Topic: Deflation and Bitcoin, the last word on this forum - page 13. (Read 135972 times)

Let's then say that the question is if business cycles are a pareto-improvement over their absence? Then the answer is no. Changes in the quantity of money (regardless of whether this is an increase or decrease) merely redistribute wealth, they do not present a pareto-improvement.

Changes in the quantity of money are merely a redistributive measure. Since money is injected through particular funnels, from which it goes to other parts of the economy, this leads to a shift of wealth in the opposite direction. In some cases, such as credit expansion through the banking system, this leads to cycles. If the production costs of money are close to the market price, and there are no legal restrictions on the competition of production of money, the redistributive effect is minimised. This works much better with gold than with fiat (if we disregard FRB). With Bitcoin, I would argue it works even better, you can very easily see how the production costs trail the market price and how marginal producers fall out. It's genius.

A change in the the price level on the other hand is are not accompanied by such redistributive effect. You could argue that a rise benefits savers and a fall benefits borrowers, but this only works if one of them mispredicts the future price development. If they have reasonably accurate predictions about future price, that will be reflected on the interest rate. So it could be said that sudden and unexpected changes in purchasing power could be a problem. But when do such things occur? Normally, they happen when this is a consequence a change of the money supply, for example, credit contraction. If people expect a fall in the prices, or if the fall is stable and predictable, then there is no "problem".

They argue that in a free banking system with a commodity monetary base, credit expansion/contraction satisfies changes in the demand for money and therefore does not cause cycles. I find their argument unpersuasive.

It's a manipulation of the interest rate, which is a type of a price. If there is a price that lies out of the equilibrium, you're going to have a mismatch of demand and supply. Since interest rate is intertemporal, it is maybe easier to obscure.

DeSoto goes into much detail about how the prices change during a credit contraction. Sadly I don't remember all of it. But basically, the stuff that is produced will be considered too expensive, and people will only be willing to buy it at a lower price. This causes a fall in the market prices. Assuming the contraction is not countered by printing more money (or regulations), eventually the price will equilibrate and the bad investments will be liquidated.

I suppose you could say that, but only until the equilibrium is reestablished. It does not go on forever.

Not necessarily. The point here is the interest rate, not the fall in prices. The interest rate must correspond to the time preference of people and their willingness to forego consumption. During the boom, the price signals that people are foregoing consumption, so more producer goods are produced. During the bust, these need to be either sold at a loss, or dismantled and in the worst case scenario, scrapped. As you hopefully see, the problem is a disequilibrium, not a falling price.

The video is a bit inaccurate, because the business cycle does not require fiat money.The elastic supply only exacerbates it. Under the gold standard, the cycle is started when commercial banks loan "from nothing". They can do this at a lower interest rate than the time preference of the savers. Other banks join, because otherwise they would lose. This is however somewhat mitigate by the risk of bank runs (as there is no lender of last resort).

I think that FRB causes the cycles, but I don't think that's illegal. While I think the freebanking branch has many interesting and new insights, in general I don't agree with their conclusions. For example, I disagree that expansion/contraction of credit satisfies "demand for money", but I agree with Selgin that in a mature economy the "outside money" (in case of gold) would not circulate. He does not explain why, but obviously it's due to transaction costs. He thinks this is the same with Bitcoin, but I argue that it works the opposite way, since substitutes are less likely to have lower transaction costs. So, in a Bitcoin economy, it is the "inside money" that would not circulate. On the other hand, the gold standard proponents do not get it right either, because they think that the solution is that people use gold coins rather than substitutes. Which obviously is not a likely occurrence as gold coins have comparably higher transaction costs than gold-substitutes, in particular electronic ones.

So I suppose I'm somewhere in the middle. I think they are both a bit right and a bit wrong.

Thank you for the clarifications and references, I'll look into them.
I also want to clarify what I mean by "good". It's like you could measure prosperity as a whole. I know it's just an abstract concept outside of nature. But paying the costs of rising people to let them die hungry in the streets later doesn't seem like a very economic deal for society, despite some guy gets more powerful because its property gets more valuable for being more scarce.
But not prosperity necessarily in an egalitarian way, probably more pragmatic than other thing. I'm not comfortable with terms that imply moral connotations but I think you can now understand what I mean when I say that business cycles are "bad".


In my words this would be "Not price deflation but monetary deflation can cause problems."
Why? What's so different?


What they think it does? They are part of nature like MoonShadow claims, right?


What force increasingly mislead investors?
Oh, you say it later, the expansion of credit.


But does the deflation take an active part on the credit contraction? Doesn't it have any side effects?
Merchants are just right watching their inventory depraciate?
Doesn't the production of real capital decrease under monetary deflation?


So how that expansion of credit starts under a gold standard?
Are you with the freebanking branch or with the FRB opponents?


Not sure what you mean here.


So deflation is the necessary solution to a problem that has no avoidable cause, it's just nature, fair enough. We agree that the managed solution just make things worse. For me it is because the solution does not attack at the root of the problem and for you no action should be taken at all, but the result is the same: no, Keynes, that's not "good".
Since my position is that the root of the cause is inherent in the monetary system (for example gold), let's discuss how propsperity works under a gold standard.
When some enterprise it's very profitable, many actor invest on it to compete for the profits, which drop by that very competition as the demand is satisfied. Real capital works in the same way. For example, if a town has very few houses in relation to its population, the rents will be high, and there will be an incentive to build more and get the rent that the houses will yield. As long as the yield of the capital in proportion with its cost of production is over the rate of interest (discounting price inflation and after paying for the risks), more houses will be built. But with more houses the offer increases and the rents drop. So do the yields. And at some point is not profitable to build more houses and the savings must be invested in other sectors.
But what happens with concrete sectors also applies for the economy as a whole: the more profitable investments are made first and in the end the less ones are left. With gold and perfect competition, after much prosperity the yields of real capital have droped so much that...

a) Tend to zero, meaning that the cost of production of capitals equal their total yield instead of being lower.
That's what I think would be natural but doesn't happen because of the non-perishability of gold.

b) When their yields reach the minimum limit set by the basic interest or liquidity premium, the market needs to reset. Some of the capital gets destroyed so that real capitals are profitable enough again. If the market doesn't do it on its own a war is needed.

c) When their yields reach the minimum limit set by the basic interest or liquidity premium, the credit starts to expand, expanding the monetary supply and causing malinvestments. After the bust the malinvestments get destroyed and also some of the good investments by the price turbulences. Lenders are ready again to invest in the now profitable pieces.

d) New innovations always appear and the rate of interest never approach those low values naturally. The human race is meant for exponential growth. We've just rejected the cornucopia by government all this time. Gold has been always perfect as money.

e) Your own, how that prosperity trend ends?

Clarifications:

1) Nominal interest rate = Real interest rate + inflation premium = basic interest + risk premium + inflation premium
So, yes, I'm counting on risks.

2) Why the basic interest is always greater than zero?
Because being the money non perishable it is always better to hold the cash and enjoy that protection against uncertainty that it offers (liquidity premium) than to lend it at zero interest, even when there's zero risk in the loan.
That externality that money holders enjoy for free (or can trade for the rent that basic interest is) must be paid somewhere else. Is it only pay by the consumers through the investors through the borrowers to the lenders or is it also paid somewhere else?

Another question. The "deflation speculators". People that make gains just by holding money in deflationary times.
How they benefit society by signaling that cash to clear debts will be even more desperately needed tomorrow than today?

Close enough for government work, yes.


I don't think that defining it that way works.  The question then becomes, "good for whom?"  Financial cycles simply exist.  They always have in moderately free economies.  There have been entire tomes written on the how & why, but largely I consider that an irrelevant question, insofar as knowing how & why cycles exist doesn't really contribute to any ability to avoid them.  Fortunes have been made by men with some undefinable quality that gives them an edge over predictions, Warren Buffet not remotely being the first in a long list, so for those rare investors cycles would most certainly be 'good'.  For most people cycles are generally 'not good' and suppressing them in their best interests, but since we can agree that history has shown that those who accept positions of such authority tend not to have such a gift, we are all better off with reactionary natural systems than managed ones.  Honestly, if I had the ability to predict markets, I wouldn't accept the position of Federal Reserve Chairman either.  I'd be spending my time and money beating the market.  Would you?


"Destructive" yes, but necessary also.  Like fire clears away the brush so that the might oak might grow.  The deflationary phase is simply the result of the expansionary phase's overreach, and must occur.  It's harsh medicine, but the illness is worse.


Again, I consider that an irrelevant question; but I tend to agree with Austrian theory in the sense that the cycle is an aggregate result of investment successes leading to overinvestment, overinvestment leading to exuberance, exuberance leading to mal-investment, mal-investment leading to investing failures, investing failures leading to panic, panic leading to liquidation, liquidation leading to under-investment, under investment leading to new investment successes for the next generation, and so on infinium.

Until I have time for a more thorough reaction I'll reply partially.

For the record, I do not know any professional Austrian economists that believes in the "intrinsic value" concept. I emailed with about a dozen of them. While some do claim that a prospective money must be a highly desirable commodity before it is a medium of exchange, this is not the same as saying that it must have "intrinsic value". Nielsio, Kramer or Smiling Dave, to name a few Austrian Bitcoin detractors, are not professional economists. They're enthusiasts. The professionals are mostly merely uninterested in understanding Bitcoin (apart from some exceptions, like Selgin or Matonis).

If you look hard, you can find plenty of evidence that Austrians can understand why Bitcoin is useful. The founder of the Austrian School, Carl Menger, wrote in 1871 that the cost of the banking system influences the evaluation of a potential trade opportunity. His successor, Ludwig von Mises, wrote in 1912 that the idea that money is valued because of its commodity use-value is fallacious.

I think that all Austrians agree that a fall in the price level is not a problem, and that a change in the decrease in the quantity of money can be a problem.

The issue is not credit/debt, but increases of money supply through credit/debt. And yes, you're right, the freebanking branch claims that credit expansion/contraction do not necessarily create business cycles.

A nice way of putting it. Many of the Austrian FRB opponents (including de Soto) claim that FRB is a violation of property rights. I think their argument is incomplete, and Bitcoin shows that empirical factors can influence whether FRB comes to being or not.

Austrian school cannot answer if things are "good" or "bad". Besides, why would anyone think that business cycles are good?

I would say that the Austrian position is that the destructive part is the boom, whereas the bust is an attempt to fix the destruction.

It works by misleading investors into believing there are more resources available than there really are. Just like any manipulation of price, it creates an imbalance between supply and demand and obscures it.

After the expansion of credit causes malinvestment, this malinvestment needs to be liquidated and this leads to a contraction of credit. This is accompanied by a fall in prices. But the fall in prices in this case is a symptom, not a cause, of problems.

I could hardly put it more eloquently than these guys: http://www.youtube.com/watch?v=d0nERTFo-Sk

Thank you for the explanation about self-regulating systems. They correct imbalances but they can't prevent them. The self-regulation acts a posteriori. And a planned monetary policy is doomed to failed by the fact that is impossible to predict the outcome of a complex system like the economy. That's a strong point in favor of denationalization of money.
Gesell also wanted to print or let the demurrage destroy money a posteriori to maintain price stability, but in the abscence of hoarding (money that is not spent nor lent by my definition) and with an increased velocity of money, smaller changes will affect more effectively and quickly. The minters could not blame the sentiments of the markets for unstable prices and they would have to take full responsibility.
His solution still requires bureaucrats taking decisions and I'm not very comfortable with that.
My main point here was that a gold standard is also an inferior solution over a truly free monetary market.
I take the winning side on this one which I think is the libertarian side. And probably today's global monetary system will be remembered as a historic argument against the planned monetary policy.

It's probable that I've misunderstood Hayek because I haven't read him deeply, just some articles by him and about him, an interview, a couple of raps...
My claim comes from this sentence from him:
http://butnowyouknow.net/those-who-fail-to-learn-from-history/hayeks-1932-letter-on-the-great-depression/

That makes me think that effectively he thought that deflation was bad for investment. He just didn't like the government spending solution. Also I read somewhere that he said that "capital intensive industries suffer more and first", which perfectly fits with the free-money theory on interest.

In any case, what we want to know is the fundamental nature of economic cycles. Is it a systemic problem derived from the monetary system? If so, what parts of it are ultimately responsible?
I think the different austrian positions on this issue reveal different fundamental understandings of the very nature of money.
Just like hearing Nielsio talking about bitcoin reveals he has a Marxian theorist of value demon deep inside, despite his best libertarian intentions.
The value of money comes from the fact that is useful in the market as a medium of exchange, not because it is redeemable by certain commodity.
This is a huge monetary division among austrians from my point of view, but we don't need to spend much time on it. Most bitcoiners will be with me when I say "the intrinsic value believers are wrong". The rest may discuss about the metaphysics of "digital commodities".

The other main source of monetary disagreement in the school as I see it are:

1) Whether or not deflation can be a problem (for some can be even "good" in general terms).
2) The effect of fractional reserve banking (and credit/debt in general) in monetary cycles.

In the second point I think lonelyminer's position is close to Huerta de Soto's (correct me when you have time), which I would simplify to something like "gold is cyclic because of fractional reserve lending". But forbidding it is repressive. Luckily bitcoin removes the need for backed paper currencies and fractional reserve altogether.
Is that approximately your position?

Since you don't agree that deflation is a problem, I have a few questions.
Are financial cycles good?
Do financial cycles have a "destructive" part? How does it work? How does deflation relates to financial cycles?
What's the ultimate cause of these cycles?

What a delightful and professional debate. Wish there were more like it. Don't have time to reply now, but will later.

Semantics, but okay.


Can I see that definition?
What do you mean exactly by reactionary here?