation of money is controlled at a sustained rate by the Bitcoin network and has a set upper limit - there should be no inflation?

This doesn't seem to follow: "bitcoin/fiat has (controlled) inflation => there should be no inflation"

Maybe if you discern "money supply inflation" and "price inflation" you'll get a clearer picture.

If bitcoin was the only money used in a certain growing economy (at a higher than the current bitcoin money supply inflation rate) prices would generally fall.

[NewLiberty]

There is also speculative borrowing.  Its not all consumption based, but the time element is always there in lending.
If I think that the price of a BTC is going to go down, against some other asset class, I can borrow BTC, convert it to the other asset class, and then reverse it in the future to repay the loan.

Folks that borrowed BTC at 120 and repay now may have done well (depending on the conversion asset).

[xxjs]

Interest is charged on FIAT currencies because there is an unlimited supply of money.
...

No, basically interest is the price you have to pay if you want to consume (or invest) before you have earned, or the reward the saver gets for postponing his consumption. The interest rate is a market, which depends on the valuation of time on part of the market actors.

Nowadays the central banks tries to affect the interest rate with lending to lower rates (of money they don't have). So nowadays the time market is somewhat crippled.

[Adrian-x]

Interest is charged on FIAT currencies because there is an unlimited supply of money.
...

No, basically interest is the price you have to pay if you want to consume (or invest) before you have earned, or the reward the saver gets for postponing his consumption. The interest rate is a market, which depends on the valuation of time on part of the market actors.

Nowadays the central banks tries to affect the interest rate with lending to lower rates (of money they don't have). So nowadays the time market is somewhat crippled.

/\ This FTFY

[Cluster2k]

There is no incentive to loan money in a deflationary currency where the economy is growing.  Why risk not being repaid when the potential lender can just sit on his or her pile of bitcoins and see their value rise (buy more goods per bitcoin) without lifting a single finger?

[xavier]

Inflation isn't the only component in interest rates.  Take a CC for example it is 20%+ even in an economy where inflation is ~3%.  Even a mortgage generally run 1% or so higher than the 10 year treasury bond (which rarely current QE fun aside) has negative real interest rates.

The issue would be that Bitcoin is currently experience very high deflation relative to the dollar and other major currencies.  However that trend will not hold forever.  I mean at only 24% USD:BTC growth we would be looking at the Bitcoin money supply worth  ~2T in a decade, then what 20T by the next decade, 300T by the decade after that.  

As the Bitcoin economy gets larger its growth rate will slow.  Bitcoin will not have extreme price deflation.  Under a scenario where the purchasing power of a Bitcoin is increasing by say 1% a year I would expect interest rates to be very similar to inflationary interest rates but 2% to 4% lower because the inflation component has been replaced with a deflation component.

For those people who think a deflationary currency is impossible , let me ask you one question.

How do you think human society evolved?

Did governments evolve before humans? Was it like this: A government arrived on the planet, before any human beings, and dictated all the rules for society to function. It dictated how much money would be circulating every year, and every year set an interest rate in order to carefully control the money supply. And, thank God it did that, because if it had not set this interest rate and carefully controlled the money supply, there is no way people would have been able to trade. Because people need the government's help for everything. Human beings cannot function without government help. They cannot trade without the help of the government. They cannot use currencies without the government. People need to pay high taxes and have central bankers slowly removing the value they have carefully saved and accumulated during their working life.

Well, let's answer the question. No, it wasn't like this. What actually happened? Human beings evolved first before governments. They traded and did business with each other perfectly fine without ANY government interference for hundreds or thousands of years. Then, around the time of the 20th century, politics began to mix with greed and self-interest, and self-interested politicians began to expand the role of government ever more, into ever more areas of the lives of the citizens, without citizens realizing exactly what was happening - because it happened incrementally.

Eventually politicians , again for their own self-interest, decided to take control of the money supply, and suddenly we are convinced by them and their journalist friends that we need inflation, that society cannot function without governments constantly printing money every year, that the currency needs to be controlled because deflation is a danger.

This is exactly like in my opinion when, hundreds of years ago, the ruling elite convinced everybody that the world was flat, and refused to acknowledge that it could actually be round, despite the logical evidence.

So, human beings have survived fine for thousands of years without inflationary fiat currencies. There is really no need for them today any more than there was 2,000 years ago.

This post by DeathAndTaxes really, in my opinion, answers the questions about deflation. Loans can still be made, sure, because the rate of deflation will be small. Why would it be large? The only flation that is large is inflation, because of governments. Why is it necessary for economies to grow? GDP is defined as the total value of all transactions in an economy. Why is it assumed that GDP always grows year-on-year? Why should people transact more next year than this year?

[Adrian-x]

There is no incentive to loan money in a deflationary currency where the economy is growing.  Why risk not being repaid when the potential lender can just sit on his or her pile of bitcoins and see their value rise (buy more goods per bitcoin) without lifting a single finger?

Correct, if you are rational.

and Economists argument for the current system because they argue market aren't rational