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db
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July 22, 2010, 06:08:09 PM
 #1

There has been a lot of worry here about the deflationary nature of a currency with a fixed amount of money. Don't worry.

Let's first make it clear what we are talking about. The general price level can decrease in two ways. The first is by a decrease in the supply of money. The second is by an increase in the supply of goods the money is used to trade in, i.e. economic growth.

The first, monetary deflation, is irrelevant. Some bitcoins will always be lost but the effect will be vanishingly small; people are not going to accidentally lose several percent of their money per year.

The real issue is growth deflation. As the economy grows the same amount of money can buy more stuff than before simply because the stuff is cheaper to produce. That is cheaper measured in real resources such as labor, electricity or steel.

This kind of deflation is very beneficial because it is interest on a loan, the return of a real investment. What is it that happens when someone sells something and keeps the money without spending it? The seller gives a real resource, such as a sandwich or a screwdriver, to someone else. In exchange they get money. The money consumes no resources and is entirely useless until it is spent. The seller hopes to regain the value lost in the sale in the future, by spending the money. In effect, the seller has lent out a real resource with hopes of getting paid back in the future. With interest.

The deflationary price drop is the interest. The seller / lender has abstained from consumption now in favor of consumption later. To avoid making a loss the buyer / debtor must find a way to put the resource to such a productive use that it grows in value at least as quick as the deflation. If the buyer can't do that the profit maximizing thing to do is to quickly sell the resource to someone who can. Or simply keep the money to begin with and let the more productive people make use of the resources, to the benefit of all.

In this scenario the deflation rate and the growth rate is the same thing. This base interest rate sends a very useful signal about what investments are worth making.

As so often, it turns out that the best economic result is not achieved by manipulating prices - in this case by creating new money - but instead by just letting the market be and do it's thing.
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Red
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July 23, 2010, 04:07:15 AM
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Really, if you are living in California, Nevada, Arizona or Florida you already understand deflation is bad. It really doesn't need to be explained to you. If you are from out of town, home prices have fallen almost 50% in many of those areas.

If you have a pile of cash USD in your bank account you are twice as rich in houses. Yay, for you right! Isn't everyone in the country cheering for the people who already had piles of cash becoming richer? I seem to be missing that on the nightly news.

Face it. Us early adopters are here because we want to spend $5 (hopefully less) on 1,000 BTC and have those coins be worth say a house or a car in three years. Yay us!

That is why deflation seems so much fun in the Bitcoin context.

If you happened to stuff a million dollars in a California mattress three years ago, you are cheering deflation too! Yay you! You could have bought two decent houses there three years ago, now you can buy four! And all you had to do wash sleep on your money! No banks, no lending, no interest required.
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July 23, 2010, 05:26:03 AM
 #3

Consumer electronics prices fall all the time, and this is good.  Why is it somehow bad that homes become cheaper?  Bad for the speculators on the long end, sure, but everyone else?  I think not.

Home prices have fallen to reflect economic reality.  They're not arbitrary numbers, and shouldn't be manipulated as though they were.

Good for the people that sat on their cash instead of using it to further fuel the housing bubble.

Good for all speculators who make the right call.  %^&* speculators who think that anybody but themselves should pay for their bets that go wrong.  %^*& politicians and central bankers whose interventions fuel speculative bubbles.  Too bad for regular consumers that buy into inflated markets.  That's about all you can say, and anything else is just bad economics, IMHO.

Oh, and no, a bitcoin windfall is not why I'm here.  I think most people who promote sound money do it because they really do care.
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July 23, 2010, 05:59:50 AM
 #4

It really isn't about houses. Deflation makes the value of all commodities go down.

Three years ago, there were few "dollar menus" at fast food restaurants. They exist because in deflationary times, people are striving to hoard what cash they have. Which makes it hard to pay the restaurant employees, which makes prices drop where they spend their money.

In deflationary times you want to hoard cash. That is why when we bailed out the big banks, they continued to refused to make new loans. You can't loan money for people to buy assets that diminish in value. Collateral disappears and people default because they legitimately don't have the ability to pay back the loans.

Give people something today that will be more valuable tomorrow and they'll hoard it.
Give people something today that will be less valuable tomorrow and they'll trade it.

P.S.: I have no ideal what "sound money" means. Put I presume you think you'll be better off under bitcoins monetary policy than you would under existing systems. Isn't that a bitcoin windfall?
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July 23, 2010, 06:02:06 AM
 #5

Some people bought houses for bad reasons. If you buy a house to live in and the price falls absolutely nothing changes, you can still live in it. If anything you might get lower property taxes. If you were buying houses to flip, speculate, whatever then you were wrong this time and you lose money. You ought lose money too because you were the reason too many damn houses were built.

And another thing. If houses fall in value and you need to move you pay less for the new place also.


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QuantumMechanic
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July 23, 2010, 06:34:16 AM
 #6

People and banks will lend if the price (interest rate) adequately reflects the risk involved in doing so.  A sustained 'credit crunch' is nothing but a shortage caused by price fixing.

Commodity prices across the board went up for real reasons (politically motivated credit expansion), and they came down for real reasons (the inevitable resulting deleveraging).  Prices are real, meaningful things.  Please don't try to fix them.  Fixing them (interest rates) is, after all, what created the mess in the first place.

I guess I might say that sound money is that which reflects economic reality over political reality.
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July 23, 2010, 12:59:33 PM
 #7

Give people something today that will be more valuable tomorrow and they'll hoard it.
Give people something today that will be less valuable tomorrow and they'll trade it.

Good summary. It's why an ideal currency is one which suffers from neither inflation or deflation.

Modern governments seem to want us all running around trying to avoid inflationary losses though. No wonder we often feel like we're on a treadmill.

BTW, I think the OT fails to recognise that the size of the Bitcoin economy will grow many fold in the future. I am concerned that this will cause monetary deflation, when judged per capita. If you don't believe me, consider how hyperinflation works:

1. Too much currency is printed.
2. Some people grow suspicious and decide not to hold the currency, but use something else more stable instead.
3. The same amount of currency is then spread between a dwindling number of people.
4. As there is more currency per head, this will result in further monetary inflation to those using the currency.
5. If there are still people holding the currency, go back to 2, with more people growing suspicious. Else currency has collapsed and is now worthless.

The number of people using the currency is just as key as the quantity of currency. It's not just the total amount of currency that is the issue, but also the user base (the size of the economy using the currency), which panic can swiftly erode. This is why hyperinflation can happen so suddenly and quickly.

Hyperinflation is triggered by a loss in confidence in a currency: fewer people using it, which then compounds the problem. The total amount printed may cause high inflation, but it goes hyper when people abandon the currency (so the economy using the currency shrinks).

With this in mind, consider the reverse: a growing number of people using a currency, without any additional currency being created; it logically amounts to monetary deflation, per capita. With a denationalised currency, with an economy varying in size (likely growing), this should be considered at length... I'm afraid I do worry.

EDIT: P.S. It's interesting to consider why we are here. I assume some are losing confidence in their national currencies and are looking for something better. With gold/silver at high prices and tech like the Bitcoins appearing, are the fiat life boats already being filled?
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July 23, 2010, 02:57:33 PM
 #8

Give people something today that will be more valuable tomorrow and they'll hoard it.
Give people something today that will be less valuable tomorrow and they'll trade it.

Good summary. It's why an ideal currency is one which suffers from neither inflation or deflation.

What's wrong with hoarding and trading if that's the efficient thing to do given the underlying economic reality as in the original post?

BTW, I think the OT fails to recognise that the size of the Bitcoin economy will grow many fold in the future. I am concerned that this will cause monetary deflation, when judged per capita.

Yeah, I'm talking about the mature Bitcoin market. On the way there we will have both monetary inflation and monetary deflation per capita. That is maybe not optimal but I can't think of a better way to do it. Anyway, it should work, and the end result is good.

If you don't believe me, consider how hyperinflation works

I'm pretty sure that's not how hyperinflation works. Do you know of any instance of hyperinflation that has not involved the central bank printing huge and rapidly increasing amounts of money?
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July 23, 2010, 03:08:40 PM
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Give people something today that will be more valuable tomorrow and they'll hoard it.
Give people something today that will be less valuable tomorrow and they'll trade it.

Good summary. It's why an ideal currency is one which suffers from neither inflation or deflation.

What's wrong with hoarding and trading if that's the efficient thing to do given the underlying economic reality as in the original post?

Nothing, but it may not be the most effective money then, but instead an asset (in the shape of a virtual commodity).

BTW, I think the OT fails to recognise that the size of the Bitcoin economy will grow many fold in the future. I am concerned that this will cause monetary deflation, when judged per capita.

Yeah, I'm talking about the mature Bitcoin market. On the way there we will have both monetary inflation and monetary deflation per capita. That is maybe not optimal but I can't think of a better way to do it. Anyway, it should work, and the end result is good.

Bitcoin has a brilliant solution to this - distributed minting - but I do think it could be tweaked to better suit the growing Bitcoin economy. It just seems a bit arbitrary (but a reasonable guess) at the moment.

If you consider that the Bitcoin economy may never truly stop growing (if the acceptance keeps growing, along with the global population ultimately), I'm not sure why it needs a terminal size. IMO, it would be great if the quantity flexed with the user base.

If you don't believe me, consider how hyperinflation works

I'm pretty sure that's not how hyperinflation works. Do you know of any instance of hyperinflation that has not involved the central bank printing huge and rapidly increasing amounts of money?


It starts with the printing of a load of money, but that's not the trigger. They could print only 20% more cash and still end up with repudiation - who wants a guaranteed 20% loss of wealth? It's the loss of confidence in the currencies ability to remain a stable money which causes the cascading failure.
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July 23, 2010, 04:10:25 PM
 #10

Really, if you are living in California, Nevada, Arizona or Florida you already understand deflation is bad. It really doesn't need to be explained to you. If you are from out of town, home prices have fallen almost 50% in many of those areas.

That "deflation" is actually great for young people looking to buy a new home. The housing prices never should have been so high in the first place.

In fact, if housing prices dropped to $1 (but the quality was the same), that would be even better for society as a whole. Imagine how easy it would be to get a house, then. Arbitrary paper numbers are not real wealth.


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July 23, 2010, 04:15:25 PM
 #11

It really isn't about houses. Deflation makes the value of all commodities go down.

Three years ago, there were few "dollar menus" at fast food restaurants. They exist because in deflationary times, people are striving to hoard what cash they have. Which makes it hard to pay the restaurant employees, which makes prices drop where they spend their money.

In deflationary times you want to hoard cash. That is why when we bailed out the big banks, they continued to refused to make new loans. You can't loan money for people to buy assets that diminish in value. Collateral disappears and people default because they legitimately don't have the ability to pay back the loans.

Give people something today that will be more valuable tomorrow and they'll hoard it.
Give people something today that will be less valuable tomorrow and they'll trade it.

P.S.: I have no ideal what "sound money" means. Put I presume you think you'll be better off under bitcoins monetary policy than you would under existing systems. Isn't that a bitcoin windfall?

I believe you are confusing monetary deflation and price deflation.

Monetary deflation: The supply of money collapses, usually because far too much money was created in the first place. This situation sucks, but is a necessary adjustment since the previous boom wasn't real. We are seeing some of this today.

Price deflation: The amount of real goods and services in the economy increases, relative to the supply of money. Therefore, you need less money to purchase these goods. This is a net win for you, and for society, because there is more real wealth to go around. People don't default, hoard, or stop consuming in this situation; in fact, the increased production ultimately allows for increased consumption.

Under Bitcoin, price deflation will be the predominant factor.

You need to understand the difference between the two. The word "deflation" simply isn't enough to go on, and most of the negative things you hear about deflation are related to monetary deflation, usually under the circumstances of a credit bust.

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July 23, 2010, 05:44:01 PM
 #12

So let's be clear. There "by code fiat" can be no monetary deflation of bitcoins. We always know where every coin is. They are all in the block list. That's the only place they can ever be.

There will be private key losses. And also by fiat, that means some coins will probably never again be able to circulate. But they are not lost. This situation is indistinguishable from hoarding, therefore they generate the same economic dynamics.

In both cases the coins still remain in the block list, and could circulate in the future either by choice (hoarding) or by hash collision (private key loss).

That being the case, everything I've tried to point out is for the case of price deflation. Not monetary deflation.


As for tv's and computers, they make lousy commodity investments. People buy them for their utility value. Exactly the same reason they buy dollar cheeseburgers.
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July 23, 2010, 07:19:34 PM
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What's wrong with hoarding and trading if that's the efficient thing to do given the underlying economic reality as in the original post?

Nothing, but it may not be the most effective money then, but instead an asset (in the shape of a virtual commodity).

Shouldn't the most effective money reflect that things get cheaper if they do? What would be the gain in some convoluted monetary mechanism trying to hide the fact that stuff is actually getting cheaper?

If you consider that the Bitcoin economy may never truly stop growing (if the acceptance keeps growing, along with the global population ultimately), I'm not sure why it needs a terminal size. IMO, it would be great if the quantity flexed with the user base.

Now this could be a real issue. What would happen? What did happen historically in gold economies when there was great population expansion?

It starts with the printing of a load of money, but that's not the trigger. They could print only 20% more cash and still end up with repudiation - who wants a guaranteed 20% loss of wealth? It's the loss of confidence in the currencies ability to remain a stable money which causes the cascading failure.

Look at this list: http://en.wikipedia.org/wiki/Hyperinflation#Examples_of_hyperinflation

Generally it goes on for several years with what looks like exponentially increasing and ever more ridiculous denominations. (And often it doesn't collapse even then!) Those 1 000 000 000 000-bills don't pop into existence out of a lack of confidence.
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July 23, 2010, 07:22:28 PM
 #14

Give people something today that will be more valuable tomorrow and they'll hoard it.

I often hear that claim, but it doesn't match the consumer behavior that I see. People keep buying stuff like flat screen TVs and computers, even though they could hoard their cash for a while and buy even more of it for the same money in six month's time.

But even if they did hoard it that would be good, not bad, as that would mean investment instead of consumption.
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July 24, 2010, 06:35:34 AM
 #15

deflation of house prices is a bad thing because houses are bought on credit.  Deflation of car prices would be bad as well, and for the same reasons.  If you have a loan which is guaranteed by something which is worth less than the loan then the temptation is to walk away from the loan.  This either leads to possible severe losses for banks or inescapable debt, depending on the structure of debt in society.

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July 24, 2010, 07:49:45 AM
 #16

deflation of house prices is a bad thing because houses are bought on credit.  Deflation of car prices would be bad as well, and for the same reasons.  If you have a loan which is guaranteed by something which is worth less than the loan then the temptation is to walk away from the loan.  This either leads to possible severe losses for banks or inescapable debt, depending on the structure of debt in society.

The idea here is that with 'sound money', such an unsustainable amount of credit would not have been extended in the first place, and there would be no sudden and inevitable deflation during a time of massively increased indebtedness.

If deflation is more or less steady and predictable, then I don't see why it wouldn't be factored accordingly into interest rates.  This is done all the time in today's inflationary environment.
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July 24, 2010, 08:22:50 AM
 #17

Give people something today that will be more valuable tomorrow and they'll hoard it.

I often hear that claim, but it doesn't match the consumer behavior that I see. People keep buying stuff like flat screen TVs and computers, even though they could hoard their cash for a while and buy even more of it for the same money in six month's time.

But even if they did hoard it that would be good, not bad, as that would mean investment instead of consumption.


Even if they don't invest it, they've still deferred present consumption of goods and services that they have hopefully justly earned.  They've provided value to the market, and until they spend the money received for it, they have not consumed any in return.

Present consumption is more valuable than future consumption, so it seems reasonable to me if his claim to future consumption - money - grants him more consumption the longer he waits to use it.
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July 24, 2010, 03:29:44 PM
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deflation of house prices is a bad thing because houses are bought on credit.  Deflation of car prices would be bad as well, and for the same reasons.  If you have a loan which is guaranteed by something which is worth less than the loan then the temptation is to walk away from the loan.  This either leads to possible severe losses for banks or inescapable debt, depending on the structure of debt in society.

The idea here is that with 'sound money', such an unsustainable amount of credit would not have been extended in the first place, and there would be no sudden and inevitable deflation during a time of massively increased indebtedness.

If deflation is more or less steady and predictable, then I don't see why it wouldn't be factored accordingly into interest rates.  This is done all the time in today's inflationary environment.

Yep, Babylon is referring to a credit boom which eventually leads to a credit bust. He is right that it is "bad" when things bust, but he must also then recognize that the "bad" began when credit was extended too easily in the first place, driving up prices in the first place.

Without such easily available credit, prices wouldn't go as high in the beginning, and it would be easier to save up and purchase goods with savings instead of credit. The problem with a credit bubble is that as prices go higher, more credit is required to purchase the assets, which drives up the prices, which requires yet more credit.

Under sound money, credit would be limited by savings and investment, and the nature of sound money means that as society gets wealthier and goods get cheaper in real terms, they also get cheaper in nominal terms as well. Price deflation is a good thing whether you're a creditor or debtor. If you borrow money and prices get cheaper due to an increase in total wealth, it means that your share of the pie is fixed. You borrow 1% of the pie, you pay back 1% of the pie. You don't start out owing 1% of the pie and end up having to pay 10% of the pie.

This is instead a problem of monetary deflation. If the supply of money decreases while the total wealth in society remains fixed (or also decreases), then what happens is that if the borrower borrowed 1% of the pie (i.e. one house), and prices declined by 90% due to a large credit bust, the borrower would end up having to pay back 10 houses to the creditor. The problem here is that the price decrease is due to a monetary contraction, not an increase in society's wealth. Therefore, he actually has to pay back 10% of the pie. This is where the imbalance comes into play.

The difference between these two forms of deflation (and the circumstances under which they arise) is where many people get tripped up. They look at Bitcoin, see that it is price deflationary, and then attribute all the problems of monetary deflation when they are talking about two different things.

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July 27, 2010, 12:17:58 AM
 #19

talking about deflation as a "thing" is the wrong paradigm to use.

deflation is simply an arbitrary term used when a group of assets prices you measure have decreased.

In terms of Bitcoins being deflationary, that is very much subject to their acceptance(demand) outpacing the supply, also, given that prices tend to be sticky to the upside and that Bitcoins are not a defacto legal tender, I would be surprised if they were to have any sort of seriously detrimental impact.
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July 29, 2010, 08:14:14 AM
 #20

Quote
If you are from out of town, home prices have fallen almost 50% in many of those areas.
Yeah, nothing could be worse than an increase of buying power. The reason you experience deflation there is because people lost their buying power in the first place. Or rather because that buying power didn't have anything to back it. Thus in order for businesses to survive they have to lower their prices to match the actual buying power people now have.
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