Topic: Bitcoin is a Zero-Sum Game - Long-term interest bearing instruments viable? - page 7. (Read 14626 times)

You are still ignoring the fact that at any point in time, anyone who can't beat the average would be better off not investing. Your cycle would only work if nobody else was smart enough to predict point 5 after point 4, but really, it's not hard at all. Thus, those not expecting to beat the average that occurs at point 5 would not invest at point 4, but just wait and benefit from the deflation other people's investments would cause. This makes deflation a tax which the people who invest have to pay to those who don't invest, in just the same way as inflation is a tax on those who have money to those who loan money.

It's self-correcting:

1. Deflation is high at ~3%.
2. Nobody invests, but sit on their money.
3. Economy shrinks,  deflation goes down or becomes negative.
4. Everybody invests.
5. Economy shoots back to ~3%.

(A fun thing here is that investing in step 2 when your money is valuable and collecting returns when money is cheap in step 3/4 would be very profitable )

And repeat. Net world growth becomes ~1.5% or more, which I actually think is close to the average over the human race's history.

The true mystery is why anyone would spend or sell their BTC today!

Can you really not see the problem in an economy where, if you can't invest in a way that beats the average productivity, you are better off not investing (and thus not producing anything) at all?

The world real GDP is 3.6% right now:
http://www.indexmundi.com/world/gdp_real_growth_rate.html

I think a mature Bitcoin economy would be deflating about the same on average. 5% may happen, but not sustained over longer time I think.

In real terms: about 33 years to pay back the investment. (1/0.03)

Considering you are dealing with machines and buildings they will probably not last longer than 20-30 years without heavy NEW investment.

Once the 33 years were over you would only be back at square one and it would take another 33 years to double your funds.

Considering that you would either be dead of age or your machines broken down from wear and tear your investment would quite simply be a bad one in terms of helping you/the economy/the world in REAL terms.

Actually your products would be priced at the rate of inflation, so you should make 5% inflation + 3% = 8%.

Your investment would be "paid back" in just 12.5 years and you would make profit from there.

However you only made money from the factory as an inflation hedge and society lost valuable resources due to this inflation induced over consumption.
This is why inflation is dangerous.


A valid concern. Lets assume the closer to real life 3.6% deflation. As we agree deflation slows the economy a bit by killing at least bad investments so make that 3%. (while saving important natural resources mind you)

What would it take to make something viable?
Well in simple terms it would have to be better than the world average, which kind of makes sense.

After all machine/building replacement costs, running costs and other costs the investment should make about 4% at very low risk in real terms. Its slightly high I will admit that, but it can be done.

Do you think investments with a risk-adjusted return of  0.000001% should recieve funding? I'm not giving a specific rate but I am saying there exists a nominal rate that determines how high of a return your investment should generate to recieve funding. This rate is refered to as the natural rate of interest. If it is higher than 3% then yes, 3% investments shouldn't recieve funding because they would be diverting resources from higher generating investments.

Any other argument seem to imply that the optimal interest rate would be 0% since anything above this make investments with infinitesimal returns unprofitable.

Note though, that as the economy grows and the supply of capital goods increases more and more investments become viable, and thus the tendency for the natural rate of interest is to go down over time. 0% actually would be the optimal interest rate if it was caused by an infinite supply of capital goods. Since all investments could take place we wouldn't need to ration funding in this scenario.

They will suffer the opportunity cost of their bad decision. If someone somewhere in the economy is making a nominal profit, then the rational thing is to lend him the money you don't want to use in the near future. Yes, you gain purchasing power by simply holding the money, but the goal is to maximize it. All possible interest rates are better than 0%.

The only rational reason not to lend out your money is if you don't see a relatively risk free and effortless avenue to do so. This is currently the case in the Bitcoin economy and it was probably the case in the depression with systematic bank failures and bank runs.

In normal circumstances though, having your money at home is probably riskier than having them at an insured bank, so there really is no reason to not lend it out and get a nominal return on top of your real purchasing power return.

You solve this paradox by realizing the distinction between capital goods and consumption goods and see where their respective values comes from. Consumption goods get their value from their immediate consumption use. The bicycle is worth the same 30 BTC to the consumer regardless of how it's produced. Capital goods derive their value indirectly from the consumption goods that they could be used to produce. The aluminum is only worth 20 BTC as long as someone sees a profitable way to turn it into consumption goods at that price.

So if a 20 BTC aluminum price makes your business plan unprofitable, it simply means someone else is outbidding you in the competition for aluminum. Maybe someone else can produce bicycles with a smaller overhead, or makes bicycles that are considered higher quality, or makes something else entirely such as 40 BTC baseball bats. Prices ration goods to those who can use it most effectively and you are simply on the wrong side of the line here.

On the other hand, if noone could use aluminum profitably at a price of 20 BTC it would simply not cost 20 BTC.
Your calculation is backwards. Prices of capital goods are determined by the value of the consumption goods they can be turned into. If the value of the green widgets is 69.300 BTC then the building and assembly line is obviously worth less than this to you. So you won't offer 110.000 BTC for them, but say 50.000 BTC instead.

This argument goes for the builder as well. If he can only get around 50.000 BTC for the building then that's his cap for all the resources that goes into building it. So that's the amount of money that he will be willing to allocate between all his suppliers. You can continue this chain of thought all the way down to the most basic capital goods such as raw materials and labor.

It seems to me like you are making calculations with inflated prices of capital goods and deflation in consumption goods, when really no capital good can be worth more than the consumption it will ultimately satisfy.

Austrian theory only describe the consequences of different actions and policies. It makes no judgement wether those actions or policies are good or bad.

Well, my example was certainly simple, but I don't see why switching to a longer-term investment changes anything.  But sure, replace the single-use widget maker with a green circle widget-making factory that can produce X units every year for Y years.  Would someone invest the resources required to build that factory in a deflationary economy? Only if it would make a profit after factoring in deflation, and if it wouldn't make a profit after factoring in deflation, that tells me that there's an even better investment (yellow square widget factory?) where those resources should go instead. Otherwise, those resources would not be bid up to their current prices.  What am I missing?

You're concerned that it doesn't make sense to make an investment that earns a 3% return when deflation is 5%.  But why doesn't the following answer that objection?


I'd also be curious to hear what you thought of the following:

Thanks!

Hyperinflation causes a lot of problems which are basically not there with a low inflation of 2-3%. With hyperinflation you are losing value extremely fast, so buying basically anything is better than holding on to them. With normal inflation the maximum loss you can get by spending more time on decisions is much lower, and you can usually get interest by putting the money in a bank. This reduces the loss or even gives a small profit. This doesn't work in hyperinflation, because the uncertainty and loss of confidence in the currency it creates means the banks can't get a good enough interest rate on their loans.

You're only looking at a single point in time though, that's the problem.  Investments are weighed in how long they take to pay off - the Return On Investment.  Your example is bad, because there IS no long term investment.  All a person is doing is assembling two parts, and then immediately selling it.  There's no overhead, no buildings to purchase and depreciate, no tools needed to manufacture these items, nothing.  So if he buys the parts for 99.5 BTC, puts them together on his kitchen counter, and resells the completed version for 100 BTC, he'll still turn a profit every time.

Now, say I want to invest in a company that creates green widgets.  I want to buy a building for 100,000 BTC, and install an assembly line for 10,000, buying 100 of the green-widget-making-machine.  My overall capital investment is then 110,000 BTC.

Assume the deflation rate is 5%.

Assume my return on investment after depreciation of my building and manufacturing equipment is 3%.

When will I recover the 110,000 BTC I invested?

I NEVER would.  I would only recover 3/5 of it, maxing out at 69,300 BTC return on my investment.

Turning it around, if I had bought the building and equipment for $1.1M, and assumed an inflationary rate of 5%, when would I recover what I had invested?

I would recover it after just over 20 years.

So, if I had the option of investing in a green widget manufacturing facility expected to generate a 3% ROI in a 5% deflationary economy, I absolutely wouldn't do it.  If I had the same investment option in a 5% inflationary economy, I absolutely would do it.

I feel like I am just repeating myself here, but I'm not sure what else to do.  You aren't separating capital investments from variable costs in your analysis.  Your take on variable costs is exactly right - variable costs will change with the economic environment.  But capital expenditures, spent with the expectation of recovering those costs down the road, is where a deflationary or inflationary economy will affect investment decisions.

I think it proves the opposite point.  Take another look at the first hypothetical:


So either the green circle widget DOES get made (because the price of the widget maker is adjusted) or an even more valuable yellow square widget gets made instead.  Now, it might be objected that my hypothetical assumes that the widget maker already exists.  And so you might ask, well what if it costs 100 BTC to build a green circle widget maker?  Wouldn't the widget maker not get made in that case, and wouldn't that be bad?  I don't think so.  To make things simple, assume that a widget maker can be built by buying two components, A and B, and fitting them together.  (And that this only takes two seconds such that there are no real labor costs.)  Assume that each of those components cost 50 BTC.  If we use the same assumptions as before about the deflation rate, the year-long manufacturing time, and the present value of a green circle widget, that investment will not make sense.  But I still don't see a problem, and the analysis seems pretty similar to the previous one.  If the prices of components A and B are set at 50 BTC and the market will bear that price, there MUST be some other more valuable use to which they can be put (e.g., maybe they can also be used as inputs in a yellow square widget maker).  If making a green circle widget maker is their highest use, the market won't bear the 50 BTC price, and it would have to be adjusted accordingly.  So the bottom line is I'm just not seeing how deflation interferes with an efficient allocation of capital and other resources.  

On the other hand, when you simply print new money and distribute it unevenly (certain people get it first), those people are able to consume real additional resources without having produced anything of value. THAT seems like something that would limit economic growth. And that's true even if you're only printing enough new money to offset the natural process of deflation and maintain "stable prices."

Why?  The investor needs to take both returns into account to make a proper investment decision.  And when we're talking about economic growth, a large part of it is reliant on how investors invest.  Both rates are completely relevant to this discussion.

What math?  Just ignore the nominal return and concentrate on the real return.

Well, my argument is that the optimal amount of investment is made at the point where a currency neither deflates nor inflates.  An inflationary currency encourages too much investment - that is, investment in opportunities that lose money.  Over spending/over lending is also a problem, and ends up causing the sort of economic trouble that we see in the world economy today.

I am adding real and nominal interest rates together because both of them need to be considered from an investor standpoint.  Please provide more specific direction if you still believe I am confusing the two.  Show the maths. 

Yes I agree here too, and paradoxically even limiting the supply to 21M sometime in the future seems to have a coercive effect in free market choices.

You say that an economy based on a deflating currency necessarily rejects some investments, and is thus less productive.  An economy that is neither inflating nor deflating is also rejecting some investments, those with a negative nominal return that would be possible under inflation.  And an inflating economy is smaller than one that is inflating a lot.  And so on.  Clearly, we need an infinite rate of inflation to allow the maximum possible range of economic activities.

Worked for Zimbabwe, right?

P.S.  You are still confusing real and nominal.

Yes - it would be better to invest in something that loses 2%/year than to hold fiat that inflates at 3% per year.  I do not see how this conflicts with my idea.  But it does go to prove my point that an inflationary currency can encourage bad investments.

You are confusing the real return with the nominal return.

To see it, just continue your idea.  If 3% deflation means that investments with a nominal return of less than 3% are pointless, and 0% inflation/deflation means that any nominal return is good, then in 3% inflation, any investment with a nominal loss of less than 3% is good, right?  Didn't Zimbabwe recently inflate itself into prosperity by inflating enough to include these otherwise unprofitable activities in their economy?

Yes, I agree with you, but inflation or deflation of currency supply per capita artificially encourages or discourages the free market choices.

It is so refreshing to read some facts distilled down to their essence.

I would like to comment, inflation in the economy is a lack of investment by the members in that economy. This is a result of one's actions and the encouraged behaviour is causal not coercion, and likewise deflation in a free market is the result of oversupply the encouraged behaviour causal not coercion.

In contrast inflation as a result of a centrally controlled bank is coercion. 

@Thumbs - I am certain I am no expect in economics, much less those of the Austrian variety.  But while I certainly agree that resources should be allocated to the most valuable investments, are you saying that investments with a risk-adjusted return of 3% would receive no funding?  And this should be normal?

It seems to me that, regardless of how you reallocate monies according to the valuation of various investments, it still does not answer the question of, what happens to those who choose to save instead of invest as a result of "gaining" 3% on just holding their money instead of investing it?  That's still a reduction in the overall investment pool, no matter how you divvy up the investments themselves.  Lower overall investment = lower economic activity.

It's a bad investment because of the maths I wrote out before.  I could, at maximum, only recover 83.33% (2.5/3) of my original investment if the net profit margin stayed at 2.5%.  Yes, the expenses and revenues are going down, but I would NOT make the same amount of profit.  2.5% of 19.42 is less than 2.5% of 20.00, and it would keep going down each year.  I'd only ever make back 83.33% of my original investment at that rate.