The Deflationary Spiral Argument

[BlackHatCoiner]

In modern economies, there's a central authority that decides the currency's inflation. If there's much unemployment (and specifically cyclical unemployment), the government can lower the interest rates to strengthen private businesses financially. The opposite happens respectively. These tasks are done to make the symptoms of cyclic fluctuations less painful.

The deflationary spiral argument goes as following: Let's imagine an economy that only uses Bitcoin, solely, as currency. When the productivity rises, the price of goods and services decreases. But, this has a negative effect: People are more encouraged to hoard their currency, than to let it circulate. This stagnates the economy as consumption drops. And when consumption drops, so does the production, because the profit decreases along with the demand.

There's a nice writeup in our wiki regarding this matter, but I can't understand the following conclusion:

The key difference is that people don't foresee a fixed cost (unit amount) that they must pay with Bitcoin. If the value of the Bitcoins that they own increases, then any future cost will take a proportionally smaller amount of Bitcoins. There isn't any fixed incentive to holding Bitcoin other than speculation.

If the economy that uses Bitcoin grows, the per-unit value of Bitcoin proportionally increases also.

Everything is the opposite of the popular fractional reserve banking system (because Bitcoin isn't a debt but an asset). Bitcoins only deflate in value when the Bitcoin Economy is growing.

Because the Deflationary spiral is a real problem in the traditional monetary system, doesn't necessarily mean that it will also be a problem in the Bitcoin economy.

Bitcoins deflate in value when the Bitcoin economy is growing, but doesn't deflation often contribute to lower economic growth?

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[Doan9269]

In modern economies, there's a central authority that decides the currency's inflation. If there's much unemployment (and specifically cyclical unemployment), the government can lower the interest rates to strengthen private businesses financially. The opposite happens respectively. These tasks are done to make the symptoms of cyclic fluctuations less painful.

Government have agencies whose roles are tied to bringing solution to inflation in the economy system but they lack the implementation policy, such a way that we only know those offices saddled with the responsibility to exist without any significant impact felt on the economy.

The deflationary spiral argument goes as following: Let's imagine an economy that only uses Bitcoin, solely, as currency. When the productivity rises, the price of goods and services decrease.

This is perfectly how an economy should be run. because going by this no one will feels hoarding any currency is the next available option, we tend to hoard because of fear of the future outcome. nothing can bring down productivity as long as law of return on labour is effective.

[_act_]

What they are talking about is that bitcoin is an asset and the price will grow over time, if the price of bitcoin grows, that means the amount of bitcoin you used to purchase goods and services at a particular price will be decreasing because bitcoin price would have increased.

What I know is that inflation and deflationary have advantages and disadvantages, if there is local currency declination (inflation) which is helpful to protect the foreign reserves and to be able to pay government workers salaries, it is highly unlikely there will be deflation because deflation will significantly affect the economy except in certain conditions like a country that has increasing GDP following significantly decreasing dependency on imports and increasing export, but this is unlikely the cases in many countries. It has been otherwise and the reason for inflation.

Inflation is a move by the government to protect the economy to reduce the negative effect of low production and low income from outside the country.

Bitcoin can not function in an economy that depends only on bitcoin, its deflationary nature may cripple the economy because people will prefer to hold. The best is for a country to have fiat which we know would be inflationary. But people can buy bitcoin, hold it and make money but yet fiat remain the currency of nations which the government can control.

[stompix]

There's a nice writeup in our wiki regarding this matter, but I can't understand the following conclusion:

The key difference is that people don't foresee a fixed cost (unit amount) that they must pay with Bitcoin. If the value of the Bitcoins that they own increases, then any future cost will take a proportionally smaller amount of Bitcoins. There isn't any fixed incentive to holding Bitcoin other than speculation.

Bitcoins deflate in value when the Bitcoin economy is growing, but doesn't deflation often contribute to lower economic growth?

Lol, this probably was said while trying to ignore reality. I've seen enough topics here about a merchant adopting bitcoin with a ton of users cheering for it but at the same time saying that they will not spend their coins yet. Open one with the title "Would you buy a house/ car with bitcoin? " and you can already imagine the results, nobody is keen on doing so since they think next March they will be able to buy 5 with the same amount of BTC.

There is no "key difference", is the same reasoning as with fiat currencies, if I live in a poor country and I know the currency is going down the drain against the $, would I spend by $ for bread? No!  The actual reason why bitcoin won't contribute to deflation is that by the time it will reach the status of global currency and it's the only one left the value will be so big a 10% increase in purchasing power overnight will simply be impossible as there would be no economic growth to match that, so there will be little incentive to hold coins while making sacrifices on your shopping list.

[Darker45]

People are more discouraged to hoard their currency, than to let it circulate.

Did you mean to say this? I don't quite get your point here. It seems you are comparing two similar bananas. If the prices of goods and services are decreasing, people won't be hoarding money. Spending would be encouraged because things are affordable. So there will be more circulation of money. On the other hand, another explanation would be that if the prices of goods and services are continuously falling, people would not be discouraged to hoard money. It's because buying in the future is better than buying at present. So there won't be circulation anymore.

The key difference is that people don't foresee a fixed cost (unit amount) that they must pay with Bitcoin. If the value of the Bitcoins that they own increases, then any future cost will take a proportionally smaller amount of Bitcoins. There isn't any fixed incentive to holding Bitcoin other than speculation.

If the economy that uses Bitcoin grows, the per-unit value of Bitcoin proportionally increases also.

Everything is the opposite of the popular fractional reserve banking system (because Bitcoin isn't a debt but an asset). Bitcoins only deflate in value when the Bitcoin Economy is growing.

Because the Deflationary spiral is a real problem in the traditional monetary system, doesn't necessarily mean that it will also be a problem in the Bitcoin economy.

To be honest, I am also confused. I think I will have to reread the entire explanation a few more times before its meaning will finally sink in. Because if this: "If the economy that uses Bitcoin grows, the per-unit value of Bitcoin proportionally increases also." then why this: "Bitcoins only deflate in value when the Bitcoin Economy is growing."

[BlackHatCoiner]

The deflationary spiral argument goes as following: Let's imagine an economy that only uses Bitcoin, solely, as currency. When the productivity rises, the price of goods and services decrease.

This is perfectly how an economy should be run. because going by this no one will feels hoarding any currency is the next available option, we tend to hoard because of fear of the future outcome. nothing can bring down productivity as long as law of return on labour is effective.

People don't hoard if they're just fearful of the future, they do it because there's deflation; respectively when there's inflation. People consume by the belief that their purchasing power will decrease. Inflation harms the savers and deflation the spenders.

There is no "key difference", is the same reasoning as with fiat currencies, if I live in a poor country and I know the currency is going down the drain against the $, would I spend by $ for bread? No!

That's exactly what I'm saying. Bitcoin favors saving. I can't comprehend what's the "key difference".

The actual reason why bitcoin won't contribute to deflation is that by the time it will reach the status of global currency and it's the only one left the value will be so big a 10% increase in purchasing power overnight will simply be impossible as there would be no economic growth to match that, so there will be little incentive to hold coins while making sacrifices on your shopping list.

This opens up another topic, regarding the stability of the price. I'll skip that and assume the price stabilizes with -2% to 2% yearly changes (which is a sci-fi scenario, but anyway); will it bring economic growth? Remains to be seen. Shouldn't there be little disincentive instead of little incentive?

BTW, the entire world using Bitcoin is, by far, the most sci-fi scenario, amongst all.

Did you mean to say this? I don't quite get your point here. It seems you are comparing two similar bananas.

I say that if prices tend to decrease, you're more encouraged to keep your coins than to let them circulate in the economy.

If the prices of goods and services are decreasing, people won't be hoarding money. Spending would be encouraged because things are affordable.

But, if they tended to decrease perpetually, it would perpetually incentivize you to keep your coins as you'd perpetually be able to afford more.

[Fortify]

In modern economies, there's a central authority that decides the currency's inflation. If there's much unemployment (and specifically cyclical unemployment), the government can lower the interest rates to strengthen private businesses financially. The opposite happens respectively. These tasks are done to make the symptoms of cyclic fluctuations less painful.

The deflationary spiral argument goes as following: Let's imagine an economy that only uses Bitcoin, solely, as currency. When the productivity rises, the price of goods and services decreases. But, this has a negative effect: People are more discouraged to hoard their currency, than to let it circulate. This stagnates the economy as consumption drops. And when consumption drops, so does the production, because the profit decreases along with the demand.

There's a nice writeup in our wiki regarding this matter, but I can't understand the following conclusion:

The key difference is that people don't foresee a fixed cost (unit amount) that they must pay with Bitcoin. If the value of the Bitcoins that they own increases, then any future cost will take a proportionally smaller amount of Bitcoins. There isn't any fixed incentive to holding Bitcoin other than speculation.

If the economy that uses Bitcoin grows, the per-unit value of Bitcoin proportionally increases also.

Everything is the opposite of the popular fractional reserve banking system (because Bitcoin isn't a debt but an asset). Bitcoins only deflate in value when the Bitcoin Economy is growing.

Because the Deflationary spiral is a real problem in the traditional monetary system, doesn't necessarily mean that it will also be a problem in the Bitcoin economy.

Bitcoins deflate in value when the Bitcoin economy is growing, but doesn't deflation often contribute to lower economic growth?

The central bank does not decide inflation, although it tries to engineer its course to a level that is deemed acceptable. We see currently in countries like the UK and US inflation approaching 10%, where in pre-covid years the target and actual level tended to stay around 2%. This created a relatively stable environment but at present the number is exceptionally high. Inflation can be effected by all sorts of external issues like supply chains, crop/commodity prices and even oil availability which are disrupted by big events like Covid and Ukraine.

[stompix]

The actual reason why bitcoin won't contribute to ~.

This opens up another topic, regarding the stability of the price. I'll skip that and assume the price stabilizes with -2% to 2% yearly changes (which is a sci-fi scenario, but anyway); will it bring economic growth? Remains to be seen. Shouldn't there be little disincentive instead of little incentive?

BTW, the entire world using Bitcoin is, by far, the most sci-fi scenario, amongst all.

If BTC becomes the only global currency and assuming the money supply stays the same (no private keys accidents, no second coming of Satoshi), it will be impossible to have an economical growth of decline without it also influencing the price by nearly the same margin. So the price will not go up or down in purchasing power unless something will happen in the economy as without this change there won't be any reason for the change price.

One more thing.
A lot of people think that money printing absolutely triggers inflation and that a limited currency will not. Everyone who thinks so should look at Japan, a country that is printing tons of money and is not managing to get inflation for more than a trimester even with a raging economical crisis.

inflation will not happen unless the prices of goods go up, if there is no demand and there is production, no matter how much you print these prices will not change, if people make a million a day but don't want to buy anything extra from condoms or cars there won't be any change in price. If the government hands everyone $100k but everyone who gets that money hides it under the mattress there won't be any change.

[Hydrogen]

The deflationary spiral argument goes as following: Let's imagine an economy that only uses Bitcoin, solely, as currency. When the productivity rises, the price of goods and services decreases.

Bolded above assumes profits and gains made from increased productivity trickle down to poor and middle class earners. If trickle down economics MMT (modern monetary theory) pan out, the statement is accurate. Else trends could shift in the opposite direction. Taxation, regulation and other aspects also factor in to the overall effect.

One key aspect to economic theory is it does not acknowledge every relevant aspect of markets and finance. Most armchair economic philosophers are not investors or traders of assets. They do not take their economic theories to the real world to test them, with their own money.

Market traders who invest with their own money, usually have a better comprehension of markets, economics and finance than armchair philosophers IMO.

But, this has a negative effect: People are more discouraged to hoard their currency, than to let it circulate. This stagnates the economy as consumption drops. And when consumption drops, so does the production, because the profit decreases along with the demand.

How many people "hoard currency"? I think most would prefer to have their currency in a bank account where it can earn interest. "Hoarding currency" is an urban legend, unless we're referring to international reserve currencies being hoarded in regions with high inflation.

I would contend: declines in consumption are more closely correlated with high taxes or wage stagnation than they are currency hoarding.

Bitcoins deflate in value when the Bitcoin economy is growing, but doesn't deflation often contribute to lower economic growth?

I think deflation can hamper borrowing, lending and credit in loan markets. But bitcoin isn't expanding into loan markets for real estate, student loans or cars. And so that negative aspect to deflationary models doesn't really apply to bitcoin market conditions.

[magneto]

I think that that would be assuming BTC ever becomes the primary unit of account.

Good stores of value, which I think BTC is aiming towards being, have always had a capped supply/been disinflationary/deflationary.

Also, it is important to realize that BTC is not deflationary, but rather disinflationary - in the sense that the emission rate is positive, but slowing.

Besides, a lot of conventional economic theory have been written during times when fiat is dominating the world order. It is not representative of what could happen with BTC as the main currency.

[Darker45]

Did you mean to say this? I don't quite get your point here. It seems you are comparing two similar bananas.

I say that if prices tend to decrease, you're more encouraged to keep your coins than to let them circulate in the economy.

Just what I was thinking. That's why I was confused a little bit. So instead of this:

People are more discouraged to hoard their currency...

You meant to say the opposite, that people are more encouraged to hoard their currency?

If the prices of goods and services are decreasing, people won't be hoarding money. Spending would be encouraged because things are affordable.

But, if they tended to decrease perpetually, it would perpetually incentivize you to keep your coins as you'd perpetually be able to afford more.

All right, deflation is more or less generic. By default, deflation is perceived to be negative precisely because of your point. However, deflation could further be qualified. If the supply is only racing against demand and ends up winning because of whatever factors like the use of better technologies, the discovery of new efficient productivity methods, and others, positive results are seen even if the prices of goods and services are falling. So while there is negative money supply shock, the reduction of circulating money, it will have little affect on the economic output.

There was this study whose findings were released in 2004 which argued that recent cases of deflation were actually economically good rather than bad.

Moreover, when Switzerland experienced falling prices for around 5 years, rather than economic downfall there was economic growth. Rather than the expected rising unemployment, there was a decrease.

[stompix]

Moreover, when Switzerland experienced falling prices for around 5 years, rather than economic downfall there was economic growth. Rather than the expected rising unemployment, there was a decrease.

No, it hasn't, and Switzerland's is a different case altogether, it has a high income per capita generated by the service sector, its currency is used as some sort of save haven in a lot of cases, is benefiting from tourism and a lot of money inflow in spending.
Even with that the only time in the last decade it experienced deflation it also triggered a decrease in GDP, as for the unemployment is has always been this century between 2-4% hardly an indicator of it, and the economic growth in the 2%.

But the most important thing is that Switzerland's population keeps increasing, from 7.8 million to 8.6 million, that 10% in a decade, its neighbor Austria grew from 8.3 to 8.9m, that's 7%, we go one border east and we have Hungary which went down from 10 to 9.7.

You can't replicate that to anything else than micronations or small countries.

There was this study whose findings were released in 2004 which argued that recent cases of deflation were actually economically good rather than bad.

We focus on the price level and growth experience of the United States, the U.K. and Germany from 1880-1913.

Hardly relevant today, we're talking of a period when less than 15% of the women were employed, just as one tiny difference.

[_act_]

Also, it is important to realize that BTC is not deflationary, but rather disinflationary - in the sense that the emission rate is positive, but slowing.

Bitcoin hedge against fiat inflation is more in long term, which means it is deflationary, but the time when the price of bitcoin increases sharply in short time, then it can be said to be disinflationary, but bitcoin price is also increasing (net increase) in long time. Bitcoin being an asset even explains this.

inflation will not happen unless the prices of goods go up, if there is no demand and there is production, no matter how much you print these prices will not change, if people make a million a day but don't want to buy anything extra from condoms or cars there won't be any change in price. If the government hands everyone $100k but everyone who gets that money hides it under the mattress there won't be any change.

Money printing will likely lead to inflation. I understand you though, you mean money printing is not the primary cause of inflation and you are right, but in countries that prints money excessively, this has led to hyperinflation in the paste, those that print money higher than before also lead to more demand of goods and services, what will later happen is that the output will not support the demand which may lead to inflation, this will be what will most likely happen and inflation happen in such economy again.

[Beerwizzard]

Bitcoin is actually the currency that can't replace fiat due  to deflation and it is not visible for many users  since they might know how their personal finance works but they have no idea about global economy.
Low inflation is helpful for economy because it makes your goods more competitive on the global market  (for example: due to lower tier countries are accepted to eurozone EUR is getting cheaper and it gives boost for economy). But if you accept only BTC then your products are rapidly getting more expensive. At a single moment the entire export might become non-competitive for the market that would cause insane loses.

Cases when BTC prices are recalculated to USD are not considered since here it is just a substitute for fiat price, not a replacement.

[BlackHatCoiner]

You meant to say the opposite, that people are more encouraged to hoard their currency?

Yep, my bad.

So the price will not go up or down in purchasing power unless something will happen in the economy as without this change there won't be any reason for the change price.

I'm not saying that the purchasing power of 1 BTC would change; I'm just trying to understand how would the economy look like. Would productivity rise or fall over the long term?

But if you accept only BTC then your products are rapidly getting more expensive.

The price of goods would likely decrease if people used solely Bitcoin. If the economy grew, but the money supply remained the same, then the exchange rate of goods would decrease.

[stompix]

So the price will not go up or down in purchasing power unless something will happen in the economy as without this change there won't be any reason for the change price.

I'm not saying that the purchasing power of 1 BTC would change; I'm just trying to understand how would the economy look like. Would productivity rise or fall over the long term?

There won't be any clear way to determine this since we don't know what will happen to a lot of other stuff.

Let's assume the population grows, there will definitely be an increase in productivity since there is a constantly growing need for products, even if there is a lower incentive for people to spend their coins there will be an unstoppable need for a lot of basic stuff from food to education to housing, things you can't really postpone, more goods needed, increase in productivity but still deflation.
If on the other hand there will be no population increase, no increase in production, we will have deflation as well as economical decline.
This is a basic scenario, throw in another twenty variables, a change into lifestyle and consumption and needs and you will need a crystal ball for it.

Oh, and the purchasing power of BTC if left alone with no other currency will definitely swing one way or the other, we're talking about a fixed supply, it's not quite the same as gold which was though the entire history continuously mined with more and more in circulation alongside silver.

Low inflation is helpful for economy because it makes your goods more competitive on the global market  (for example: due to lower tier countries are accepted to eurozone EUR is getting cheaper and it gives boost for economy). But if you accept only BTC then your products are rapidly getting more expensive.

The scenario is with no other currency present, so your goods will cost the same as long as the manufacturing process is the same, bitcoin will no longer grow in price as there is no longer such thing as BTC price.

[fiulpro]

Hoarding a currency is only a viable option for the people who already have a lot of money and are barely suffering from the effects of inflation, therefore I do think that leaves you with very little options, like right now the people are not taking jobs, not because there is a lack of availability but because the government is not providing them with enough rights, therefore people are leaving their jobs as well.

Hoarding your currency won't give you much but I would rather suggest converting it into bitcoins and other Altcoins making it a better investment, a better option.

Government can refuse anytime to let you withdraw money as well therefore you need to make sure you have your financial stability and freedom in place.

[MinMan]

The deflationary spiral argument goes as following: Let's imagine an economy that only uses Bitcoin, solely, as currency. When the productivity rises, the price of goods and services decrease.

This is perfectly how an economy should be run. because going by this no one will feels hoarding any currency is the next available option, we tend to hoard because of fear of the future outcome. nothing can bring down productivity as long as law of return on labour is effective.

People don't hoard if they're just fearful of the future, they do it because there's deflation; respectively when there's inflation. People consume by the belief that their purchasing power will decrease. Inflation harms the savers and deflation the spenders.

Bitcoin being a bit of a hoarding method is not really an argument made against bitcoin, it is argument made against using it to buy something. However, what you are forgetting is that there are people who have to spend it, like for example my boss pays me in crypto, he can't pay me in fiat, even if he wanted to pay me in fiat that would take days to get to me and would cost so much to get here.

It means that he has to pay me in fiat and usually more often than not he uses cheap transaction coins, and even in btc, he uses segwit bec32 addresses so it is cheaper. Long story short sometimes we need to spend it, even if we do not prefer to, because the alternatives are even worse.

[Beerwizzard]

The scenario is with no other currency present, so your goods will cost the same as long as the manufacturing process is the same, bitcoin will no longer grow in price as there is no longer such thing as BTC price.

No. In such scenario we still got another currencies in another countries in order to have a global competition on markets. Therefore, exchange rates would remain.
it is highly unlikely that BTC become a single payment method worldwide, we shouldn't count on such scenario.

But if you accept only BTC then your products are rapidly getting more expensive.

The price of goods would likely decrease if people used solely Bitcoin. If the economy grew, but the money supply remained the same, then the exchange rate of goods would decrease.

So how should it decrease?
Imagine people in country A (this country already have its economy, production, import and export etc) decided to switch to BTC only. Since they are trading with another countries they have all production costs in BTC and they are selling everything for BTC while country B (which pays with their own money) is having continuously increasing prices. In the end, you only your products way overpriced in the world market just because you have switched to BTC.

[wiggi]

Imagine people in country A (this country already have its economy, production, import and export etc) decided to switch to BTC only. Since they are trading with another countries they have all production costs in BTC and they are selling everything for BTC while country B (which pays with their own money) is having continuously increasing prices. In the end, you only your products way overpriced in the world market just because you have switched to BTC.

The difference between competitive production costs within your country, or your products becoming overpriced abroad is perhaps not about nominal inflation or deflation, but how people react to it. Who has pricing power, will workers go on strike and demand more increase than current inflation, or will they just do nothing about it. In deflationary spiral, the country could also buy products and labour for cheap from countries that have printed too much fiat. In the end, nothing will be permanently overpriced due to deflation.