Will deflation be the fatal weakness of bitcoin?

[commonancestor]

I wonder if there are any failed deflationary currencies. Actually I guess no.

The difference between deflationary and inflationary money is that deflationary money are valued more than inflationary. It means that under deflation people buy just what they need. Subsequently, deflation induces lower prices, lower production of goods, people spend less time creating useless stuff at work, and with their overstuffed bitcoin wallets they go fishing.

[bg002h]

There is one weakness of it, which I hope someone can invalidate. Suppose I'm a car-dealer and I buy 1 car for 100 BTC from my supplier. By the time I can sell it to a customer, I can only ask 95 BTC for it, because of deflation. Now everyone argues that isn't a problem, because the prices at my supplier also have dropped with the same amount, so I can buy a new one there for 95 BTC, and again have 1 car in stock, and don't suffer any losses. But if I did absolutely nothing I would still have 100 BTC, so why should I work hard as a car-dealer instead of hoarding?

I can't see why this would be good for Bitcoin. People said that it's good because it forces merchants to keep their stocks low, or produce goods only on-demand. But then you're asking merchants to change the way they have been doing business for decades, which seems unlikely to happen.

So how can Bitcoin solve this problem for merchants?

While the value of Bitcoin is unstable, it can only succeed as an intermediary currency (ie, you exchange fiat for btc, transact, and reverse the exchange quickly). When value is reasonably stable, Bitcoin can be used like fiat.

[DeathAndTaxes]

I wonder if there are any failed deflationary currencies. Actually I guess no.

There is a simple reason.  Inflation hurts the productive and helps the debtors. 

Collectively around the world who are the largest debtors?  Governments of course.
Who sets monetary policy?  Governments of course.
Who benefits the most from an inflaitonary policy?  Governments of course.

Any government that adopted a deflationary policy would face their unsustainable debt growing in value rather then robbing their creditors with inflation.  The US national debt can grow to any amount it wants.  The only true metric if debt/GDP and guess what happens when you inflate your currency 20%.  Nominal GDP goes up 20% while the amount of debt is fixed (assumming no new debt).  The "real" (adjusted for inflation) carrying cost of the debt is reduced.   Using the same "trick" governments can deficit spend forever.  Just rack up debt to less than the rate of inflation and in real terms you debt will decline towards zero.

Free money!!!!!

[markm]

The only way to solve this problem is to get rid of 21.000.000 cap.

The best way to solve it is leave Bitcoin alone and go make a different coin with whatever properties you think are superior, and then let them compete.

Already beta-testing and tuning new coin. But I need Bitcoin stay alive to keep cryptocoin ecosystem healthy.

Great, I've been waiting for over a year now for Inflatacoin so I know where to direct people who think the 21,000,000 limit is bad.

Both GRouPcoin and DeVCoin keep on minting the same number of coins per block forever. So "inflatacoin" already exists, in two denominations, one producing 1000 times as many coins as the other per block.

-MarkM-

[wormbog]

You can buy 100,000 devcoins right now for a mere 12 bitcents at vircurex.com. Now *that's* inflation!

[commonancestor]

There is one weakness of it, which I hope someone can invalidate. Suppose I'm a car-dealer and I buy 1 car for 100 BTC from my supplier. By the time I can sell it to a customer, I can only ask 95 BTC for it, because of deflation. Now everyone argues that isn't a problem, because the prices at my supplier also have dropped with the same amount, so I can buy a new one there for 95 BTC, and again have 1 car in stock, and don't suffer any losses. But if I did absolutely nothing I would still have 100 BTC, so why should I work hard as a car-dealer instead of hoarding?

I can't see why this would be good for Bitcoin. People said that it's good because it forces merchants to keep their stocks low, or produce goods only on-demand. But then you're asking merchants to change the way they have been doing business for decades, which seems unlikely to happen.

So how can Bitcoin solve this problem for merchants?

As a car-dealer you add value to the products you sell, like people don't have to travel all the way to the factory to buy a car. You need to sum the costs of doing your business and calculate it into the prices you ask. If the car itself costs you 100 BTC, plus you incur other costs like rent and salaries worth maybe 20 BTC per car, then you will ask 120 BTC per car. Something like this happens to every car-dealer. People can choose either to pay 120 BTC to a car-dealer, or to travel to the factory and buy for 95 BTC. I think it is fair.

EDIT: Also to protect from deflation, the car-dealer can slide the price like this: Now - 125 BTC, in 3 months - 120 BTC, in 6 months - 115 BTC. If he sells his cars in 3 months in average, then his profit is not affected.

[Gabi]

Gold is deflationary

Did gold fail so far? No.

[Etlase2]

Is gold still a currency? lols

[Piper67]

Is gold still a currency? lols

It would be if you could send a milligram over the net instantaneously.

[Gabi]

Is gold still a currency? lols

Lol for you gold is worthless?

0/10 troll.

[Come-from-Beyond]

Is gold still a currency? lols

Lol for you gold is worthless?

0/10 troll.

Gold is not a currency anymore. Those who still believe it is should read http://en.wikipedia.org/wiki/Gold_standard.

[Technomage]

Some people seem to have it backwards. Deflation is the intended solution to the debt problem of fiat money and the inflation tax. It's not the problem or a problem, nor is it simply a solution. It's the solution.

Bitcoin provides, eventually, the same level of value store that gold does and at the same time it's massively more convenient as a medium of exchange. Bitcoin I believe, could become a universal currency. The nonpolitical nature of it, the store of value capabilities and the convenience as a payment method, Bitcoin has it all.

All of this is of course dependent on Bitcoin being able to withstand the attack it will likely experience in a few years time. I'm personally not worried about it, even if Bitcoin fails new cryptocurrencies will arise and take its place.

[cbeast]

Is gold still a currency? lols

Lol for you gold is worthless?

0/10 troll.

Gold is not a currency anymore. Those who still believe it is should read http://en.wikipedia.org/wiki/Gold_standard.

Gold and silver are legal tender in Utah.

[tynt]

There is one weakness of it, which I hope someone can invalidate. Suppose I'm a car-dealer and I buy 1 car for 100 BTC from my supplier. By the time I can sell it to a customer, I can only ask 95 BTC for it, because of deflation. Now everyone argues that isn't a problem, because the prices at my supplier also have dropped with the same amount, so I can buy a new one there for 95 BTC, and again have 1 car in stock, and don't suffer any losses. But if I did absolutely nothing I would still have 100 BTC, so why should I work hard as a car-dealer instead of hoarding?

I can't see why this would be good for Bitcoin. People said that it's good because it forces merchants to keep their stocks low, or produce goods only on-demand. But then you're asking merchants to change the way they have been doing business for decades, which seems unlikely to happen.

So how can Bitcoin solve this problem for merchants?

This is true if you have hyperdeflation and your business's profit margin is 0%.
Lets take a scenario where annual deflation is 5% and you take 5% cut of each car sold. You have BTC100. First month you buy BTC100 car and sell a month later. Car costs now BTC99.5 due to the deflation. To take your cut you sell it for BTC104.5.
(BTC100- 5% / 12months)* 1.05 = BTC104.5
Pocket the BTC4.5 and buy another BTC100 car. Do that for 1 year and you end up with BTC154. If you count in the deflation you are now 58% richer.
If you didn't do anything then you are only 2% richer.

[mpfrank]

Someone may have pointed this out already, but Bitcoin is not necessarily deflationary.  This is because it can be (and if it's successful, most likely will be) used as the base currency for a fractional-reserve banking system that continually issues "new money" (i.e., bank notes) denominated in Bitcoin, in amounts greater than the underlying BTC deposits held by the banks.  By this means, the effective money supply of BTC-denominated paper money can be inflated almost arbitrarily above the base amount of actual BTC.  This is the same as how the effective money supply of, say, U.S. dollars in bank accounts today is much larger than the actual amount of hard currency (US dollar-denominated coins and bills) in circulation.  Thus, Bitcoin is not inherently deflationary, but neither does it inherently solve the problem of today's debt-based currency that is prone to causing defaults, bank failures, etc. whenever the economy shrinks and the debts cannot all be paid back.  That can only be solved by outright banning fractional-reserve banking (whether based on dollars, gold, or BTC as the base reserve asset).  Arguably, such a ban should be instituted, since it is inherently a fraudulent practice for a bank to issue notes in excess of their physical deposits - no matter that bankers have been doing exactly this ever since the Renaissance, and this practice has been much of the basis for their whole business model.

[wormbog]

Someone may have pointed this out already, but Bitcoin is not necessarily deflationary.  This is because it can be (and if it's successful, most likely will be) used as the base currency for a fractional-reserve banking system that continually issues "new money" (i.e., bank notes) denominated in Bitcoin, in amounts greater than the underlying BTC deposits held by the banks.  By this means, the effective money supply of BTC-denominated paper money can be inflated almost arbitrarily above the base amount of actual BTC.  This is the same as how the effective money supply of, say, U.S. dollars in bank accounts today is much larger than the actual amount of hard currency (US dollar-denominated coins and bills) in circulation.  Thus, Bitcoin is not inherently deflationary, but neither does it inherently solve the problem of today's debt-based currency that is prone to causing defaults, bank failures, etc. whenever the economy shrinks and the debts cannot all be paid back.  That can only be solved by outright banning fractional-reserve banking (whether based on dollars, gold, or BTC as the base reserve asset).  Arguably, such a ban should be instituted, since it is inherently a fraudulent practice for a bank to issue notes in excess of their physical deposits - no matter that bankers have been doing exactly this ever since the Renaissance, and this practice has been much of the basis for their whole business model.

Interesting point. The difference is, since BTC is already an electronic currency with no physical aspect (cash, metal, etc.) there would be little motivation to accept a placeholder credit for BTC instead of BTC itself.

Further, since it's impossible to create new BTC (other than mining) there would be now way to create new currency to bail out overextended banks.

It would be possible for the blockchain to eventually get so active (and large) that only banks and governments would have the resources to deal in actual BTC. In that case, banks could collude to overlend some new type of currency that is supposedly backed by BTC, but is secretly not backed at all.

[n8rwJeTt8TrrLKPa55eU]

Someone may have pointed this out already, but Bitcoin is not necessarily deflationary.  This is because it can be (and if it's successful, most likely will be) used as the base currency for a fractional-reserve banking system that continually issues "new money" (i.e., bank notes) denominated in Bitcoin, in amounts greater than the underlying BTC deposits held by the banks.  By this means, the effective money supply of BTC-denominated paper money can be inflated almost arbitrarily above the base amount of actual BTC.  This is the same as how the effective money supply of, say, U.S. dollars in bank accounts today is much larger than the actual amount of hard currency (US dollar-denominated coins and bills) in circulation.  Thus, Bitcoin is not inherently deflationary, but neither does it inherently solve the problem of today's debt-based currency that is prone to causing defaults, bank failures, etc. whenever the economy shrinks and the debts cannot all be paid back.  That can only be solved by outright banning fractional-reserve banking (whether based on dollars, gold, or BTC as the base reserve asset).  Arguably, such a ban should be instituted, since it is inherently a fraudulent practice for a bank to issue notes in excess of their physical deposits - no matter that bankers have been doing exactly this ever since the Renaissance, and this practice has been much of the basis for their whole business model.

My hope in this scenario is that the built-in public nature of the Bitcoin blockchain will force banks to compete on reserve ratios and transparency.  In other words, as you're starting to see in the lender forum here, banks/lenders could make themselves more attractive by certifying certain addresses as theirs, so that customers could see how much Bitcoin reserve they actually held versus liabilities, in real time.  Customers could then choose to invest according to their risk tolerance: in a full reserve operation at zero interest rate, or a fractional reserve operation at a higher interest rate.  The main problem with FRB in our current system is the lack of disclosure to the customer, I bet not even 1 in 100 people actually understands that the bank is basically making bets with their money instead of holding it in storage.

[Roger_Murdock]

I think these examples I used in the "Deflation and Bitcoin, the last word on this forum" thread were pretty useful:

Imagine that it's Jan. 1, 2020, and you're an investor in an economy where the currency is deflating 10% a year.  You're considering making an investment in a programmable widget-maker.  The widget-maker costs 100 BTC (naturally everyone uses Bitcoins in 2020).  To simplify things, assume that the widget maker is disposable and can only be used once, after which it has zero value.  Also assume that all you have to do to use the widget maker is to input two choices, e.g. color and shape, and then wait exactly one year.  Let's say that you know that you can make a green circle widget that will be worth 105 BTC in present 2020 BTC.  So it sounds like a smart (and wealth-creating) investment, right? Except there's a problem. You also know that when you can actually sell the widget on Jan. 1, 2021, it will only sell for 94.5 BTC as a result of deflation. So you're better off just sitting on your 100 BTC, and you certainly won't borrow money to make the investment.  Is that a bad result for society? I don't think so.  First, it should be noted that if the widget maker were only capable of making green circle widgets, it wouldn't sell for 100 BTC because no one would pay that much (everyone else would make the same calculation you did). In that case, the price would be adjusted downwards until it made economic sense.  But if it DOES sell for 100 BTC, what does that tell us? It tells us that there's someone else (who's presumably also aware of deflation) who knows that they can make, e.g., a yellow square widget worth at least 111.11 BTC in 2020 BTC (meaning it will sell for at least 100 BTC in 2021).  So there's no problem.  The asset goes to its most productive user and doesn't just sit on a shelf.

More generally, what does a 10% deflation rate tell us assuming a constant money supply?  I'm perhaps oversimplifying, but basically it tells us that the economy is growing at around 11.11% a year (with 10% deflation, the purchasing power of every BTC increases 11.11% each year).  So you now have the same amount of money chasing more goods.  If the economy is growing that rapidly, that tells you that there must be lots of investment opportunities with a return of at least 11.11%.  Basically, that's the number to beat.  If you're looking at an investment opportunity with a measly 5% return, deflation is telling you not to waste your time because there are higher and better uses of that capital. 

Krugman makes it sound like it's a bad thing that "just sitting on cash becomes an investment with a positive real yield." But I don't think that it is. And again, the only reason that sitting on cash can produce a positive real yield for some people is that many other people AREN'T just sitting on their cash.  There MUST be even higher-return investments occurring.  And it seems to me that "just sitting on cash" SHOULD return a positive real yield.  Deferring consumption is not something people typically like to do.  And people who do make that sacrifice ARE providing something of value to society by doing so.  By sitting on their cash, that cash is temporarily not competing with other cash for goods and services, thus keeping prices low for everyone else, including investors.

Now let's look at an inflation scenario.  Assume that it's Jan. 1, 2000 and the inflation rate is 10% (you're stuck using inflationary U.S. fiat because Bitcoin hasn't been invented). You're looking at a widget maker that costs 100 USD, but this widget maker is not programmable.  It only makes orange triangle widgets and once again, it takes a year to do so.  But these orange triangle widgets can only be sold for 95 bucks (in 2000 dollars).  But that means that on Jan. 1, 2001, when you can actually sell the widget, you'll be able to get $104.50 for it.  So buying the widget maker with your 100 bucks makes more sense than just sitting on the cash despite the fact that it's a wealth-destroying investment.  That seems bad.  Basically, it seems like inflation causes people to treat cash like a hot potato which will sometimes lead to economically-wasteful transactions.

[anu]

Your main idea is obviously right, but please fix your numbers.

[Roger_Murdock]

Your main idea is obviously right, but please fix your numbers.

I'm assuming you mean me? Which numbers do I have wrong?