Topic: Bitcoin Supply Engine Vs Economic Demand (Read 1004 times)

Below is my commentary on an article published in Forbes by Jon Matonis, Exec. Director of Bitcoin Foundation, who has kindly referred me to it in response to my inquiry about the position of Bitcoin Foundation regarding the price-deflationary nature of Bitcoin and the prospect of its future use as a dominant currency.

link to the article: http://www.forbes.com/sites/jonmatonis/2012/12/23/fear-not-deflation/

 
"Deflation is actually a good thing, because in a deflation prices drop
and money becomes more valuable, so deflation encourages people to save
money."

Is then the purpose of money to be saved?

Also, money supply driven price deflation inevitably drives wages down as well.

"The way a society, like an individual, becomes wealthy is by producing
more than it consumes. In other words, by saving, not borrowing."

The product is the actual value/wealth; money, on the other hand,
testifies to equal exchange of value-for-value being only partially
completed, exchanged for a promise, and a promise which is deferred
constitutes a temporary absence of real value. Saving money therefore
perpetuates that absence.

Also, producing is not equivalent to saving. Industrial production in fact hinges on availability and affordability of finance (cheap money or credit), on borrowing. And consuming

"during an inflation, you want to get rid of the money. You want to
consume. You want to spend."

Spending is not only associated with consumption but also with
production: to build a house you need processed materials and tools. And
then, all wages are someones else's spending. If there is no spending
there can be no employment, and no possibility of selling your products.
All that remains is barter, and thus money fails in its
primary function as the facilitator of exchange of goods and services.

"Deflation creates a great number of losers, and many of these losers
are perfectly innocent people who have just not been wise enough to
anticipate the event. But deflation also creates many winners..."

Yes, the poor who need to use all their money for food and shelter
instead of Harvard education are of course too stupid to predict when
the bankers will contract the money supply. The rich on the other hand
are smart because they had the foresight of being, precisely, rich.

"deflation is at least potentially a great liberating force. It not only
brings the inflated monetary system back to rock bottom, it brings the
entire society back in touch with the real world"

Actually, it rewards the "winners" who had the "foresight" of being
rich, at the expense of the productive workforce (the creators of real
value) i.e. the "losers".

"Lower prices increase demand; they do not reduce or delay it. That’s
why more and more people own flat-screen TVs, cellular telephones, and
laptop computers: the prices of these goods have fallen, and people with
lower incomes can afford them."

I agree in microeconomic sense, but that's fundamentally different to
aggregate price deflation caused by inadequate money supply.
One cannot consider prices and ignore wages, so what is the use
of lower prices if you have proportionally less money.
If less money goes to employers, less comes out as wages,
and all antecedent debts not only increase in terms of exchange
value, but the means to repay them are proportionally and permanently diminished.

"benign deflation which is the result of an increase in productivity"

I agree insofar as productivity still keeps growing rather than
contracting. But benign deflation is never a result of low money supply
but rather, is subject to temporary conditions that drive productivity
irrespective of the shortage of money. Industrial revolution being a
rare example where the printing presses could not keep up with real growth.

"Ultimately, the market will reach an equilibrium between investment and
savings"

Yes, deflationary usury and consolidation of power in the hands of the
"winners", whose only investment is desperation of the productive workforce.

"Proper economic growth through sound investments will lead to a
productivity-driven deflation."

That calls for a definition of such "sound investment" and evidence that it
"will lead to a productivity-driven deflation", otherwise its just a pie
in the sky.

Yes, thank you. I did have a look at Freicoin and many others, but none is actually coupled to real economic p[roductivity but only attempts to impose some inflationary element or periodic adjustments. That is a step in the right direction but still requires oversight and constant tuning, and that could be illicitly exploited. The problem is that unless the money supply grows hand in hand with the growth of real value which it 'represents', the net effect will be deflationary. If these supply engines are not coupled the supply curves are bound to diverge, and in absence of corrective measures must result either in hyperinflation or depression. That applies only if a particular crypto-currency was aiming to replace the present fiat system, as the dominant medium of exchange (that is my objective). Does not really matter if we are dealing only with a complimentary and highly speculative currency, like Bitcoin is now.

I will soon start a thread with my concept how to couple the two supply engines, although it may not be applicable specifically to Bitcoin, but first I will let the present discussion reach some natural resolution.

It certainly seems that Bitcoin is destined to remain deflationary, and there is no way of determining with any certainty where that will take it, primarily because it is not the main medium of exchange in trade and commerce and therefore can endure a lot of instability without having serious economic consequences. In any case Bitcoin is a great experiment that we all stand to learn from, even if we disagree about our modelling methodology. For that matter I was educated by Austrians, but that does not mean I agree with every premise of particular Austrian theorists. The primary advantage/insight that Austrian Econ has over Keynesian is that economic cycles are driven by money supply and not by arbitrary demand for goods (i find it reasonable to assume that, for all practical purposes, demand is always infinite, that people want it all all the time, and the only thing that limits demand is how much money you have:) But back to the core of the topic-

The only issue I have raised is if a currency with deflationary characteristics such as Bitcoin can function as a viable replacement for bank issued monetized credit, not as a complimentary addition to the pool of media of exchange but as the dominant currency for daily use in trade and commerce.

"you claim that people will not spend deflationary currency"

No I do not. I said : "I am then likely to spend inflationary dollars only and hold onto my deflationary 'investment'." There is a difference between 'tendency' or 'disincentive' to spend and total cessation of spending. That is enough to slow the economy. A subtle misdirection I must say. The fact is that majority of Bitcoins are either hoarded or traded by speculators as a commodity rather than used as a medium of exchange per se. If hoarding is not universal it is partly due to the fact that Bitcoin, due to its limited supply and still subject to dissemination, is not linearly deflationary by overridden by cycles of speculative volatility. It is decoupled from real productivity so its value is very much sentiment sensitive, and that creates a lot of movement that can be exploited by differential trading.

A statement is not necessarily an arbitrary assertion, it could be result of deductive reasoning. By your standard of qualification several of your statements are also assertions; being specific as to logical merits of each deduction might be more productive. I will try to address the ones you have enumerated:

Quote from: Jock on November 03, 2013, 11:48:03 PM
'due to associated appreciation of its purchasing power, it is hoarded by speculators.'

That statement epitomizes speculation. It is almost a dictionary definition given that hoarding does not need to be permanent but can be subject to bets and trading among speculators. It is rather that the cumulative pool of currency which is subject to speculation tends to grow if such currency pays dividends simply by being held in possession.

Quote from: Jock on November 03, 2013, 11:48:03 PM
'it also precludes Bitcoin from functioning as a self-standing medium of exchange.'

I agree that this may need more elaboration. In essence, new ventures generally require finance. If finance is not available because too few new units of currency are created to keep up with real growth and a large proportion of existing units are held as deflationary investments, not used for investment on productive ventures, it impedes the function of currency which is to facilitates for trade of goods and services. For example, you want build a home for your family but you find it difficult to get a loan for the materials (even if you have the skills to build it yourself) because major currency holders can benefit more and risk free just by holding onto the money and waiting for its value to appreciate. If someone will lend you the money, they are justified in expecting to get re-paid more than the anticipated rate of deflation, so your debt to them will grow nominally as well as your capacity to repay it will progressively diminish, due to lower wages. And that's your another point of contention:

Quote from: Jock on Today at 03:21:14 AM
'Under deflation the wages drop and unemployment grows also, due to reduced economic activity'

If the prices of goods decrease across the entire economy, wages must decrease also, because reduced prices have impact on the nominal revenue of producers. The amount of money that goes out as wages cannot exceed the amounts that comes in as earnings unless it can be borrowed, but if borrowing becomes increasingly risky and expensive it is less likely to happen or it adds to nominal cost of production. And that is the deflationary spiral, a positive feedback loop that drives currency towards the rich from the poor.

That's enough for now, other deductions follow from the above.

Could you state your criterion of 'success' for Bitcoin, that is, what conditions must be met for you to say that Bitcoin has 'succeeded', and 'succeeded' at what?

I agree that is entirely dependent on purpose of said currency, but there seems to be some obfuscation about what that purpose is.

You've made a whole lot of assertions here.  I think you'll find that many Austrian supporters of Bitcoin do not share your views and that discussion will be difficult since you can't agree on a set of basic assertions.

Regardless, since changing the minting rate of bitcoin would require 100% consensus (and I can guarantee you won't reach 100% consensus on such a change), bitcoin will succeed or fail on its own merits.  There appear to be a whole lot of people who believe it will succeed on those merits.

Interestingly, you claim that people will not spend deflationary currency, and yet people spend bitcoin every day.  It appears that your entire hypothesis immediately falls apart on that point alone.

There is a 0% chance that the generation of bitcoins will ever change. Not many people will even bother to discuss it seriously. However, there are some alt-coins that are designed to be inflationary in different ways. I recommend that you take a look at them. Freicoin is especially interesting, as it implements demurrage instead of inflation.

Hi Foxpup,

The question of what was the 'cause' of Great Depression is not an observable fact but an interpretation, and as such it remains arguable. But that is a peripheral issue. For purposes of my argument it suffices to say that the contraction of money supply inevitably results is the contraction of investment in new ventures and therefore in higher unemployment, in reduction of prices and wages alike, and as the wages drop it becomes impossible to repay antecedent debts. While I cannot prove that deflation was the primary 'cause' of Great Depression I can demonstrate that deflation creates a positive feedback loop that, unless mitigated by other means, is bound to result in depression.

"Don't you know that if you just hold on to your money for a year, you can buy the exact same computer for half the price?"

Well no, because the dollar economy is inflationary. If I hold to my dollars for a year the purchasing power will, on average, drop (and we should not confuse aggregate deflation with microeconomic price deflation, which may have many contributing factors such as technological advancement in production of a particular product, fashion, sentiment etc). If, on the other hand, I am in possession of some currency or gold that appreciates in purchasing power I am then likely to spend inflationary dollars only and hold onto my deflationary 'investment'.

But I suppose your point might have been that if we 'only' had a currency that appreciates in value then i would need to spend some of it for things that are needed to function in society. In that sense I agree. But the effect of necessity lasts only as long as you have money to spare. Under deflation the wages drop and unemployment grows also, due to reduced economic activity: money becomes increasingly thinner distributed and therefore valuable (and the antecedent debts un-repayable) and human labor cheap. Consequently, those who do not have much savings will be the first ones going hungry, then the middle class; but the rich investors who can wait the deflation period out will get to buy everything at bargain prices. Great Depression was also a great transfer of wealth that made the rich richer at the expense of all others.

If Bitcoin is to be only a pyramid scheme for fleecing the gullible kiddies of their beer money, then deflation is not a problem;) but if we seek to create a viable alternative to global dominance of bank controlled fiat we must take such issues seriously.

I will not be telling you or anyone what one should should 'brush up on' but simply get on with the discussion based on merits. If we can manage to stick to the three Aristotelian rules of logic as bare minimum we are likely to identify any suppressed inconsistencies in each others reasoning and go far in advancing common meaning.

Yes, it's a very serious issue all right. A deflationary spiral would be very bad, since it would result in people starving to death while waiting for the price of food to go down. Fortunately, this will not happen, because at some point the value of having something now rather than later exceeds the price of buying it now rather than later.

You're an example of this yourself: you're reading this on a computer, right? But why on Earth would you ever buy a computer? Don't you know that if you just hold on to your money for a year, you can buy the exact same computer for half the price? Of course you do (unless you're totally ignorant of the depreciation of electronics). But you don't want a computer in a year, you want one now, and you're willing to pay more to get it now. The same goes for everything else that depreciates in value. A deflationary currency means more things will depreciate in value, but as we can plainly see, people will still buy them anyway. Unless, of course, people don't really need the things they're buying, but encouraging people to not buy things they don't need is only a good thing.

You also need to brush up on your history. Deflation was a consequence of the Great Depression, not the cause. The cause was a credit crisis leading to a system bank failure.

Greetings!

I wish to contribute to the discussion on Bitcoin minting protocol.

At present, Bitcoin minting rate is by far too low to keep up with real economic growth and therefore, due to associated appreciation of its purchasing power, it is hoarded by speculators. Appreciation of purchasing power (its 'value' measured in terms of real goods and services) may seem attractive to many Botcoin holders but it also precludes Bitcoin from functioning as a self-standing medium of exchange. Price deflation kills investment and economic activity because the currency appreciates in exchange value simply by being held, what ultimately leads either to economic depression (like the one we know from US history) or to currency collapse, as the case may be. If the objective of Bitcoin community is to formulate a genuine alternative to bank controlled Fiat we need to take the above issue very seriously.

I have been working on developing a minting protocol that could advance Bitcoin to full economic functionality, that is, hyperinflation proof and depression (deflationary spiral) proof, while serving as the dominant medium of exchange in trade and commerce.

I have spotted a thread 'Inflation and Deflation of Price and Money Supply' in the Economics section but if there is a more appropriate thread to discuss the above mentioned item please let me know.