
Bitcoin is Deflationary, and That's OK - bdr
http://andrewbadr.com/log/19/bitcoin-is-deflationary-and-thats-ok/
======
yyqux
I found this remarkably unconvincing: none of the arguments really seem to
address the actual concerns with deflationary currencies, but seem to be
directed at some (vaguely implied) strawman. I mean, why is the fact that
there is a liquid market for bitcoins relevant at all? I don't think that has
any bearing on whether a deflationary currency is bad or not. One failure mode
for a currency is that it's completely illiquid, but that's not the most
likely problem. E.g. there was always a liquid market for gold but it's
probably the main example of a deflationary currency in practice.

~~~
lingben
Agreed. The author is beset by muddled thinking. None of the arguments he
brings forward are relevant to the question at hand.

The most important consequence of bitcoin is watching programmers and other
tech oriented people play armchair economist. They certainly seem to be having
lots of fun but they are playing a game no economist recognizes.

~~~
bdr
> None of the arguments he brings forward are relevant to the question at
> hand.

That's an unfair criticism, since the arguments I address are exactly those
raised by everyone else who has written on the subject.

~~~
stevesaldana
Your third point is good and one that I personally think is the most
impactful. At the end of the day, everyone has their "price". You can't take
BTC to the grave with you, so at some exchange rate, you are a seller. For
some people this amount is $130, or $500, or $5000. But at every new BTCUSD
high, it introduces a new group of sellers and eventually all hoarders will
get shaken out.

I'm not sold on your second point "someone who sells a Bitcoin for X would
have been equally happy to spend it on something they value at X." Using daily
volume on Gox as an example, just because $2M changed hands yesterday, it
doesn't necessarily imply that these folks would have happily exchange their
coins for a good or service. A lot of this volume could represent traders
getting in and out of a position, not someone ready to empty their account.
However, your general point is that liquidity is a positive reinforcing
signal, and I can agree with that. If liquidity is increasing because more
merchants need to swap out, this is a direct indication that spenders are
willing to transact.

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jstalin
Expect lots and lots of arguments against bitcoin because of its deflationary
nature. Nearly the entire universe of modern academic economics rests on the
Keynesian and/or Monetarist foundation that increasing money supply (thus
inflation) is a good thing.

Most people don't connect the fact that their money is worth less year after
year with the fact that it is the government itself devaluing their money.
Heck, most people don't even realize their money is losing value. Only savers,
especially in our current zero interest rate policy environment, come close to
understanding what is going on.

Nothing illustrates better what has happened to our money than the current
market value of US coins made before 1965. For instance, a 1964 dime
(nominally worth 10 cents) is actually worth $1.64 in silver content. That's
somewhere around a 95% devaluation in just the last 50 years!

~~~
Guvante
Are you saying there is something wrong with nominal inflation? 2% a year is
scary when you talk big numbers like that, but the only time that money spans
that large of time spans is retirement, which is invested at well over
inflation even if you choose something like government guaranteed bonds.

To my knowledge the only way to lose money to inflation is to sit on cash
(stupid for other reasons), have it in short term treasury bonds (which are
bought by companies that have nothing to do with their flex cash), or have a
bad savings account.

~~~
jstalin
Yes, it is harmful, particularly to savers. Of course, the Holy Keynesian view
is that savings is bad and that we all need to be encouraged to _spend_.

Tell me right now where I can save and earn more than 2%. Maybe 30 year
treasuries (with nominal values at 30 year highs, meaning that they have no
where to go but down, further eroding savings), but certainly not in savings,
a CD, or any other classic savings product. 2% compounding per year is a 22%
loss in value over just 10 years. Chasing yield over that 2% per year further
distorts savings and markets, and of course that 2% loss per year is good for
what? It's just confiscation by the money printers to devalue future debt
payments, making it _seem_ all the easier to borrow and spend unsustainably.

But, of course, a steady 2% per year is the pipe dream of central planners and
doesn't happen in real life. See, e.g., the 1970s.

~~~
sergiosgc
Saving is not harmful nor beneficial. It all depends on what you do with your
savings. If you stuff them under the mattress, saving is harmful. If you
invest, then it's beneficial.

An inflationary currency promotes investment. A deflationary one promotes
mattress stuffing. You may draw the conclusion yourself.

~~~
jquery
> If you stuff them under the mattress, saving is harmful.

I don't see how. Isn't this equivalent to a distributed loan to everyone who
holds dollars?

~~~
sergiosgc
It is unstable. The currency is deflationary by design and the mattress effect
effectively reduces monetary mass, creating more deflationary pressure. Up
until the point price drops suddenly. It is the poster example of a bubble:
artificial valuation, self feeding cycle, disruptable only by change of public
perception.

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RockyMcNuts
Falling prices and strong growth tend to be mutually exclusive in the real
economy. Suppose you’re an investor and an entrepreneur comes to you with a
proposal to build a factory, and the business plan shows next year the factory
will cost 5% less to build, and the products will sell 5% cheaper. Why build a
factory today if you can get 5% a year increase in purchasing power just by
hoarding currency? You need much bigger margins than are currently typical
outside tech and zero marginal cost products. Incur debt, and even at the zero
interest rate bound, you need 5% more real income next year to pay it back. In
a modern economy, especially where there's a lot of debt finance, price
deflation is death.

Anyway, since Bitcoin isn't a currency in the sense of a transaction medium, a
stable store of value, and a unit of account, but more akin to a digital pet
rock or Beanie Baby, deflation doesn't really matter very much.

~~~
nandemo
Why build a factory today if you can buy your country's bonds and enjoy a
risk-free x% a year?

Why buy a smart phone today if you can wait 1 year and get a much better one
for the same price?

~~~
RockyMcNuts
The short answer is, you don't. When real interest rates are at 5%, that is
not normal and those are not usually good times.

Bonds in the US have earned a real 2.3% since 1926. From 1937 to 1981 bonds
lost a real -0.72% per year.

You don't buy bonds to earn the rate of growth of real GDP or better. If you
want to do that, you have to take risk.

The last 30 years of declining inflation have been the anomaly. People built
businesses instead of buying bonds because bonds looked pretty unattractive,
but when inflation kept surprising to the downside, bonds did better than
expected.

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Steko
None of these arguments is at all persuasive.

"First of all, the present value of a perpetually appreciating asset is not
infinity"

Straw man. No one is claiming the present value of anything has to be
infinity. And I don't see anyone saying real estate is a good medium of
exchange.

"Second, there is a liquid market for Bitcoins."

Another straw man. No one is saying there will not be any trade in
deflationary currencies. The amount of Bitcoins that are not being circulated
speaks to exactly what people don't like about deflationary currencies though.

"Third, the marginal utility of money is diminishing."

A true fact that has no impact on the criticism of Bitcoin because it's
deflationary. Red herring.

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YokoZar
The article hits on an entire class of silly arguments I've seen against
bitcoin from the start: people claim that bitcoins will be worthless because
they will be too valuable to trade.

The language used for "too valuable" may vary (scarcity! illiquid! deflation!)
But, as the author notes, that's not at all what matters -- all that's
necessary is that they're tradeable and people have different values for a
bitcoin at a particular time.

------
hristov
I think it is not ok, and I think that the deflationary nature of Bitcoin is a
wonderful practical example of the problem with deflation.

To the best of my knowledge bitcoin does not seem to be used as currency that
much. It's explosion in popularity is not matched in explosion in currency
usage. And why would it? If you, for example, buy a toaster online with
bitcoin and it keeps appreciating, this toaster may end up costing you a $1000
in a year.

If bitcoin were to fullfil its promise, a large portion of online transactions
should take place with bitcoins. AFAIK, thus far this is only happening for
illegal drug transactions, for which there is no other alternative.

Thus far bitcoin is something people buy and hold hoping it appreciates. If
they are tired of holding it, they sell it back. It is not a currency, it is
an object of investment/speculation.

------
dnautics
It shines a light on the problem with inflationary currencies - one, costs of
real goods tend to go down as technology advances, this is the "rising tide
that lifts all boats", and is supposed to bring the lower economic classes to
enjoy luxuries only available to the riches in eras long ago. Why are we
trying to raise the prices on these goods?

Secondly, why are we urging the economy to have exponentially increasing
production to maintain nominal value, when we have limited resources on this
planet?

~~~
chii
There are several parties in the game - the "normal plebians", and the upper
eschlons. Guess who benefits the most from inflation? Guess who decides
monetary policy that leads to inflation?

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Xcelerate
A lot of these arguments against the future of Bitcoin rest on the ill-founded
assumption that the Bitcoin protocol is static and unchanging. This isn't
necessarily true; there's already reactionary plans should SHA-2 or secp256k1
become comprised.

It seems fair to reason that a community consensus would alter the protocol
should deflation ever really become a problem.

~~~
wyager
Replacing the underlying crypto is 1000x simpler than replacing the coin
production mechanism, for both political and practical reasons.

~~~
tlrobinson
I think miners who have invested in farms of ( _very_ application specific)
ASICs would disagree.

Then again, in theory it's the "economic majority", not that miners, that
matter: <https://en.bitcoin.it/wiki/Economic_majority>

~~~
wyager
You can replace RIPE or ECDSA or even SHA (in the address-generation
mechanism) without impacting the miners at all.

------
johnrob
I would think a large majority of bitcoins would end up in the hands of people
living somewhere with low interest rates - instead of parking their money in
banks, they'll park it in bitcoins. The demand for investing - which applies
across all currencies - could easily be greater than the demand to spend
bitcoins.

Investment demand has caused deflationary problems in other areas too,
specifically food prices when a lot of investment was made in certain
agricultural futures.

~~~
johnrob
Replying to my own comment, deflation isn't the worst thing that can happen to
bitcoin IMO - unstable prices could be a bigger challenge. Since the market
for bitcoins is not regulated, it could end up subject to all manor of tricks
to create panics or booms. If the price fluctuates rapidly then timing the
market becomes a burden of using the currency.

------
tlrobinson
Deflation may prevent Bitcoin from replacing all government fiat currencies,
but I don't think it has much impact on Bitcoin becoming a popular form of
payments / transfer / store of wealth.

Some Bitcoin proponents would be disappointed by that prospect, but I think it
would still be a big win.

It likely means several orders of magnitude difference in price, but in either
case the price would go up significantly.

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bdr
Hm, HN traffic has grown. The server will be back up in a couple minutes.
Edit: All good, I think.

This post has been in the draft folder for a while, but I decided to just run
it. A better title would be "Common Flaws in the 'Bitcoin is Deflationary'
Argument". There might actually be a convincing "Bitcoin is Deflationary"
argument to be made, it's just that no one has made it yet.

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jiggy2011
The comparison to housing seems a little off to me. For example with the
property boom, people didn't want to sell their houses because they were going
up in value. Therefor they go up in value some more. Therefor people can't
afford to buy them, so we fix that with sub prime mortgages..

~~~
dnautics
Right, whereas, if we didn't create subprime mortgages, if people couldn't
afford to buy them, eventually the price would have had to come down, or else
you have idle stock. Instead, we inflated the price bubble by enabling risky
individuals to make purchases they shouldn't be able to, and so when the
prices actually came crashing down, not only did they take down the housing
sector, but the defaulted loans exerted magnified, collateral damage across
the entire economy.

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gnoway
What stops you from doing business in fractional bitcoins? I'm pretty sure
shift is a basic instruction in every architecture.

~~~
jellicle
Dealing in fractional bitcoins doesn't solve deflationary problems in the same
way that Zimbabwe printing a $100 trillion dollar banknote didn't solve their
inflationary problems.

