Economic of Deflationary Spiral

[FreeMoney]

If speculators become too powerful/too few they can game the market to their advantage.
Examples are buying up large quantities of a commodity to make a fake scarcity or downright fraud and manipulation with the production chain (Enron)

How could there be "too few" speculators?

[mp420]

The problem I see with holding onto the liquid bitcoins is the fact that there are systemic risks that could render BTCs valueless very quickly. The biggest issue is a scenario where a significantly more advanced anonymous electronic money scheme is launched and quickly supersedes bitcoin in popularity. The mere fact that this could happen will keep people from hoarding bitcoins as a long term investment. Since the value of one bitcoin is correlated with the size of the whole BTC-denominated economy divided by the number of BTCs in circulation, if a better system emerges and is quickly adopted (far quicker than bitcoin was and is being adopted, since the new currency is by definition more tempting), BTCs will be dumped so fast that they will lose their value pretty much instantly. Bitcoin then becomes just a pyramid scheme where everyone is trying to convince everyone else that BTCs are still worth something while not believing that themselves.

I think this is fundamentally a good thing, since it encourages people to spend their BTCs instead of holding onto them. However the risk is so abstract that it is very difficult to quantify.

[tomcollins]

If speculators become too powerful/too few they can game the market to their advantage.
Examples are buying up large quantities of a commodity to make a fake scarcity or downright fraud and manipulation with the production chain (Enron)

How could there be "too few" speculators?

Without speculators, you have a much thinner market.  That makes it easier to manipulate.

[edd]

The problem I see with holding onto the liquid bitcoins is the fact that there are systemic risks that could render BTCs valueless very quickly. The biggest issue is a scenario where a significantly more advanced anonymous electronic money scheme is launched and quickly supersedes bitcoin in popularity. The mere fact that this could happen will keep people from hoarding bitcoins as a long term investment. Since the value of one bitcoin is correlated with the size of the whole BTC-denominated economy divided by the number of BTCs in circulation, if a better system emerges and is quickly adopted (far quicker than bitcoin was and is being adopted, since the new currency is by definition more tempting), BTCs will be dumped so fast that they will lose their value pretty much instantly. Bitcoin then becomes just a pyramid scheme where everyone is trying to convince everyone else that BTCs are still worth something while not believing that themselves.

I think this is fundamentally a good thing, since it encourages people to spend their BTCs instead of holding onto them. However the risk is so abstract that it is very difficult to quantify.

The risk applies to any new electronic currency, as well. With every passing day, Bitcoins gain a stronger, more entrenched reputation and any contender will have to either convince Bitcoin users to give them up for a new system, or persuade a significant percentage of people who weren't interested in purely electonic money before that they should be now. What you need to ask yourself is, how much of a magnitude better would a new currency have to be and how likely is that to happen.

IMO, hoarding won't be an issue because Bitcoins are most appealing for reasons other than their intrinsic investment value; more people will want to actually use them than just sit on them.

[kiba]

The problem I see with holding onto the liquid bitcoins is the fact that there are systemic risks that could render BTCs valueless very quickly. The biggest issue is a scenario where a significantly more advanced anonymous electronic money scheme is launched and quickly supersedes bitcoin in popularity. The mere fact that this could happen will keep people from hoarding bitcoins as a long term investment. Since the value of one bitcoin is correlated with the size of the whole BTC-denominated economy divided by the number of BTCs in circulation, if a better system emerges and is quickly adopted (far quicker than bitcoin was and is being adopted, since the new currency is by definition more tempting), BTCs will be dumped so fast that they will lose their value pretty much instantly. Bitcoin then becomes just a pyramid scheme where everyone is trying to convince everyone else that BTCs are still worth something while not believing that themselves.

I think this is fundamentally a good thing, since it encourages people to spend their BTCs instead of holding onto them. However the risk is so abstract that it is very difficult to quantify.

No. A currency even  better than bitcoin is a good thing!

Bitcoiners and Satoshi should be proud.

[pusle]

If speculators become too powerful/too few they can game the market to their advantage.
Examples are buying up large quantities of a commodity to make a fake scarcity or downright fraud and manipulation with the production chain (Enron)

How could there be "too few" speculators?

What I meant was only a few or one big speculator operating in a commodity market would be able to buy up most of production and sit on it and wait for the price to go up.  Increase in production does not happen over night while the continuous demand would drive the price sky high. (applies to some, not all markets)
If there are many "players" in a market this would be unlikely because you can not predict what the others will do.

But sure, in a truly free market system I guess cartels and monopolies are unavoidable as they maximize profits.

[asdf]

@Mashuri @tomcollins
You've opened my eyes. Speculators serve society in their way. [No sarcasm]

@Mashuri
I just want a currency that performs the function of measure of value. If the only way to achieve this is by heavy market intervention, I'm out. In fact, if there's needed any market intervention I'd probably don't like it.
I think Ripple or Terra (none of them public) could achieve this.

What I've been trying to tell you is that a fixed supply currency precisely achieves the function of measure-of-value. price inflation/deflation is then only a function of supply and demand of goods/services/labour. Whereas monetary expansion and artificial interest rates distort the true price of currency and everything else, necessarily resulting in a miss-allocation of resources that retards economic growth.

I don't want all the products in the market to have a stable value (that's impossible), I just want to prevent inflation and deflation. Not even that, I just want to prevent its effects.

You seem to have a bizarre concept of inflation/deflation. prices are inherently unstable due to fluctuations in supply and demand. Please distinguish between price deflation/inflations and monetary deflation/inflation.

If the money supply is fixed and population is stable then an overall decrease in prices is simply a result of economic growth: Society is producing more goods for the same amount of labor, so the same dollars are chasing an increased supply of goods. Prices will fall. This is the beauty of capitalism, not some evil that you need to negate. Things are supposed to get cheaper!

[jtimon]

What I've been trying to tell you is that a fixed supply currency precisely achieves the function of measure-of-value. price inflation/deflation is then only a function of supply and demand of goods/services/labour.

With price inflation/deflation the function of measure of value gets damaged.

Whereas monetary expansion and artificial interest rates distort the true price of currency and everything else, necessarily resulting in a miss-allocation of resources that retards economic growth.

Agreed. But I think price deflation can lead to miss-allocation of resources too. For example, a business closed when it would be profitable without price deflation.

I don't want all the products in the market to have a stable value (that's impossible), I just want to prevent inflation and deflation. Not even that, I just want to prevent its effects.

You seem to have a bizarre concept of inflation/deflation. prices are inherently unstable due to fluctuations in supply and demand. Please distinguish between price deflation/inflations and monetary deflation/inflation.

I meant price deflation/inflation. What you mean (correct me if I'm wrong) is that price inflation/deflation is unavoidable with a fixed supply.

If the money supply is fixed and population is stable then an overall decrease in prices is simply a result of economic growth: Society is producing more goods for the same amount of labor, so the same dollars are chasing an increased supply of goods. Prices will fall. This is the beauty of capitalism, not some evil that you need to negate. Things are supposed to get cheaper!

Yes. The beauty of capitalism is that it's self regulated. I think it has its ugliness too. That ugliness doesn't come from free market but from the very nature of hard money. I'm discussing this same things here:

http://bitcointalk.org/index.php?topic=6366.0

I'll to post there soon.

[da2ce7]

Agreed. But I think price deflation can lead to miss-allocation of resources too. For example, a business closed when it would be profitable without price deflation

Both ends of the business are effected by price deflation/inflation.  All other things equal, the business should maintain the same profit margins.  (Income and Costs decrease at the same rate)

With price inflation, that means that either the economy is getting smaller. Or there is a redistribution of wealth...  Both of those make otherwise profitable business unprofitable.

With price deflation, that means that the economy is growing. (Or people are saving for future hard times).  Either the business must be unprofitable and is made redundant by competition. Or is deemed 'not important' by the community v.s. saving for the future.

[Teazer]

What I've been trying to tell you is that a fixed supply currency precisely achieves the function of measure-of-value. price inflation/deflation is then only a function of supply and demand of goods/services/labour. Whereas monetary expansion and artificial interest rates distort the true price of currency and everything else, necessarily resulting in a miss-allocation of resources that retards economic growth.

To be precise, mis-allocation only occurs if there is unexpected inflation. To the extent that inflation is entirely predictable (eg if money growth were kept at some fixed rate) the resulting inflation can be incorporated into contracts, investment choices etc perfectly. Since in the real world the economy fluctuates even without central bank money supply policy changes, even a fixed money supply will result in periods of low level inflation and deflation that are uncontractable and so lead to mis-allocation. The question is whether central bank counter cyclical policies tend to increase or decrease the unpredictability of inflation. The jury's still out on that.  Through the early 1980's it increased it, but afterwards not.

If the money supply is fixed and population is stable then an overall decrease in prices is simply a result of economic growth: Society is producing more goods for the same amount of labor, so the same dollars are chasing an increased supply of goods. Prices will fall. This is the beauty of capitalism, not some evil that you need to negate. Things are supposed to get cheaper!

On the flipside, see the baby-sitting coop story:
http://www.slate.com/id/1937/
If the money supply gets too limited, there's a tendency towards hoarding that reduces overall trade and economic growth. So long as monetary expansion is predictable, the "lubricant" trait of money is optimized, whereas the loss of storage value can be minimized through contracting.

[FreeMoney]

To be precise, mis-allocation only occurs if there is unexpected inflation. To the extent that inflation is entirely predictable (eg if money growth were kept at some fixed rate) the resulting inflation can be incorporated into contracts, investment choices etc perfectly.

I disagree. Even an expected transfer of wealth from the productive to the violent mis-allocates capital.

[BitterTea]

On the flipside, see the baby-sitting coop story:
http://www.slate.com/id/1937/
If the money supply gets too limited, there's a tendency towards hoarding that reduces overall trade and economic growth. So long as monetary expansion is predictable, the "lubricant" trait of money is optimized, whereas the loss of storage value can be minimized through contracting.

I don't think this story is comparable to Bitcoin, or any general purpose currency. Their scrip was centrally issued, not at all divisible, and only exchanged for one thing - baby sitting services. Their problems were distinct from those normally ascribed to deflation - the unwillingness to spend what will tomorrow be more valuable, to purchase what will tomorrow be less expensive. They literally had not enough currency to allow for savings and spending simultaneously.

Think of it this way: When consumer confidence declines, it is as if, for some reason, the typical member of the co-op had become less willing to go out, more anxious to accumulate coupons for a rainy day. This could indeed lead to a slump--but need not if the management were alert and responded by simply issuing more coupons.

Consumer confidence declining, to me, means that people are saving more and spending less. This is actually a good thing. So the answer is to dilute their savings with an inflated money supply? Ridiculous.

Perhaps because of its aging population, perhaps also because of a general nervousness about the future, the Japanese public does not appear willing to spend enough to use the economy's capacity, even at a zero interest rate.

Another example of this fallacious idea. Why do people think that reduced spending and (I assume) increased savings is a problem? The point of an economy is not to get bigger, but to supply people with the things they need and want. If they don't need or want the things a company sells, the company should change its business model or disappear. The answer is not to "stimulate" consumer spending by lowering interest rates.

[asdf]

With price inflation/deflation the function of measure of value gets damaged.

If a tree grows 1 inch, is the ruler damaged because you get a different length?

If you increase the length of an inch by %10, is the tree %10 taller?

It's monetary inflation/deflation that damages the measure of value.

Agreed. But I think price deflation can lead to miss-allocation of resources too. For example, a business closed when it would be profitable without price deflation.

If the cost of the businesses product goes down because of efficient competition and it can't stay afloat, then it deserves to go out of business. The market as correctly allocated resources to it's competitor.

Where is the miss-allocation?

Printing currency and giving it so someone is a miss-allocation of resources; stealing purchasing power from people holding currency, limiting their ability to allocate the resources they command.

[ottodv]

A nice deflationary example is computers. I can buy one now for X Euros, but if I wait a year I can buy a much better one for X Euros or the same one for much less than X Euros. This isn't apparently stopping people from buying computers.

What I think is more of an issue, is that with the current extreme exchange rate changes of BTC it's simply hard to put a BTC price on things. I've seen BTC prices for things that now appear to be absurdly high. You have to constantly adjust the price of your products or services. If you accept bitcoins their value might be significantly different in a matter of hours (even minutes). Fine when it goes up, but not that great when it goes down.

Of course a solution is to simply fix your price in Euros or Dollars and always quote a BTC price based on the latest rates, but still.

[jtimon]

Agreed. But I think price deflation can lead to miss-allocation of resources too. For example, a business closed when it would be profitable without price deflation

Both ends of the business are effected by price deflation/inflation.  All other things equal, the business should maintain the same profit margins.  (Income and Costs decrease at the same rate)

This assumes price deflation/inflation is affects every good and service the same way, simultaneously and instantly. Time preference not only varies from one person to another, but also from one good to another. People won't stop buying food, no matter how much price deflation there is.

One example could be a chair manufacturer. He's competitive and has happy clients. But during a deflation their clients wait until the deflation passes. Even if he's very efficient, maybe he can not afford to not sell a single chair for two months.
After the deflation, people will demand the chairs again, but our manufacturer has gone bankrupt and another one will take "his place". Maybe the new manufacturer is less efficient than the first. I think this is a miss-allocation of resources.

With price inflation, that means that either the economy is getting smaller. Or there is a redistribution of wealth...  Both of those make otherwise profitable business unprofitable.

Maybe both. The economy is getting smaller and it leads to redistribution of wealth.

With price deflation, that means that the economy is growing. (Or people are saving for future hard times).  Either the business must be unprofitable and is made redundant by competition. Or is deemed 'not important' by the community v.s. saving for the future.

I think that there is redistribution of wealth with deflation too, to the money owners from everyone else.

In the case of price inflation the redistribution is from the money owners to everyone else. If the price inflation is caused by monetary inflation, most gains of the redistribution goes to the first receivers of the new issued money, since don't suffer the price inflation when they first spend it.
In the case of a currency run, other currencies (or other forms of money) holders also gain. For example, when the dolar collapses, owners of precious metals will enjoy a big wealth transfer.

[jtimon]

With price inflation/deflation the function of measure of value gets damaged.

If a tree grows 1 inch, is the ruler damaged because you get a different length?

No

If you increase the length of an inch by %10, is the tree %10 taller?

If you increase the length of an inch and everybody knows it at the same time, the measure would be equivalent. But a contract denominated in inches will change its contents. Will all the contracts denominated in inches be changed at that same time?

If the physicists decide tomorrow that the meter will increase its length by 10%, all the books written before the change will become wrong.

It's monetary inflation/deflation that damages the measure of value.

Price inflation/deflation damages the measure of value, but since monetary inflation/deflation almost always lead to price deflation/inflation, they damage the measure of value.

Agreed. But I think price deflation can lead to miss-allocation of resources too. For example, a business closed when it would be profitable without price deflation.

If the cost of the businesses product goes down because of efficient competition and it can't stay afloat, then it deserves to go out of business. The market as correctly allocated resources to it's competitor.

Where is the miss-allocation?

Printing currency and giving it so someone is a miss-allocation of resources; stealing purchasing power from people holding currency, limiting their ability to allocate the resources they command.

I meant that efficient business can disappear because of deflation in the same way that inefficient business can appear because of inflation.
With a changing value of money, every entrepreneur can afford to be less efficient in his field if he can compensate this by knowing more about the changes in the value of money and how to predict them.
Ultimately, speculate becomes the more profitable business.
From J parsson's "Dying of money":

"Speculation alone, while adding nothing to Germany's wealth, became one of its largest activities. The fever
to join in turning a quick mark infected nearly all classes, and the effort expended in simply buying and selling
the paper titles to wealth was enormous. Everyone from the elevator operator up was playing the market. The
volumes of turnover in securities on the Berlin Bourse became so high that the financial industry could not
keep up with the paperwork, even with greatly swollen staffs of back-office employees, and the Bourse was
obliged to close several days a week to work off the backlog."

This is not equally true for deflation, because with it you have less trade "than it would be natural", and speculation needs trades.
With inflation, there are more trades "than it would be natural".

[jtimon]

On the flipside, see the baby-sitting coop story:
http://www.slate.com/id/1937/
If the money supply gets too limited, there's a tendency towards hoarding that reduces overall trade and economic growth. So long as monetary expansion is predictable, the "lubricant" trait of money is optimized, whereas the loss of storage value can be minimized through contracting.

If the babysitting co-op would have used a LETS or Ripple system, they would had always as many coupons as necessary: never more nor less.

[tomcollins]

On the flipside, see the baby-sitting coop story:
http://www.slate.com/id/1937/
If the money supply gets too limited, there's a tendency towards hoarding that reduces overall trade and economic growth. So long as monetary expansion is predictable, the "lubricant" trait of money is optimized, whereas the loss of storage value can be minimized through contracting.

If the babysitting co-op would have used a LETS or Ripple system, they would had always as many coupons as necessary: never more nor less.

That babysitting co-op article is just so awful.  Hey, let's try to make a commodity out of a good/service that isn't, and then fix the exchange rate!  This is like having a land coupon good for 1 acre, and wondering why some people aren't willing to sell their land in Malibu to a guy with 1 acre in South Dakota.

[kiba]

I meant that efficient business can disappear because of deflation in the same way that inefficient business can appear because of inflation.

In a deflationary  growth economy, less efficient companies die and more efficient company thrives. The culling effect of firms is much harsher, but would it be a bad thing? Nope.

[da2ce7]

I think that there is redistribution of wealth with deflation too, to the money owners from everyone else.

In the case of price inflation the redistribution is from the money owners to everyone else. If the price inflation is caused by monetary inflation, most gains of the redistribution goes to the first receivers of the new issued money, since don't suffer the price inflation when they first spend it.
In the case of a currency run, other currencies (or other forms of money) holders also gain. For example, when the dolar collapses, owners of precious metals will enjoy a big wealth transfer.

Yes, that is because an 'investment' in the economy money is the same as an 'General Investment' in the entire economy.  Think of it as a weighted basket investment in every venture in the entire economy... That is what money is.

When somebody 'makes' money, they are getting this investment for no-cost (theft, or predetermined inflation).  When the money supply is fixed, that means that the only way to get such an 'investment' in the economy is to buy if from somebody in the economy.

The 'wealth redistribution' is a fury then also.  As the only reason that a 'money holder' is getting more wealthy, is because the entire economy is getting more wealthy. (if there is no monetary inflation).  The only way that this 'money holder' can get money, is to trade it for goods and services. (being part of the economy)