Topic: Krugman makes some good points - page 6. (Read 7193 times)

Your premise is, providing incentive for economic activity is the duty of a currency alone. If the currency doesn't motivate economic activity, all markets grind to a halt. This is very hard to argue for, especially with practical examples. Also, I want to repeat my question: If that is so, why didn't all markets grind to a halt till now because of gold?

There is certainly something to be said to create a more sustainable society, but I dont think the way to get there is by causing massive unemployment and killing the economy.  Sure, doing so  will preserve some resources for a bit longer, just like for instance the killing of 5 billion people would,  but surely there are better ways to achieve that? A deflationary currency doesnt discriminate between resource intensive economic activity and eco friendly one, it will affect either in the same way. So if your claim is that it will decrease economic activity and therefore is desirable, then I think thats a silly proposition. You might as well argue for mass killings, war or famine

You are hungry. A hamburger costs 3.89 mBTC. What do you do?

> Wait four months when deflation reduces the price to 3.88 mBTC
> Buy the hamburger now and not worry about small amounts of deflation.

But people will pay via fiat! Or that only applies to necessities!

You want this shiny new game that's released. It costs $60

> Wait six months before it costs $30
> Enjoy the game now and pay $60

We can see a "deflationary environment" in League of Legends. Champions costs more the first week that it is released (or something, I don't care, I'm using it as an example). People still pay for it because they want it now and slow but predictable deflation won't significantly impact spending.

+1  

Yeah, your coin is now worth a whole lot more goods than when you traded for it.  And people think this will discourage spending your coin?  That's like saying that lower prices discourages shoppers.

Exactly! In an expanding world (resources and people) infinite value helps you exploit nature and grow population as fast as possible. But now finite is on the table, and decreasing population. Only gold and bitcoins work in that environment.

No problem.

We need to be careful to differentiate between changes in prices and expectations of these changes. If the expectations are mostly accurate, the direction of the change is irrelevant. The only reason why people might consume more during an inflation is if they are tricked, i.e. if they think the prices will rise slower than they really will.

There are several issues here too. First of all, the price of the capital goods is derived from the price of the consumer goods. Unless there is friction in price adjustments then, it's impossible for the unit of account to have a negative nominal interest rate. The real interest rate can't be negative even irrespective of that, as that would mean that people value the same good in the future more than they value it in the present, and that contradicts the axiom of human action.

Of course, a negative nominal interest rate can hypothetically occur with something that is not a unit of account. But this is not as big a problem as mainstream economists assume. I did a simulation and presented the results at the London Bitcoin Conference 2012. In my simulation, a merchant with a 6% real markup and a turnover/stock ratio of 6 was able to have a positive nominal RoI using a deflationary currency that is not unit of account even at a 50% deflation (i.e. the prices in that currency halve within a year). Even income taxes did not revert the positive RoI (of course that depends on the details of the tax rules, but I took those that according to my research should be applied to Bitcoin in Europe).

In fact, because the prices dropped, after a year the simulated merchant would be able to double his stock, i.e. he saved enough capital to be able to expand his business. This is a hint that a deflationary currency edit: falling price level is highly beneficial for consumers, as it increases the amount of goods available to them. And if you don't believe the simulations, just look at consumer electronics.

Thats not currency deflation. Cellphones and computers actually are getting cheaper to produce. Its called an increased productivity and if that is what is causing the price deflation; then there is nothing wrong with that, on the contrary. We had the same during the industrial revolution; we got massive increases in productivity causing price deflation. But also causing more production of actual physical wealth because we produced more goods more efficiently. As a society we actually got richer and the increased purchasing power of our money was just a reflection of that. But you cant reverse that. Making money more scarce doesnt cause an increase in productivity or production, let alone wealth- anymore more than printing more money can make everyone rich.

I'd like to point out, that this might actually be a positive aspect. Right now the worlds monetary system is geared towards infinite growth. This strikes me as not very smart since last time I checked, we were living on a planet with finite resources. A deflationary (not sure, this technically applies to Bitcoin. Bitcoin does have inflation, but it's small, controlled, predictable and finite) currency might act as a catalyst for change in the way we think about the economy and lead us from a growth oriented to a sustainability oriented model. I don't see it as a threat to general prosperity if people stop spending currency like it's hot potatoes and going into debt in order to fuel consumption - on the contrary. A currency increasing in value over time encourages saving - delayed consumption, as in "lets' not strip the planet bare to the bones right now to have 5 ipads and 4 cars each but let's leave something for later generations". Just my two Satoshis.

I couldn't agree more!

All the people who say Bitcoin stinks because it must inevitably increase in value - do you think they do the logical thing that their belief points to and put their money in Bitcoin?

I don't have in depth knowledge about Economics, so I'll try to give practical examples. Please point out where I'm wrong; I'm prepared to do some recommended reading.

Let's assume I'm a Cypriot who lost trust to the banking system and decided to preserve my wealth in Bitcoin. I don't see any reason why I wouldn't spend the BTC for my needs, since I would be doing it if it was sitting as EUR anyway (or not, in the same manner). I always could have stored the value in deflationary vehicles in my control, but I didn't, because it wasn't liquid enough. Well, with Bitcoin, I can both store it in a deflationary vehicle and spend. It's both better than EUR in a bank or gold under my pillow. Granted, my BTC stash will decrease over time, but my overall wealth will still increase. Just as I won't lock my EUR in a good investment while depriving my children of a good education, I won't try to preserve my coin stash at the expense of their benefit.

Another personal example is, a few years ago, I bought land from an old guy. I was pretty sure that it would appreciate in time, and I'm sure he thought the same. He sold it to me anyway, because he wanted to expand his business. If he is successful now, he might have made more money than he lost to appreciation. If he isn't, tough luck; but it is a fact that he made that decision. Since Bitcoin is more liquid, to spend coins to make more coins is an easier decision IMHO.

In turn, all my family combined probably do not hold as much land as our forefathers did. Still, we are much wealthier than they were. Of course, if they did hold the land, it would be worth a lot more than all of ours combined. But at what cost? It's almost impossible to imagine.

All in all, I could understand the argument more easily if there were no deflationary vehicles one can invest in. But there already are. At this point, I'm pretty sure I'm missing something. Instead of investing in gold and keeping some EUR to spend, I can keep it all in Bitcoin. If I chose to invest in something other than gold, then I would do the same with Bitcoin. Should I not?

The only mechanism I can think of is, if investing in deflationary vehicles are made accessible only to a minority of the population. Bitcoin breaks this condition almost perfectly, therefore will result in market failure.

This.  And as was mentioned here


It's hard to emphasise this point strongly enough, especially since most people don't get it.  In our world of fiat currency, money is created out of nothing, based on little more than the existence of debt.  And given those conditions, deflation can certainly be a concern.  But under a currency that operates to different rules (eg. physically backed, or fixed supply) the conclusion that deflation is bad is erroneous.

Just found this excellent article on twitter that explains Krugmans errors very clearly:

http://www.libertariannews.org/2011/06/11/the-economics-of-bitcoin-why-mainstream-economist-lie-about-deflation/

"Krugman’s argument that people would be less willing to spend and borrow, and this would lead to unemployment, is as ridiculous as saying that because computers keep getting better and cheaper into the future, people would be less willing to spend money on a computer today because they could simply wait and buy an even better/cheaper computer in the future.  That is obviously not how people think.  People have needs and desires that have to be met, and they will purchase things as soon as their desire for the product is larger than their desire for future earnings on savings."

If everyone *knows* that the money supply will increase a certain way (at a decreasing rate), then this information will be factored into the price of Bitcoin. It is not a surprise to anyone. If the rate of inflation would cause the price of Bitcoin to increase, it would increase instantly at the beginning, and not gradually over time. Therefore, you can not expect the price of Bitcoin to inevitably increase.

The price of Bitcoin is increasing because it is becoming more popular, not because the number of Bitcoins in existence is increasing at an ever-slowing rate.

I hope I'm not alone in not buying this whole "deflation is bad" argument.  By your logic, Samsung should be broke because the SGS3 that used to retail for $800 is now available for $350.  And by the same logic, I will never buy a computer because in a month's time it will always be cheaper than buying today.

Any business that borrows money to make/sell widgets needs to do price/expense/cash flow management to decide if the venture is profitable and sustainable.  The cash flow implications of falling sale prices over time is no different to falling sales volume over time (ie. saturating the market), or any other rising input cost.

Just because a business agrees to pay back +X% over a 12 month loan when they know the price they can sell their goods at will fall by Y% per month doesn't mean they'll necessarily go broke - and if they do, it's because their outgoings are more than their incomings.  That their outgoings are falling slower than their incomings (due to deflation) doesn't make deflation bad in and of itself.  It just means they didn't do their sums.

If it costs BTCX to make a widget, then you better sell that widget for more than BTCX, inflationary, stable or deflationary environment.  If that means you can't drop the selling price of your widget as much as your competitors, then you don't deserve to be in business any more.

And as for assertions that:

Again, I don't buy it.  Deflation just raises the bar for what is deemed an acceptable return on your funds.  If you can make X% through deflation, then any investment must make >X%.  Some could argue that inflation lowers the bar too far, allowing malinvestment to consume valuable resources that would be better deployed elsewhere.

And for the person who asked

The loan and repayment of borrowings are part of the capital stock of the currency (I may be muddling my words here).  Interest payments comes from the flow of money through the system.  The amount of money in the system hasn't changed - what changes is the distribution.

Krugman is an idiot, proof under your nose.


http://pizzaforcoins.com/

https://www.bitcoinstore.com/

https://bitcointalksearch.org/topic/the-latest-avalon-announcement-in-chinatranslated-batch-3-price-and-more-155345

https://bitcointalksearch.org/topic/dont-forget-there-will-probably-be-further-batches-from-avalon-157809

http://www.libertariannews.org/2011/06/11/the-economics-of-bitcoin-why-mainstream-economist-lie-about-deflation/

Krugman fails to acknowledge the fact that money is a substitute for future goods and service, i.e. delayed consumption. A deflationary currency "rewards" those who can delay the consumption to a time significantly in the future. However, what ultimately determines the consumption decision is the need. In an inflationary environment you have an incentive to spend your money on things you don't really need, while in a deflationary environment you spend money preferably only on things you need.

Krugman is trapped in his keynesian assumption of the broken window economy, where spending money on useless stuff increases overall productivity.

Its hard to argue against this. A purely deflationary currency provides no incentive for investment or economic activity; it only causes rich people to get richer just from being rich and sit on their money. Its a great system if you have money,  but economically its..  not very smart to put it mildly. 

I think the solution to this problem is -  or could well be  ripple; or something like ripple. It allows the issuing of credit money at a rate that keeps pace with economic growth (or shrinks if the overall economy shrinks). Bitcoin could act as monetary base like gold did for fiat. Although one could question if in the longer run, if such user issued credit money becomes mainstream; if there really is a need for the monetary base in the first place.

I agree, and I'm sorry about that.  I didn't misinterpret you on purpose.  I'm not trying to be dense, but I'm still not sure that I understand your argument.  Are you saying that inflation doesn't cause people to save less?  The current situation in US retail banks seems to suggest that people do save less when interest rates are lower than inflation.


I presented that wrong.  Krugman doesn't actually talk about lending in his short essay (it's only a few paragraphs long).  I gave my description of Krugman's argument after I gave the link to it, and threw in the credit part to show the problems I think we might see with deflation.

You are right that the nominal interest rate would be lower for a deflationary currency like BTC, but the real interest rate is what will make things more difficult.  Lets run some numbers to see how a loan would work out:

Alice loans Bob 120 BTC for 1 year at 1% simple interest to purchase a physical capital to build a widgit factory.  That means that payments will be 10.1 BTC per month for 12 months ((120 BTC * 1.01)/12 months).  Widgits currently sell for 0.10 BTC per unit.  Deflation is 5% per month.

In the first month Bob has to sell 101 widgits to make his 10.1 BTC loan payment to Alice.

In the second month deflation effects Bob's business.  Because deflation is at 5%, widgits now sell for 0.095 (0.10 BTC - (0.01 0.05))  If we round up (assume widgits are not divisible), this means that Bob has to sell 107 widgits to make his loan payment.

In each successive month Bob has to sell more widgits to make his loan payment.  This continues along these lines, every month Bob has to sell more and more widgits to make his loan payment, resulting in this table (rounded to 5 decimals):

Month |	Widgit Price |	Widgits Sold
1	0.10 BTC	101
2	0.095 BTC	107
3	0.09025 BTC	110
4	0.08574 BTC	118
5	0.08145 BTC	125
6	0.07738 BTC	131
7	0.07351 BTC	138
8	0.06983 BTC	145
9	0.06634 BTC	153
10	0.06302 BTC	161
11	0.05987 BTC	169
12	0.05688 BTC	178

Bear in mind, this is in addition to the iron law of wages, which drives down prices as more competition enters the market place.  Lets assume that Bob has a monopoly, though, just for the hell of it, and that widgits are in no way necessary to anybody's survival, so he's still a price taker due to the trivial nature of the product.  Lets say his widgits are something stupid like Justin Beiber albums.

If the market for Justin Beiber albums demanded exactly 150 units per month reliably, then the latest Bob could possibly operate is month 8, because even with zero overhead, Bob could not make his loan payments any more (and music fans rejoiced!).  That isn't because there is no demand for Justin Beiber albums and it isn't because Bob is a bad businessman who let his overhead run away on him.  People are willing to buy them, Bob is willing to make them, this transaction just can't take place because the financial system will not support the transactions because deflation killed the real value of Bob's business.

This is just the effect of one very short term loan on a small business.  Imagine a 30 year home mortgage.  Deflation would put everybody underwater almost immediately and keep them there for the life of the loan (assuming there is no insane housing bubble or something).  Deflation effects wages as well, so people would find their nominal income shrinking as time goes on, making it harder for them to make their mortgage payments.  If the bank came in and repossessed a home after a few years they would loose even more money.  It would be an endless cycle of loss for the banks and consumers.