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Author Topic: Lending at negative interest rates. (People like bigger numbers.)  (Read 7316 times)
Insti
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August 02, 2010, 08:14:45 AM
 #1

In a thread in the general discussion forum bytemaster made what I think is an awesome post. Unfortunately the thread then wandered in a different direction, but I thought the post merited further discussion, and this was the best place for it.

In a highly deflationary environment lenders would lend money at negative interest rates and still make a real profit. 

The real problem is that people like the idea of numbers getting bigger more than they like the idea of smaller numbers doing more.    Who wants to take a nominal pay cut! 

So to counter this mental handicap of society, it may make sense to simply debase the currency via a "stock split/rebasing" to keep a basket of goods a constant nominal BTC value.   In effect this would make the "real return on investment" caused by deflation tangible to the thick headed public that thinks 4 pennies is better than 1 nickel because 4 > 1. 


Assume the number of goods in the economy grows at 5% per year. 

Normally Joe earns 100 BTC this year and a gallon of milk costs 100 BTC.   The economy grows by 5% thus the price of milk would fall to 95 BTC; however, the nominal BTC value of Joes labor also fell and his boss gave him a 2% nominal pay cut and the average Joe gets ticked (too stupid to realize he really got a 3% raise). 

Now if you "rebase the currency" then the price of milk will remain 100 BTC, Joe's boss gives him a 3% raise and the average joe is "happy" even though his employer really gave him a real pay cut!  But because the price of milk stayed flat "joe" feels richer (and he IS richer because all of society has more goods), but not as relatively rich as he would have been under deflation.   

Where as if we did not do any "stock splits" Joes salary would have fallen to 98 BTC but milk would now cost 95 BTC. Clearly hie is richer.     

In my view it is a GREAT THING when someone loses their bit coins because the value (read purchasing power) of lost coins gets evenly distributed among all other coins. This is a WIN for all of society except the poor sap who lost his coins.

Discuss.
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Insti
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August 02, 2010, 08:19:02 AM
 #2

Red did have a question about it which I've tried to answer myself:
In a highly deflationary environment lenders would lend money at negative interest rates and still make a real profit. 

This seems quite silly as opposed to not lending the money and making even more real profit.

Perhaps I don't understand what you are saying?

If everyone just hoards the economy stagnates. By lending out bitcoins it is possible to stimulate growth in the economy.

As a simple example:

Say 1 bitcoin buys you 1 loaf of bread, and the entire economy is based on comparisons to loaves of bread.

Scenario 1:
At the start of the year I have 1000 bitcoins, I lend out 100 for 1 year at -50% interest.
This stimulates the economy to grow 100%
At the end of the year, I will have 950 bitcoins, but they are worth 1900 loaves of bread.

Scenario 2:
1000 bitcoins, I lend out 0.
The economy doesn't grow at all,
At the end of the year, I will have 1000 bitcoins, but they are still only worth 1000 loaves of bread.

There is a lot more math you can do to cover more complex scenarios and make more acurate estimates of growth, but I think this illustrates the general principle.
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August 03, 2010, 02:38:23 AM
 #3

I think I'll just restate what I said in the post he was responding to.

-----------

f there is deflation and people start hoarding money thinking that their money will value more later (so they have an incentive to start spending their money later - half the money for milk), credit creationists would intervene on this opportunity.

This logic is mathematically flawed. People don't realize it because they have never seen it.

If external value starts to flock to bitcoin, than the external value to trade increases, while the number of coins to trade stays the same. That means if the value of external commodities traded doubles overall, than the value of each bitcoin doubles as well.

Example: If there were 100 loaves of bread a day and 100 bitcoins the mean value of bread is 1 BTC. If you want to trade an additional 100 loaves a day, you either have to double the velocity of the coins, or trade in 1/2 BTC coins at the same velocity.

That's the easy part! What is counter intuitive is the dynamic vs lending.

In this situation your argument says that people would start lending their excess bitcoins (at interest I'm presuming). So what would the interest rate be in this situation? So if we presume that the amount of value people want to trade using bitcoins will double this year (not unlikely) what is a reasonable interest rate? Well, just putting them in my mattress will give me 100% interest in commodity value with 0% risk.

However, if I want to borrow the money to start a business manufacturing some commodity widgets, the if I borrow the equivalent of 100 widgets today in BTC, then I need to pay the BTC back with the equivalent value of >200 widgets in a year. So if my widget business is growing at 50% growth a year, I'm screwed.

Deflation make lending very expensive, and very risky. That is why there is minimal lending now, EVEN THOUGH the government is giving away free money for banks to lend.

People are not used to this in their regular life because they are used to price inflation.

Inflation means that money in your mattress is worth less to you (in commodities) next year than it is worth today. That encourages you to LOAN your money to a bank in hopes that they will pay you at least as much interest to make up the difference. A little extra is even better!

This makes lending cheap for new businesses and much less risky for lenders. Business need a much smaller growth rate and profit margin to succeed. Including the bank to whom you lent your money.

------------

In my follow up to his reply (which you used to begin this thread) I said

In a highly deflationary environment lenders would lend money at negative interest rates and still make a real profit. 

This seems quite silly as opposed to not lending the money and making even more real profit.

Perhaps I don't understand what you are saying?

-------------

And he replied

U r right. To justify lending then they would want a positive interest rate.   This means that no one could borrow for less than the average productivity of society.  This makes perfect sence because any activity that isn't at least that productive is not worth the risk. With inflation or price stability people are forced to take unnesisary risks just to avoid losing money.   

-------------

So generally I think the negative interest rate argument is bunk.

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August 03, 2010, 02:58:44 AM
 #4

Expanding upon "bunk"

As a simple example:

Say 1 bitcoin buys you 1 loaf of bread, and the entire economy is based on comparisons to loaves of bread.

Scenario 1:
At the start of the year I have 1000 bitcoins, I lend out 100 for 1 year at -50% interest.
This stimulates the economy to grow 100%
At the end of the year, I will have 950 bitcoins, but they are worth 1900 loaves of bread.

Scenario 2:
1000 bitcoins, I lend out 0.
The economy doesn't grow at all,
At the end of the year, I will have 1000 bitcoins, but they are still only worth 1000 loaves of bread.

There is a lot more math you can do to cover more complex scenarios and make more acurate estimates of growth, but I think this illustrates the general principle.

Lending 100 BTC and having it double the economy is an example equivalent to saying, "And then monkeys fly out of my butt..."

So here's more monkeys!

Scenario 1:

YOU:
At the start of the year you have 1000 bitcoins, you lend out 100 for 1 year at -50% interest.
This stimulates the economy to grow 100%
At the end of the year, you will have 950 bitcoins, but they are worth 1900 loaves of bread.

ME:
At the start of the same year I have 1000 bitcoins. I lend out 0.
You stimulate the economy to grow 100%
At the end of the year, I will have 1000 bitcoins, but they are worth 2000 loaves of bread.

I win!

Scenario 2:
Neither of us loans coins.
The economy increases
We tie in value.



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August 03, 2010, 03:03:05 AM
 #5

Expanding upon "bunk"

As a simple example:

Say 1 bitcoin buys you 1 loaf of bread, and the entire economy is based on comparisons to loaves of bread.

Scenario 1:
At the start of the year I have 1000 bitcoins, I lend out 100 for 1 year at -50% interest.
This stimulates the economy to grow 100%
At the end of the year, I will have 950 bitcoins, but they are worth 1900 loaves of bread.

Scenario 2:
1000 bitcoins, I lend out 0.
The economy doesn't grow at all,
At the end of the year, I will have 1000 bitcoins, but they are still only worth 1000 loaves of bread.

There is a lot more math you can do to cover more complex scenarios and make more acurate estimates of growth, but I think this illustrates the general principle.

Lending 100 BTC and having it double the economy is an example equivalent to saying, "And then monkeys fly out of my butt..."

So here's more monkeys!

Scenario 1:

YOU:
At the start of the year you have 1000 bitcoins, you lend out 100 for 1 year at -50% interest.
This stimulates the economy to grow 100%
At the end of the year, you will have 950 bitcoins, but they are worth 1900 loaves of bread.

ME:
At the start of the same year I have 1000 bitcoins. I lend out 0.
You stimulate the economy to grow 100%
At the end of the year, I will have 1000 bitcoins, but they are worth 2000 loaves of bread.

I win!

Scenario 2:
Neither of us loans coins.
The economy increases
We tie in value.





Or the economy is stimulated less than usual, and you end up with less total wealth growth between the two of you.

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August 03, 2010, 03:32:09 AM
 #6

Or the economy is stimulated less than usual, and you end up with less total wealth growth between the two of you.

By the way, I made the "monkey" crack before I saw the thread on monkey economics. It is worth watching the video.

People do tend to make decisions in relative terms rather than absolute ones.

But notice he could have also said, I loaned out all 1000 BTC at -50% interest and get back 500 BTC which is worth the same, but I've done a wonderful thing for society and it cost me nothing.

Or I loaned out all 1000 BTC at -35%(ish) and ended up with 650 BTC worth 1,300 loaves of bread. whether or not it is a good argument depends on the random absolute numbers you pull out of your but with the flying monkeys.

But in the end, humans don't tend to make decisions this way. We say minimize risk if we expect to be gaining value. Gamble overly optimistically if we think the trend is down, but there is a chance we might be saved from loses. Las Vegas was built on this principle. Ask the monkeys.
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August 03, 2010, 04:43:58 AM
 #7

Perhaps you did not notice my later post where I realized that:

1) Red was right, lending at negative interest rates will make a real return, but not as big of real return as not lending at all!

So, think about what this means:

1) Supply of goods is constantly increasing as people keep going to work and becoming more creative.
2) Supply of money is relatively fixed.
3) Value of money increases as a result. (your % of total economic output remains fixed)
4) The "interest on savings" realized as increased purchasing power is equal to average productivity of society
5) Lending money only makes sense for ventures that are more productive than average.
6) 0 risk "investment" is possible! 

The alternative
1) Supply of goods is constantly increasing as people keep going to work and becoming more creative.
2) Supply of money "grows" to keep up, but new money is distributed differently from old money (borrowers, bit coin miners, etc)
3) Value of money stays flat or decreases (your % of total economic output shrinks, unless you get the new money)
4) Saving results in your share of the economic pie shrinking
5) You are now forced to find *SOME PLACE* to invest your money to compensate for the debasement
6) 0 risk "investment" IMPOSSIBLE


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August 03, 2010, 08:08:13 AM
 #8


Thanks for your well thought out replies guys.

1) Red was right, lending at negative interest rates will make a real return, but not as big of real return as not lending at all!

I do not agree that this is necessarily true.

It probably doesn't matter if no-one lends anyway. We'll just end up with the anti-Tragedy of the commons where it gets overgrown because no-one is going to let their cows out onto it.

People in general are REALLY bad at observing the negative effects of things that do not happen.
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August 03, 2010, 08:32:43 AM
 #9

Imagine all the various possible lenders and their risk/reward desires and imagine all the potential borrowers with their various expected returns and risks. How do you decide which projects get the funds and which lenders lend?

It's just like any other market fundamentally! If no one else is lending then you get to choose the absolute best project and get to charge as high a rate as the project can bear. You will make huge profits if there is even one single excellent project out there because it's all yours. You could even take the seven best projects! Of course this isn't going to last, these huge profits are going to entice other potential lenders. They may not want to take the 8th best project, they may offer a lower rate than you did so that they can get the most reliable project. You can move down to a less good project, or you can compete on the rate.

This market will tend toward clearing where all the best X projects being charged roughly according to their riskiness and the Y most willing lenders having bid each other down on rates getting paid according to their risk appetites. This will leave projects in the wings waiting for someone to be willing to take a tad more risk, and investors in the wings waiting for someone to come up with a tad better project.

To address the "growing the economy" points. If a project returns less than it takes in then it is not growing the economy. The way we know someone is doing something productive is if there exist people for whom the outputs of the project are more valuable than the inputs were to anyone else. If people value the ingredients of an apple pie more highly before they are put together then it is wrong to say you are growing the economy by baking pies. You might as well be damaging apples with a fork and reselling them. You are making resources less valuable if you are not turning a profit.


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August 03, 2010, 03:47:59 PM
 #10

It's just like any other market fundamentally! If no one else is lending then you get to choose the absolute best project and get to charge as high a rate as the project can bear.

Exactly!

But the premise of the thread was that in a highly deflationary period, people would be naturally incentivized to lend money at low (even negative rates) because the additional commodity growth would accelerate deflation fast enough to make up the difference. The now even greater deflation would then compound the incentive to lend.

That argument is bunk.

In every marketplace, incentives to lend increase with inflation and they decrease sharply with deflation. Furthermore, the higher inflation is the lower the relative delta between inflation and interest rates.

For example in an economy with 1% inflation you could easily lend at 5% interest (5x inflation).
However, with 10% inflation while you could likely get 15% interest (1/2 x inflation), you certainly couldn't get 50% interest (5x inflation).

As inflation goes up, the relative risk of lending goes down. If you are already going to lose 10% of your value in a year, a 3.5% gain starts to look really good.

Remember we are comparing lending vs not lending.
HOLD: 100 btc present value = 90 btc present value after 1 year of 10% inflation. 
LEND: 100 btc present value @15% = 103.5 btc present value after 1 year of 10% inflation. 

On a one year loan, that is a 13.5 btc delta over NOT lending. However, the borrower only has to create 3.5% gain in commodity value to pay back the 15% interest. That makes the venture LOW risk.

Deflation plays on the same spectrum. Not an inverted one.

HOLD: 100 btc present value = 110 btc present value after 1 year of 10% deflation. 
LEND: 100 btc present value @15% = 126.5 btc present value after 1 year of 10% deflation.

On a one year loan, that is a 16.5 btc delta over NOT lending. However, the borrower has to create 26.5% gain in commodity value to pay back the 15% interest. That makes the venture HIGH risk.
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August 03, 2010, 03:59:48 PM
 #11

So do we NEED an inflationary economy for anyone to actually do anything other than sit at home on their pile of bitcoins  with a shotgun?
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August 03, 2010, 04:48:22 PM
 #12

No.

But in periods of increasing bitcoin popularity with an influx of commodities and high deflation rates, expect little lending.

As people begin to get frustrated that the bitcoin rich are getting richer under deflation, while doing zero work, they will begin to take their commodities and sell their bitcoins. Thereby reducing deflation rates, perhaps even causing momentary inflation.

It is during these times that lending will start to look like a good idea. If the loans drive the creation of new commodities traded in bitcoins, the deflation will resume and the frustration cycle will start again.


But take the case of the very early adopters as an example. The system started with coin generation and zero commodities to trade the coins for. The very early adopters were awarded coins easily and for nearly free since block generation was low.

Now compare the case of those who sold their early generated coins to knightmb and those who continue to hoard their coins. The sellers were bearish on bitcoin. The hoarders are bullish on bitcoin's success.

Knightmb is bullish on bitcoin. Otherwise he would be trying to borrow coins rather than buying them outright.

If the commodities that want to trade in bitcoin increase the early adopters who hoard (bullish) are proven correct. They indeed get more for nothing than the early sellers. If bitcoin is abandoned, those who sold (bearish) are proven correct because they at least got something for nothing.

But in general, deflation steals from the cash poor and gives to the cash rich.
Inflation steals from the cash rich and gives to the cash poor.
That is why deflation causes uprisings but inflation causes malaise.
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August 03, 2010, 05:31:56 PM
 #13

Ok, STOP throwing around the words inflation and deflation without identifying whether you are talking about monetary or price *flation.

First of all, to steal implies that something was taken from you or a fraud was committed.  There is NO THEFT in price *flation.   

Printing money from nothing transfers wealth from those who hold the "money" to those who just created it.

The savings rate is all about the time-preference of money.  How badly do you want that new computer?  If you hold out you can get 2x the computer for the same price in a year.   Yet people keep buying computers even though they are a VERY deflationary price environment.

When you choose to "hoard" you do not get "something for nothing" you are forgoing present consumption for future consumption.   Having something now is always worth more than having it later.

So everyone should *thank* the savers because their act of saving reduces prices for todays spenders.   EVERYONE benefits and no fraud or theft occurs.

It is the printing press, the passing of of IOU gold as if they were warehouse receipts, etc that is fraud and steals from the whole to give to those who got something for nothing.


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August 03, 2010, 06:56:08 PM
 #14

Most of this post is just mantra with very little attempt at understanding what I posted.

I always talk about price inflation and deflation. Central banks increase or decrease the money supply to effect monetary policy. It is only coincidence that increase and inflate are synonyms. This site is the only place I've ever been to where people try to confuse dissimilar concepts.

For the record, bitcoin has a fixed monetary policy. There are 21,000,000 bitcoins by definition. That number is constant for all time. Some coins circulate some are being hoarded. Most are in a logical sense being hoarded in a roughly 17,500,000 coin central reserve to enter circulation with predictable timing based upon a fixed central policy.

No coins can be destroyed, beyond the known 21,000,00 none can be created. Therefore there is zero monetary inflation or deflation in bitcoin. Get over it! Coins can only circulate or be hoarded purposefully or accidentally.

Printing money does squat. The US is printing money at a huge rate at the moment and prices are still deflating. Or I could be lying and the government could be burning money at a huge clip. You can't know and you don't have to care.

Printing money "transfers" nothing! The money just sits in a vault until some bank borrows it at interest. The interest is determined by the goals of monetary policy. Which is to deal with PRICE inflation or deflation!
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August 03, 2010, 07:41:20 PM
 #15

Ask the people in zimbabwe if printing money does "squat". 

I could print 1 zillion dollars and it would do squat until I tried to spend it.   If I print money and hold it my "supply and demand" cancel out.   If I print money and "spend it" then my demand for money I just printed is low and thus the supply of money chasing other goods increases.  Thus, there is no point to printing money *unless* you are spending or lending it.   In the current system they printed up a ton of money to cancel out losses and maintain their theoretical reserve requirements.   The only reason the banks are holding the money is because they are being PAID to hold it and not spend it/lend it.  It is a TIME BOMB.

I make a big attempt to understand every argument people put out.   And to be fair, almost EVERY FORUM I ever visit is full of people who do not understand money, inflation, deflation, or anything other than repeating the lies, half truths, and fallacies promoted by the government economists.

The #1 requirement for stable money is predictability.  The #2 requirement is that resources to not get reallocated by political clout.   

In the bit coin world, resources cannot be reallocated by endlessly printing money.  The vast majority of the bit coins are allocated to future block generation which was a choice made by the original owner of all bit coins, the creator.   He could have just as easily "auctioned" the coins into existence. 

My only point is that inflation/deflation need not be "managed" by a central authority and that the market automatically adjusts the relative price of all goods and services according to the law of supply and demand.  There are no "economic paradoxes" that require "intervention" to solve.  Money is just another commodity that is subject to the rules of supply and demand.  It just happens to have the quality of universal demand, divisibility, and uniformity making a convenient asset to barter for/with. 

So as long as we prevent fraud (Bit coin does this), then the system is good.  As soon as we start introducing fiat and resource reallocation in the name of economic stability we have a problem.   

One last note, the laws of economics are not suspended by the government actions, people still make free decisions.  The only thing that changes is the price of goods in the black... err.. free market to compensate for the increased risk caused by the bully government.  In many cases the black market prices / risks are too high and the result is a shortage, or loss of quality. 


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August 03, 2010, 08:15:37 PM
 #16

Bitcoin does not prevent fraud. It simply isn't a fraud itself. You can still lie and be lied to, tricked into payment for bad service, no service, etc.

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August 03, 2010, 08:20:25 PM
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"But in general, deflation steals from the cash poor and gives to the cash rich.
Inflation steals from the cash rich and gives to the cash poor.
That is why deflation causes uprisings but inflation causes malaise."

This is an invalid argument if applied to price inflation/deflation. Those phenomena are caused by supply and demand and have nothing to do with theft or fraud, unless you are implying that it is somehow theft if I buy 1000 shares of Apple and the price goes up as a result.

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August 03, 2010, 08:28:52 PM
 #18

Printing money does squat. The US is printing money at a huge rate at the moment and prices are still deflating. Or I could be lying and the government could be burning money at a huge clip. You can't know and you don't have to care.

The money supply is actually decreasing, in spite of fed actions. The next step will probably be to directly buy treasuries to spur on inflation.

Printing money "transfers" nothing!

This is an untrue statement. Money spent into existence alters the price structure into something different than what it would be if that money had not been created. The people whom receive the new money first benefit the most, as they can still take advantage of lower prices in the market. By the time the money filters through the economy and raises the general level of prices due to more money chasing the same amount of goods, the non-recipients of this new money are left with less purchasing power than before.

This is always true, unless the following conditions hold:

* Everyone's cash balances and debts are simultaneously and synchronously increased by exactly the same proportion.
* The newly created money is never spent and never entered into circulation.

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August 03, 2010, 09:21:19 PM
 #19

Ask the people in zimbabwe if printing money does "squat". 

Bad government is bad government. But I'm sure you'll find that zimbabwe was trying to redistribute the wealth. They did that by printing money to cause inflation. They could have burned the fields and cities, the prices would have spiked just as fast.

As I pointed out, inflation steals (in commodity value) from the cash rich, and gives to the cash poor.

In a related note, bad banking is bad banking. The US and Europe showed that lots of their bankers can suck too.

My only point is that inflation/deflation need not be "managed" by a central authority and that the market automatically adjusts the relative price of all goods and services according to the law of supply and demand.  There are no "economic paradoxes" that require "intervention" to solve.  Money is just another commodity that is subject to the rules of supply and demand.  It just happens to have the quality of universal demand, divisibility, and uniformity making a convenient asset to barter for/with. 

While I agree with lots of what you said, I think this statement is unsupported.

If you could point to any recent example of a group of people trading with an absolutely fixed fiat commodity it might help. However, I can't point to any government anywhere trying to preserve a monotonically deflationary environment.

What evidence is there that such an environment is one that wouldn't turn into Feudalism?

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August 03, 2010, 09:41:39 PM
 #20

"But in general, deflation steals from the cash poor and gives to the cash rich.
Inflation steals from the cash rich and gives to the cash poor.
That is why deflation causes uprisings but inflation causes malaise."

This is an invalid argument if applied to price inflation/deflation. Those phenomena are caused by supply and demand and have nothing to do with theft or fraud, unless you are implying that it is somehow theft if I buy 1000 shares of Apple and the price goes up as a result.

This of course was a metaphor, but if you are having trouble getting it, how about an example.

Suppose on average it take 100 BTC a year for a person to buy all the necessities of life for a year. Food, rent, minimal stuff.

Now we have two people doing the same job, one rich in cash, say because he happened to discover bitcoin four years before the other guy. The second person just discovered bitcoin today. So they start in the same job at the same wage (100 BTC) with the same needs (100 BTC). However, 4 years ago the rich guy traded a stack of old porn for 1000 BTC and then hoarded them. Say it was worth $5 at the time.

Now say it is a really good year for bitcoin adoption. The "demand" for bitcoins doubles and the prices of necessities falls by half. Now let's say salaries fall to match. Now both guys make 50 BTC and spend 50 BTC. So who cares?

Well the rich guy went from having a 10 year reserve of BTC to having a 20 year reserve of BTC. The other still has no reserve.
The rich guy did no more work than the poor guy. AND!!! This is the important part!!!  His hoard of 1000 BTC added no more value to the overall economy than the poor guys 0 BTC hoard. In productivity value, all hoards are equal.

Hence the over all transfer of wealth to the rich. You might not consider it "stealing" however certainly both people and their stashes benefited the economy equally, one got disproportunate reward.

If you think about it, this is how Feudal systems work. However the important commodity is land rather than BTC.


Now inflation should be self explainatory. If prices doubled, the rich guy went from a 10 year reserve to a 5 year reserve. Which is still a huge benefit from a stack of porn. It is in his best advantage to spend the money right away before it goes from a 5 year reserve to a 2 year reserve.



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