Topic: Deflation and Bitcoin, the last word on this forum - page 23. (Read 135972 times)

What are the conflicting assumptions?

You've calculated the consequences of a set of conflicting assumptions. That's kind of like figuring out what happens if both "X=3" and "x>5" are both true. Even if you do the calculations correctly, it's hard to figure out what your results apply to.

If you take the deflation and the interest, you will be able to take the equivalent of 1.08 rc worth in btc (too lazy to calculate it) next year.
Then 1.05 rc next year <= 1btc today = 1.08 rc worth in btc next year
Correct.
I though you were claiming 1.05 rc today <= 1btc today

But does that observation invalidate my other calculations?

Correct. Since 1 bitcoin includes the right to have 1.05 rc next year, the present value of one bitcoin must be at least as much as the present value of 1.05 rc next year (in any comparable units).

If your assumptions lead to the present value of 1.05 rc being less than 1 bitcoin, then you have conflicting assumptions. Something that includes something else and then some cannot be worth less than that something else.

1 rc is a stable unit of real value equivalent to a btc today.
If we assume 5% price deflation for bitcoin, the exchange between them will be
today 1 btc = 1 rc
next year 1 btc = 1.05 rc
2 year 1 btc = 1.05 ^2 rc
...
n year 1 btc = 1.05 ^n rc

Sorry, I cannot be more clear.


Let' introduce interest here too.

If the price will be traded at 1 btc = 1.05 rc next year
and 1 rc today = 1.03 rc next year
Then 1.05 rc next year <= 1btc today

Is that what you claim?

Right, so you're doing it wrong. If 1 bitcoin will be worth 1.05 rc next year, then the present value of 1.05 rc next year cannot possibly exceed 1 bitcoin. So your assumptions conflict. (Most likely because you aren't being clear about whether your inflation percentage is in real value or in bitcoins.)

Ok. 5% deflation - 3% interest = 2% increase in value
(0.97 - 1.02) + (((1.05^1) - 0.03) - (1.02^2)) + ((1.05^3) - 0.03 - (1.02^4)) + ((1.05^4) - 0.03 - (1.02^5)) + ((1.05^5) - 0.03 - (1.02^6)) + ((1.05^6) - 0.03 - (1.02^7)) + ((1.05^8) - 0.03 - (1.02^9)) + ((1.05^9) - 0.03 - (1.02^10)) = 0.892444074

We defined that the price was today 1 btc = 1 referenceCoin.
If we factor 5% deflation and 3% interest in the way you suggest, we come up to the conclusion that 1 btc costs 0.892444074 refcoins today. That is in contradiction with the first definition.


If the price will be 1 btc = 1.05 rc next year, 1.05 rc <= 1btc today

But 1.05 rc > 1 btc today because 1 btc = 1 rc today.

You haven't fixed either error:

1) The 1.05 is the future value of the future value, you're supposed to subtract the present value of the future value. Even if 1 bitcoin today will be 1.05 units of value next year, 1.05 units of value next year isn't worth 1.05 units of value  now.

2) If a person can turn 1 bitcoin into 1.05 units of value next year, then the present value of 1.05 units of value cannot possibly exceed 1 bitcoin.

It seems to me that you're pointing to the same error with both points.
I'm not taking into account the interest (or time preference if you prefer).
With 3% interest

(0.97 - 1.05) + ((1.05^1 - 0.03) - 1.05^2) + (1.05^2 - 0.03 - 1.05^3) + ...
Still a negative result, even more than before.
Anything wrong with my math ?

You are making two mistakes:

1) You are forgetting to convert future nominal currency values to their (lower) current value. 10 stc next year is not worth as much as 10 stc this year because you have to subtract the benefit of everything you could do with the 10 stc during that year. So 10 stc next year may be worth, say, 9.5 stc right now.

2) You are forgetting that even a deflationary currency is worth more today than it will be next year. 10 BTC today *includes* the present value of 10 BTC next year because one of the things you can do with 10 BTC right now is have 10 BTC next year. So the *present* value of N BTC can never, ever be less than the present value of the future value of N BTC at any point. (So none of the terms can be negative, each is the present value of holding a bitcoin for a year. At worst, that's worth zero because you can't find anything useful to do with it.)

The mere existence of a reliably deflationary currency changes the time value of money equation because one of the factors that goes into that equation is the inflation/deflation rate. It's the same way if gold was $2,000/oz today but we all knew it would be $3,000/oz next year, $3,000 next year wouldn't be worth much more than $2,000 now because you can turn one into the other by buying/selling gold.

(Assuming perfectly constant, perfectly predictable deflation.)

I see. You take into account all the possible horizons (for the "predictable" future).
Let's see if I got this right...
We know there's going to be a 5% deflation for 10 years.
We have a reference currency that keeps its value stable.

1 btc = 1 stc      (year 0) 
1 btc = 1.05 stc   (year 1)
1 btc = 1.1025 stc (year 2)
...
1 btc = 1.62889463 stc (year 10)

According to your definition
1 btc = (1 - 10.05) + (1.05 - 1.1025) + ... + (1.05^9 - 1.62889463) stc
(1 - 1.05) + (1.05^1 - 1.05^2) + (1.05^2 - 1.05^3) + (1.05^3 - 1.05^4) + (1.05^4 - 1.05^5) + (1.05^5 - 1.05^6) + (1.05^6 - 1.05^7) + (1.05^7 - 1.05^8) + (1.05^8 - 1.05^9) + (1.05^9 - 1.05^10)

I know the definition of the reference currency is a little bit tricky for this case, but...
What's wrong with my math? How can be the value of a bitcoin negative?


If you're right on this, the time horizon can't matter, understood.
But I still don't know how can deflation disappear. I mean, if there's 5% annual deflation, there's 5% annual deflation How can the pricing mechanism eliminate it instantly.
Why do we have inflation then, should it be also priced in?
Deflation means an exponential growth of the value of money over time.
How can the time horizon be irrelevant when talking about a function that depends on time?


Fair enough. But you could show me where it's incorrect rather than saving it.

You have to discount each future value to its present value. $15 next year is not worth as much as $15 right now.

To put it another way, 1 bitcoin is worth:

1) The value of being able to spend a bitcoin right now but have to pay it back next year, plus
2) The present value of being able to spend a bitcoin next year but have to pay it back the year after that, plus
3) The present value of being able to spend a bitcoin in two years but have to pay it back in three years, plus ...

Because a bitcoin today gives you the right to do all of those things. But note that you have to compute the present value of each future 'loan'. The deflation increases the future value of each term but decreases the ratio of future value to present value. It winds up more or less cancelling out.

The value of a bitcoin is what it is. That already includes the value of everything you can do with that bitcoin, including the right to hold it as it deflates.

The time horizon doesn't matter. And that is right, the deflation disappears. Predictable deflation is already built into the price.

It's not my job to figure out how to save your example.

Let's say we have a currency with an expected deflation of 5% for the next fifteen years. Its price in terms of a currency with its same value today will be in 15 years:

1.05^15 = 2.07892818,

Should one unit of the deflationary currency double its price right now or your rule only applies for one year?
Why one year and not 15, 0.5 or 30 years?
If he corrects its price automatically now, doesn't the deflation disappears.

Again, How would you modify my example to take your theory into account?


For me it represents more than anything the freedom of a decentralized issued currency with "fixed" rules for its creation.
A radical negation of central banks.

This is very simple common sense. If the price of gold was expected to be $5,000/oz next year, it would rise to very close to $5,000/oz right now.

If you have a bitcoin today, you also have the right to sit on that bitcoin as it deflates. So the value of a bitcoin today must include the value of the right to reap the rewards of that deflation. That is precisely what the bitcoin represents.

mMy eample only assumes stable prices in for the first case.


No is not. That's what we're discussing.


I don't buy your "deflation is factored in the current price of the currency" argument.
Can you tell us where did you get it from?
Can you suggest how to modify my example to take this into account?

I agree.

No is not, stating your position again without providing additional arguments doesn't help.


The bakery costs whatever quantity you want at the beginning and will cost less over time.
The nominal interest will not adjust to deflation over time.


Agreed.


He borrows a currency that is more valuable than last year and will be more valuable next year. But he doesn't care about last year, the only things that matters to him is that the currency he has to pay back is more valuable than the currency he gets.


No it's not.
An inflationary currency just increase the nominal interest, leaving the real interest untouched.
A deflationary currency hurts its financial market.
Other currencies with other qualities than those you're used to think of allow lower interest rates. See my sign for more details on this.

Your example tries to hold prices stable while it imagines a change in the value of the currency. You can't do that. Whether or not the bakery is an efficient use of real capital is a currency-neutral question.

This is most clear when you say that with "deflation, you also have to cover the gains of money from deflation to get the loan." This is not true. That gain is given to you when you borrowed the money, you just need to give it back. When you borrow $50,000 of a deflating currency, you are also borrowing its deflation value which you may then spend or invest, so your return will be higher. When you borrow $50,000 of a non-deflating currency, you do not have that value to spend or invest, so your return will be less.

Whether the currency is inflationary or deflationary, you borrowed some amount of value. You can then obtain some rate of return on that value. If that rate of return is sufficient to cover the interest on the value you borrowed, you win and the loan works. If not, you lose. This is inflation/deflation neutral. With a deflationary currency, all other things being equal, you will borrow a bit less money because you will also be borrowing its deflation value, and you will consequently pay a bit less interest because all the money you pay as interest is a bit more valuable because it's expected to deflate.

All other things being equal, would you rather have an inflating currency or a deflating currency? Answer: A deflating one because you can hoard it and you can also sell to others the highly-desirable right to hoard it themselves. So you would be willing to accept a bit less of it in exchange for things. This means the borrower obtains currency that is more useful and pays back with currency that is more desirable. (Which perfectly cancels out the factors pushing in the other direction.)

The logic of loans is currency neutral. The borrower needs to consume a certain amount of value in a way that creates a surplus from deferring production until after consumption. He pays back that same amount of value plus some of the surplus which is split between the borrower and the lender.

I've make an example on how deflation discourages investments in real capital.
I would like to know if there's any false premise in it.

I think that big xflation rates can be destructive even if they're factored, but I get your point.


Yes, we're just to used to monopolized money (at least inside a country) from which commerce can't escape to avoid price unstabilities.
But the appreciation bitcoin has had since its creation would probably hurt severely its financial market if it existed.


What I claim is that during the bust cycle, some good (not the best but still good) investments are not funded because of this need of clearing debts.


What do you mean exactly by easy credits? Low interest, risky or not secured loans?
 
What interest causes by itself is the exponential growth of the wealth of creditors. To sustain that exponential growth, debtors must grow at the same rate to pay the interest, at a higher rate to be able to pay the loan or let their debts grow exponentially.
That growth cannot be sustained and eventually, society reach an unsustainable level of debt, then the clearing debt cycle begins.
Also since capital yields get low by competition, lenders must accept more and more risky investments to produce interest. If the central bank interferes to avoid the beginning of the bust cycle, risk premiums are maintained low, and mal-investments are made. If not, the interest rates become higher and higher helping to precipitate the debt clearing by springing bankrupcies.

I wish I had seen this earlyer I could have posted to this thread so many times. This is an awsome statment thanks mate to OP

Usually, but it's when the inflation/deflation rate is not correctly factored in that problems arise.  This is exactly why I said that the disruption occurs when the rate crosses the zero.  It's hard to predict the changes due to a central bank's change in outlook.  It's not nearly as difficult to predict inflation/deflation under a true gold standard.  This is why Bitcoin shines, as one variable of that calculation (the present and future total monetary base) is highly predictable.  Moreso than even gold.


I mean that catastrophic deflation is not likely in a bitcoin economy, even without a stable user base.  This is partly because of the above variables being highly predictable, thus speculators temper the sudden price movements to whatever extent that they are predictable.  I will not claim that catastrophic deflation isn't possible, it's just that it has never been seen in the real world; under a gold standard or since.  The claim that the Great Depression was an example of such is provablely false, yet it is a myth that persists.  There is simply no reason to expect that a catastrophic deflationary environment is possible under Bitcoin.  If the Bitcoin economy grows too fast, it simply will limit it's own growth via it's excessive price deflation.  There is no way to overshoot that mark and destroy itself.  None that I can see, anyway.


This is simply not so.  Bad investments do get funded during the 'boom' cycle, that then turn obviously bad and result in the 'bust' cycle that must occur to clear out the bad investments.  It's the access to easy credit, not the interest rate itself, that results in the business cycle.


Of course this is a valid view of the business cycle, but the interest rate is not the cause per se, but the access to easy credit, which tends to be reflected in the interest rate.