Deflation and Interest

[HeidelbergKid]

I've looked at the system of the bitcoin, and from what I know, there seems to be a few problems which revolve around the fact that only 21 million bitcoins can possibly exist at a time. Let's look at each of the problems. We'll begin with a background where the economy is growing. Everything is fine, until the bitcoin mines run dry: all 21 million bitcoins have been harvested. In order to adjust to the growing economy, an individual bitcoin becomes more valuable (deflation). During a period of deflation, money becomes more valuable even when it is unused. People realize this: why should they risk loss in investment when their money will gain value risk-free by letting it sit? As such, people stop investing and let their money sit untouched. Companies are no longer able to take out loans. Companies wither and die, people lose jobs. New companies cannot start as they cannot get their initial loan money. Due to the lack of production, the bitcoin shrinks sharply. The people who just kept their money away suffer, too, as the bitcoin is no longer backed by an economy. Bitcoins suddenly lose value and face hyperinflation. Now we're back we've a shattered economy, the bitcoin's a 21st-century German Mark after WW1 (i.e., worth practically nothing), and literally everybody involved has suffered. How is this supposed to be avoided?

In some ways, the bitcoin reminds me of the gold standard, the bitcoins simply being virtual gold with literally no value except as money. Gold, although not exactly world's most useful substance, has practical use for its electrical conductivity, malleability, and its resistance to corrosion. Here's one way the bitcoin reminds me of gold.

The bitcoin, like gold, is a limited resource. There is only so much gold in the earth to dig up, and the bitcoin has been set up so that a finite number of them (21,000,000) can exist. Gold was often hoarded, taking it out of use. I fear bitcoins could also be hoarded. Since there are only so many bitcoins out there, each bitcoin hoarded is one less which can contribute to the economy. The hoarders will grab every bitcoin they can reach. In order to counteract the hoarding, individual bitcoins become more valuable, just like any scarce resource. This too leads to the same problems above (bitcoins gain value without contributing anything useful, causing economic depression and hyperinflation), only quicker and without the period of growth I've mentioned in the background above. Point is, hoarded money is taken out of use, and leads to deflation.

Also, even without central banks, there is still a major problem with banking in the bitcoin system. Alice begins systematically lending out bitcoins with interest. As such, she gains more money. Although this money is being invested and doesn't face the same problems as the hoarders face, there is a problem if the money supply is not infinite. Alice's share of the money supply increases, until she eventually gains all of it. It's impossible to pay principal and interest from a total money supply which only contains the principal. Even though the money isn't being created as debt, it doesn't matter. Alice ends up with all the money, and once all the foreclosures and such are filed, she ends up with all the real stuff, too. Even if Alice could just create new bitcoins into existence for all the money she loans out, she doesn't create the interest. No matter how the money is created, systematically charging interest means Alice soon gets everything. Good for Alice, not so good for everyone else. Alice needn't be a single person: Alice is actually the sum of all the lenders in the bitcoin system, but the result's just the same as if it were all one person. If lending with interest is forbidden, then why would Alice even go into banking? She would do better off just holding onto her money and letting it sit, leading to the deflation problems above.

Then there is conversion. Between other currencies, that is. How is it determined how much a bitcoin is worth in dollars, pounds, euros, pesos, yens, rubles, shekels, or whatever currency you use? An easy pseudo-investment technique could be to buy bitcoins with an ordinary currency (call them monies), let it sit and let deflation do its work, then convert all your bitcoins back into monies for a huge profit. Bitcoins converted out of the bitcoin system means less bitcoins available in the bitcoin economy and more monies available in the other economy without anything at all behind them. Are ordinary currencies converted to bitcoins producing new bitcoins which didn't previously exist, or do the converters pay from their pockets? Why would the converter want to remain in business if they lose more in bitcoins than they gain in ordinary money as a commission? What becomes of the original bills or coins? Are they taken out of circulation or what? Once all 21 million bitcoins have been mined, it becomes equivalent to any other currency with the exception of being tethered to a non-existent object, which I call "somniaurum" (loosely "dream gold" in Latin). As such, it would be subject to rampant deflation as mentioned above, something which other currencies would be immune from due to being tethered to the strength of the economy rather than literally a no-thing. Not even a vacuum, not even space. No-thing. Nothing but a thought. A currency based on nothing but a thought is stupid and childish. Even most fiat and debt currencies out there today have value in the sense of real-world objects and the economy. The bitcoin is strange, and not in a good way. Could somebody please address all these problems?

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[paraipan]

all your concerns and "problems" have already been addressed on this forum before...
care to spend a little of your time reading on those before posting ?

[HeidelbergKid]

Okay, I figured that. But could you please tell me here anyway so I don't have to go looking around? Thanks.

[BurtW]

No

[paraipan]

No

+1, do a search on the forum, we've turned immune to this kind of posts after seeing so much of them

edit: https://bitcointalk.org/index.php?topic=11627

[Gabi]

oh the deflation troll

[HeidelbergKid]

Here's an idea: actually respond to my questions and statements instead of redirecting me to a brief explanation of Keynesian and Austrian economic schools. I'm stating that bitcoin is flawed because it is built to deflate. I explained why such deflation would be a major problem. Now, if you do not see deflation as a problem with Bitcoin, then you will need to post here with an explanation of why my logic (on how deflation would be catastrophic) is flawed and how deflation would be positive or at least neutral. I also don't have any tolerance for Austrian nuts. The very paper that founded the school (AFAIK) has a subtitle of "how I learned to stop thinking and love stupidity". Now, either reply with an actual explanation or begone. I don't care if you copy-paste from another post, provided you attribute if it's from someone else. Just please, either reply to this with an actual answer or go away. Thank you.

[Eveofwar]

Here's an idea: actually respond to my questions and statements instead of redirecting me to a brief explanation of Keynesian and Austrian economic schools. I'm stating that bitcoin is flawed because it is built to deflate. I explained why such deflation would be a major problem. Now, if you do not see deflation as a problem with Bitcoin, then you will need to post here with an explanation of why my logic (on how deflation would be catastrophic) is flawed and how deflation would be positive or at least neutral. I also don't have any tolerance for Austrian nuts. The very paper that founded the school (AFAIK) has a subtitle of "how I learned to stop thinking and love stupidity". Now, either reply with an actual explanation or begone. I don't care if you copy-paste from another post, provided you attribute if it's from someone else. Just please, either reply to this with an actual answer or go away. Thank you.

No.

[notme]

Your assumptions are disconnected.  If people hoard and don't circulate, the deflation doesn't continue.  This has been discussed HUNDREDS of times.  Please read the existing posts if you want more information.

[Gabi]

Here's an idea: actually respond to my questions and statements instead of redirecting me to a brief explanation of Keynesian and Austrian economic schools. I'm stating that bitcoin is flawed because it is built to deflate. I explained why such deflation would be a major problem. Now, if you do not see deflation as a problem with Bitcoin, then you will need to post here with an explanation of why my logic (on how deflation would be catastrophic) is flawed and how deflation would be positive or at least neutral. I also don't have any tolerance for Austrian nuts. The very paper that founded the school (AFAIK) has a subtitle of "how I learned to stop thinking and love stupidity". Now, either reply with an actual explanation or begone. I don't care if you copy-paste from another post, provided you attribute if it's from someone else. Just please, either reply to this with an actual answer or go away. Thank you.

More like you go away and learn how to do your homework instead of trying to waste our time.

[BurtW]

On the tabs above click on the "Home" tab, then type the word "deflation" in the forum search bar and you will find dozens if not hundreds of very good threads that fully debate and discuss every single one of your concerns/points ad nauseam.

Plus you have already been given a very good thread as a starting point.  So just click here:  https://bitcointalk.org/index.php?topic=11627

[Gabi]

But bwagner, if he follows your suggestion, how can he troll? 

[BurtW]

HeidelbergKid,

Instead of getting into yet another long boring thread about deflation - there are so many already - I have another idea.  Recently I have been reading a very facinating thread here:  https://bitcointalk.org/index.php?topic=47053.0

Here is the first post of the thread:

The Mappers/Packers theory holds that there are basically two ways to think about the world.

The first, Mapping, involves creating a logical model about the world.

http://en.wikipedia.org/wiki/Mapper_orientation
- A person with mapping tendencies receives new information; facts, techniques, abilities, and undergoes a process of incorporating the new information into a personally developed and self-adaptive model of the world.

The second, Packing, relies on pattern matching. A person with this orientation tries to match a new theory or situation to a previous one where there are known 'correct' answers. Most people are packers.

To really appreciate Bitcoin, you've got to have a good working mental model of what money is, how cryptography works, and the shortcomings of current online methods of payments.  This combination is rare - especially understanding money (hence the famous saying "Only two people really understand money and they disagree.") You can see in the writings of someone like Falkvinge, he really understands all of these things. Mappers who do really get very exicted about Bitcoin.

To a packer though - it's pretty simple. Bitcoin looks just like a Ponzi scheme or a Pyramid scheme. Lots of money going in, no real work being done, nothing real being produced, early adopters getting rich. All the hallmarks are there. If it looks like a horse, and smells like a horse . . . This kind of thinking is remarkably widespread and usually effective - but is never sufficient to understand a radically different system like Bitcoin.


Full Description of the Mapper/Packer Theory here
http://the-programmers-stone.com/the-original-talks/day-1-thinking-about-thinking/

So are you a mapper or a packer?

[HeidelbergKid]

At the time I begin writing this, I have seen fourteen (15) posts in this topic. Here, I'll talk about each I feel I should address here.

1 is just my own initial ranting.
2-5 aren't really comment-worthy.
6 is accusing me of trolling. I'm not doing this maliciously. I plead the n00b, by which I mean, I am new to this forum, so I have an excuse to be naive to this kind of thing.
7 was my asking people to give an actual reply. I made that one a little in frustration. Not very much reply needed.
8 is a one-word response to 7: "no".
9 says that the hoarding would mean the deflation wouldn't continue. I think the exact opposite: the hoarding would lead to increased deflation, at least until the economy catches up due to lack of capital. Bitcoin deflates --> Hoarding becomes safe + profitable --> People hoard more bitcoins --> Bitcoin supply decreases --> Bitcoin deflates more to compensate larger economy --> Hoarding becomes even more profitable --> etc. How is this logic flawed?
10 claims I'm trying to waste time. No. I want to understand so I can get a more informed opinion about bitcoins.
11 says people have debated my exact points ad nauseum. I read the topic post for the "last word" on deflation. I didn't find it helpful. It said economics is a social studies, said that Keynesian economics sees deflation as bad and Austrian economics sees deflation as good, and that you don't need to complain, just watch and see. Doesn't really address my complaints, but simply says different economic schools see deflation in different ways. What I'm looking for is for somebody to explain where and why my links in my chain are faulty.
12 again brings back the whole "troll" thing. I'm not a troll. I'm a naive n00b trying to learn.
13. Uh, this one isn't just one minor statement. I'll quote it sentence by sentence.

Deflation is not bad. It encourages people to save their money rather than spending it frivously.

If an economy sees little spending, it typically isn't seen as very strong. I agree that deflation leads to saving money rather than spending. But, as good as saving may be individually, an economy needs to see some spending to stay alive. Money socked away isn't doing anything but sitting there. Saving in the sense of taking money to a bank is an investment. But deflation encourages saving in the sense of hiding money in a box in your backyard or under your mattress , i.e. hoarding. Hoarded money isn't invested: it isn't contributing anything.

It also makes borrowing money with interest harder, so only profitable ideas will get funding.

Like I said, but people could hoard so much it becomes virtually impossible to gain loans. I may be unintentionally exaggerating: I highly doubt the bitcoin would actually reach the level of hyperinflation the mark faced after WW1. I apologize. Touché.

Additionally, Could there not be things like fractional reserve lending, to mitigate the deflation.

I kind of thought that bitcoin would get away from the concept of fractional reserve banking like it got away from central banking. The two were very closely related. Well, it feels good to get rid of a hidden presumption I had. Besides, even FRB could only get us to a point unless me make the ratio of debt bitcoins to somniaurum bitcoins an infinite amount to one. And then the only difference between bitcoins and normal currencies are the lack of central banks in the former.

I invite you to watch the video "Money as Debt". It's ~45 minutes long, and really informative on deflation and FRB. It's available here]www.youtube.com/watch?v=Dc3sKwwAaCU[url]here[/url]. The whole "fractional reserve banking" thing seems very fishy to me.

Computer memory is deflating, in a sense. You can get twice as much memory for your computer by just waiting a couple years. Why would anybody buy a computer now, knowing you can get a much better computer later? Because people want things now. Just like in the future, when bitcoins are deflating rather than inflating, people will continue to spend them to get stuff.

Dammit, I fell into the pitfall of replacing Homo sapiens with Homo economicus]rationalwiki.org/wiki/Homo_economicus[url]Homo economicus[/url]. I just thought that something like "hoarding your money in a deflating economy is safe [compared to investing] and profitable" is kind of obvious. When people used the gold standard, gold hoarding led to problems. I feel something similar would happen with bitcoins and the somniaurum standard. Touché.

On the topic of interest, it is possible to lend out bitcoins at interest because bitcoins can move more than once. They move from person to person, and so the total value transfered is higher than the total money available at any one point in time.

You lost me after the final comma. Could you please explain it in different words and/or elaborate?
14. Another detailed one.

Bitcoin is backed by the people offering goods and services for bitcoin, just like the US dollar is backed by people offering goods and services for dollars.

With the way it was set up, I thought bitcoins were backed by an imaginary substance, kind of like the gold standard but with gold replaced with an imaginary substance with only the value we assign to it. Hence my name for it, "somniaurum" from Latin for "dream gold".

If making money by just holding bitcoins is so easy, you should do it. You might find it is a bit more complex than that.

I just want to know what I'm getting into before I get into it. If my logic is flawed, I want to know. If I believe something which is false, I want to know. I want to have a rational discussion here.

Also, you should go read some basic introduction to bitcoins to see where they come from (here's a hint: there is a nice article on wikipedia)

I did read the introduction on the BitcoinWiki. I realize bitcoins have advantages. I just want to clear up any disadvantages so I can make informed decisions.

In regard to exchanging other currencies for bitcoins, at the time of the transaction neither currency is created or destroyed. If I trade 10 USD for your 3 btc, we did not create or destroy either bitcoins or usd.

Sorry, I'm oblivious as to exactly how any currency conversions occur in the first place. Another thing I'll have to look into.

15. I'll answer this one later, I'm a little tired. It's late where I am. I'll respond tomorrow.

[BurtW]

I have been thinking about it and I will try to answer my own question as that is only fair:  I think I am a packer with exciting fits of being a mapper.

Also I have noticed that I and most people I know are packers when it comes to things they “really know”, their particular areas of expertise and their career.  For me, as an engineer, that applies to all the things I know and have done my whole career.  For example this post (and my other posts to this same thread) concerning finite field mathematics and group theory as applied to a paticular issue related to the eliptical curve cryptography used in the Bitcoins system:

https://bitcointalk.org/index.php?topic=53177.msg635010#msg635010

However, one of the things I find most exciting about Bitcoin is that it stretches me into new areas, areas where I really don’t know much (but sometimes think I do) – areas where I can be a mapper!

As an example which is relevant to this thread I participated in an economics thread where there was a very lively and technical discussion concerning the definition of the money supply and how it applies to Bitcoin.  If you read this entire thread – and that is my suggestion and hope for you – and you watch my posts you will see that I start out on one side of the debate but at one point I have one of those eureka moments and switch to the other side of the argument.

If you could do me a favor and read this entire thread from start to finish (yes, all eight pages) and then report back on your thoughts here I think you will enjoy it:

https://bitcointalk.org/index.php?topic=51899.0

Please note that the thread starts out kind of slow but keep with it because it gets more technical and interesting as it progresses.

[HeidelbergKid]

Okay, when I begin writing this, there are eighteen (18) posts in this thread, including the initial topic post. Continued from yesterday:

15. Am I a mapper or a packer? Well, I'd have to say a mapper. I don't see bitcoins as a ponzi/pyramid scheme. I see it as something totally different, with its own sets of advantages and problems. I like the philosophy of mapping: it also reminds me of the process of science and how it progresses: self-adaption.
16 is my responses to 1-14.
17 is a reply to 16's comments on 13. Detailed one.

I realize there is a difference between straight saving (holding onto money) and investment saving (giving money to others who promise to return it when you ask). Because we live in an inflating economy, most of the savings people do today is of the investment variety, such as putting money into a savings account at a bank that carries an interest.

Good so far.

But there is still a valid reason to hold your own funds: in the case of a banking system collapse, the 100 ounces of gold in a box buried in your back yard will be worth something for trading, while little slips of green paper might only be good for starting fires. What I mean is that some people still want the security of holding their own money.

It's worth noting that in the aftermath of the Great Depression, where the banking system did collapse, the government insured bank accounts up to $250K. So you'd still get your money back, and invest-saving rather than hoarding has the added benefit of interest.

It's also worth noting that gold doesn't really have that much value besides that assigned to it by society. Like paper money, you can't eat gold (well, you could, but gold has no taste or nutritional value). You could theoretically build a shelter from gold bricks, but such would be needlessly complex as more abundant alternatives exist, e.g. stone and wood. Gold's main practical uses are for its beauty, malleability, electrical conductivity, and resistance to corrosion. The former is the most well-known use, yet gold being beautiful is a value assigned to it by society. Paper money's main practical uses are for its assigned value and as, like you said, a fire-starter. The main difference is that gold is in limited supply.

In the eventuality of a deflating bitcoin economy, there will still be many people who want to hold their own bitcoins, but presumably there will be institutions who offer to give you some interest to hold the bitcoins for you.

So, institutions will be set up to add interest to money invested in them to make it a better alternative to hoarding with deflation, while also lending out the money so the money is not lost. That gets rid of that problem, thanks.

Speaking of interest, let me elaborate with a simplified economy of Al, Bob, and Cal: Al has one bitcoin, Bob and Cal have none. Bob borrows one bitcoin from Al at 100% interest. Then Bob trades his bitcoin to Cal for a swatch of leather, which he then makes into shoes. Bob then sells a pair of shoes to Cal for one bitcoin, and pays half his debt to Al. Bob then sells a second set of shoes to Al for one bitcoin and the pays off the remainder of his debt. So in our little story, there was never more than one bitcoin in existence, but Al recieved 2 bitcoins of payment from his 1 bitcoin loan, and I think a total of 6 bitcoins were transacted.

Okay, got it. Bitcoins are used more than once, so the number of bitcoins transferred is higher than the # of bitcoins. Fractional reserve banking (hereafter FRB) produces more bitcoins and counteracts deflation by increasing the money supply.

The whole economy is of course much more complex, but the point is that interest is possible because it is not just bitcoins in the economy, there are goods and services going in and out as well, bitcoins are just a medium of exchanging value.

Good point. FRB can occur provided the bank has money already and people need money lent.

Most people here believe that if bitcoins become widely accepted the price will go up, and when the inflation period is done (when most bitcoins have been mined) there will be deflation so the price will generally go up. So it makes sense that if you buy some bitcoins now the price to exchange those bitcoins back to dollars will be higher at some point in the future. The part that is hard is to see how quickly that price is rising; the profit you make by holding bitcoin might be very high or it might be a lower return than putting those same dollars into a savings account at your local bank. Additionally, as we have seen the past year, the price does not only move one direction, it goes up and down. The general trend since bitcoin began has been an upward price, but it has been a very bumpy ride.

Now I see where the claims of bitcoins being a ponzi scheme come from. But, as we've seen above, the deflation is being alleviated so hoarding is not recommended as invest-saving would return higher interest rates, and FRB produces more money to counteract deflation. I won't try to explain my thought processes here, simply that it all makes sense and bitcoins aren't a scam.

18 is an explanation on how the poster is a packer in areas of his expertise, but is a mapper in unfamiliar areas, e.g. bitcoins. He also recommends me to read a provided link. I'll begin looking at it.