Perhaps bitcoin is not deflationary after all

[odolvlobo]

Thesis: In a Bitcoin economy, V may increase faster than M/Q decreases in the equation of exchange, MV = PQ, resulting in rising prices.

For the sake of discussion, let's relax the definitions of inflation and deflation as changes to the money supply, an consider prices instead.

It is said, and generally accepted, that bitcoin is a deflationary currency. The argument is that the money supply is constant or falls slowly while the economy grows. In other words, in the equation of exchange, MV = PQ or P = MV/Q, M will be constant or falling and Q will rise, so P must fall.

Notice that one factor is left out: V, the velocity of money. We are assuming that V is constant, but what if it isn't?

Bitcoin is an efficient payment system, and that is its advantage over the status quo. A direct result of Bitcoin's efficiency will be a rise in V. Furthermore, suppose that Bitcoin's efficiency improves at the rate of Moore's Law, which is at least as fast as the economy will grow. If that is the case, then V will increase faster than M/Q will decrease, and prices will rise.

[Ibian]

No. Inflation and deflation refers strictly to money. When you start to factor in goods then you have cases where the price of one thing is inflating while the price of another is deflating. It's not useful and only adds to confusion and obfuscation, which is 90% of why we are in this mess in the first place.

[FenixRD]

I'll jump in on this to the extent that because of the reason you said, and also because of a lot of other things involved with the equation of exchange, even if the equation is flawless -- and it may be, it looks good to me -- it's likely that most applications of it have been flawed.

Assuming k is inverse to V, as is common, is obviously a fallacy in USD because it is impossible for us to know what the actual supply is (including because it is variable and unpredictable for all but a handful of elites), and therefore k, as a ratio of supply to that which is "hoarded", is impossible to determine. The use of the equation as written (which is a reduced form) is contingent on that and a few other assumptions.

Additionally, because this has always been mostly used to treat an economy as a universe on its own, while we clearly are ever more often interrelated with each other, it is questionable how well the equation itself can ever work with so many variables that are inevitably unknowns in black box "universes" within the global economy.

+1 for making me think about this again in terms of Bitcoin and its place within all of it, and what degree of the equation can be applied. TBH, I have been in the field for so long that I usually use the equation only intuitively. I haven't tried to step back to manipulating the equation itself for a long time.

[FenixRD]

Also -- having thought some more: It does mean that P will likely not fall in exact proportion, but something slightly less, as it becomes more and more valuable (and valued) to keep things within the Bitcoin economy, for its lack of friction (which should result in higher V).

This phenomenon is related to the reason the Japanese just devalued the JPY starting fall 2012, dropping it from 73¥ per 1 USD to ~102¥ per 1 USD. Internally to Japan, things cost "the same" (although but they lost buying power for goods dependent on foreign origin. Likewise (and why they did it) they can export goods to the US etc. again for competitive prices WE can afford, which was hurting their electronics and auto industries relative to S. Korea in particular.

So that right there is one demonstration of a recent precedent where prices of goods from a semi-isolated economy can go down when a currency is made more inflationary (they upped their inflation target to 1.5%, from basically nothing). Therefore it does stand to reason that there could be the opposite effect by doing the opposite, and since every four years Bitcoin becomes less inflationary, perhaps we will see this.

I will also say that this will not be a bad thing by the time that it happens to any noticeable effect. Actually, the more I think about it in these terms, the more I am amused by the amount of (accidental?) perfection for a first-attempt cryptocurrency.

The reason I say this is, this only means that things which are available exclusively as Bitcoin will have an increasing (or perhaps a less-decreasing than expected) P. Because Bitcoin is completely borderless, anything else can be had by buying it in its local fiat price (even if they accept Bitcoin -- most places today that do this are pricing their goods in local fiat and accepting the BTC equivalent, often truly so by way of Bitpay etc.), which will continue to be less and less expensive relative to Bitcoin. So, for non-Bitcoin holders, Bitcoin-only products will increase in P dramatically, and always much faster relative to any P trajectory for those within the Bitcoin economy.

This is analogous to how with each passing day (up until fall 2012 reversed the trend), for a Japanese, going on a trip and buying "expensive" designer crap was ever cheaper for them, even despite those prices rising for us at the 3%-ish rate. Obviously, that was a good thing if you were Japanese. Indeed, if you don't know why, the only reason they changed it at all was because they too have made the mistake of their government promising Social Security-style "pyramid schemes", and are scrambling to deal with their declining birthrate, multiplied with the decreasing influx of money from exports. Therefore, declining GDP where they were on a trajectory where future promises were not able to be kept.

Basically, unless I have a major realization, I believe Bitcoin and the question of the rising P (aka the P which does not fall as proportional as you'd expect because of a rising V) is a nonissue and in fact another very positive aspect of Bitcoin, as long as Bitcoin is not able to promise its economy future payouts that are rooted on future "Bitcoin GDP" from production and/or foreign trade rising at a rate X amount higher than the global GDP. In fact I've always assumed that in the end, Bitcoin GDP growth (manifesting as the rate of price deflation) would roughly come to equilibrium with the true global GDP, which is somewhere around 5%.

[Impaler]

V isn't assume to be perfectly constant, it is generally assumed that a change in any one factor of MV=PQ will ripple out into the other three, in varying degrees and the equation is telling us primarily the DIRECTION of movement to expect in the others.  Claims that 'an increase in X always going into Y and only Y' are claims above and beyond the basic theory, and I personally do not hold them in much regard, to form a reliable prediction of change that detailed, you need to know why the unique situation might cause a factor to be constant or more resistant to change then another.

We have a well demonstrated history of falling P in BTC and no evidence of a change in V, in fact a naive look at BTC transaction volumes could lead one to conclude V is actually dropping because BTC's M has risen over the last year but transactions are roughly flat meaning each individual BTC is moving less often then it used too.  But I don't put any weight on raw transactions as so many (and an unknowable amount) are just sending to ones self and thus don't constitute actual purchases which are what matters to V.

But in a broader sense we would not expect perpetual rise in V to avert deflation because their is simply a practical limit too how fast people can transact.  At some point you will want to sleep and you will probably have coins in your wall when sleeping, that's going to put a huge drag on V.  Also you need to consider the need for liquidity, people who are engaged in an economy want and NEED to hold an amount of money in a liquid state and that amount is proportional to Q, aka people want to hold money sufficient to buy goods consumed in a time period.  So as the economy grows, wealth increases and Q rises people want (and business need too) hold more money.  This significantly resists V from rising to infinity, instead P falls so that a smaller nominal sum can satisfy the desired liquidity.

In a larger sense though we can't even apply MVPQ theory to BTC at it's present stage of development because BTC valuation isn't being supported by a circulating economy of goods and services with a P and Q.  It's being supported by a scarce commodity supply-demand model which simply pushes a P value out into an embryonic economy that has been build around highly variable exchange rates.  I think the OP understands this, and is discussing the hypothetical future of BTC, but I'd like to make it clear that MVPQ in the present tells us nothing because major axioms of the theory are not met by the BTC economy.

[FenixRD]

To give a little tl;dr before this really gets out of control as all us armchair economists come out of the woodwork (well, I actually am degreed in applied maths with some specialization in game theory effects in economic systems, but this is the Internet so how do you really know that?):

The equation—the full one, not the reduced form—will almost certainly work just fine for Bitcoin. Unfortunately no one uses it right for USD either (or perhaps those who do become bankers), so applying it to Bitcoin may be beyond the scope of damn near any living economist. There are important variables that are governed by black-box systems in non-BTC currencies. To the extent the BTC economy trades and exchanges with black boxes, it too will gain unpredictability. But because none of Bitcoin itself is a black box, we are at a distinct advantage. As I unpack my filed-away thoughts on this equation, I have concluded it was perhaps ahead of its time; a truth in search of a transparent system to unlock its potential. I'm reminded of the years Edison spent racking his brain for a way to make... basically, Bitcoin.

Now, not only is OP correct that V cannot be assumed constant (because it is not artificially held high by maintaining a low k, via incentives where spending is incentivized because holding is highly penalized) but also it cannot be just assumed that V=1/k. Because of this, then, we can conclude therefore P, in response to a non-constant V, cannot be assumed to behave exactly as stated by OP. There is more to the equation already than the form used by OP.

The whole premise of OP's statement is dependent on this: V is assumed to be inverse to k. Normally everything in Keynesian systems is tweaked to minimize k. Normally you might imagine the cost of moving money, which we tend to call its friction, to be one limit on V, and it is. But instead of a normal equilibrium forming between V and k (and the rest if the system), V remains high, despite rising amounts of friction (another way of saying the sources of it have been getting steadily more greedy and brazen).

All this is possible only because the same things which profit from the friction (government and banks—they are 99% of the friction in commerce, at present, both in a time sense, and a cost sense) are the ones which make the rules that penalize the market, preventing the expected rise in k in compensation (via managed inflation, whereby it is clearly more lossy to hold USD than to keep them moving: either because your purchase will cost more tomorrow, or by investing, which with few exceptions ultimately results in those USD moving somewhere. We already know V is not coupled to k with Bitcoin anyway, and k increased while V increased rapidly.

[odolvlobo]

But in a broader sense we would not expect perpetual rise in V to avert deflation because their is simply a practical limit too how fast people can transact.

V is not the rate of transactions, it is the "reuse" of the money supply. If Bitcoin were efficient enough (and modified somewhat), a single satoshi could be enough to support all transactions. Increasing the efficiency of the payment system lowers the demand for the currency, and prices rise as a result.

[Impaler]

V is quite definitely a measure of transactions, it is relative to money supply which may be what you mean by 'reuse'.  If their is an M of 1 million and the total value of all transactions is 1 million in the specified period (usually yearly) then we would have a V of 1, it matters not if this is 1 million transactions of 1 unit or 1 transaction of 1 million units.

A single unit of currency transacting billions of time while the rest are frozen could theoretically do all transactions but it utterly impractical which was my point.  Every single person making transactions would need to receive and spend the one unit in a short period of time.  And to do that each individual would need to hold it for virtually no time at all, were talking fractions of a second.  Obviously the block-chains 10 minute rate is a barrier which is why your saying 'modification' would be necessary and I've got no argument with removal of technical barriers to V, we already have an incredibly low barrier in the electronic Dollar which can transact as fast as a computer can communicate.  

But I discussed the HUMAN factors that make that kind of scenario impractical, people hold money for appreciable time periods in the real world.  Some times it's just our natural slowness as humans, but most of the time it is an actual goal they have not just the result of 'friction'.  All it takes is 1 person in that chain of 1 second transactions to decide to hold and poof velocity plummets.  This is why we would not expect velocity to able to rise to infinity, are you claiming otherwise?

[nodroids]

Oh, gosh. Look how quickly this became religious ie.., Monetarism vs. I agree, velocity could really pick up with BTC. We winter in a surf town in Mexico, the costs of major transactions down here is very high converting from banks and credit cards back home. VERY HIGH, bitcoin reduces those costs greatly. I am trying to use BTC more down here, and even Mexicans (who typically have never heard of BTC) are ready to accept it even though they are cash illiquid for living expenses (for next week).

We upper middle-class and wealthy are now much more global, especially with our work much more doable from anywhere. It is very common to have homes in multiple places for different seasons and reasons. To play and gamble in resorts and casinos world wide.  This will bring more BTC out of reserve and into transactions, but not for a while yet. On the bullish side this speaks to more wealthy, in seeing the liquidity of BTC reserves, keeping more reserves in BTC. So I think it balances out in overall market cap continuing to climb at least until something like %5-35 of btc are actually transfering each month for consumption.

[nodroids]

And ya, the transparency of blockchain is major, it'll make a lot of Hayek's work that he could only dream of being relevant now relevant. Re-read Price & Equilibrium from 1927 and take out all of the caveats of "if there were transparency" and then create formula with them, and you are all of a sudden up for a Nobel prize.

[FenixRD]

And ya, the transparency of blockchain is major, it'll make a lot of Hayek's work that he could only dream of being relevant now relevant. Re-read Price & Equilibrium from 1927 and take out all of the caveats of "if there were transparency" and then create formula with them, and you are all of a sudden up for a Nobel prize.

Already did and I've been testing and adding detail to it daily. The Nobel committee can fuck itself, however. Krugman. Obama. No, I should be very insulted if I were to be nominated.

Oh, gosh. Look how quickly this became religious ie.., Monetarism vs. I agree, velocity could really pick up with BTC. We winter in a surf town in Mexico, the costs of major transactions down here is very high converting from banks and credit cards back home. VERY HIGH, bitcoin reduces those costs greatly. I am trying to use BTC more down here, and even Mexicans (who typically have never heard of BTC) are ready to accept it even though they are cash illiquid for living expenses (for next week).

We upper middle-class and wealthy are now much more global, especially with our work much more doable from anywhere. It is very common to have homes in multiple places for different seasons and reasons. To play and gamble in resorts and casinos world wide.  This will bring more BTC out of reserve and into transactions, but not for a while yet. On the bullish side this speaks to more wealthy, in seeing the liquidity of BTC reserves, keeping more reserves in BTC. So I think it balances out in overall market cap continuing to climb at least until something like %5-35 of btc are actually transfering each month for consumption.

Where before M was opaquely manipulated and k held at a minuscule fraction, to maximize the fiat system's conditions for the profit of a few banks and governments who set the numbers, we (the system of networked users) now adjust k autonomously to maximize the conditions of the system in our favor. If the house always wins, we have become the house to a far greater degree than ever before.