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Dan Kervick: Bitcoin’s Deflationary Weirdness

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Yves here. Some readers questioned the discussion of Bitcoin’s deflationary qualities in a recent post, so this discussion is a useful follow-on.

By Dan Kervick, who does research in decision theory and analytic metaphysics. Cross posted from New Economic Perspectives

I appeared today on The Attitude, broadcast by WNHN 94.7 in Concord, New Hampshire, to talk with host Arnie Arnesen about the Bitcoin phenomenon. The podcast of the second hour of the show can be accessed at the link below. My appearance occurs right at the beginning of the hour:

The Attitude – Bitcoin

The purpose of our brief discussion was just to provide some general background information for Arnie’s listeners about Bitcoin, including what bitcoins are and why anyone would buy them or accept them in exchange for goods and services. We touched on several topics related to the Bitcoin phenomenon, but there is one very peculiar and puzzling feature of Bitcoin that we didn’t get to discuss and that seems especially important to me: the Bitcoin system has what appears to be a built-in deflationary architecture.

When the Federal Reserve System was created, it was charged with providing the US with an “elastic currency”. That means that the quantity of Fed-issued dollars in circulation is supposed to vary in response to the changing dynamics and needs of the real economy. The Fed is expected to monitor economic activity, and conduct a monetary policy that provides us with a stable but flexible medium of exchange.

Bitcoin, by contrast, is much more rigidly designed so that new bitcoins are introduced into the system at a mathematically predictable rate that is almost completely independent of any economic activity for which bitcoins might be used. New bitcoin production is supposed to take place at an exponentially decreasing rate so that production decreases by about 50% every four years. As a result, the number of bitcoins in existence will effectively flatten out at 21 million in about 2040 – if anybody is still using the Bitcoin system by then. But long before 2040 the rate of bitcoin growth will slow very dramatically.

The Bitcoin system therefore possesses a hard-coded and extremely rigid monetary policy determined by the software itself, software which lives on the computers of everyone who is participating in that system. Now, you could say this means Bitcoin’s monetary policy is decentralized. That’s certainly how Bitcoin enthusiasts tend to describe it. But another way of looking at it is that it is that Bitcoin’s monetary policy is highly centralized in the persons of the people who wrote the Bitcoin code, and who established a weirdly inflexible Bitcoin monetary policy regime in advance – determined for all time.

Now what does this mean for the future value of Bitcoin as a medium of exchange? That all depends on whether the Bitcoin economy – the universe of producers of goods and services who accept bitcoins in payment – continues to grow, or instead settles into a small and unchanging niche economy for a limited number of enthusiasts. But suppose as a thought experiment that the Bitcoin economy continues to grow, and that the volume of goods bought and sold with bitcoins continues to increase, as the rate of bitcoin creation first slows and then flattens. Then one of two extremes might occur: either (i) prices in bitcoins remain stable as the rate of bitcoin transactions increase, or (ii) the rate of transactions stays roughly the same, but bitcoin prices fall as the finite quantity of bitcoins is spread over more and more transactions. Since the pace of transactions depends on real-world constraints on production and consumption, the effect that is likely to be the dominant one is that prices will fall. In other words, there will be a deflationary spiral in the Bitcoin economy. This makes Bitcoin a poor long-term candidate for a stable, alternative medium of exchange.

Deflation might appear to be an attractive thing at first look. Wouldn’t it be nice for our money to appreciate in value as the prices for goods and services continually fall? But economists associate deflation with two negative phenomena: First, if prices are falling then the incentive to hoard the currency increases, since anybody who possesses that currency is seeing its value increase each day. Thus, the currency itself becomes an appreciating investment vehicle for its owner, so long as it isn’t spent. Hoarding by an individual agent is no big deal, but it is clearly bad news for the economy when hoarding is widespread, since if people stop buying things, then producers stop producing things and stop paying workers to produce things. That’s one reason why downturns are often associated with deflation, and growth is usually associated with modest inflation.

The other problem with deflation is that contracts and debts are usually fixed in nominal terms, and so deflation makes debt more onerous. Imagine an office worker, Sal, with a $50,000 annual salary and a $200,000 debt, such as a mortgage debt. Now suppose there is a general deflation, and both consumer prices and wages drop 20% over some period of time. Sal’s wages fall to $40,000. Sal’s ability to buy groceries is unaffected since grocery prices have also fallen by 20%, but the $200,000 debt is now worth five times Sal’s annual salary rather than four times the salary, and has become much more burdensome. If the deflation continues, Sal will be wiped out. But before that happens, Sal’s creditor makes out handsomely as the real value of Sal’s monthly payments increases.

Bitcoins are infinitely divisible, so while there is an ultimate cap on the quantity of bitcoins, there is no lower limit on Bitcoin denominations: there is no Bitcoin “penny” that can’t be subdivided further. So Bitcoin’s designers seem to have built these deflationary prospects into the system as a feature, not a bug. And here we must look at another curious feature of the Bitcoin system, the feature its developers decided to call “mining”. As we have noted, Bitcoin has a built-in mechanism for adding new bitcoins to the system at a decreasing geometric rate. But note that new bitcoins are not simply sprinkled evenly among all bitcoin users when they are added to the system. They are awarded to “miners” – in practice, people who have substantial computing power and computing speed at their disposal – in exchange for those miners using some of their computer power to win online races to authenticate new blocks of bitcoin transactions.

So you can see why you would very much like to be a miner in a thriving Bitcoin economy and why early adopters of Bitcoin are so fanatical about keeping the system going. Those who manage to accumulate bitcoins in the earlier stages when the pace of bitcoin creation is high, could profit handsomely when the deflationary phase kicks in. These miners would, if the world-conquering dreams of the Bitcoiners ever came to pass, be something like the descendants of medieval vassals who acquired some poor land from their lords in an early era when there was still much land to be claimed and settled, and who then became fabulously wealthy over time by hanging onto their holdings as the finite stock of land was all brought into private owner ship and production while the population continued to increase.

So it looks to me like the developers of Bitcoin were thinking like this: “Mining system + deflationary architecture = we’re rich!!!”

However, none of these get-rich dreams are likely to materialize. Since the system’s architecture is set in the unchanging software, and we are looking at only a few years rather than several centuries as the time frame for the rapid exponential decrease in new bitcoin additions, sophisticated investors can all see the pre-determined and rapidly approaching deflationary future of Bitcoin, and will price that into their decisions now. Their incentive is to buy in the immediate term, accumulate some bitcoins, watch closely as they appreciate, and then dump them on suckers at the first sign of the broad market realization of the inevitability of the deflationary stage. There might be a few volatile swings before the final collapse hits for good, but eventually the speculative demand for bitcoin will evaporate, there will be a massive selloff, the deflation will reverse into a brief hyperinflationary spasm … and then pfffft.

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109 comments

  1. YankeeFrank

    The reasons for the deflationary aspect of bitcoin are irrelevant to the consequences, but its still interesting… either the idea was to perform a self-limiting experiment or the finite nature of bitcoin design was meant to attract the austrian/libertarian types, or both.

    However, it seems to me that it wouldn’t be impossible to simply modify the code in order to continue the expansion of the bitcoin universe, making it easier to “mine” them and removing the cap. In fact, it wouldn’t be that difficult to do this in a dynamic way in order to stabilize the price and remove the speculative interest from bitcoin: imagine a bitcoin system where coins aren’t “mined” in the silly and wasteful way they are now, but that new coins are “minted” by the software and apportioned equally to all current bitcoin holders as the relative bitcoin price rises versus other currencies, and then bitcoins are removed from accounts when prices drop. This would all be done in a decentralized fashion, but using (roughly) the principles central banks use with fiat currencies to moderate inflation/deflation.

    A system like this could be a vast improvement over our current central bank operations, which dump money on banks that then employ that money destructively by hoarding it and running up speculative bubbles while the real economy languishes in depression. The money printed by the “central bank” would be evenly spread directly to users of the currency via fiscal stimulus. There would be no monetary “operations” isolated from the real economy.

    In fact, this sounds like the model for a virtual currency based on MMT-style theory rather than the stupid Austrian/libertarian superstition-school of economic thought.

    Any MMT/post-Keynesians want to give it a shot?

    1. jrs

      I think that’s actually what is good about bitcoin, not that it’s embedded ideology is the right one, but that it is an experiment. And experiments are worth 1000 economists pontificating on what will happen. Now trying out economic experiments on entire countries is what is known to be disasterous. But bitcoin, limited in scale, voluntary, if anyone is foolish enough to put their entire networth in bitcoins, then you can have a general safety net, but you can’t save everyone from that kind of reckless.

      As for the wasteful mining of bitcoins, yes indeed. But you know all those theories about the petrodollar, and how the dollar is actually backed by oil, etc., which I’m too dumb to have an opinon on at present. Gold could also be said to be petroleum backed as it takes energy to mine it. Bitcoins are maybe intended to be a resource (energy) backed currency. The problem there is one might say there are better uses for energy than currency and economic experiments. So other experiments would be neat. The computer genius radical leftists I know are bored with money crankery (ho hum new monetary systems will not save us), but there has got to be some smart maybe computer science grad students out there willing to have experiments.

      The biggest problems with bitcoins seem to me to be just the problems with true anarchy in general (and not just “anarchist ideas” in a world with a state, which may be good). The guys empowered by such secretive currency may be quite worse than governments as bad as they are (and governments are pretty bad if you are say adding up dead Iraqis). Nontheless, it can *always* get worse and people may well regret unleashing that particular lawless element, the type empowered by an entirely encrypted currency.

    2. 66Scorpio

      You couldn’t “simply” tweek the system without unanimous consent among users or else the action of some centralized authority, which would defeat the purpose. What you would need is a completely new currency and system combined with a structured way to transition from Bitcoin to Bitcoin 2.0; and the transition structure would have the same inherent problems of getting unanimous agreement.
      .
      There is also the spectre of an infinite number of competing virtual currencies, each with their own “monetary policy”.

  2. Jim Haygood

    ‘The Bitcoin system has what appears to be a built-in deflationary architecture. When the Federal Reserve System was created, it was charged with providing the US with an “elastic currency”. That means that the quantity of Fed-issued dollars in circulation is supposed to vary in response to the changing dynamics and needs of the real economy.’

    When the Federal Reserve was created on 23 Dec 1913, the U.S. Consumer Price index stood at 10. Ninety-nine years later in March 2013, the CPI had ballooned to 233 (rounded):

    ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

    So Kervick’s wondrous ‘elastic currency’ now preserves only 4.3% of the purchasing power it had when official counterfeiting by a bankster cartel was ‘legalized’ a century ago.

    Obviously, anyone concerned about conservation of purchasing power wants a currency whose supply is strictly limited.

    But in Kervick’s morally inverted universe, incontinently-created dollars serve as the reference, while a conservatively-managed currency is dismissed as ‘deflationary’ in terms of the dollar’s rubber yardstick.

    Kervick is an emblematic example of ‘defining deviancy downward,’ a wonderful expression bequeathed to us by the Clinton years.

    1. Dan Kervick

      So Kervick’s wondrous ‘elastic currency’ now preserves only 4.3% of the purchasing power it had when official counterfeiting by a bankster cartel was ‘legalized’ a century ago.

      And how much did an hour of your labor purchase in 1913? How many dollars did you receive for it? The purchasing power of the currency itself is irrelevant to standard of living and labor purchasing power. In 1913, a union plumber earned 75 cents and hour in Chicago. Now the average plumber makes about $26 dollars an hour. If the price level is now, as you say, 23.3 times what it was 100 years ago, and the hourly wage in a profession is 34.7 what it was 100 years ago, then the purchasing power of an hour of labor in that profession has increased by 49% and members of that profession are better off.

      http://www.bls.gov/oes/current/oes472152.htm

      http://www.bls.gov/oes/current/oes472152.htm

      Of course, the purchasing power of an hour’s labor was increasing faster in the olden days of the mid-late 20th century before neoliberals destroyed labor bargaining power.

      1. 66Scorpio

        A 23200% increase in the CPI over 99 years is a compound rate of just over 5.6% annually. Modern central banks like the Bank of Canada aim for 2% per year which is about as close to zero as they can get without risking deflation, which has proven far more damaging to economies.

    2. Samuel Conner

      I like the MMT distinction between “stock” and “flow”. Very little of the stock of currency from the time of the founding of the Ged still exists. But the flow of currency through the economy and the activity this flow has facilitated has made the US immensely richer than it was. The writer seems to regard the principal function of currency to be “store of value”. It’s also “medium of exchange”, and the medium of exchange function is vastly more important than the store of value. There are all sorts of real assets one can use as a store of value in place of currency. There are very few mediums of exchange, as we almost found out in 2008 when the payments system threatened to break down.

    3. Susan the other

      Question: What is the difference in elasticity between the infinite divisibility of bitcoin and the sovereign capacity to print or tax?

      1. Massinissa

        Turning a dollar into ten dimes doesnt actually increase the amount of money.

        Money printing actually creates more money. Its different than just dividing a dollar or bitcoin into parts.

    4. from Mexico

      Jim Haygood says:

      Kervick is an emblematic example of ‘defining deviancy downward,’ a wonderful expression bequeathed to us by the Clinton years.

      Well I suppose a good offense is the best defense. But notwithstanding good rhetorical strategies, your unitary focus on the “conservation of purchasing power” of the currency, while completely ignoring other important considerations, is just a little bit “deviant” in itself, to say the least.

      Argentina, and the anti-neoliberal polices implemented by your hated Kirchners, provide one of the best counterfactuals to the hard money lunacy you daily proselytize on these threads.

      Since Argentina defaulted on its debt back in 2002, inflation has been quite high by many standards. The yearly clip has varied between 6.1% and 41%. But in spite of this, GDP growth has been robust, around 9% per year except in the depths of the GFC, when in 2008 to 2010 it registered 6.8%, 0.9% and 7.5%. In 2011 it rebounded to 8.9%.

      The population below the poverty line has fallen from 37% in 2001, under the old neoliberal regime, to 30% in 2012.

      The unemployment rate has dropped from 25% in 2001, under the old neoliberal regime, to 7.2% in 2011.

      Industrial production growth has also been robust, racking up health gains between 4.3% and 16.2% every year except 2009, when it fell 1.2%.

      And perhaps just as important, none of this is being financed by foreign hot money. Externnal debt has fallen from $155 billion in 2003 to $136.8 billion in 2012. From 2004 to 2011 Argentina ran a positive current account balance.

      Here are the charts:

      http://www.indexmundi.com/g/g.aspx?v=66&v=69&v=74&v=71&v=78&v=145&v=94&c=ar&l=en

      1. from Mexico

        Argentina has had an amazing run, brought about by defying the neoliberal juggernaut. “The government shuns orthodox policies and spends heavily to stoke swift economic growth,” Reuters reports.

        http://www.reuters.com/article/2012/08/10/us-argentina-economy-idUSBRE87912G20120810

        It’s of course unclear whether it can keep it up, for no one can predict the future, even though the neoliberal harbingers of doom are convinced they have a crystal ball. But I think actual past performance speaks louder than mere speculation. As Jose Ignacio De Mendiguren, head of the Argentine Industrial Union (UIA), put it: “Our main concern is competitiveness. People know devaluing (the peso) is bad but you need to look at why we’ve gotten to this point.”

      2. from Mexico

        And as Reuters goes on to report:

        Maintaining a competitive exchange rate was one of the pillars of economic policy under Nestor Kirchner, Fernandez’s late husband and predecessor as president.

        [....]

        Many economists say inflation will remain high because of the central bank’s heavy volume of money-printing, part of which ends up financing the government as its fiscal deficit widens.

        The broad M2 measure of money supply grew 33.5 percent in 2011, official data shows. That tempo has cooled slightly but still showed a 31.5 percent year-on-year expansion in June.

        In addition, state spending outstrips revenue growth and analysts see the first primary deficit in years.

        A charter reform passed in March made it easier for the central bank to lend money to the Treasury and freed up the use of more foreign reserves to pay government debt. It also shifted its focus away from controlling inflation to boosting economic growth and employment.

    5. reason

      Yawn!

      Now project that back 2000 years and everybody (EVERYBODY I SAY) should be fabulously rich! (Remember all those arguments about saving a penny in 2000 with interest at 1% – what would it be worth today?)

      mmm. See the logical fallacy? I guess not. (Hint every now and then some people get wiped out). Making positive returns requires risk – why do you think you should be an exception to this rule?

      Then read the original piece or Samual Connor’s excellent reply.

    6. Valissa

      Jim, you are always such a troublemaker… I love it!

      Some bitcoin cartoons to lighten things up a bit…

      The Bitcoin Comic, part 1 http://fc00.deviantart.net/fs71/i/2011/210/4/d/the_bitcoin_comic_by_z1xwitch_by_z1xwitch-d420ssd.png

      The Bitcoin Comic, part 2 http://24.media.tumblr.com/tumblr_lmvszogYsm1qziwyso1_500.png

      The Bitcoin Comic, part 3 http://fc00.deviantart.net/fs70/i/2011/168/2/8/the_bitcoin_comic_by_z1xwitch_by_z1xwitch-d3j5ykp.png

      The Bitcoin Comic, part 4 http://fc05.deviantart.net/fs71/i/2011/174/1/4/the_bitcoin_comic_by_z1xwitch_by_z1xwitch-d3jszv3.png

      Bonus cartoon with article… How Bitcoin could destroy the state (and perhaps make me a bit of money) http://www.spectator.co.uk/columnists/hugo-rifkind/8874321/how-bitcoin-could-destroy-the-state-and-perhaps-make-me-a-bit-of-money/

    7. Calgacus

      Jim Haygood: You would only have had such a purchasing-power loss if you had held your money in a zero interest checking account since then. A description which would fit nobody at all, probably. If you held the money in printed bills in a mattress, the numismatic value would be much larger than the face value.

      But those are just jokes. If, realistically, you had held that money in interest bearing Treasury bonds, you – more realistically, your descendants – would have comparable purchasing power – in a very different world. Interest rates in the 20th were higher than the 19th. And contrary to mainstream quackonomics, this will probably cause higher inflation, not lower, especially over such very long runs.

      Obviously, anyone concerned about conservation of purchasing power wants a currency whose supply is strictly limited. Well, that is the MMT proposal – to eliminate unemployment by strictly limiting how many dollars can be obtained from an hour of labor, through a fixed wage Job Guarantee, which will be much less inflationary than (quite possibly deflationary) the crazy idea of forcing people to be unemployed.

      Over a comparable period – well – bitcoins will be a long-forgotten scam. Bitcoin holders, if really lucky, there might be some curiosity value, but collectors will probably want something more physical. Which would you pay more for – the computer that received or sent the first email, or a chain of attestations of the receipt of the first email?

      All currencies are “virtual” and always were. Fiat dollars mean something, are intrinsically valuable, and they are always linked to the real economy. Bitcoins mean nothing a buy-in to the greater-fool theory. Could last a while, markets can be irrational longer than short-sellers remain solvent. But the end is inevitable, when big bitcoiners need to cough up some real dough (say they’ve overleveraged in the real world, for real fiat money) and start selling their bitcoins.

  3. Richard Kline

    Bitcoins as digital prions for the libertaustrianards? Mephistopheles is alive and well, and living on a floating island in the bitstream.

  4. Stefan Loesch

    Bitcoin can only survive if it becomes a transactional ‘parallel’ currency (eg for cross border transactions); if people start hoarding it rather than using it for transactions it will become easy to attack (and hence fail) once mining slows down. As a parallel currency however it does not need to be deflationary once demand is settled at a decent level – but of course a lot of stars must align for this configuration to be stable

    http://www.oditorium.com/ou/2013/04/why-bitcoin-will-never-be-a-good-store-of-value/

    As an aside: bitcoin is not infinitely divisible- 100,000,000 Satoshi is one BTC; so approx 20m is maximal number of bitcoins outstanding, so maximal money supply is 20m x 1m x 100 Satoshi = 20tn x 100 Satoshi

  5. Claudius

    I think you, perhaps, ascribe too much of a monetary basis to aka Nakamoto in the vre3ation of Bitcoin and not enough of a practical; consideration. As commented in an earlier Bitcoin post by Yanis Varoufakais.

    Ref: http://www.nakedcapitalism.com/2013/04/yanis-varoufakis-bitcoin-and-the-dangerous-fantasy-of-apolitical-money.html#comment-1218973

    Specifically:

    “…..But alongside Yanis’ two fatal flaws there are three (or more) others that will actually limit/prevent the use of crypto currencies. (1.) Crypto-currencies won’t be allowed to go much further), 2.) Crypto-currencies can’t, practically, go much further (and 3 potentially, almost, everyone using crypto-currencies will want to stop using them).

    2.) Why can’t Crypto-currencies go much further?
    Inherent within the design itself, all crypto currencies to-date depend for their operation on a block-chain, a digital entity that chains together every transaction that has happened dating back to the currencies’ launch. The reason, perhaps, aka Nakamoto designed a currency limit is because by its nature, this type of block chain will grow rapidly and without limit, ultimately becoming cumbersome for ordinary end-users running a client program on a PC – imagine being the 50 billionth transaction on your atom CPU, 1500Mhz mobile phone processor.

    The rate of Bitcoin issue is almost (not quite) in relation to Moore’s Law (and Wright’s Law) and provides approximations of the pace of technological progress. Moore noticed that the number of transistors per square inch on integrated circuits had doubled every year since their invention. Moore’s law predicts that this trend will continue into the foreseeable future (though, there are some predicted limits emerging).

    Looking at Amex, MasterCard, Visa , the cards only, the handles on average around 2,500 transactions per second (tps), – with a daily peak rate of 4,500 tps but, have “burst” capacity for over 11,000 tps – which they need to handle the busiest points.

    Bitcoin is currently able to perform around 8000 block-chain signature verifications per second on an quad core Intel Core i7-2670QM 2.2Ghz processor (because, it‘s a peer-to-peer transaction – not a centralized’ish processing transaction such a Visa). This means 4000 tps (about the same rate as Papal) is just achievable with a fairly mainstream CPU. And that’s the point…. currently, mainstream computer. Anything more and the CPU would fry like an egg on a Texas highway.

    If Bitcoin is to scale to include all economic dollar transactions worldwide, including cash, it would be a lot higher than those 4000 tps; more like 4,000,000 tps. Assuming a constant rate in the increase of transactions in relation to the number of coins in circulation, the Bitcoin chain-block would quadruple about once every 18 months.

    Aka Nakamoto may not have been a deflationary economist, but he was certainly a fan of Dr. Moore.

    1. Dan Kervick

      Yes, I believe all of those things too. The monetary system is part of the broader economic system, and decisions about how it should be structured are, and should be, inherently political. I just wanted to bring out one point that I had hoped to raise in the interview but didn’t get to, because I think it points to something telling about the mindset of Bitcoins developers.

      Bitcoin has a monetary policy. But it’s a very weird monetary policy because the pace at which new bitcoins are released into the world is pre-determined by a mathematical algorithm that has almost nothing to do with how and whether bitcoins are functioning in the real world of economic exchanges external to bitcoins. So Bitcoin looks to me like an exercise in pure mathematical computer science uninformed by common-sense economic thinking.

      Now I suppose Bitcoin’s monetary policy can change, and its code can be re-written. Who will make these decisions?

      1. Paul W

        I find it hard to believe that after 2008 and the behavior of our politicians since then(in every western nation) that an intelligent observer would still believe monetary policy should be controlled by politicians. How many more economic disaster do we need to have before people realize that monetary policy subject to the whims of the most dishonest members of society is not in the best interest of the average person? You need to get politicians and bankers out of the equation and provide people with a stable monetary policy they can count on.

        1. Susan the other

          That is probably the eternal quandary. In order to have functional finance you first have to have functional politics. But if some clever software designer could design bitcoin to be such a controlled commodity, another clever soul could certainly design software that would distribute and maintain the wealth equitably throughout any system.

        2. jrs

          But are they the most dishonest members of society? Yes maybe there are incentives and you need to be dishonest to get in (the corruption of the political system with money would tend if that direction, even though I’ve never seen proof you 100% have to be corrupt even at the lower levels). But is it the only system with incentives attracting the corrupt at this point? Incentives to attract corruption or more broadly harmful behavior don’t strike me as unique to the government, or that there is any reason they should be.

          So yea, if any, I’m partial to alternative currency with a built in moral bias. That tries to properly account for the value natural resources, etc.. Otherwise you may have a stable currency, which may be of benefit, maybe it prevents a 2008 for all I know (which was not only painful to many people personally (lost jobs) but also provided a pretext for massive wealth transfer to the already wealthy), but I’m not sure the world you will have won’t be just as viscious and frankly if ecosystems are not valued I suspect doomed.

        3. jrs

          But why should currency worry about the environment? Well there have been attempts to build this into currency which might be promising, but maybe currency itself shouldn’t be concerned with this. But bitcoin isn’t only anti easily manipulatable currency (the gold standard when implemented by governments was that), it seems it’s trying to evade government entirely and not just in the currency realm (via being non fiat) but in the transactional and money making realm (via crypto). So … who will control the worst private and black market abuses of this? Which could be environmental, but immediately are probably just more pure black market.

        4. Nathanael

          Paul, there is quite literally no alternative to politicians.

          What would you prefer? Dictators? (They’re politicians too.) Anarchy? (Impossible: a demagogue will quickly rally enough people to end it.)

          *By the definition of the word*, the people running the government are politicians. There is no way to avoid having a government, so there is no way to avoid politicians.

          You can reconstruct the system so as to have *very different* politicians who are *nothing like* the ones we have now. That would Actually Make Sense. The random, meaningless ranting against “politicians” doesn’t make sense.

      2. Phil

        Now I suppose Bitcoin’s monetary policy can change, and its code can be re-written. Who will make these decisions?

        If any one entity controls more than 50% of the processing power in the transaction processing network (i.e., the “mining capacity”), they can make their own rules based on which version of the software they run. So the answer, in that context, is whomever puts the most processing online.

        There is currently a move away from GPU-based mining to ASICs; the first movers are putting vastly more processing power on the network than anyone else, and because the difficulty of mining new coins scales with processing power (so a new block containing coins is found roughly every ten minutes), the declining profitability of GPU mining will cause many people to exit the enterprise. (It’s almost laughably unprofitable at all but the most speculative prices for Bitcoin anyway; miners seem to be powering through that with a combination of ideology, non-rigorous thinking and the sunk cost fallacy.)

        As a result of these two trends, one mining pool is very close to the 50% mark, and I think we could expect them to exceed it in short order.

        Even now, it’s possible for a small number of parties to collude in order to manipulate the blockchain. Recently a software bug created two divergent versions of the blockchain. The software developers reached out to a couple of people who run the large mining pools and the coordinated to ensure that one of those versions won; no effort was made to compensate people who had mined coins or registered transactions on the other version.

        So the answer to your question, as in most practical implementations of Austrianism, is: the strong.

        1. Thisson

          I would submit it for your approval that the miners are, in actuality, stealing the electricity that powers their processors, so they are in fact making money at lower bitcoin prices than you suspect.

    2. Dichromate

      The whole thing was carefully designed to pay off massive returns to the architects of the system, who to this day control the bulk of existing bitcoins.

      1. Valissa

        Of course! How is this any different from the creation of the Fed? Or of any type of monetary system ever. People create such things for their own benefit, though they sometimes manage to convince others it’s for theirs.

        Why do people keep trying to find the fair-money fairy? If you want a so-called fair money system you’ll have to create it yourself, not expect the authorities to do it for you.

        1. LifelongLib

          In a democracy it’s the authorities job (among many others) to create a “fair money system”. If we no longer live in a democracy (or the authorities aren’t doing their job) we have far worse problems than just the money system.

          1. Valissa

            That is an ideal, esp. a liberal ideal. There is nothing wrong with that ideal, however as student of history I have never seen it enacted. In high school we were taught a lot of idealistic propaganda about democracy and our gov’t. It’s not reality, though. Some eras have been slightly more fair to the little guy, and sometimes the elites have tried a bit harder to meet that ideal (or been pushed into some of it by the little people) but in the end it’s ALWAYS been about power and money.

        2. reason

          Please list the designers of the Fed and how they PERSONALLY benefitted from its creation.

      2. Phil

        There’s actually substantial evidence that this isn’t true. The original author of the Bitcoin white paper was involved with the community for a while after its publication. During that time, he clearly regarded it as a cryptonerd thought experiment, and not as a “production-ready” system. He stopped disappeared before people seriously tried to make Bitcoin a working monetary system.

        It is evident from the blockchain that no “dragon horde” of Bitcoin exists that might be analogous to a founder’s share. There are large, old wallets, but if there were an El Dorado outlier, it would be obvious. (Those old wallets were almost certainly all created when mining was cheap and Bitcoin was a novelty and/or a mildly interesting distributed computing problem. Most of them were subsequently deleted or the passphrases were forgotten, and the coins are therefore forever lost. This paper estimates that 51% of all the coins mined ended up trapped in “dormant wallets” like this. It’s possible that Satoshi is hiding out there, I suppose, but it’s really unlikely.)

        If Satoshi had such a horde, it’s hard to think he wouldn’t liquidate in the runup to $250. That value was unheard of, even during the first Bitcoin bubble, and there is no fundamental reason to think it’s a fair price, or one we will ever see again. (There is also no reason it won’t shoot up to $1000 out of sheer crowd psychology, so I guess there’s wiggle room for a conspiracy theory there, if you’re so inclined.)

        1. Dan Kervick

          During that time, he clearly regarded it as a cryptonerd thought experiment, and not as a “production-ready” system.

          That’s my guess too.

  6. Paul W

    What’s the difference between someone who hoards money and someone who saves money? People who hoard money actually save their capital and many invest it. This used to be what caused growth in capitalism, before creditism took over.

    I am one who hoards money. Guess what, I still have to eat, which means I still spend it(I just don’t spend all of it or spend more than I have). I do not sit at home hungry and wait to spend my money tomorrow because products will be cheaper. Likewise if I need to pay for major expenses I do not put them off because I can save money later. It’s a great idea – right up my alley. Instead of buying a new furnace this year I’ll go next winter without one(or using the old one as little as possible to reduce the chances of a breakdown) then buy a cheaper one in 2014. Perhaps a year from now I’ll decide to wait until 2015. Heck! why not do without a new furnace and just hoard that money forever?

    I’m sorry but few people save money for the sake of saving it. They use money to buy the things they need, to save for future security or to invest to earn more money for either of the above reasons. Deflation does not dictate how much more they save. In fact I know many people who are not capable of saving. I knew some in the early 1980s when interest rates were 20% and I know some in the easy money era of today. Deflation might protect these people from themselves. However endless inflation just preys on their weakness and exploits them.

    As for your friend with the $200,000 debt, in a more stable, slightly deflationary world of bitcoin or a gold standard she is never going to be able to run up that large a debt in the first place. Easy money allows for that and further easy money is not going to put an end to such practices.

    1. JCC

      Not that I’m a big fan of bitcoin, but the author brings up an interesting point regarding deflation and debt, as does Paul W. and the difference between saving and hoarding.

      Why not, regarding bitcoin’s deflationary tendency, put a mechanism in place that, as prices fall, the amount of debt also falls accordingly? In other words, contracts could be written such that if the measured deflation is 20%, the debt is also adjusted by the same 20%. Voila! A stable money system.

      Maybe we would lose the, I believe misplaced, reliance on massive consumption (mostly junk) in order to prop up an economy long-term, not to mention that savers (not hoarders) would benefit for a change.

      1. Dan Kervick

        The same is true in an inflationary system. People can make contracts that peg the payment terms to the CPI or some other arbitrarily chosen measure of the price level. Inflation expectations are often priced into interest rates. But these rates are always somewhat unpredictable.

    2. washunate

      I don’t support a gold standard (I don’t think the monetary system should be tied to any specific commodity), but I wholeheartedly agree with your comments on saving and debt.

      I am amazed at how broadly the notions that ‘saving is bad’ and ‘debt is good’ have spread. It’s such a silly position that I have a hard time believing that that is actually what people are advocating. Surely there is a mis-communication somewhere in there…yet, these arguments keep coming up about how deflation is terrible because it means people hoard capital. And the solution to excessive debt is to inflate it away rather than putting incompetent lenders through bankruptcy (and preventing excessive debt from happening in the first place).

      Oh noes, the horror of saving!

  7. JGordon

    Feel free to debase your “political” currency (from the private Fed issuer) as much as you like. The more you debase, the more motivated I’ll be to use something else.

    Now, if the Fed were managing it’s currency worth a damn, we wouldn’t be having this debate at all, now would we?

    1. Malmo

      Don’t fret, JGordon, it will all be good once we dispose of the corrupt folks that saturate our plutocracy. Then we can all be one happy family, 300 milllion strong. LOL.

      1. jrs

        Sure glad noone corrupt could possibly use bitcoins to advance their corruption. Whew, so glad we can live in anarchist paradise now. I’d like to buy the world a coke …

        1. Malmo

          Who said anything about an anarchist paradise? Criticising the present corrupt arrangement is off limits in this framework? Reacting to said corruption with an interest in the idea behind bitcoin makes one an anarchist? Really? What brand of anarchism? Right wing–libertarian– anarchism? You do know that libertarian anarchism is seen as a contradiction in terms, at least in juxtaposition to anarchism as viewed by the left?

          1. Valissa

            I have observed that the left is becoming increasing hysterical and irrational about anything remotely labeled libertarian. Once the whiff has been scented, the dogs start salivating and the formula works like this… libertarian=Ayn Rand=Koch Brothers=EVILLLL…. and there is never any rational, non-emotional conversation on this, just ranting. I don’t think most folks have even bothered to go to Wikipedia and read up on libertarianism to see how diverse the thought really is. It’s all about selectively picking the worst aspects of it (and yes, those do exist as all political ideologies have their downsides, and no, I’m not a libertarian… I’m an unbeliever).

            btw, there is such a creature as an anarco-libertarian, and there are many left libertarians. If you do an internet search on these topics you will find quite a bit of interesting information.

          2. jrs

            I don’t think there is any lacking of criticizing the current corrupt arangement here in the blog or the comments. I interpreted it the original point I was replying to was that hoping for a solution by disposing of the corrupt folks in our plutocracy is too idealistic and naive. And I was just trying to make a point that hoping for a solution in an *amoral* currency completely outside government is also and equally if not even more naive in my view. Certainly I don’t see anyone hoping for that to have much basis to criticize those who would turn thier efforts to fighting corruption in government.

            As for anarchism, if the system wants to be completely outside of government I think anarchist is not an inappropriate word. I’d concur the statelessness embedded in bitcoin has a distinctly right wing flavor (or the built in ideology would be different).

            I dont’ think I’ve posted here in any form of hysteria, other sins maybe, but hysteria and in a bitcoin discussion of all things? More like I’m not convinced that bitcoin is really any kind of solution.

          3. jrs

            I tend to see libertarians as either just defenders of the existing economic system or an even more harsh version of it (the existing economic system only minus all safety net will be even harsher!). Libertarianism as cover for that harsh agenda is not unheard of and is probably why many people who are really just Republicans (but not religious right) self-identify as libertarian.

            Or else I see them as extremely idealistic and naive because they think they know exactly how some world without government would function, and it seems so dubious to me.

          4. Malmo

            Libertarians aren’t monolithic at all. I identify strongly with the anti authoritarianism that runs through many of their ilk though. In fact, I consider myself a person of the left–in general– but what annoys me most about many leftists is their control freak personas (authoritarian bent). I’m for as much freedom as is humanly possible. At the same time I want a social safety net that is far beyond what exists at present. We really can’t get away from living togetehr as a people, but at the same time I don’t want busy body Joe in DC micro managing my every move. I want to share the nation’s spoil more or less evenly, but I don’t want to roped in by centralized bureaucrats dictating my every move. Libertarians aren’t the enemy. Technocratic control freaks are.

          5. Valissa

            @Malmo… well said & very sensible! But it’s a tough balancing act because the more gov’t helps people the more it knows about them and the more it can’t help but want to control them more and all of that makes the gov’t ever bigger and invasive. It’s a nasty feedback loop.

          6. Malmo

            I generally like people of all stripes, so even if we don’t exactly thread the proverbial needle as a society I can still be more or less content and happy. I hate those who needlessly have to suffer though. That is simply disgusting. It’s at that point where I part ways with many pick yourself up by your bootstraps libertarian types.

          7. Valissa

            The extreme self-sufficiency end of the libertarian spectrum seems to me to be a bad case of macho posturing. Lots of big tough guy talk.

            I therefore claim to show, not how men think in myths, but how myths operate in men’s minds without their being aware of the fact. — Claude Levi-Strauss

            This quote can be applied to politics as readily as religion, since they are very similar.

            Sakka asked the Buddha: “Do different religious teachers head for the same goal or practice the same disciplines or aspire to the same thing?”

            “No, Sakka, they do not. And why? This world is made up of myriad different states of being, and people adhere to one or another of these states and become tenaciously possessive of them, saying, ‘This alone is true, everything else is false.’ It is like a territory that they believe is theirs. So all religious teachers do not teach the same goal or the same discipline, nor do they aspire to the same thing.

            “But if you find truth in any religion or philosophy, then accept that truth without prejudice.”
            -Digha Nikaya

    2. reason

      Wrong
      The more it is “debased” the less motivated you will be to “hoard” it. “Hoarding” is NOT the same as “using”. A small stable positive inflation rate encourages “use” but not “hoarding”.

      You really need to be careful with semantics.

      1. JGordon

        The more it’s debased, the more I’ll be motivated to take my toys and leave up out of the game entirely. Your cute little theory works in a small, limitted range of circumstances, but here you’ve run with it and imagined that it applies every where all the time, which is ridiculous.

        If you’re ideas could be generalized then fiat currencies would not constantly be collapsing. But since no one has yet found a pure non-commodity backed fiat currency that survives for more than a few decades it’s pretty clear that you are engaging in some patently fallacious reasoning there, as monetarists/Keynesians always have to do to sustain their bizarre beliefs.

    3. F. Beard

      Now, if the Fed were managing it’s currency worth a damn, we wouldn’t be having this debate at all, now would we? JGordon

      Correct, which is why the MMT folks are going to have to decide between a free-spending monetary sovereign limited only by price inflation and the current government-backed credit cartel, which is a huge source of price inflation.

      1. JGordon

        I don’t know that MMT has ever thought about this. These guys seem incredibly confused and aimless when it comes to things like the Fed and corruption.

        I mean, is there ever a case where spending money into existence is bad? Before you all say that I’m twisting your ideas around and putting up strawmen or some crap like that, get serious: where in MMT are there hard and certain rules about where spending money into existence is a bad idea–because if there aren’t any, then guess what: spending money to increase corruption, wars, and Monsanto helps the economy according to MMT–and that’s not a strawman. Actually, there’s another kind of fallacious thinking that MMTers themselves are guilty of: special pleadings.

  8. Kukulkan

    I presume bitcoin is intended to replace other currencies for all types of transactions, which would include lending money at interest. If there’s a fixed number of bitcoins available, then paying interest would only serve to increase the proportion of bitcoins held by the lender.

    That is, if the total number of bitcoins is 21 million, then the number of bitcoins held by any individual can be expressed as a percentage of that that total. So, someone with 210,000 bitcoins would have 1% of the total number of bitcoins. If they were to lend a portion of that, say 2,100 bitcoins at 1% interest, then when the loan was repaid they would get 2,121 bitcoins back, meaning they would now have 1.0001% of the total. Repeat this process sufficiently and the fraction of the total bitcoins controlled by the lender would increase — slowly at first, but at an accelerating rate — while the fraction of bitcoins available to everyone else would decrease.

    As far as I can tell, this would lead to a crisis very much like the one that hit in 2008: a massive amount of debt — claims by lenders for bitcoins that far exceed the total number of bitcoins available, say total claims for 40 million bitcoins (mostly generated by accruing interest) while there are only 21 million bitcoins available — leading to increasing austerity and privation being imposed as lenders try to squeeze as many bitcoins out of everyone else they can in an attempt to get what they’re owed.

    If anything, bitcoins would be even more prone to this particular type of crisis than the current system. The only way a bitcoin economy could avoid it would be to have a regular jubilee in which all debts are dissolved in order to ensure that the total number of bitcoins (both owed and actual) never exceeds the total of 21 million that are available.

    Either that, or bitcoins simply could not be lent out at interest. Which would mean that in a bitcoin economy no-one could live off their investments, including retirees.

    Or, am I missing something?

    1. reason

      The one problem I see with this argument, is that given the deflationary bias in the system, why would anybody ever borrow?

      1. Kukulkan

        reason wrote:
        The one problem I see with this argument, is that given the deflationary bias in the system, why would anybody ever borrow?

        Probably for the same reasons they borrow now: to buy a home or a car or start a business or fund the expansion of an existing one or pay for a college education or deal with some other immediate need. People who actually use money as a medium to facilitate exchange end up with all sorts of situations in which they need spending power now rather than latter.

        You might as well ask, given the deflationsry bias in the system, why would anyone buy food today, when they could buy the same amount of food for less tomorrow? The answer is because you need the food today; no matter how much less the food would cost you tomorrow, it will not help you live until tomorrow. Also, if you wait until tomorrow, there’s no guarantee that there will be any food available, since those producing the food may decide that, since no-one is buying (they’re all waiting to buy it for less tomorrow), there’s no point in producing more food, there obviously being no market for it.

        1. reason

          You are forgetting this is an optional currency (i.e. they can use something else instead) and a deflationary bias pushes up real interest rates.

  9. pebird

    Not exactly infinitely divisible, to 8 decima places. . Not trying to nitpick :)

    As long as there are alternative currencies, Bitcoin will trade like a commodity, the limited supply property is a method to provide some confidence there will be value. If everyone hoards, alternatives will be used for exchange, which will decrease the value of Bitcoins, drawing them back into circulation.

    1. Phil

      Not exactly infinitely divisible, to 8 decimal places. Not trying to nitpick :)

      This is an artifact of the software, which uses double-precision floats to store the values. If they ever change to an arbitrary-precision data type, arbitrary fractions of bitcoin could be traded.

      I personally don’t think that limited supply (or really, anything) is sufficient to maintain a minimum value on Bitcoin. They are a thought experiment that, as a practical implementation, has serious flaws. (Some of them are probably intractable obstacles to the establishment of a decentralized virtual currency.) Eventually Bitcoin will be forgotten about, and their value will go to zero.

      Some people have created physical representations of Bitcoin, trying to jumpstart their use in the “real world.” I imagine those might have some collectible value someday.

    2. reason

      This is crazy – why would inflation (i.e. increased price of real goods in bitcoins), pull them back into circulation rather than cause a complete crash. Who would then accept them?

      This always seems to be the problem people don’t realise that money has to work always in two directions – both for buyers AND sellers, lenders AND borrowers. Complaints about inflation seem only to come from lenders (or worse hoarders). Don’t they realise that lenders fundamentally depend on borrowers – just as much as the other way around?

      1. reason

        This is why Dan Kervick wrote
        “the deflation will reverse into a brief hyperinflationary spasm”

        You need to think of dynamics not just some hypothetical negative feedback equilibrium. Maybe there is positive feedback.

  10. Bert Markgraf

    In my not-versed-in-economics view, it seems that a bitcoin economy might match a real world of limited resources very well, discouraging consumption, spending and lending while promoting saving and conservation.

  11. Dan Kervick

    A lot of the proposals for modifying the Bitcoin software seem interesting. But I think my basic issue is that any viable currency needs a viable monetary policy, i.e. a viable system for regulating the currency. And IMHO, there is no viable monetary policy for any currency that consists in coding-in a method for creating and distributing new units of the currency (or for holding the number of units constant) according to some pre-determined algorithm.

    Monetary stability depends on the way that form of money interacts with the real economy, and responds to changes in the real economy. Real economies are living, evolving and unpredictable things; and so the monetary policy for the currency has to be similarly flexible, responsive and adaptable. It’s an inherently messy and human problem, requiring human flexibility and ingenuity. While experience can teach some enduring lessons, there will never be a substitute for making much of it up as you go along.

    Bitcoin smack too much of the gamer/coder’s authoritarian Pygmalian urge to control a virtual world of his own creation. But the creative and chaotic world of production, exchange and innovation in the real world is no one’s creation and can’t be mastered via algorithm.

    If someone’s goal is to create a system of virtual money for buying virtual swords to behead virtual trolls in a virtual world whose rules that person has written, then fine. But the real world doesn’t work according to a simple algorithm.

    1. Phil

      If someone’s goal is to create a system of virtual money for buying virtual swords to behead virtual trolls in a virtual world whose rules that person has written, then fine. But the real world doesn’t work according to a simple algorithm.

      I don’t even think it works well there. But others might be better-versed on the economic complexities of Eve Online, Second Life or Team Fortress 2 than I. Yanis Varoufakis, for instance :)

      1. mfrohike

        I played eve for several years and did a lot of the economic side of it. Money is generated by killing npcs, completing quests, and selling items to shopkeepers. It’s destroyed by paying money to shopkeepers and minimal transaction taxes (base sales tax is 1% and can be lowered by training a certain skill). There’s probably an upper limit on money creation because you can only kill so many npcs or whatnot in a given period, usually measured in hours.

        The dev team brought in an economist a few years ago in order to make the economy more of a free market. Simple things were done like changing the makeup of store-bought components to effectively remove price floors for minerals which are the building block of just about everything in the game. As an example, a friend and I used to buy tons of a certain component and would refine it (break into its component pieces) for the mineral. The item was sold by the npcs, so it was at a fixed price, and was bulky. The bulk limited how many we could buy and move at a given time, but it did put a floor on our costs. When this item was changed in composition to remove the price floor, the mineral prices floated. The price of the things we would build, like ships and their components, really didn’t change much at all. The basic mineral, which we got from that item, increased in price over 50% but other minerals, which had been more expensive, declined in price for various reasons.

        The economy was pretty open for basic items but far more restricted for more advanced items. There’s stiff competition for the basic stuff in terms of price. If you sell in populated areas, your margins suck. We figured out how to use the in-game map to check population trends and where people traveled to set up shop in a backwater that had attractive npcs for players. In a backwater, you could boost your prices, sometimes ridiculously high, and people would pay it both because of convenience and because travel times are fairly slow. Essentially, we set up a market hub for a small area and were able to rake in the money.

        There’s more to be said, but it’s been a while and it’s late. Hope this helps a bit.

  12. F. Beard

    It should be obvious that a currency should neither increase nor decrease in real value. But “real value” is to a large extent subjective. Thus we should be “free to choose”* what currency(s) we use for private debts.

    *I don’t think M. Friedman ever advocated private currencies though. That was a “bridge too far” for him, I reckon.

    1. Phil

      I’m not sure it’s productive to think about currencies having a quantifiable value like commodities do. The “value” of a currency is that it facilitates productive economic activity. So many other factors influence productive economic activity that the importance of currency to that activity might vary widely from time to time, or even from transaction to transaction.

      It may be better to think of currency like a catalyst in a chemical reaction. We can develop guidelines and a large theoretical foundation to understand how they work, but in practice how much is needed and where is situational, and depends on what we want to happen. And that’s why chemical engineers (and central bankers) exist.

      (Assuming we can’t talk them down to the level of dentists, maybe we can convince central bankers that they’re only as important as chemical engineers? A man can dream.)

      1. F. Beard

        Our current money system has replaced workers with automation financed with the workers’ own stolen purchasing power. It was always going to lead to trouble and it has.

        Without the government-backed credit cartel, it is likely that business would have had to “share” profits with the workers instead of loot them.

    2. Thisson

      I don’t think it is obvious because people’s preferences for holding cash and their time preferences change, both individually and in the aggregate. When preferences change, values change.

  13. washunate

    Sure, if bitcoin supply stabilizes while dollar supply increases, then the bitcoin world is deflationary relative to the dollar world.

    Look, I just summarized it in one sentence :)

    As for some economists not liking deflation, who cares? I don’t mean that flippantly; I’m serious. In a monetary system with a currency supply growing more slowly than productive output (deflation) the benefits accrue to productivity – the people who are creating wealth will have the easiest access to capital. In a monetary system with a currency supply growing faster than productive output (inflation) the benefits accrue to finance and connected insiders – the people closest to the expanding currency supply.

    There is no absolute truth about which system is superior. Rather, there is only relative truth about which system you personally prefer. It’s no wonder many modern economists prefer inflation, because their wealth and prestige is premised upon an inflationary system. Or to say it differently, of what use are big banks and interest-based lending in a monetary world of mild deflation instead of mild inflation (a hyperdeflationary collapse would obviously be Not Good, but then again, ditto for a hyperinflationary collapse)? You wouldn’t have to charge as much interest, because the simple return of your lent capital would compensate you for much, or even all, of the risk of lending the capital.

    But with less/no interest, there would be slower/no corresponding expansion of debt, and with no debt expansion, how would the elite keep the indentured servants indentured? Transfers of wealth from workers to politically connected insiders would have to be more direct, because they couldn’t be hidden as easily in the broader trend of some things rising faster than others (such as median wages and CPI rising more slowly than health insurance premiums and executive compensation).

    This particular author’s preference is revealed in the story about Sal. First, it is dangerous to have $200,000 in mortgage debt if you only make $50,000 per year – that is one of the prime failures of inflationary systems; the out of control expansion of debt! Realistically, to have that much debt, you should have at least $40,000 invested in the property, which is an absolute minimum purchase price of $240,000. At a 2.5 – 3x ratio of affordability, the minimum compensation to afford such a place would be $80,000 a year, with $85,000 – $90,000 a year being more comfortable and $100,000 being not unreasonable for conservative financial planning.

    Second, deflation doesn’t mean Sal’s nominal wages go down. Rather, it means his productivity goes up. If there is some sort of major crash that could send his wages plummeting by $10,000 per year, in principle, Sal wouldn’t continue paying the $200,000 mortgage with these ‘more valuable’ dollars. He would discharge the debt, writing it down to a more reasonable level, and then continue on. Companies do this all the time. The reason it is trickier for individuals in the real world is because public policy has made this tricky – part of the broader goal of transferring wealth upward – not because deflation is inherently more problematic than inflation.

    1. F. Beard

      – the people who are creating wealth will have the easiest access to capital. washunate

      What capital? Deflation rewards risk-free money hoarding. Why take any risks when doing nothing brings real gains in purchasing power?

      1. washunate

        What? If you don’t take any risks, you will have exactly what you have. That’s kinda the point of risk-free behavior. If, on the other hand, you think you can do better than what you have, then you take the risk. You open that coffee shop. You start that computer business. You buy some farmland. Whatever.

        You’re asking why anybody does anything: because they conclude that the outcome will be worth more than doing nothing.

        Also, this notion that saving is bad I find very weird. The whole point of currency is that it doesn’t matter if people hoard it. It has no value other than the symbolic representation of the mental construct of money. It serves no real world purpose in and of itself whatsoever.

      2. washunate

        Maybe a real world example would be better than theorizing.

        Whether you like Apple or not, I think we can agree on two things:

        1) Their products are better today than they were 30 years ago.
        2) Their products are cheaper today than they were 30 years ago.

        That is hardcore deflation: both increasing quality and decreasing currency price. Yet, employees are still interested in working at Apple, and customers are still interested in buying Apple products.

        If hoarding realling is a systemic threat, why do people buy consumer electronics devices, particularly computers? Why not just wait until next year when they’ll be better and/or cheaper?

        1. F. Beard

          You’re confusing consumption with investing. Consumption is risk-free since the best one can buy today is useful TODAY even if next year an equivalent or better can be bought for less money. And despite that, people DO put off electronic purchases.

          But if people can gain purchasing power risk-free by doing NOTHING then doing NOTHING is encouraged.

          Money should not lose purchasing power but neither should it gain purchasing power.

          1. washunate

            I feel like I mostly agree with you, but I am not following you on this. My original point is that hoarding isn’t a problem. People will still borrow and still lend without meaningful inflation – just less. The hurdle for risk being ‘worth it’ is higher if the currency isn’t being inflated.

            That’s a Good Thing. Companies that lend recklessly should be put through bankruptcy (deflation), not bailed out (inflation).

          2. Nathanael

            Historically, deflation leads to a seizing-up of the vast majority of lending and borrowing.

            Borrowing becomes incredibly dangerous — so only crazy people do it. (More people will borrow if there is a generous system of easy bankruptcy. Which is of course inflationary.)

            Meanwhile, lending has a terrible payback — you can generally do better just sitting on cash — so only extremely gambling-mad people do it.

            Anyway, just look at one of the many deflationary periods throughout history (all pre-20th century) and you’ll see what actually happens.

          3. F. Beard

            My original point is that hoarding isn’t a problem. washunate

            See Matthew 25:14-30.

            People will still borrow and still lend without meaningful inflation – just less. washunate

            See Deuteronomy 23:19-20.

            OTOH, the Bible appears to have no problems with common stock as private money. But why should it since common stock as private money requires no borrowing or lending, much less usury? Nor does it require fractional reserves, a form of fraud. Nor does it require profit taking, another Biblical no-no. Nor does it oppress the poor as the current system does.

          4. washunate

            Thanks to both of you for continuing a great conversation.

            Nathanael, if it is possible to speak broadly, what has generally been bad about deflationary periods IMO has been the lack of basic social insurance programs and ROI-positive public works projects, not deflation itself. It’s the transition time for ordinary people, not the writing down of bad debt (decreasing the money supply), that is the challenge.

            Moreover, I’m talking about reasonably mild and predictable systems. The exact same point can be said about inflationary times – when they get out of hand, it’s bad. There’s nothing inherently better about expanding the money supply faster than the productive growth of the economy.

            F. Beard, that’s exactly my point. Humanity longs to be creative and productive and innovative. We don’t need an inflationary monetary system to push that. Who cares if one person buries their talent in the back yard? The other two go out and create something better. We celebrate the two who created more, and we mourn (even revile) the one who just buried it.

          5. F. Beard

            We don’t need an inflationary monetary system to push that. washunate

            I didn’t say we did. Ideally, a currency should neither lose nor gain real purchasing power. But “real purchasing power” is to a large extent subjective which is one reason we need to allow genuine private currencies (for private debts ONLY) and NOT allow a government-backed money cartel (as we now have).

      3. Thisson

        This reasoning is quite faulty. Prices for electronics continually decrease, yet people still buy electronics today even though they know that if they wait they can get something cheaper later. People don’t continually “hoard” their money instead of buying a computer or cell phone.

    2. washunate

      P.S., forgot to mention this at the top:

      “The Fed is expected to monitor economic activity, and conduct a monetary policy that provides us with a stable but flexible medium of exchange.”

      No, the Fed is expected to inflate the money supply, not keep it stable. I support having a central bank in principle (I’m not someone who thinks the Fed is responsible for all our problems), but why can’t we tell the simple truth that the Fed as currently organized is assigned the task of growing the money supply, not keeping it stable?

      Obama supporters especially, and many Dems generally, would be going absolutely ballistic if Bernanke announced he wasn’t going to fund the military misadventures and financial bailouts and all the rest of the waste in the budget – and of course, Obama wouldn’t have appointed him in the first place if Bernanke wasn’t going to print every dollar passed by Congress and signed by the President.

    3. Dan Kervick

      Sure, if bitcoin supply stabilizes while dollar supply increases, then the bitcoin world is deflationary relative to the dollar world.

      It has nothing to do with the exchange vs. the dollar or any other currency. The point stands even if Bitcoin were the only currency. The issue is about what the currency can buy in terms of real goods and services.

      Here’s some common sense I think: All-in-all, an economy functions better if prices are relatively stable and predictable. That makes it easier for people to make contracts with one another. Now if an economy is growing, the quantity of currency in circulation needs to grow along with the economy just to preserve price stability. If the quantity of the currency is pre-determined to grow at a slower pace than the growth in the total value of goods and services for sales, prices will have to fall.

      Whatever you think about mortgages and such, in modern economies people contract debt. A debt is just what you get when people make some kind of contract in which one of the parties has to perform their end of the contract at some time later than the first party performs. A lot of debts are monetary debts. Deflation – especially when it is unpredictable – benefits debtors and harms creditors. If you think that’s a good thing because debtors should be punished, fine. But it’s hard for me to see what social benefit is supposed to flow from this deflationary trajectory.

      If you want to design a new currency system, why not design one that delivers stable prices and that adapts as needed to the actual world of unpredictable economic activity, rather than being hemmed in by a rigid mathematical formula?

      1. F. Beard

        Deflation – especially when it is unpredictable – benefits debtors and harms creditors. Dan K

        You mean inflation, doan cha?

      2. Thisson

        The quantity of money does not need to grow to preserve price stability. Prices do not need to remain constant; they merely need to be reasonably predictable. So, for example, a fixed quantity of currency can suffice and, in such an instance, we would expect to see deflation; but so long as deflation is predictable, it is no more problematic than inflation. This predictability is part of the reason why the Fed targets a steady rate of inflation (2%) — you don’t see them trying to maintain constant prices with 0% inflation.

        1. F. Beard

          So, for example, a fixed quantity of currency can suffice … Thisson

          Who are you or anyone to decree what the proper amount of private money is?

        2. F. Beard

          but so long as deflation is predictable, it is no more problematic than inflation. Thisson

          Both inflation and deflation unjustly transfer purchasing power so BOTH are problematic.

      3. washunate

        “If you want to design a new currency system, why not design one that delivers stable prices and that adapts as needed to the actual world of unpredictable economic activity, rather than being hemmed in by a rigid mathematical formula?”

        I don’t have a problem with that. What I have a problem with is people saying that deflation is inherently inferior to inflation. There is no one right answer; it depends on how close you are to control of the currency.

        I also have a problem with this notion of ‘punishing’ lenders or borrowers. If suffering a financial loss due to engaging in the risk of economic activity is punishment, then there is no moral justification for allowing people to realize a financial gain from engaging in economic activity. The government should simply own all resources and distribute them by decree.

  14. Min

    “So it looks to me like the developers of Bitcoin were thinking like this: “Mining system + deflationary architecture = we’re rich!!!”

    “However, none of these get-rich dreams are likely to materialize.”

    I think that they already have. “Satoshi” has not been heard from for some time. OC, “his” work is done. But at the same time, I expect that he or they have already cashed out enough to live quite well.

    1. ian

      I’ve always wondered if the whole thing wasn’t a clever get-rich quick scheme by the authors. You get in at the start when the cost of mining is essentially nil, accumulate a bunch, then dump them later on if it takes off.
      If this is true, my hat is off to them.

  15. Beppo

    Tthe obvious weakness and exploitability of bitcoin hasn’t put off a load of fucking idiots who couldn’t tell a scam if it stunk like shit and they had dog-nose transplants. I made a hot dollar on them, anyway. The people who control the exchange are not on the level, do not buy bitcoins unless you’re using them as a semi anonymous intermediary exchange mechanism to buy drugs online. Thanks

    1. jrs

      Well actually I’d only buy or mine them to see how the system worked. Not as my new retirement savings vehicle (I’ll take my chances with worthless over-feed 401ks thanks), not instead of a lottery ticket. That kind of experimentation ok?

  16. kevinearick

    it’s a timer…

    Cinderella Economics on a Ship of Fools

    Only within an imploding empire of fools can a Krugman be fashioned to appear intelligent and only in an ivory tower collapsing from the bottom up can he garner groupies paid to worship debt as money. And only in the relatively knee-jerk psychology of divide and conquer politics, in which each peer pressure horizon controls the one below it, with arbitrary conditions, at the behest of the one above it, can digital monetary expansion with no mooring appear to be the solution for austerity, which was caused by the same monetary expansion, to hide an inherently flawed demographic insurance ponzi.

    As Mr. Market is so amply demonstrating, the only difference between employing paper gold as a lever and debasing a currency by other means is the efficiency and speed of empire collapse. Those on the leading two edges are not fooled and simply double down, forcing the empire to do the same, to accelerate capital control, collapsing itself. Gold is an effective standard bridge, but its utility is always relatively brief. The leading edge must advance to complete the circuit with the new technology, which it cannot yet see. Net, the middle class collapses, slowly at first, and then with increasing speed.

    There are many event horizons within the middle class, but it shares one characteristic that all middle class patrons have shared throughout feudal History, whether it has been dressed in socialism, communism, or capitalism, and that is the desire to get something for nothing, competing to see how much property can be taken with the least possible effort, enslaving others to the resulting debt for the purpose, to preserve the ponzi status quo. And what better patsies than the unborn, of robots programmed for the purpose. Of coarse they are obsessed with automation that eliminates people, automating their own path back to the DNA churn pool.

    America is a whore, inviting to the drunken debt consumer stumbling out of the bar at 2am, but revolting in the light of day upon awakening with the resulting hangover. The individual is beginning to wake up, in numbers, to see Hollywood for the whore it is, along with all the willing participants in the majority. That’s just how it goes in the end stage of the empire cycle. The Euro didn’t solve the problem, and neither will any other mongrel coming from any other marriage of failed cultures / empires.

    If you design the technology that can make or break economies, why would you accept debt from a failed culture, or a mongrel of failed cultures, as payment? Whatever you do, make sure I am the last in your line of lines, so you may employ me as a nigger to wash your dishes. Funny, there are no elevators in Mendocino. All politics is local, aggregated, and the prevailing currency will come from a community built for the purpose. Pot doesn’t work; it just makes the majority dumber, better empire fools.

    That is the State of the City…ComRats. I’m here; come get me when you are ready to be removed from the planet. I build bombs for Navy. That’s my function. What’s yours?

    1. kevinearick

      The majority pleads that it must follow the edicts of the elite, to stand on the heads of those so disenfranchised, to build the elite a watchtower, to supply and fortify it, and to build their own equity around it, crying that the outcome cannot be changed no matter which way it votes, saying one thing and doing another, despite outnumbering the elite many, many times to one. Never send a eunuch as a proxy for a feminist to do a man’s job, unless you want to make the feminist appear intelligent in comparison. Beware the Black Widow, which seeks only to make you brittle as it incorporates another to break you. Place another dress on the empress and try, try, try again.

  17. kevinearick

    ok, lets see what words are unacceptable…

    it’s a timer…

    Cinderella Economics on a Ship of Fools

    Only within an imploding empire of fools can a Krugman be fashioned to appear intelligent and only in an ivory tower collapsing from the bottom up can he garner groupies paid to worship debt as money. And only in the relatively knee-jerk psychology of divide and conquer politics, in which each peer pressure horizon controls the one below it, with arbitrary conditions, at the behest of the one above it, can digital monetary expansion with no mooring appear to be the solution for austerity, which was caused by the same monetary expansion, to hide an inherently flawed demographic insurance ponzi.

    As Mr. Market is so amply demonstrating, the only difference between employing paper gold as a lever and debasing a currency by other means is the efficiency and speed of empire collapse. Those on the leading two edges are not fooled and simply double down, forcing the empire to do the same, to accelerate capital control, collapsing itself. Gold is an effective standard bridge, but its utility is always relatively brief. The leading edge must advance to complete the circuit with the new technology, which it cannot yet see. Net, the middle class collapses, slowly at first, and then with increasing speed.

    There are many event horizons within the middle class, but it shares one characteristic that all middle class patrons have shared throughout feudal History, whether it has been dressed in socialism, communism, or capitalism, and that is the desire to get something for nothing, competing to see how much property can be taken with the least possible effort, enslaving others to the resulting debt for the purpose, to preserve the ponzi status quo. And what better patsies than the unborn, of robots programmed for the purpose. Of coarse they are obsessed with automation that eliminates people, automating their own path back to the DNA churn pool.

    America is a wh-, inviting to the drunken debt consumer stumbling out of the bar at 2am, but revolting in the light of day upon awakening with the resulting hangover. The individual is beginning to wake up, in numbers, to see Hollywood for the wh- it is, along with all the willing participants in the majority. That’s just how it goes in the end stage of the empire cycle. The Euro didn’t solve the problem, and neither will any other mongrel coming from any other marriage of failed cultures / empires.

    If you design the technology that can make or break economies, why would you accept debt from a failed culture, or a mongrel of failed cultures, as payment? Whatever you do, make sure I am the last in your line of lines, so you may employ me as a ni-er to wash your dishes. Funny, there are no elevators in Mendocino. All politics is local, aggregated, and the prevailing currency will come from a community built for the purpose. Pot doesn’t work; it just makes the majority dumber, better empire fools.

    That is the State of the City…ComRats. I’m here; come get me when you are ready to be removed from the planet. I build bombs for Navy. That’s my function. What’s yours?

  18. Neal

    “Their incentive is to buy in the immediate term, accumulate some bitcoins, watch closely as they appreciate, and then dump them on suckers at the first sign of the broad market realization of the inevitability of the deflationary stage.”

    Your logic eludes me. You dump them on suckers as soon as it is obvious that they will increase in value?

    1. Dan Kervick

      You dump them as soon as everyone else catches on to what is about to happen. Once the broad user base of bitcoin holders realizes that bitcoins make for a bad currency system, they will all realize others are going to dump them, and will start to dump them themselves. Hence the rush out of bitcoin begins.

      Ultimately, bitcoin has no stabilization mechanism. That might seem attractive to people who believe that laissez faire markets are self-stabilizing. But how many people still believe that Greenspanian doctrine? No currency that is as volatile as Bitcoin has been is a good system for transacting the everyday business of life.

      1. Thisson

        The problem(s) with bitcoin are not related to its lack of a stabilizing mechanism. That is the least of the problems with bitcoin. The main problems with it are (a) lack of barriers to entry to competing bitcoin variants; (b) lack of transactional anonymity (given the possibility of contextual analysis; (c) regulatory risk (seignorage does not like competition); (d) attack on the blockchain from concentrated sources of computer processing power.

        1. ian

          I think those problems are surmountable. I opened a wallet just for the hell of it and _the_ biggest problem I had was how long it took to use it. It wasn’t convenient *at all*. For small transactions, thats a killer.

  19. Brent McCulloch

    Great Article! Your arguments about deflation highlight the exact reason i never buy technology. I think the whole sector will crash and burn. Why would anyone spend their money on an iPad2 now, when, if they just hold onto their money for a bit longer and wait for the iPad3 to come out, they’ll get much more value for their dollar? Why then spend it on that iPad3 when it comes out, we know the iPad4 is just a year away right? If they hoard their money for just 12 more months, for the iPad4, it’ll have so much more effective purchasing power. As soon as people catch on to this scam they’ll stop spending their money on any kind of technology, it’s just too deflationary! This realization is bound to cause a “hyperdeflationary spasm” in the tech sector – companies will have a hard time selling the latest and greatest tech even at pennies on the dollar, and poof! The tech industry will crumble, and all my shorts on AAPL will pay off!

  20. Calgacus

    any viable currency needs a viable monetary policy, i.e. a viable system for regulating the currency … Monetary stability depends on the way that form of money interacts with the real economy, and responds to changes in the real economy. Some might find this confusing. Terminology: That sort of “monetary policy” is usually called “fiscal policy”.

    1. Dan Kervick

      Not necessarily. However the monetary policy is set, the people responsible for conducting it will attempt to accommodate an increased demand for money by supplying it.

      1. Calgacus

        Monetary & Fiscal policy can segue into one another, but it is not a meaningless distinction, and that kind of money policy (maybe a better term?) usually means fiscal policy, as I said. A central bank / monetary authority with an interest rate target is constrained by it, and the general MMT view is that such purely monetary policy doesn’t do all that much.
        Except the sort of raising and lowering the US has indulged in since the 60s-70s does nothing but destabilize finance, and lowering rates can undo (some of) the damage raising them did – my “usually” not applying then.

        The true, important increased demand for money is increased demand for NFA, which shows up as unemployment, people demanding money, fiscal policy, from the state, the modern ultimate source of base money / currency / NFA, and which only the state, not the central bank can accomodate. When we’re in a ZIRPy world like Japan & a bit less, the USA now, there really isn’t any other sort of money policy than that, by assumption. I doubt we disagree here, just indulging my obsessions.

  21. ian

    “there is no Bitcoin “penny” that can’t be subdivided further.”

    Bitcoins are divided into 10**8 smaller units (Satoshis) which AFAIK can’t be further subdivided.

  22. passerby

    Can more than one bitcoin system develop, each independent (at least initially) of the other?
    If so can they interact with each other and still be independent of central banks and governments?

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