Velocity of Bitcoin and Deflation

[jjames888]

This entire thread came from this paragraph of a time magazine article.

"As an economic principle, velocity has been considered a constant. According to Gelleri, it was stable in the 1950s, '60s, and '70s but starting in the '80s velocity has decreased as more money has been diverted to the financial sector. This scenario may benefit financial centers, but money tends to drain away from other places. Gelleri says that both the Euro and the U.S. dollar have slowed way down. "In the last several months velocity has declined sharply because there's less GDP and more money," he says. "The money doesn't flow. More money is being printed, but it's not going into circulation."

Velocity of money is: https://en.wikipedia.org/wiki/Velocity_of_money

To my knowledge, a flourishing economy has a high velocity currency. Bitcoin, being a deflationary currency, by definition does not promote velocity of money because you are encouraged to hold on to the money because it will rise in price because of deflation.
Or is it deflation that causes velocity?

I realize I am making deflation of a currency, and an economy one and the same. Are they not the same?

Discuss...

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[justusranvier]

Deflation means that in order to get people to spend their money you must actually offer products and services that are compelling enough on their own merits to convince them to part with currency. Inflation pushes people towards unnecessary consumption because the are driven to spend their money more quickly as it loses value.

Naturally people who want a system that allows them to live comfortable lives by skimming value away from the productive prefer inflation and high velocity to deflation and capital formation.

[justusranvier]

I see how it leads to unnecessary consumption. Now that you mention it, that seems like a no brainer.

I do not see how it leads to someone being able to skim value away from the productive. Can you elaborate?

In order for inflation to occur new currency (money or credit) needs to be introduced into the economy. The introduction of new currency devalues each unit proportionally but the first people who get to spend it do so before the devaluation manifests. So the way the monetary system works now people who have access to credit creation get to enjoy privileges indistinguishable from those of a counterfeiter - the ability to consume value produced by other people without any need to produce an equivalent amount of value first for someone else first.

[AnonymousBat]

Deflation means that in order to get people to spend their money you must actually offer products and services that are compelling enough on their own merits to convince them to part with currency. Inflation pushes people towards unnecessary consumption because the are driven to spend their money more quickly as it loses value.

Naturally people who want a system that allows them to live comfortable lives by skimming value away from the productive prefer inflation and high velocity to deflation and capital formation.

This is one of the best answers I've seen, I'm stealing this.

[justusranvier]

You are saying that the Printer of the money can print how ever much money he so desires, and this takes value away from the productive because he just made money for the product made by the productive. This is only possible when there is no backing of a money. Bitcoin has no real hard backing. Am I reading this correctly.

Currency backing is a red herring.

Imagine an economy consisting of 100 people who produce 100 widgets/time and trade with 100 currency units. The price of each widget is going to be equal to 1 currency unit and each person gets a widget every unit of time. Now imagine one person manages to forge 10 currency units and he goes out and buys 10 widgets before anyone else realizes what is going on. Now the other 99 people will be left with 100 currency units to buy with but only 90 widgets left to buy. The price of a widget will now get bid up to 1.11 currency units and will stay there because the extra 10 currency units will remain in circulating in the economy. The actual effect during the first round is the other 99 people either get less than a full widget each or else somebody gets none at all.

If the counterfeiter can get away with this continually he'll always be able to consume more than he produces at everybody else's expense.

[justusranvier]

As the example above shows economics is not at all difficult in principle but we're taught so much self-serving misinformation that it's hard to figure out what's going on.

I'd recommend reading some Frédéric Bastiat. His examples are very approachable.

[benjamindees]

Not saying you're doing so, but it's important to realize the error in simply equating velocity with a healthy economy.  Velocity is just one measure of a healthy economy.  It's possible for a healthy economy to actually have no velocity at all.  What's the velocity of the Star Trek economy?  Zero.  They don't trade anything at all.  Everything they want is just replicated out of thin air.  That's important to keep in mind.

But let's say the economy is like a person on a bicycle.  A healthy economy can ride the bicycle very fast.  An inflationary currency is like a lawnmower engine strapped to the back of your bicycle.  It will make you go very fast, for a while, until the gas runs out.  Once the gas runs out, it will instead make you go very slow, as you are now weak and emaciated from never pedaling, and you have to haul around a worthless lawnmower engine.

The Federal Reserve, of course, is the guy selling you gas in exchange for you helping him siphon it out of a competitor's tank every once in a while.

[AnonymousBat]

I am an amateur at best in economics, did well in school though.

I hope it wasn't 'economic classes'.

You're going to have to do a lot of unlearning, all of that crap is wrong. Just look at everyone in government central economic planning with all of their degrees and their absolutely terrible job.

You wouldn't hire a doctor that has a 100% record of his patients dying.

[nedbert9]

Not saying you're doing so, but it's important to realize the error in simply equating velocity with a healthy economy.  Velocity is just one measure of a healthy economy.  It's possible for a healthy economy to actually have no velocity at all.  What's the velocity of the Star Trek economy?  Zero.  They don't trade anything at all.  Everything they want is just replicated out of thin air.  That's important to keep in mind.

But let's say the economy is like a person on a bicycle.  A healthy economy can ride the bicycle very fast.  An inflationary currency is like a lawnmower engine strapped to the back of your bicycle.  It will make you go very fast, for a while, until the gas runs out.  Once the gas runs out, it will instead make you go very slow, as you are now weak and emaciated from never pedaling, and you have to haul around a worthless lawnmower engine.

The Federal Reserve, of course, is the guy selling you gas in exchange for you helping him siphon it out of a competitor's tank every once in a while.

Instead of this bitcoin stuff we should be working on replicators.

[Foxpup]

What's the velocity of the Star Trek economy?  Zero.  They don't trade anything at all.  Everything they want is just replicated out of thin air.  That's important to keep in mind.

What about all the gold-pressed latinum and Federation credits used to trade things which can't be replicated, such as real estate and professional services?

[tynt]

AbelsFire's example is good because it's pure logic and mathematics. You can obscure with different "economy" schemes all you want but in the end, someone in the 100 people economy will get scammed if you add up the numbers.

[vv01f]

You wouldn't hire a doctor that has a 100% record of his patients dying.

In fact we do - noone is undying - and for that all doctors have 100% of their patients dying at the end.

sorry, couldnt hold to point that out,
but the other things you explained a lot better 

[nybble41]

Imagine an economy consisting of 100 people who produce 100 widgets/time and trade with 100 currency units. The price of each widget is going to be equal to 1 currency unit and each person gets a widget every unit of time. Now imagine one person manages to forge 10 currency units and he goes out and buys 10 widgets before anyone else realizes what is going on. Now the other 99 people will be left with 100 currency units to buy with but only 90 widgets left to buy.

Shouldn't that be 110 currency units (including the counterfeits) and 100 widgets? The ten widgets bought with counterfeit currency are still part of the economy, at least until they're consumed. The effect is similar, but the price is 1.10 afterward, not 1.11. (Assuming an idealized equilibrium economy with no goods other than currency and widgets, where the people are perfect widget-producing, widget-consuming perpetual-motion robots...)

[justusranvier]

Imagine an economy consisting of 100 people who produce 100 widgets/time and trade with 100 currency units. The price of each widget is going to be equal to 1 currency unit and each person gets a widget every unit of time. Now imagine one person manages to forge 10 currency units and he goes out and buys 10 widgets before anyone else realizes what is going on. Now the other 99 people will be left with 100 currency units to buy with but only 90 widgets left to buy.

Shouldn't that be 110 currency units (including the counterfeits) and 100 widgets? The ten widgets bought with counterfeit currency are still part of the economy, at least until they're consumed. The effect is similar, but the price is 1.10 afterward, not 1.11. (Assuming an idealized equilibrium economy with no goods other than currency and widgets, where the people are perfect widget-producing, widget-consuming perpetual-motion robots...)

I was talking about the instant after the purchase of the 10 widgets, before the 10 new currency units circulate. If you continue the thought experiment a little further there will be a new equilibrium but I don't think the difference between 1.10 and 1.11 in a simplified example is relevant to the overall point.

I was thinking about a writing a slightly more involved example with some long-term consequences; maybe I'll do that later today.

[nybble41]

I was talking about the instant after the purchase of the 10 widgets, before the 10 new currency units circulate.

If you're not considering the increase in currency, the numbers should be 100 units currency and 100 widgets, i.e. no change, not 100/90. Either way, the supply of widgets doesn't decrease just because some of them changed hands.

Anyway, we're in agreement that someone who can introduce new currency "for free" has an advantage over those left to deal with the resulting inflation. Naturally, this is only a problem when the market value of the currency is kept artificially high via a monopoly or other market manipulation (as with USD); otherwise, save for a genuine currency shortage, the cost of introducing new currency would already be approximately equal to the market value of the currency, leaving little incentive to introduce more (as with precious metals, or Bitcoin after the introductory block incentives go away).

[justusranvier]

Either way, the supply of widgets doesn't decrease just because some of them changed hands.

It does if widgets are consumed. In the long term production will ramp up but there's a delay so at the instant the newly-minted currency is spent it reduces the number of widgets that are available for other people to purchase. I'll explain that in more detail in a future post.

[justusranvier]

Imagine an economy consisting of 100 people who all work 40/hr per week to collectively produce 100 widgets/week and use a money supply of 100 units to buy those 1 widgets per week which they consume to survive.

One of these people, let's call him Ben, decides that he doesn't enjoy working and would rather find some other way to obtain the 1 widget/week he needs to survive. He builds a printing press and on Monday prints 1 currency unit and takes this to the store to buy his 1 widget. Now the rest of the people in this economy have a problem. Because Ben has decided to stop working only 99 units will be produced but he's already bought one of them so there will only be 98 available to buy at current production rates. No one has noticed that Ben isn't working so they don't know why production is coming up short but since they all need 1 widget/week they all start working longer hours in order to make up the slack. Everybody increases their work week by about 1%, which is equivalent to about 1 minute shorter lunch break. By the end of the week the 99 people who are still working managed to produce enough widgets for everyone although the price has gone up to 1.01. Wages have gone as well but the increase in wages doesn't result in an increase in purchasing power because 1 week's labor still only buys 1 widget.

Ben is overjoyed at the result and decides to continue this every week. The second week he has to counterfeit 1.01 but that's no problem. The other 99 people still need to work an extra 1% to cover for the loss of labor represented by Ben's exit from the workforce but they hardly notice. Their wages are still going up by 1% per week but so are the prices so their extra work isn't creating any extra benefit for them. As long as Ben only steals a small, hardly noticeable, amount from everybody he gets to live for free and nobody will ever be the wiser.

"There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

If the population of this economy start inventing labor-saving devices then life gets even better for Ben since now he can siphon off even more production from those that are still working without being noticed. If their productivity goes up by 10% it means that the 99 working people will produce 108 widgets while working 40 hours per week. If they were allowed to keep that increase they would only need to work 36 hours per week to maintain their standard of living or keep working 40 hours per week to increase their standard of living by 10%. But Ben can print enough currency to buy up those extra widgets for himself without raising prices although maybe he'll let them keep a few scraps for themselves so they think they're making progress. If Ben has trouble consuming that much alone he might invite his friends Fred, Irene, Rachel and Edward to the party too. Greg will surely want a piece of the action as well.

As long as Ben and friends are careful to make sure nobody can see exactly what is going on they can get away with this scam for a long, long time.

[Equilux]

Imagine an economy consisting of 100 people who all work 40/hr per week to collectively produce 100 widgets/week and use a money supply of 100 units to buy those 1 widgets per week which they consume to survive.

One of these people, let's call him Ben, decides that he doesn't enjoy working and would rather find some other way to obtain the 1 widget/week he needs to survive. He builds a printing press and on Monday prints 1 currency unit and takes this to the store to buy his 1 widget. Now the rest of the people in this economy have a problem. Because Ben has decided to stop working only 99 units will be produced but he's already bought one of them so there will only be 98 available to buy at current production rates. No one has noticed that Ben isn't working so they don't know why production is coming up short but since they all need 1 widget/week they all start working longer hours in order to make up the slack. Everybody increases their work week by about 1%, which is equivalent to about 1 minute shorter lunch break. By the end of the week the 99 people who are still working managed to produce enough widgets for everyone although the price has gone up to 1.01. Wages have gone as well but the increase in wages doesn't result in an increase in purchasing power because 1 week's labor still only buys 1 widget.

Ben is overjoyed at the result and decides to continue this every week. The second week he has to counterfeit 1.01 but that's no problem. The other 99 people still need to work an extra 1% to cover for the loss of labor represented by Ben's exit from the workforce but they hardly notice. Their wages are still going up by 1% per week but so are the prices so their extra work isn't creating any extra benefit for them. As long as Ben only steals a small, hardly noticeable, amount from everybody he gets to live for free and nobody will ever be the wiser.

"There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

If the population of this economy start inventing labor-saving devices then life gets even better for Ben since now he can siphon off even more production from those that are still working without being noticed. If their productivity goes up by 10% it means that the 99 working people will produce 108 widgets while working 40 hours per week. If they were allowed to keep that increase they would only need to work 36 hours per week to maintain their standard of living or keep working 40 hours per week to increase their standard of living by 10%. But Ben can print enough currency to buy up those extra widgets for himself without raising prices although maybe he'll let them keep a few scraps for themselves so they think they're making progress. If Ben has trouble consuming that much alone he might invite his friends Fred, Irene, Rachel and Edward to the party too. Greg will surely want a piece of the action as well.

As long as Ben and friends are careful to make sure nobody can see exactly what is going on they can get away with this scam for a long, long time.

Thank you very much for taking the time to write this, I understand these basic economics quite well but this detailed but easy example makes it even more comprehensible.

[miscreanity]

As long as Ben and friends are careful to make sure nobody can see exactly what is going on they can get away with this scam for a long, long time.

Fantastic explanation. Would you be willing to describe the mechanism with the inclusion of a non-consumable along with the consumable widget?

[justusranvier]

Fantastic explanation. Would you be willing to describe the mechanism with the inclusion of a non-consumable along with the consumable widget?

I not sure there's enough of a fundamental difference to be worth cluttering up the example. Is there something specific you want to see illustrated?