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Krugman on BitCoin (krugman.blogs.nytimes.com)
254 points by mef on Sept 7, 2011 | hide | past | web | favorite | 302 comments

"What we want from a monetary system isn’t to make people holding money rich; we want it to facilitate transactions and make the economy as a whole rich. And that’s not at all what is happening in Bitcoin."

Spot friggin' on, Mr. Krugman. Bitcoin's supply limiting design has added a psychological dimension that encourages collecting. Perhaps when Bitcoin reaches supply maturity the value will stabilize but for now its value just too unstable to be used as a currency.

> Perhaps when Bitcoin reaches supply maturity the value will stabilize

I absolutely hate Krugman, but this is Econ 101 and even he gets it right. Bitcoin was a flawed experiment from the start because it has an absolute supply limit. Reaching that limit won't help. It'll make things worse. The money supply needs to expand for healthy economic activity and growth. If it doesn't, weird shit starts to happen.

Here's an example. In a normal economy, the population is constantly expanding. That means you need more $$$ in the system for each new person. If more money doesn't enter the system, the value of money goes up because of increasing demand and you start experiencing deflation.

Deflation is really really bad. Imagine you're a store owner. All of a sudden, people stop buying your stuff. Not because they don't want to, they love your stuff ... they just don't have enough money. So you lower your prices. Things go back to normal. Your own expenses go down as well, after all, everybody experienced deflation.

No big deal, right? This is what happens when a computer scientist creates a currency. Just adjust to the new price level, right? WRONG. It IS a big deal.

Think of the psychological effect of having to CONSTANTLY lower your prices on your goods. At some point, you'll hang yourself. You want to charge more, not less. It is absolutely depressing and has a real effect. Deflation is absolutely horrible.

The problem isn't the psychological effects of needing to constantly lower prices – this happens all the time in the tech industry, and everyone in that industry is doing just fine psychologically.

Rather, it has to do with the fact that constantly down-shifting prices cause people not to buy nearly as often as they would if prices were stable or slightly inflationary. As a result of that, the economy slows down (sometimes dramatically).

Exactly. In the bitcoin world, you make more money by not investing the money you have and instead holding onto it in the hopes that you'll be able eventually convert it to a stable currency in the future. That's a disaster. Who, for example, is going lend their precious bitcoins to a risky startup when they can just sit on them and watch them appreciate?

Finance 101, its called hedging. You can invest in dollars, euros, bitcoins, google, gold, food or whatever. They all have relative leverage and are all investments. Purchasing bitcoins means to investing in a share of the bitcoin economy. Its a startup currency which has never happened before. The increase in trading value has created an enormous amount of funding for bitcoin startups.

But what about the people that want to use it as a currency, to buy things? If everyone views it as an investment, and not a vehicle for trade, it will fail as a currency / never take off as a currency.

A lot of this logic is circular - the value will continue to rise because people will keep investing because the value will keep rising, etc.

People are not all going to hold on to it and not spend. Some people are going to feel that due to hoarding, it won't become a currency, and hence it's not a good investment, and will be more likely to spend.

"...due to hoarding, it won't become a currency, and hence it's not a good investment..."

Not necessarily.

The prospect that it's not a currency is what makes it attractive to hoarders. Hoarders/investors don't want Bitcoin to be a viable currency; they want it to be an investment commodity. And that's the crucial problem with Bitcoin: its use as a currency, and its use as an investment, are fundamentally at odds with one another. At any given time, it makes sense to be either buying/selling (hoarding) or buying/spending (transacting); at no point in time does it make sense to be doing both.

Transactors essentially believe that the value of Bitcoins will converge around a stable mean, thereby facilitating the currency's use for transactions. Hoarders believe the opposite: that the value will either be totally volatile (with lots of peaks and valleys against which to speculate), or that it will steadily climb.

Finally, we should distinguish between "selling" and "spending." A hoarder who wants out of the market will not spend his hoard; he'll sell it. A transactor also buys and "sells" Bitcoins, but in his case, "selling" involves spending them on goods or services -- not converting them back to dollars. This is a subtle, but crucial distinction. Both users buy into the market, but they exit the market differently and with different outcomes. And both will only be able to exit the market if there's liquidity in the form of willing new buyers or willing acceptors of BTC in exchange for goods and services. Each of those two outlets has a different liquidity dynamic, too.

(Sorry for the tl;dr)

"The prospect that it's not a currency is what makes it attractive to hoarders. Hoarders/investors don't want Bitcoin to be a viable currency; they want it to be an investment commodity. "

Bitcoin will not be a good investment unless it's a currency. It has no other uses besides as currency. It's not a precious metal with industrial or ornamental uses for example. It's an abstract piece of data that could be useful in trade.

" Both users buy into the market, but they exit the market differently and with different outcomes. And both will only be able to exit the market if there's liquidity in the form of willing new buyers or willing acceptors of BTC in exchange for goods and services. Each of those two outlets has a different liquidity dynamic, too."

An investor who believes bitcoins will drop in value has the option of selling it or trading it for a good/service. Both accomplish the goal of getting out of a depreciating asset.

Some people are going to feel that due to hoarding, it won't become a currency, and hence it's not a good investment, and will be more likely to spend.

But if I as an individual consumer feel that bitcoin won't become a currency, why would I even be converting my money into bitcoin in the first place?

He's talking about the situation where you already have bitcoins. If their value is deflating fast enough, then the most sound "investment" is to just hold onto them.

The other big problem is that debt loads don't drop along with prices - which effectively makes them rise. Falling prices (which lead to falling wages) + stable debt loads make it far harder for debtors to pay off their debts, which puts even further drag on the economy.

Wow, for all I've read about Austrian Economics, I've never heard that simple yet devastating argument.

Just to be clear, it's an argument against fiat currency as deflationary and inflationary shocks occur in those systems. The effects of deflation and inflation over time are countered with market-set interest rates -- higher savings and loan rates in an inflationary period and low-to-negative rates in a deflationary period. Yes, in a deflationary economy a (for example) -5.00% interest rate might be fair and would happen were it allowed.

Why would you ever lend money at a negative interest rate? You can always get 0.00% with virtually no risk just by socking the money away in a secure location. This is the heart of the problem with deflation (and deflationary currencies like bitcoin) - there's a 0.00% floor on the time cost of money.

Yes, you are right of course. The interest rate could not rationally go down below zero, but there would still be demand for loans during the deflationary period, so there would be other compensation (like equity in a business) in exchange for the load so that the risk/return would be proportionate to the risk-free rate of holding cash.

There will certainly be demand for loans, but the supply and demand curves for loans may not intersect anymore, meaning that no loans are made (because given a deflation rate of 5%, a nominal interest rate of, say, 1.5% (only a very small premium over the minimum risk-free rate of 0.00%) is still a real interest rate of 6.5%, which may be more than many of the loan customers are willing to pay.

In other words, deflation makes financing any risky enterprise much harder, so only the mostly highly profitable projects succeed. This makes sense, because in a deflationary environment just holding a pile of cash is a profitable endeavour.

Adam Smith talks about this phenomenon in Chapter IV (The Origin and Use of Money) in The Wealth of Nations:

“By means of those operations [inflating the coinage], the princes and sovereign states which performed them were enabled, in appearance, to pay their debts and fulfil their engagements with a smaller quantity of silver than would otherwise have been requisite. It was indeed in appearance only; for their creditors were really defrauded of a part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor, and have sometimes produced a greater and more universal revolution in the fortunes of private persons, than could have been occasioned by a very great public calamity.”

It follows, of course, that deflating the currency is favorable to the creditor and ruinous to the debtor; although I can't find where Smith says that, I think he does. In a sense it's worse: the creditor's losses in inflation are limited to the amount she originally lent.

Austrians don't advocate for a deflationary currency, they advocate for competing currencies. Rothbard, one of the "pillars" of Austrian Economics, even stated that The Great Depression was due to deflation not inflation.

Lots of people that scratch the surface of Austrian Economics immediately start shouting the ills of inflation and such.

Most "hardcore" Austrians I know would like a currency that's supply grew with economic growth. Economy grows by x measure then so does the currency, to keep it stable.

Thanks. I knew this was wrong as soon as it left my keyboard.

I guess the problem we're having is that the Fed's mandate is to keep unemployment low, not to expand the currency as the population expands.

I really don't understand how a currency supply is supposed to track growth, when one of the means of controlling currency expansion, the discount rate, can actually stimulate growth sometimes, right?

Yes, instead of taking on debt people would be incentivized to save money before spending it.

With inflation you get the reverse effect: people are incentivized to take on debt to spend.

I would not short gold or Apple either, the risk would be huge! So are you agreeing that bitcoins will become worth more then? So I shouldnt take a bitcoin loan out, I should take a dollar loan out and buy bitcoins with it. Or you are saying bitcoins are bad so they will go down in value ... and I should... whaaat?

He's saying that the characteristics of bitcoins make it a lousy currency (people have little incentive to spend or loan it).

Whether or not it's an asset worthy of investing in is a separate question. (I'd argue that it isn't, but that's a separate issue from the characteristics that make it a bad currency).

As an investment, it's like gold but without the intrinsic value part and the "historically used as an investment for the past couple of millenia" part.

The intrinsic value of bitcoin is as an uncensorable way to transfer money, for example to donate to Wikileaks when Visa and Paypal won't let you. It becomes more valuable the more governments try to stop transactions. This is why I'm bullish on it.

Oh, uncensorable? You mean as long as the government permits both parties to be connected to the internet. When they block either of you, it's about as good as a hundred dollar bill.

The intrinsic value of gold is quite a bit less than its market value, though - it's very hard to separate that from the "historically desired" aspect.

If you want intrinsic value, you're probably better off investing in good quality rifles.

Well, of course. But bitcoin doesn't have even that.

Though I would suggest that you would have to time your entry into the quality rifle investment market well to avoid getting hit by a speculative markup caused by people's expectations of their future intrinsic value.

But this contradicts itself. If it makes it a lousy currency, then people wouldn't expect its value to rise, and hence would have an incentive to spend it, hence it would be a good currency and its value would rise.

Rationally, people should wait as long as possible to buy tech because they'll get more later. Instead, they buy it at a furious rate. Why is that?

stevenwagner shows by example why this isn't so, but to spell it out: If you were buying a CPU as an investment like a share of a mutual fund, to buy, hold, and sell, you'd want to wait as long as possible. In fact, you'd never buy one; we pretty much always expect the price of a given CPU to go down in the future.

But if you're going to use it to generate value, you should buy it as soon as your expectation for the marginal value it will generate is greater than the price of the CPU.

That makes sense, but what I'm wondering is: why doesn't the same argument apply to all products in the presence of deflation?

It seems to me the real problem of deflation is that debts get harder to pay off, not that people put off their purchases. But the "deflationary spiral" of delayed purchases is what people keep talking about, and I haven't heard a good reason why the tech industry is uniquely exempt from that.

Deflationary spirals happen when the average price of everything, economy-wide, is going down. It’s perfectly normal for some things in the economy to get cheaper while other things get more expensive. Consumer technology is conspicuous and the way it gets cheap is conspicuous, but it accounts for a small proportion of what the average American spends money on. (The average American spends a small proportion of his/her income on consumer electronics because they’re so cheap.)

Sure, but why does that make the difference? Why doesn't that incentive work the same way when it's one class of products, as when it's all products?

Also, there are several periods in American history when we had modest deflation and a booming economy. The Roaring Twenties was one. How did that happen?

Consider the effect on wages.

If computers get cheaper while the average consumer’s disposable income stays constant, then people will just buy fancier computers, or spend less on computers and use their savings to buy more of other things, or be grateful that the cheaper computers make up for rising prices in other things they want (e.g., health care).

If the average price of everything goes down, then the average consumer’s disposable income must eventually decrease; to make up for the lost income, employers will have to either cut wages or lay off workers.

PS: The Roaring Twenties were not always so roaring. There was a depression in 1920–21, and according to the helpful St. Louis Fed graphs, there were two other recessions between 1921 and 1929.

First explanation I've seen that makes some sense.

I know! The iPad is going to be so much cheaper in 10 years. Im waiting.

The total number of bitcoins in circulation is capped, even though the total quantity of wealth in the world continues to increase. If bitcoins were the only currency used, then yes, this would cause hoarding problems. Does this mean bitcoins are flawed? No. It just means that there is a cap on how much wealth can be purchased with bitcoins.

It is 21.00000000 million-- or 2.1 quadrillion of the smallest-possible-unit.

So every person on earth only gets 300,000 of the smallest possible unit?

With the current software yes. It could always be expanded if need though.

In other words, prices of goods (in bitcoins) will (eventually) stop deflating, even though there is a fixed quantity of bitcoins, because other cryptocurrencies will be introduced.

>Bitcoin was a flawed experiment from the start because it has an absolute supply limit. Reaching that limit won't help. It'll make things worse. The money supply needs to expand for healthy economic activity and growth. If it doesn't, weird shit starts to happen.

Everyone has an opinion about BTC's deflationary nature, but few people seem to consider the possibility that BTC might be the first currency that works substantially differently in this regard to all other past currencies.

BTC is the first currency that is infinitely subdivisible. Ostensibly only 21 million BTC will be created, but since it is subdivisible to 8 decimal places, there will be [21 million / .00000001] = 2.1 quadrillion atomic units.

And that is only an artifact of the data structure used to implement it in code, not an inviolable requirement of the protocol. The precision, and hence the quantity of BTC, can be increased in the future if necessary.

This aspect of BTC, along with the fact that is not a debt-backed interest-bearing fiat currency might require a rethinking of the Quantity Theory of Money as it applies to Bitcoin-like currencies.

Additionally, only ~7 million Bitcoins have currently been created, only ~33% of the eventual total. The BTC economy is so new you can't buy much with it besides other currencies, computer parts from Newegg etc., and perhaps illegal drugs. Finally, forks like Solidcoin are appearing based on perceptions of consequential flaws in the BTC technology (absolute dependence on miners to extend the blockchain, etc.).

Imho it's worth withholding judgement for a few years at least and just observing how it develops. It's something potentially new, to which the old rules may not apply.

> The precision, and hence the quantity of BTC, can be increased in the future if necessary.

The ability to subdivide BTC is irrelevant to the question of depreciation. If 1 BTC goes from $10 USD to $20 USD, then 0.5 BTC goes from $5 USD to $10 USD. It doesn't change the money supply any more than slicing up a gold nugget creates more gold. Bitcoin is still inherently deflationary. All subdivision does is avoid imposing a minimum transaction size.

Bitcoin is also unique in that a substantial portion of the total BTC that will ever exist have already been destroyed, as many early adopters abandoned or lost their wallets.

> In a normal economy, the population is constantly expanding.

That may be, but the western world is then abnormal. US population is projected to peak at 2030, and a number of countries already have negative population growth. Exponential growth assumptions should not be made for long periods ahead.


Our economies, culture, the whole of our civilization is based on the assumption of population growth. Because, quite simply, that's how it's always been.

We have never before experienced a reduction in the human population for any extended period of time.

I wouldn't count the US out yet, it can easily augment its population with immigration. So can all the other developed countries.

Anyway, regardless, making a currency with a fixed supply doesn't work under any scenario. With a constant or increasing population, you want to increase the money supply. With a decreasing population, you want to decrease it.

Most people don't seem to realize that when your currency inflates, there are people who get the new money. Inflation=wealth redistribution

Inflation does not mean creation of new money. This usage of inflation has become obsolete with the end of the gold standard.

Inflation is by definition a rise in price levels, usually measured by the CPI (whose definition is sometimes subject to debate, but no measure of price levels is perfect; the important thing is to choose one that's reasonable and then stick to it).

Inflation, i.e. a rise in price levels, can then cause an increase of money supply measures, as producing firms take on larger amounts of credit to finance their operations, and this leads to a (rather weak, and only valid over the long run) correlation of inflation and growth of money supply. There are also tertiary effects that can cause both inflation and growth of money supply (such as excessive government deficits). But it's important not to confuse those things.

You're assuming the government turns on the printing press and then spends some money on some social programs? That really doesn't happen anymore (if it ever did).

Various operations by the Treasury and Fed affect the banks. Then you get a shiny new credit card in the mail. I wouldn't call that wealth redistribution.

I've never seen anyone, including keynesians try to claim that newly created money goes directly to consumers. wow. read more.

It is. It's upward wealth redistribution.

Unless the person at the top is loaning his money, then inflation is distributing downwards.

In addition to population growth the need for an increase in money supply is also driven by increases in productivity per worker, which is enabled by technological progress. If, on the same fixed income, technological progress leads to the people of the 2030s expecting to have pet androids, HIV vaccinations and flying cars (we've been waiting a while for those) in addition to all the stuff they'd need to have to keep up with the Jones', the prices of the stuff we have now have to deflate.

I don't think we'll reach a peak of technological progress in the 2030s.

Unless, of course, economic stagnation is encouraged by discouraging the inherently risky process of investment by making the average return zero.

How is it any better when prices keep going up? Imagine you're, gasp, a saver, and one day you decide to buy that hamburger, but now you need five or ten times the money to make the purchase as you did, when you stashed it away twenty years ago.

Inflation encourages the savers to put their money to work (by investing in the stock market, for example) so that the amount of money that they have increases in proportion to the growth of the overall economy. This is a benefit.

You can't have it both ways. Either consumption is encouraged via inflation or investment is encouraged. For example, say that prices were slightly deflationary, as they are with computer equipment, across the board.*

I could easily make the case that saving goes up! Why? Well if I took my goldbucks and lent them to you at 1% interest we would both be happy. My total return would be something like 3% per year (2% deflation + 1% interest) non-risk adjusted. You would be happy because there are plenty of people that are willing to lend money to you. Because you have access to lending capital, you hire more decreasing unemployment. You can try to make the case that you wouldn't hire because there would be no demand for your goods, but in practice there are A. Other countries, and B. A precedent that people do continue to buy, even during deflationary pressures.

The reason people buy computers and cars despite the fact that they are becoming better and cheaper as time goes on is that they expect that cars and computers are going to continue to get better and cheaper as time goes on. They know that they will face the same "save or spend" decision 2 year later, and they really do need a computer and a car.

The problem with inflation is that "encouraging spending" practically only happens to the poor or middle lower class. I can afford to research gold, silver, lithium, cesium, grain futures, bitcoins, etc. and protect my assets from long term depreciation, but they can't. So you end up with a class of people that have a negative net worth, that is totally unprepared for long term retirement.

* I know that money velocity starts to make a difference, but it is in effect the same as printing more money.

Inflation/deflation has very little impact on the poor; the poor spend almost 100% of their income within a short window of receiving it just to survive. From the view of poverty, saving money is a rich man's luxury, and worries about inflation/deflation rates goes along with it.

For those with excess money, inflation does encourage investment. Under a steady inflationary pressure, it is irrational to hoard your excess money under a mattress or put it in the bank and earn interest, because interest won't keep up with inflation. Your money evaporates away under that scenario. Instead, if you want to act rationally, you would look for other places to put your money where it could outperform inflation. That's the only way you have a chance of holding onto the value it represents.

Deflation discourages spending, but it also discourages investment. Sure, you could justify rolling the dice on some investments to try to outperform the constant bump in value you get every day from deflation, but why bother with that extra risk? If you just sit on your money, trying not to spend it, you'll have way more value in the future than you could ever hope to get out of it today.

This isn't about saving vs. spending, it's about using money for what money is meant for -- exchange of value for value, not as a durable permanent store of value.

The poor and lower middle class do not spend 100% of their money 100% of the time. But nearly 100% of any saved money a poor person has is in the form of raw cash, or non-interest paying bank accounts.

The rich can afford to move their money to more stable currencies and commodities in an inflationary environment. They are more likely to have insights and are way less likely to spend a large portion of their wealth year-to-year.

I disagree that deflation discourages investment. Given a stable deflationary rate rational actors will look at the returns their fellow citizens are getting (from say a mutual fund, or even government bonds) and will conclude that their purchasing power can be furthered.

Furthermore, the United States had a (quazi) gold standard for years, as did most of the world, and investment continued.

Deflation removes some of the incentives for investment, but I agree -- not all of them.

And in practice, to most rational actors a mild deflation is almost indistinguishable from a mild inflation. It's when either of those swing wildly that we have issues. Bitcoin increased in value 11x in the six months from Sep'10 to Feb'11. That would be a major problem if we were all using bitcoins instead of dollars.

It's not just the wild swings; it's the systematic tendency towards deflation [mild or otherwise] inherent in Bitcoin: a closed Bitcoin economy reaches zero deflation only where population and productivity growth is zero.

Mild deflation is indistinguishable from mild inflation to a rational investor only where he expects said mild deflation to be temporary, offering him positive average returns on long term investments.

"For those with excess money, inflation does encourage investment." If they have their savings in a bank account, it's invested anyways via lending so inflation doesn't change the amount invested. What it can change is how wealth is invested, e.g. high inflation causes people to abandon the currency as a store of wealth - you get people buying and "hoarding", say, appliances they don't need as a store of wealth whose nominal ROI is higher than bank interest on savings accounts.

It is undoubtedly true that high inflation is bad. Very bad.

What you want, ideally, is a currency whose value doesn't fluctuate much at all in the short term, and which has a long term trend towards slight inflation.

Actually you can have it both ways. In an inflationary economy there are essentially two viable alternatives: consumption or saving. Holding cash above and beyond the amount needed for liquidity is an irrational preference.

In a deflationary economy, it becomes a very valid option which will serve to drive down the other two, particularly investment in productive assets

In a deflationary economy, holding cash offers a net return equivalent to the average investment return, without the associated risks or loss of liquidity. Essentially investment would become equivalent to spread betting (the costs of running an investment operation being analogous to the bookmaker's spread which makes it certain the average investment returns a loss); you'd only consider it if you thought you were a lot smarter than the rest of the market.

Given falling prices, it would also be more appealing to delay consumption than it is now, though people would still need and want things.

The economy won't come to a complete standstill - people people would continue to buy what they need and some investors would be tempted to gamble. But it would certainly slow down.

Do any desirable economic conditions come out of a deflationary system? What I mean is, is there any economic outcome desired by any world view that is best served by continuous monetary deflation?

If someone wanted the social trend to be towards historic lifestyles, would deflation accomplish that? It's hard to phrase what I am trying to ask so I hope I am being clear. Imagine that someone wanted everyone to live like the Amish. Would persistent deflation accomplish that? Would persistent deflation produce a world where people spend less of their time feverishly trying to make more money and more of their time enjoying what they already have? Would persistent deflation reduce the rate at which we destroy the environment around us?

If inflationary economic systems reward those with money to leverage into investment returns, do deflationary systems reward those who do not? If inflationary systems encourage people to lend out the product of their labor to others to use to create their own wealth, do deflationary systems discourage this, and if so, would the result be that it would be harder for people who are at an economic disadvantage to better their situation? Conversely, would it be harder for people who are at an economically advantageous position to increase their wealth because investment vehicles are less numerous and more risky?

I get the feeling that some people believe that economic growth is an objectively desirable outcome; but must it always be? I do not know exactly how I feel about it, but I feel that it doesn't seem like it should be the given that others seem to believe that it is.

> Either consumption is encouraged via inflation or investment is encouraged

That's not true except in an economy already operating at maximum capacity. The argument for a depreciating currency is that it encourages people to spend or invest it, while if you have an appreciating currency, people just hold onto the bank account numbers instead of generating any economic transactions or activity.

Mind you, there are counterarguments and other problems you get from a depreciating currency, but that's the argument.

Why can't investment and consumption be encouraged? The more money that is invested into companies leads to more salaries being paid, which leads to more consumption. That is the basic theory at least. The details of course can be debated such as 'trickle down economics.'

> Inflation encourages the savers to put their money to work.

And deflation encourages the sellers to sell today.

So, in theory, don't deflation and inflation both encourage economic activity?

It doesn't ecourage you, it forces you. Yet currency is misleadingly sold to society as a legitimate store of value.

Please cite one credible source of mainstream financial planning advice that suggests parking savings in US Dollars.

Anyone offering you salary in US dollars instead of a share of the product is implying that the dollar is a better store of the value you provided them with than the actual thing you produced.

No, it implies that US dollars are a better means of transferring value for time, because they're for example, highly liquid and fungible.

Properties that they posses at least in part because of the fact that currency is not a good long-term value storage proposition, and so they are not hoarded.

Are you suggesting that goods that retain value are intrinsically illiquid? Certainly, liquidity is not important for investment targets, but I don't think that relationship necessarily goes the other way.

Yes, currency is used (where available) for transfer of value because it is highly liquid, but I would not say that liquidity alone disqualifies a potential good from consideration as value storage. Quite to the contrary. And since currency circulates rather than being reformed as tissue paper at the end of every transfer, it effectively stores a constant amount of value until such a time as it is retired.

You are using these words but putting them together in an order I don't understand. Liquidity isn't important for investments? "Quite the contrary" that liquidity doesn't "disqualify" a good as a store of value? Are you saying suitability as a store of value varies inversely with liquidity? Do you park your money in antiques and artwork? Currency "stores a constant amount of value"? It doesn't inflate and deflate?

Okay. I'm a poor communicator, so let's see if I can explain those better.

No, liquidity isn't important for investments. Liquidity is important for trade, and investment is not trade. It's perfectly acceptable for the transfer of long-term investments to take minutes, days, even months.

msbarnett suggested that currency is liquid partly because it cannot store value. I asserted that value stores do not need to be liquid, but it's a nice property for them to have. This is not strictly contrary to non-storing implying liquidity, so that was poor wording.

By currency storing a constant amount of value, I was referring to the fact that the money base is a concrete amount. It comes into existence in exchange for some value, and represents a debt equal to that value. Money is, in very real terms, a store of that predetermined value (convolved with the plausibility of collecting that debt), same as any debt marker.

Why treasuries and bonds are purchased ?

Because they pay a (small) risk premium.

Whats financial planning?

"Think of the psychological effect of having to CONSTANTLY lower your prices on your goods. At some point, you'll hang yourself. You want to charge more, not less. It is absolutely depressing and has a real effect."

This is not a big deal and people adapt to what provides the maximum real profit. You're only going to get depressed if you're used to the old trend of ever increasing prices.

"In a normal economy, the population is constantly expanding."

Exponential growth can never continue forever. We are probably at or near the practical limits to growth on this planet.

I think inflationary currency is an ugly hack to cope with the era of exponential growth.

> I absolutely hate Krugman....

Why? ... Perhaps your views are different. Can you please point to a few good writers which you like with contrasting views than his.

(Asking a serious question. Since I, for one, like his views a lot)

> Why?

He has a tendency of twisting basic economic theory to fit his political agenda. It makes me nauseous.

> Can you please point to a few good writers which you like with contrasting views than his.

Just read the Wall Street Journal. They actually specialize in this sort of thing. You'll get a far more accurate picture of what's going on. NYT is good for regional and national news, not for business and economic commentary.

Thats it? Your big punch on deflation is the "psychological effect"? You seem to fundamentally not understanding math and have an emotional attachment to a particular scale of measurement.

Bitcoin is not a flawed experiment -- it made the mysterious early adopters quite a bit of money.

But isn't one rule of money that it should at least hold it's value? Isn't that the main reason gold was used before? What is the point of using something as money if it keeps decreasing in value?

If money is decreasing in value, it gives people a huge incentive to do something with it - buy something or invest. As long as the decrease to the value is small (1-3%) and predictable, this is a good thing.

Since deflation is an obvious tax on investment and purchasing, arguments that increases in the value of a currency are "obviously" a good thing serve as a sort of litmus test for why people are interested in things like Bitcoin.

The subtextual motivation for Bitcoin advocacy has always been "it's a speculative asset and I hold a position in it". Everything else is just rhetorical cover.

The unfortunate reality is that even by reasoning through Bitcoin's programmed-in deflation, we're dignifying Bitcoin. Bitcoin itself is a sham. The original paper may have been a good-faith contribution to the state of the art in cryptocurrencies, but the "economy" is a trap; a realistic-looking distributed transaction clearing system built on a deliberately volatile wholly synthetic "asset" that exists for the purpose of creating pump-and-dump scams.

I wouldn't be so sure that the (original) Bitcoin people are running a pump-and-dump scam - there is very little evidence either way. And there are plenty of people who genuinely seem to believe that Twitter causes and/or wins revolutions: love of technology, libertarianism and something we'll call optimism do occur together, and cypherpunks are not the least vulnerable.

To be clear: I'm not saying the original design was a scam. Only its realization as a real system people can interact with and spend money on.

This whole system is morally no different than Zynga tomorrow setting up a system to trade options on Farmville tomatoes.

To be clear: I think that some people really do believe that Bitcoin is going to overthrow the monetary system and free us all from the evil government. I also think that quite a few more people believe that Bitcoin can only go up (designed for deflation, right?)

"Bitcoin is a scam" is simply not enough to explain stuff from the Bitcoin bulletin to open source GPU mining software - hard work by obviously capable people, and not even remotely the most effective way to become rich.

Mind you, I think the "true believers" are incorrect, sometimes naive and occasionally downright stupid; but declaring them "evil" leaves quite a few unanswered questions. [EDIT: Even if the speculators are probably in the majority.]

(Also, I wouldn't be surprised if EVE had a foostone contract future market...)

EDIT: also, there was nothing wrong with the system design. A bit uninspired, maybe; current research involves zero-knowledge exchanges and the like.

The people that recommended Madoff's fund to their family and friends were probably well intentioned too. And the fund probably wasn't a Ponzi scheme from the beginning either but in the end a scam is a scam.

People trading goods and services cannot be a sham. Your definition of a sham is "something I believe will depreciate".

I don't really buy this argument. People invest to increase their capital, not to stop it from decreasing. When inflationary pressure is actually tangible, money becomes a hot potato that no one wants, and poof, there goes the economy in a blaze of hyperinflation.

Arguing that inflation is good is tantamount to arguing that illiquidity is good. If I were to argue for inflation, I would go with some other angle, like that capital should evaporate after a lifetime.

In between "hot potato that nobody wants to hold" and "gold brick that nobody wants to relinquish from their grasp" lies the happy medium that we need.

Inflation != hyperinflation. You're conflating the two in your argument.

Yes. When the argument for inflation is that rational actors should not want to hold on to money, I will conflate it with the scenario where rational actors should not want to receive money.


Please cite a source on this "one rule of money" you're thinking of?


says one of the properties of money is that it has to be a 'store of value'.

Logic that suggests that roads aren't a medium for transportation because they have friction.

Just because something was widely held to be true in the past doesn't mean it's widely held to be true now. Some examples: "Gold is a good thing to base our money on", "Black people are mentally inferior to white people", "Homosexuality is unhealthy", "The economy requires slavery".

The goal of an economy should be to produce as much as possible given the available resources. The goal of money should be to facilitate this happening. Money in itself is not a resource of an economy, it is a tool used to lubricate transactions.

When Bitcoin reaches supply maturity, there will be no more bitcoins to mine, making those that are currently held even more valuable, making those who hold them even more inclined to keep hoarding them, no?

Not to mention, as bitcoins are inevitably lost here and there (a deleted wallet.dat here, a hoarder there, a transaction wired to a mistyped address that doesn't exist) the supply of bitcoins will actually shrink.

Wow, that's an excellent point. That doesn't happen easily with gold. People retrieve gold from ships sunk hundreds of years ago.

Actually, is there an efficient way that physical gold or other precious metals can be intentionally destroyed or put beyond use? Has anyone tried to use this technique to corner a market?

What would happen if Hugo Chávez actually got his hands on 211 tons of actual gold and announced he has verifiably shot half of it into the sun? Presumably, you could make money on such an event through the options market.

So it's a great point that it's comparatively easy to do such a thing with Bitcoin. It's even entirely possible to do it by mistake (i.e. a programming error).

Physicality is a fantastic hedge against loss.

Gold can be "destroyed or put beyond use" by stockpiling (similar to DeBeers & stockpiling diamonds) or by disseminating it such that recovering it is not cost-efficient. For example, the oceans have a small percentage of dissolved gold, but extracting it is too expensive to make a profit.

Actually, is there an efficient way that physical gold or other precious metals can be intentionally destroyed or put beyond use? Has anyone tried to use this technique to corner a market?

In Goldfinger, the eponymous villain tried to irradiate all the gold in Ft. Knox with a dirty bomb, making it worthless.

Oh wow, how could I miss that? Well, now it comes out that I've never seen Goldfinger. And I've listened to all the Bond discussions with John Gruber on The Talk Show. Shame on me!

Wouldn't that actually not make it worthless? Wouldn't you just have to encase it in lead?

Your argument is valid, however I want to point out that the third scenario you describe (mistyped addresses) is extremely unlikely due to a built-in checksum in bitcoin addresses to prevent exactly that.

That would be true if owning bitcoins had intrinsic value, but they only have value in terms of the things they can purchase, so no. Bitcoin maturity will actually cause bitcoins to decrease in value as inflation in the rest of the economy outpaces the rate of new bitcoin creation.

Collecting a currency wouldn't be a problem if there was some type of Bitcoin bank. These people who are hoarding the currency could put their Bitcoins in the bank for a promised interest rate, and in the mean time the bank could loan out the money to borrowers for new investments, thus growing the economy.

I'm also not sure how much Krugman has looked at the price of Bitcoin. Every time I've looked at the price it continues to go down in terms of USD. A couple months ago it was around $16 now its at $7.

I think Bitcoin's real problem is the fact that it's not actually a commodity, because it's price isn't backed by any real goods. In that sense it's more similar to the dollar.

I think you need to read more about bitcoin. First, having a centralized bitcoin bank defeats the purpose of a peer-to-peer system entirely. Your identity is no longer anonymous.

Second, providing interest to those that hold their bit coins in this bank must provide some facility for the bank to be able to give out bit-coins they didn't previously have (fractional reserve banking). Due to the mining nature of bit-coins which is not regulated by the fed but limited to an absolute supply, interest can not always be guaranteed to the holders, and there would be a run on the accounts to pull out.

What you've described is the system we have- BitCoin is an experiment on something different.

I'm well aware of how bitcoin works, and for starters bitcoin isn't completely anonymous. It's semi-anonymous. Secondly, a bank doesn't have to practice fractional reserve banking, they can practice Full-reserve banking. In this case the deposit to the bank is really a loan to the bank, with the bank promising an interest rate on the loan. On your point of interest rate, interest rate can't be truly guaranteed in any system, and a run is prevented in a full-reserve banking system, because it's not a deposit it's a loan.

Now, I'm not saying anyone should actually try to do these things. In fact I agree that Krugman is missing the whole point of bitcoins to the point where he doesn't even bring up it's semi-anonymous nature. I simply wanted to counter his argument that commodity currency wouldn't allow the economy to grow, but as I said earlier bitcoin isn't a regular commodity. It is a currency whithout intrinsic value.

> they can practice Full-reserve banking.

??? A bank makes money by taking deposits (giving interest) and then lending them out (collecting a higher interest). The reserve percentage is that amount that remains unlent.

Full reserve = no loans = no profits = no bank.

Edit: Yes, you can practice full-reserve with a negative interest rate, which is effectively a safe-deposit box does (they charge a fee for the box).

That is the tl;dr of the wiki link.

A negative interest rate actually makes sense in the presence of deflation, and if bitcoins turn into a serious currency, deflation is pretty much guaranteed.

Bitcoin is not designed to be anonymous. From bitcoin.org: "While the Bitcoin technology can support strong anonymity, the current implementation is usually not very anonymous."

If a bitcoin clone were to spin-off where inflation was controlled by a set algorithm, would we still consider it to have a limited supply?

Inflation and deflation aren't "controlled" by Bitcoin's design. The money supply is. Because the money supply is capped, over the long term, deflation is predictable.

The week-to-week reality of Bitcoin is one of wild swings in the "valuation" of the Bitcoin "asset". Describing these swings as "inflationary" and "deflationary" dignifies Bitcoin. Was the collapse of PETS.COM and resulting devaluation of its stock "inflationary"? Was its run-up "deflationary"?

That would solve one problem, although it seems impossible to pick the right level of inflation. Then we could get on to discussing Bitcoin's other problems, such as slow transaction clearing and poor usability.

He also mentioned that in general any limited commodity such as bitcoin or gold is worse than the current system of currencies.

Fiat currencies discourage saving by gradually stealing the value of the saved money via inflation. Theft isn't essential to trade: people will still innovate and exchange without being coerced into doing so by the systematic devaluation of their previous economic contributions.

Inflationary currency does absolutely nothing to discourage saving value, it merely discourages saving value in currency by stuffing it under a pillow, where it does no one any good.

Save your value in assets.

Converting money to an asset isn't a great boon to the economy, and assets are vulnerable to depreciation.

The North American drumbeat urging the sacrifice of security for "the economy" is interesting... reminds me of communism's drive to sacrifice for "the collective".

I don't think there is any reason to encourage saving money. Living within your means, yes, investing, yes, but saving under your pillow, especially if you had a non-inflating currency, isn't good for the economy.

Even if it should be encouraged, it doesn't matter the logic of it, people won't accept making less and less money over time. Non-fiat currency + population increase makes that inevitable.

> saving under your pillow, especially if you had a non-inflating currency, isn't good for the economy.

It actually is. It you earn $100, by producing $100 worth of goods for the economy, and you don't spend it, you're producing more than you consume. This increases the supply of all goods on the market, decreasing the price, effectively making the entire world richer by that amount. Other people can use that extra money partly to increase their consumption and partly for investment purposes. When you take your $100 out of your pillow and spend it, you're then having the opposite effect. So in the end, you're allowing people to consume more at an earlier time (when you put the money in) and less at a later time (when you're taking it out). This is a very valuable service, as shown by the fact that people are willing to take out loans where they pay money (interest) for the ability to temporally distort their consumption patterns in this way. Some people can even use the temporary possession of additional goods as capital to generate permanent wealth.

A constant pattern of people saving under their pillow will simply reduce prices by a certain percentage and hold it there. If deflation is small, then this secondary price reduction will be lower than the primary reduction and the economy will remain stable. The problem only arises when deflation becomes too high - then, the secondary reduction becomes greater than the primary reduction, and causes a still greater tertiary reduction, leading to a deflationary spiral (ie. bubble), which screws up the economy until it inevitably pops, but if deflation is within reasonable margins it should not be an issue.

> Even if it should be encouraged, it doesn't matter the logic of it, people won't accept making less and less money over time.

How do we know this? One could imagine a deflationary society where people ask how people could possibly stand their money buying less and less over time.

>Living within your means, yes, investing, yes, but saving under your pillow, especially if you had a non-inflating currency, isn't good for the economy.

It's good for the individual if investment opportunities aren't adequately regulated.

Value will stabilize against what? Not USD ever.

There's another argument against fixed currencies like bitcoin that should resonate with the hackernews crowd, and it's this:

A currency with inflationary pressure incentivizes investments into new enterprises. A currency with deflationary pressure, instead, discourages investment outside of banking.

Here's why. With a slight inflation, money slowly loses value. Even if you put it in the bank and earn interest, it loses value over time. So the rational thing to do, if you have a lot of excess money, is to find places to put it where it outperforms inflation, where it has a chance of not evaporating over time.

With deflation, money is instead guaranteed to be more valuable tomorrow than it is today. Sure, you could still try to invest some of it to try to outperform the gain you get from deflation, but it would be completely rational to just stick all of it in the bank, and live the good life forever, as your money automatically becomes more money (because its buying power increases), every day.

Why is there so much money managed by VC and Angel funds? While not the only reason, I'd claim it has a lot to do with inflation.

And, of course, I'm making things more b&w than they really are. Both massive inflation and massive deflation are really bad things. Currency that stays largely stable, or that deflates/inflates slowly over time, seems to work out fine.

A counter-argument is that people invest in new enterprises even when the banking real interest rate is positive.

Deflation doesn't remove all incentive to invest, but it does destroy the "gotta keep ahead of inflation" one. I meant to be more explicit about that when I said, "you could still try to invest some of it to try to outperform the gain you get from deflation."

To paraphrase jwz (like that's never been done before), "When the rebuttal to your argument is 'The Industrial Revolution', generally that means that you've lost the argument."


My snark decoder is broken. Please explain the parent comment.

Ahh, but they only invest in new enterprises that they feel are likely to significantly out-perform the prevailing real interest rate (risk free rate of return).

Significant deflation raises the bar, by putting a floor under the risk free rate of return.

1. What we want from a monetary system isn’t to make people holding money rich; we want it to facilitate transactions and make the economy as a whole rich.

Bitcoin is facilitating transactions. The Bitcoin economy is growing, slowly. There are a lot of people, including funded startups, working on making it useful in more cases. It's far, far too early to say that Bitcoin isn't facilitating enough transactions.

2. Bitcoin hoarding is not due to the fixed total supply, but due to the expectation that the Bitcoin economy will grow. If there was built-in inflation at 3% and the economy was growing at 20%, hoarding would still happen.

3. No matter how much hoarding is happening, there will be some exchange rate from Bitcoins to dollars. The existence of a traded exchange rate is proof that some people think Bitcoins are not undervalued. These people will be willing to spend their Bitcoins.

4. The claim that Bitcoin is worthless because of guaranteed deflation is self-contradicting.

5. Volatility is bad for a currency, but this is an addressable problem. Bitcoin-priced marketplace The Silk Road offers its sellers currency-hedged escrow.

6. Even if it fails as a currency, Bitcoin is interesting and novel as a technological invention. For the essence, see the last paragraph of Hal Finney's insightful email from 2008 (and the surrounding thread): http://www.mail-archive.com/cryptography@metzdowd.com/msg099...

Agreed. Couple more points that may not be obvious:

7. Even if Bitcoin is not a useful currency today, not only is it a novel tech invention but it is also a useful medium of exchange (akin to credit cards). You can buy coins temporarily just so you can buy something from Amazon.com and have it shipped to Africa (as one Bitcoin startup does international shipping for many US-only retailers).

8. Bitcoin could be a useful currency someday, but it might take 200 years. What most people don't realize is that all the properties of Bitcoin (such as the maximum supply or its present growth) can be adjusted with a new genesis block at any point (effectively forking the currency). If the majority of the network clients agrees with this fork, Bitcoin continues under the same name. Side note: I remember hearing that Gavin was going to start a non-profit to help guide (read: sort-of regulate) the official Bitcoin fork. Not sure if this happened, I've been out of the loop.

9. There is no way Bitcoin as it is today could reach any kind of significant scale, purely from the perspective of the protocol. Bitcoin was built with the intention of evolving further down the line. This is part of what makes the technology really interesting.

7. You can buy coins temporarily just so you can buy something...

This is so kludgey that I don't see it as a benefit, and IMO touting it as a benefit just makes Bitcoin look worse.

8. all the properties of Bitcoin can be adjusted if the majority of the network clients agrees with this fork

I suspect that there will be many Bitcoin forks, and none of them will take off due to a combination of path dependence (i.e. kooks sticking with "the true Bitcoin") and the paradox of choice.

>> 7. You can buy coins temporarily just so you can buy something...

> This is so kludgey that I don't see it as a benefit, and IMO touting it as a benefit just makes Bitcoin look worse.

It's a benefit if it can easily add anonymity to transactions under existing currency schemes.

"So how’s it going? The dollar value of that gold has fluctuated sharply, but overall it has soared. So buying into gold has, at least so far, been a good investment.

But does that make the experiment a success? Um, no. What we want from a monetary system isn’t to make people holding money rich; we want it to facilitate transactions and make the economy as a whole rich. And that’s not at all what is happening in gold.

Bear in mind that dollar prices have been relatively stable over the past few years – yes, some deflation in 2008-2009, then some inflation as commodity prices rebounded, but overall consumer prices are only slightly higher than they were three years ago. What that means is that if you measure prices in gold, they have plunged; the gold economy has in effect experienced massive deflation.

And because of that, there has been an incentive to hoard the gold rather than spending it."

I'm willing to stomach lots of negatives to take away the government's power to inflate to pay for war. Historically inflation has always been for war.

Exactly! You can substitute Bitcoins in that text for gold, Swiss Franc or even Brazilian Real. What a ridiculous pseudo-criticism by Krugman.

Perhaps Econ 101 is escaping me, but the idea of deflation being dangerous is massively overstated. First of all falling prices mean a higher standard of living for everyone in the economy. Second, nobody is going to indefinitely put off purchases due to a decreasing price level. Time is a factor in demand, and you require food today, fuel tomorrow and a new laptop before 2020 would be handy. Even if the price of the 2020 Macbook Pro/Air equivalent has fallen to 100 USD.

He's just begging the question. That a fixed currency supply creates deflation is not a new insight. The idea that this causes 'hoarding' is highly questionable. Prices in consumer electronics fall significantly every year. Does this cause people to hold onto their money instead of buying computers, tvs, and iphones? Of course not. Why would other types of goods be any different? People still need what they need and want what they want and are going to buy those things regardless of what relative prices will be in the future. The difference with a stable currency supply is savers and fixed income earners wouldn't have their purchasing power sucked away from them year after year--on the contrary, they'd become continually wealthier as the economy grows around them.

That's not exactly an apples-to-apples comparison. But, to answer your question, "Does this cause people to hold onto their money instead of buying computers, tvs, and iphones?" The answer is yes (with qualifiers). Many late adopters are late adopters because they are holding out for a cheaper price for those goods. From personal experience, I've done this very thing (waiting for prices to come down on a TV before I bought it). I put that money into something with a higher return for the time being.

But, the reason that's not exactly a fair comparison is that the currency itself (in this case, USD) was not deflating. Ergo, my "hoarding" was actually putting it into something with a better return for the time being, which was available because the currency was stable. If the best return I could get was holding on to my money (instead of putting it in some sort of investment vehicle), then that would be deflation.

"The answer is yes (with qualifiers). Many late adopters are late adopters because they are holding out for a cheaper price for those goods. From personal experience, I've done this very thing (waiting for prices to come down on a TV before I bought it). I put that money into something with a higher return for the time being."

But you could have kept waiting and prices would have kept falling. Eventually you spent your money anyway. This seems to indicate that it wasn't the situation of falling prices that prevented you from buying a TV, since that never changed, but some external factor.

"But, the reason that's not exactly a fair comparison is that the currency itself (in this case, USD) was not deflating. Ergo, my "hoarding" was actually putting it into something with a better return for the time being, which was available because the currency was stable. If the best return I could get was holding on to my money (instead of putting it in some sort of investment vehicle), then that would be deflation."

The currency was deflating relative to TVs. Holding cash does provide a better return than holding a TV. The value of a TV depreciates much faster than cash. That's the point--why would anyone ever buy a TV when if they just held onto their money for a month they could always get a better TV for the same amount? Since TV prices are always falling, this question reduces to: why would anyone ever buy a TV? The answer is pretty simple--people want TVs. At some point if they want one, they're just going to buy one regardless of what the prices are doing, just like you did. So where's the problem?

But you could have kept waiting and prices would have kept falling. Eventually you spent your money anyway. This seems to indicate that it wasn't the situation of falling prices that prevented you from buying a TV, since that never changed, but some external factor.

Prices don't fall linearly, in many cases, but hit a floor representing the cost of manufacturing and distribution. Then, different brands have different price decay curves. Finally, the price decay of a given good has to be offset against the buyer's utility function. In practice, I don't sit there and calculate everything out; I start with a budget and a list of manufacturers I prefer, and then look for the best products that fit within those constraints.

People who want TVs (or who want to replace their current TVs) will buy one eventually. But if you’re in the TV-manufacturing business, there’s a big difference between a world in which the average TV gets replaced every three years and a world in which it gets replaced every four years.

And if TV prices were rising instead of falling, people would replace them more often?

Why do people line up for things like day-after-Thanksgiving sales? Because they know that the retailer is offering someting they want that will become more expensive later. So yeah, people who want TVs, and who think that TVs are about to become more expensive, will hurry up to get TVs, while those who think that TVs are about to become cheaper will put off their purchases.

In countries that have hyperinflation, you see extreme cases of this: middle-class consumers spend their paychecks as soon as the money is deposited, because they’d rather have anything on hand than cash in the bank.

There's a difference between some goods -- electronics -- getting cheaper every year and all goods getting cheaper every year.

Deflation isn't necessarily a problem; but runaway deflation is, and the structure of bitcoin makes deflation a self-perpetuating cycle.

"There's a difference between some goods -- electronics -- getting cheaper every year and all goods getting cheaper every year."

Which is what exactly? People buy electronics even though they get cheaper every year but they wouldn't buy Xs if they got cheaper every year? Can you give me an example of some Xs?

If houses got cheaper every year, very few people would want to buy them, and people stuck with mortgages would have a powerful incentive to walk away from them. If cars got cheaper every year, then people would put off buying new cars for longer. If gold got cheaper every year, then a lot of gold coins would be dumped on the market.

If everything got cheaper every year, then people with money in the bank (or under the mattress) have an incentive to reduce how much money they spend, in general. This would lead to factories reducing their production and laying off employees, giving the remaining employees an even more powerful incentive to hang onto their savings.

The flaw in your argument is that currency is subjected to demand pressures as well. How so? When demand for housing, food, electronics is high, then it automatically implies demand for currency is low. That is another way of saying people are willing to give up currency for real goods; which is another way of saying people are putting less value on the currency over physical goods; which means the barter power of the currency is decreasing; which means lower buying power with respect to the currency. That is key point. This means that there is rise in prices (without monetary intervention) when there is preference to own goods. And we all want goods and services in the end game. But this rise in prices do not spiral out of control because there is demand for currency as well - which really is demand for time preference, that being the choice to consume later on. We also know the demand for time preference is not unlimited because ultimately have to consume to make good of the money. Therefore, with greater population, comes with greater demand for money, but also comes with greater demands for owning/consuming goods. So that is why price levels will not absolutely decline over time because money supply is fixed. In fact, history proves this point -- look at the USA data in pre-federal reserve era.

> This would lead to factories reducing their production and laying off employees

Trade imbalances resulting from an economy run on bitcoins would also decimate most domestic production, so sethg's statement is doubly true. It's the same reason you hear members of congress railing against China's currency peg that artificially deflates the yuan; it makes Chinese exports cheaper to the rest of the world.

Does "deflates the yuan" mean the yuan is deflationary?

In that case its value should get higher and exports should decrease, as happened with the Japanese Yen.

A deflated Yuan allows you to buy more Chinese goods for the same USD[1]. Regarding the second half of your question, you must look at the supply of the currency versus the demand for that currency. It's common for governments to intervene in foreign exchange markets as a means to an end. This makes it a difficult market to invest in, as artificial forces can move the market. Just because there might be a fundamental economic reason for the Yen to appreciate, that doesn't mean the Japanese (or some other) government won't intervene in order to improve their trade balance.

The mechanism that the Chinese government uses to keep the Yuan pegged to the USD, is the purchase of U.S. treasuries[2].

Here is some additional info:



[1] http://en.wikipedia.org/wiki/Fixed_exchange_rate_system#Mech...

[2] http://www.treasury.gov/press-center/press-releases/Pages/js...

I actually do postpone electronics purchases because of falling prices. Electronics have low resale value and resale/upgrade is time-consuming. I tend to just wait for a price drop and then buy last year's best thing, rather than worry about having the fastest computer on the block.

If it's for work and there's some measurable benefit to the latest and greatest (rather than just showing off), that's different. But as a matter of habit, I only build a new PC once every 3 years; for about the same amount of cash, I get a roughly 400% speed boost.

Electronics don't get cheaper every year because the dollar strengthens. They get cheaper every year because the production process becomes more efficient.

Some things can't really get cheaper every year (without some exogenous shock) -- anything with really high fixed costs of production OR a requirement of some level of quality by purchasers.

For example, it takes a ton of land to grow corn. As the population grows, the demand for and value of land will rise. That means that for the farmer to keep growing corn on his land, instead of selling it or using it in a new profitable venture, the corn needs to be producing a higher level of income for him than it had previously when land was cheaper.

Similarly - grass fed beef is not going to get cheaper. In addition to land requirements, there is the quality requirement also. If someone demands higher quality food, higher standards need to be followed, higher quality inputs need to be used, and a third party needs to ensure that those requirements are being followed.

Houses are a one example. Suppose you're looking at buying a house that's $200k. Then assume that you live in a deflationary environment where all goods get cheaper every year, say by 10%. The immediate conclusion is that in 1 year, the house you want will cost $180k. If you can wait 2 years, $162k, and so on. So while you may eventually buy as the house still has utility, you are likely to delay the purchase as long as possible to avoid losing money to deflation.

(The opposite of this scenario is housing inflation, and causes people to buy houses sooner and for more money than they would ex-inflation. This makes some sense if the inflation continues as buyers expected.)

This scenario is different from single goods getting cheaper every year in that when the prices of all goods are going down, it's very clear that the value of money is also going down. Deflation slows spending primarily via expectation of future deflation, so across-the-board price declines will have more impact transmitting deflation expectations than mixed signals (electronics down, oil up).

Did you mean the "value of money is going up" in your last paragraph?

Electronics are a special market. I think people have in general come to accept and understand that the money they lose in buying electronics now, instead of later, is small compared to the utility they get now.

It also helps that constant development and improvements keeps the decline in pricing small. An iPod today, while much more impressive, I believe still has a similar price to 10 years ago.

I've never seen convincing evidence that inflation is a good thing (to be honest I haven't spent my life searching for it).

It is however pretty easy to see why inflation is good for people in power, in particular governments; it's a hidden tax. And yes it does encourage people to spend, in fact it encourages people to borrow and then spend. Even borrow so much that it crashes the system.

So as far as I'm concerned the fixed money supply is about the only good property of Bitcoin. Other than that it's a ponzi scheme and it's a lot more cumbersome than electronically traded gold.

A slow, predictable devaluation in the currency encourages individuals not to store large amounts of value in the currency. It doesn't simply encourage people to spend; it also encourages people to allow better-positioned entities to allocate capital, which is why new business ventures don't need to go door-to-door to fund new factories. Individuals are crappy at allocating capital, because they have small amounts of it and are too busy mastering Dentistry or Architecture to build expertise in risk management.

Unsustainable debt is an orthogonal issue. We've encouraged unsustainable debt not by allowing our currency to inflate, but by failing to regulate lenders and by offering them incentives to ignore risk management.

Again, though: this "is a little inflation good, and is a little deflation bad?" thing is a fake controversy that dignifies Bitcoin. Bitcoin isn't a currency; it's a gambling game powered by a distributed transaction system that may or may not on any day function well enough for two parties to exchange dollars for off-label hosting services without either one losing their shirt.

One could make a case that moderate inflation isn't a bad thing. Inflation generally happens when the economy is producing close to its capacity (think of a factory working overtime to meet a lot of demand - at some point they make the same amount of money in fewer hours simply by raising their prices). This means that you'd also expect pretty decent employment, etc. You certainly don't want runaway inflation, but a healthy economy would have some.

Electronics are not commodities -- you get value out their use. Electronic devices would have to fall in price enough to exceed the value of having and using the device.

If you look at people's behavior with a commodity like gasoline, you'll see similar behavior. When prices go up, people will "top off" their cars more frequently. When prices are falling, people tend to go further between fill-ups.

People definitely do that with electronics too. As prices have dropped, people are upgrading their computers or buying their first more often. I'd wager the rate of consumption has been directly proportional to the rate of price drop for electronics. Of course, we are unlikely to see computer prices rise anytime soon.

"Electronics are not commodities -- you get value out their use. Electronic devices would have to fall in price enough to exceed the value of having and using the device."

So how much would computers have to fall in price every year before people stopped buying them?

The number depends on your cost structure. I can tell you that where I worked, we traditionally planned on keeping most servers in service for 40-72 months.

When Nehalem processors came out, the economics shifted, and there was a financial case for retiring devices at 24-36 months and consolidating them into virtual machine clusters.

Without that consolidation opportunity, we probably would have extended the lifecycle of our server longer to preserve cash in 2009.

The idea that this causes 'hoarding' is highly questionable.

It can cause hoarding. It's not a given. But it can get into a downward spiral.

Does this cause people to hold onto their money instead of buying computers, tvs, and iphones? Of course not.

Are you sure? No one would argue that all people would stop buying all consumer electronics, the question is: what would sales be like with stable prices? I don't know how to answer it but I don't know how you can say for sure that sales are not lower than they would be with stable prices. Or rather, I am sure it is possible to construct models to try to understand the relation but I am doubtful that you have done so or have a particular model in mind. Please correct me if I am wrong.

The difference with a stable currency supply is savers and fixed income earners wouldn't have their purchasing power sucked away from them year after year--on the contrary, they'd become continually wealthier as the economy grows around them.

Generally inflation is priced into interest rates. If you look at countries with much higher inflation they tend to have much higher basic interest rates.

Krugman's arguments in the post are pretty brief, he's just stating his opinion and not conducting a thorough examination. Likewise, I don't find your arguments very persuasive but that doesn't mean that you are wrong and he is right.

"People still need what they need and want what they want and are going to buy those things regardless of what relative prices will be in the future."

What about "investors" instead of "consumers"? Right now an investor simply makes a choice between losing money by sitting on it (through increased supply ... printing money leads to inflation) or investing. If the money supply were fixed would that not make it more attractive to investors to sit on assets?

Prices decrease under a stable money supply because the economy grows. Goods and services are being produced more efficiently and are therefore more plentiful relative to the same quantity of money and therefore cheaper. Growth in the value of money will simply reflect baseline growth in the value of the economy as a whole. There are still much higher returns available to investors who are willing to take greater risks--no external motivation is necessary. Monetary expansion doesn't alter this basic relationship, it just ruins the currency as a reliable store of value.

Fair enough, but I think most economists would agree that we shouldn't be trying to make savers and fixed-income earners wealthy in the first place. We should make it economically advantageous for the people with money saved up to invest it into the economy.

I've always been suspicious of this "spending is better than saving" mantra. I'm sure it's better in some situations, but I don't think it's better in general.

The point of an economy is not to spend money, it's to create more wealth for more people by allocating resources efficiently. If someone "hoards" money, and prices are stable, that person is effectively staying out of the resource-allocation business. It doesn't mean that there are fewer resources to allocate, it just means that other people are doing the allocating (even though those people collectively have less money because of "hoarders", prices are lower because of them, too).

You can make an argument that everyone needs to take part in efficiently allocating resources, and that makes a lot of sense. But to say that buying a bunch of consumer junk is a good way to do that is ridiculous (and bad for the environment).

A middle ground is to buy the things you need, a few things you want, and make conservative investments. That allows most individuals to mostly stay out of the resource allocation business, but still enjoy the benefits.

In fact it's not a question of being in the game or out of the game, just a question of time preference. The sole purpose of accumulating money is to eventually spend it. Maybe it will be spent tomorrow, maybe by future generations, but it will eventually contribute to the economy and allocation of resources on whatever schedule and for whatever purpose the owners of the money deem best given their unique situations. The argument in support of inflation is that it's somehow preferable, in the vast general case, for people to spend their money sooner rather than later, and worth using force to accomplish this. It's as presumptuous and arrogant as it is arbitrary, an essentially totalitarian position.

You don't need to take away people's purchasing power to encourage them to invest. If an economy is growing, there will always be higher returns in investment than in holding cash. Monetary expansion encourages unsustainable consumption and debt accumulation. Why is this preferable to saving? When people save, they don't do it with the intention of one day dumping the money in a lake. They are still going to use the money, just on a longer time scale for a better-considered purpose.

I don't want to take away people's purchasing power now, I want to sap away their purchasing power over time. If I do that I encourage them to take their money and invest it into a factory producing widgets instead of squirreling it away into a bank. Inflating the value of money gives an unfair advantage to people who use their money to improve the world by producing things. Being in debt sounds like an OK trade to me so long as it's not pathological.

But inflating the money supply doesn't take away everyone's purchasing power. It redistributes it to the people who get the new money.

yep, butt it still depends on your standpoint - where u stand in the economic ladder matters a lot.

If you are on top, you wouldn't want to make extra effort to stay there!

I don't agree. The falling prices are holing me and many other frugale people back from buying electronics frequently. The reason people buy new electronics so often, is because there is so much improvement and innovation.

So you'd buy more electronics if the prices went up every year?

In economic speak, he's saying he'd be less willing to defer the utility of purchasing electronics if they increased in price every year.

Currently, you can invest your money elsewhere at the opportunity cost of foregoing the utility of whatever gadget it is that you want to buy until the utility of said gadget is worth to you what its price is.

The next hacker currency should keep Bitcoin's strengths, i.e., decentralization and anonymity, and lose its weakness, the fixed supply.

Is anyone working (in public) on the problem of designing a currency that adjusts its supply algorithmically based on appropriate metrics? Sort of a Greenspan-o-matic?

I've thought about this for all of 90 seconds, and it seems like the metric might be some combination of transaction volume, a price index, number of users, and the current money supply.

Most people who use bitcoin don't believe that the fixed supply is a weakness. A lot of us are vastly frustrated at the previous lack of an easy-to-tranact-in pseudonymous INflation-proof currency. The others that were in common use (eGold, Liberty Reserve, and Pecunix) have all become relatively unsafe recently due to their centralized natures.

That said, there are bitcoin-network forks out there that remove the maximum cap on new coins, if I recall correctly. You are welcome to go and use one of those if you choose.

How would I find one of the forks?

What I find far more interesting about BTC is its decentralized and (mostly) anonymous nature, rather than arguments about fixed money supply.

BitCoin is no more anonymous than your IP address. As soon as your BitCoin address can be tied to your identity, such as by trading through a major exchange, your transactions might as well have your name on them.

Like IP, anonymity can be emulated through routing mechanisms. Basically laundering your packets and coins. Tor, the state of the art in this kind of anonymity, is not without faults. And there isn't really an equivalent to Tor for BitCoins that I know about.

Related, I know BitCoin can be run over Tor, but this is not the same as a Tor for BitCoin. This merely protects against traffic analysis to tie your BitCoin account to your IP address.

Tor for BitCoin might look more like a network of wallets that simulated a perfectly noisy economy. If A wanted to pay B, A's coins would go everywhere to B, C, D, E, F and so on. Over time coins would pass in and out of people's wallets until at some point the right number would stick to B's wallet equal to the number A sent. Hopefully, the ones that stick to B's wallet will be a mix of ones that A actually sent and other coins being anonymized by the network.

There are obvious flaws in this design. But hopefully it helps illustrate why BitCoin isn't anonymous and the difficulty of making it anonymous.

This is certainly key to the appeal to the current enthusiasts, but (to pick an obvious example) suitcases full of dollar bills or Krugerrands are also decentralized and anonymous, compared with centralized and usually non-anonymous methods such as credit card transactions or bank transfers. Most people don't find these other decentralized and mostly anonymous currencies to be especially interesting unless they are engaged in illicit activities or traveling to places where the banking system cannot be relied upon.

I expect the actual appeal is that the value is these attributes in common with the fact that it is virtualized -- i.e. the value resides in data rather than in a physical object such as dollar bills or gold. With data, you don't have something tangible that you have to smuggle across a border in person, you just store it safe somewhere and retrieve it over a secure computer connection wherever you need it.

Or alternatively, you could use bitcoins to purchase something else virtual anonymously. (If you use it to purchase something physical, than there is an audit trail attached to the transference of the physical goods that defeats some if not all of the value of the anonymity.)

Perhaps this makes bitcoins especially useful for some scenarios, but overall I haven't yet seen any use cases that lead me to believe that this is a breakthrough of any particular kind.

tl;dr: The soaring value of bitcoin forces those holding currency to hoard it. The Bitcoin economy has, in effect, experienced massive deflation.

He also touches on a great point:

What we want from a monetary system isn’t to make people holding money rich; we want it to facilitate transactions and make the economy as a whole rich.

This is where I think Bitcoin fails as a currency. While some people invest in currencies, the point of currencies is to allow goods and services to flow through the economy. Currency is and should not be primarily an investment vehicle.

Exactly. Bitcoin is a commodity, not a currency.

What's the difference?

Volatility. An ideal currency is immune to supply and demand and is simply a medium of exchange for actual commodities (which can be burned/eaten/used to manufacture things). Of course no currency can meet this ideal, but maintaining stability is a key task of a central bank.

I'd like to add that being useful isn't a negative for something's properties as a currency - for example, the reason cigarettes become a currency in a lot of jail/P.O.W. situations is because they are always liquid due to smokers needing to smoke.

Often in those situations, cigarettes come into the economy as a ration (or a purchase limit) that people get whether or not they are smokers, and the economy revolves around getting this commodity that everyone gets to the minority that need it. Pretty quickly, you end up with non-smokers trading cigarettes with each other, because you can always get whatever you want through paying a smoker in cigarettes.

Bitcoin could benefit from that if it encouraged a very large drug market, because people need their drugs. If an easy, comfortable bitcoin drug market could get a lot of volume, it would become a lot easier to buy a cup of coffee or a car with it, and the prices would rise and fall based on the relationship of the ease of purchasing drugs with bitcoin vs. the ease of purchasing drugs in dollars. Maybe money laundering could keep bitcoin stable, too. In any case, to be successful, IMO bitcoin will have to be driven by something other than belief in bitcoin.

The use of the USD? It can be used to pay US taxes.

"A commodity is a good for which there is demand, but which is supplied without qualitative differentiation across a market... Examples are petroleum and copper. The price of copper is universal, and fluctuates daily based on global supply and demand."

You could say a commodity is like a currency many people can produce.

Considering how commodities are often produced, the term "Bitcoin mining" is shockingly apt.

Post is being downvoted, but it's a valid point. Lots of things have been used as currencies. WW2 POWs used cigarettes; some Pacific islanders used huge, immovable rocks. If anything, BitCoin is much more like a currency, because, unlike commodities, it has no other use.

Commodities are things people buy. Currencies are what people use to buy commodities with.

So what's the Swiss Franc right now?

Note that people treating the Swiss Franc as a commodity is harming the Swiss economy.

See http://www.npr.org/blogs/money/2011/08/19/139791374/the-frid... and http://www.npr.org/blogs/money/2011/09/06/140211340/swiss-to...

Yes, that's why I chose that example. The thing is, currencies are and have always been a commodity with many traders. Bitcoin being treated as a commodity does not prevent it from being a currency.

The reason I cited those examples is that once currencies cross a certain commodity-threshold, they become much less useful as currencies.

cube13's characterization is a simplification, but I think it still captures their intended uses. Bitcoin's deflation, and the Swiss franc's high value compared to other currencies, harm their ability to act as they were intended to. Right now, I agree with Duffy's original point, which is that bitcoin is more of a commodity than a currency.

A penny is made of zinc, but not all zinc is a penny.

A square is a rectangle, but not all rectangles are squares.

Scott is on the right path -- there's some sort of threshold where a substance is more valued as a transaction medium than for its intrinsic value.

But Bitcoin has no intrinsic value. So what's the threshold there?

Intrinsic value is set by the marketplace. Right now, the market perception is that prime numbers (or whatever bitcoins are) are scarce, valuable resources.

Bitcoins are not simply prime numbers. They are account balances in a system that distributes the validation of account balances in such a way that is cryptographically secure, trustable, and decentralized. Provably correct, tamper-proof accounting balance sheets are nothing to sneeze at and it was really a stroke of genius to discover the algorithmic means to create such a thing that is the cool thing about Bitcoin.

I personally believe that it will never achieve anything other than niche status as a currency for trading illegal goods; it will be used for other types of transactions, but it will be a very small number of transactions when compared to contemporary financial transaction systems like, e.g. credit cards, or paypal. I say this only because in practical terms it is not very easy to use, and furthermore, its benefit of being pseudoanonymous is also is downfall; very safe for the recipient to receive bitcoins but very risky for the sender to send them since the sender has absolutely no insurance or any recourse in the transaction. There is no authority to appeal to for transactions gone bad, and even if you could sue over bitcoin transactions and the courts would understand them, the pseudoanonymity would make it very difficult to know who to sue.

I don't think Bitcoins will achieve prime status either, but not for the reasons you listed:

- Easy of use: this is mostly a matter of software, and I see no reason to believe it has to be difficult to use. With current proposals such as specific tags for websites and such, sending money can be made as easy as inserting someone's email address, the amount and hit "send."

- Unsafe for the sender: nothing in the design of bitcoin prevents the creation of escrow services. It's simply not an issue to be fixed by the currency but by higher level services, just like with other currencies.

- Pseudoanonymity: it's mostly a red herring. When I'm buying from a random Chinese 'shop' through Ebay I won't be able to sue him either. When I'm buying from a reputed shop in my country, I don't need to ask its bank to know who I need to sue.

A currency that people are hoarding because they feel that the faith and credit of Switzerland is proportionally better than other currencies, especially the Euro.

He also touches on a great point:

What we want from a monetary system isn’t to make people holding money rich; we want it to facilitate transactions and make the economy as a whole rich.

By that logic the best money will be hot potatoes.

You're not wrong. In one prison, for example, cans of Mackerel served as an internal currency precisely because they had no inherent value. http://online.wsj.com/article/SB122290720439096481.html

As long some commodity (X) gains monetary value (demand for X is demand for a medium of exchange) it no longer needs any other value to function.

Still I doubt that cans of mackerel have no other use than monetary in prisons. Not many McDonalds around, beside if those were never consumed their supply would be grow continually which will to "mack" inflation.

P.S. Have you missed the point about the hot?

If Bitcoin ever becomes a successful, liquid currency, it will have been partly thanks to the current speculators. They're the ones "mining" the bitcoins. They're taking the risk. In a way, it's similar to gold miners of old. They would invest money in digging and mining for the chance of finding gold. They were in it for the profit. Still, it did benefit other people since there was more gold available for both utilitarian and liquidity purposes.

I think the point isn't about speculators, it's about hoarders. If it becomes a successful, liquid currency, it will be in spite of those hoarding.

Coincidentally, with the market looking like it does, at an individual level it's absolutely the right thing to do to hold them, or at best to slowly diversify out, while still not using it for much purchasing. As long as it seems like the right move to hoard them, and their transactional use is a tiny fraction of the amount hoarded, they're not going to be a successful currency as he defines "successful". Closer to a ponzi scheme and/or asset bubble IMO.

Hoarders are also speculators! They're betting bitcoin will go up in value.

By the way, "hoarder" is a loaded term. One man's "hoarder" is another man's "saver". Without people who save, there's no way people can borrow, and so on.

Upboat. The guy left with all the bitcoins has a lot of bitcoins. What else?

What risk? All the Bitcoin miners I know are patting each other on the back on how much mining their fancy GPU is doing. Risk: one or more graphics cards (that are also used to play videogames) and a slightly elevated electricity bill from leaving the computer on all day and night. There isn't a lot of effort or ingenuity going on here, just an information asymmetry.

There's exchange risk as with any currency. If you exchange US dollars for Mexican pesos, there's a risk that the pesos will lose value relative to the dollar. Of course, the risk of keeping bitcoins is much higher than that of Mexican pesos.

By the way, you seem misinformed about the way people are mining bitcoins. Nowadays it's done mostly by professionals running rigs with tons of GPUs, not by individuals who put an extra graphic card on their gaming PCs.

But won't it also encourage people to be wiser with their money, and not waste them on unimportant stuff? If what you're buying has higher value to you than holding the money, then you'll buy it. Isn't overspending what got us into this financial mess in the first place? And getting into too much debt, whether it's the Government itself or the people.

Also the deflation effect should only be this great in the early years of the currency. Once it becomes a solid popular currency (like say the euro or the dollar), and it has reached its maximum of 21 million bitcoins, the deflation should be a lot smaller and insignificant to people who would want to "invest" in keeping bitcoins to themselves, because there won't be an avalanche of people wanting bitcoins anymore, so the value of the currency won't surge so much from that point forward. The currency would become more stable and with a more steady growth as it also becomes affected by the law of big numbers.

>> Isn't overspending what got us into this financial mess in the first place?

Nope, it was overborrowing. One of the reasons that the economy is sluggish is that consumers are underspending.

>> it has reached its maximum of 21 million bitcoins, the deflation should be a lot smaller

That's when deflation in bitcoins will get worse, because while wealth will increase, the amount of currency in circulation will not.

Yes, overborrowing, but peopled overborrowed so they can spend more, not to invest.

A lot of that overborrowing was to buy homes, a commodity which (according to conevtual wisdom) always increases in value.

So yes, a lot of that overborrowing was for investment.

People kept spending because there were investments available (housing) which outperformed bank interest rates, 401k's, and pretty much everything else. There was no incentive to save because they were saving merely by owning their homes. This happens when there are bubbles. I don't see how the Bitcoin economy is immune to them, so you wouldn't have actually avoided what happened merely by using a different currency.

Let's say the total value of Bitcoin's in the world in 15 years is the same as the total value of Australian dollar's (AUD) in the world. Based on the rate of production it's going to take a massive amount of deflation to get there. That might make Bitcoins a good investment but it also makes them a terrible currency. (~261 billion AUD * 1.1USD/AUD / 21 million bitcoins = 13,600$/bitcoin.)

All of which is beside the point, unlike banking transactions each bitcoin computer needs to be connected to the internet so you can't create a truly secure network. If the average American had 10+$ in bitcoins on their computer a significant number of them would get hacked on a regular basis and simply lose all that money. Which means for the average consumer they need to deposit that money into some sort of bank and there is no FDIC for bitcoins so when that bank is hacked all that 'money' goes up in smoke. I think we may end up with a pure digital currency sometime soon but bitcoin’s don’t really work (yet). If you want secure anonymous transactions we already have cash and several digital equivalents based on cash, but if you want stability commodity bubbles demonstrate that finite quantities does prevent bubbles and their associated crashes.

I'm not sure I see the value of a pure digital currency, anyway. My dollars are digital when I want them digital (paycheques, moving between accounts, bill payments), and physical when I them physical (ATM withdrawal, quick cash IRL transactions).

And non-existent when the organization holding them for you (e.g. Paypal) decides to freeze your account.

The organizations holding them for me are chartered banks regulated by the government of my country, if they decide to allow freezing the amount I have larger problems.

As it happens I consider the need for a private third-party money transferring organization to be one of the larger failures of North American consumer banking systems, but I digress. It's slowly improving in Canada, I can now do inter-bank digital transfers between my accounts without shelling out $50 for a wire. Maybe in another decade or two we'll get to SEPA level.

Currencies are goods like any other goods and the people who own them have divergent purposes. When Krugman writes "we want [a monetary system] to facilitate transactions and make the economy as a whole rich", he's assuming a lot. Obviously, some of the people who own bitcoins right now are not interested in facilitating financial transactions to the detriment of their net worth. So, for people who want that facilitation, bitcoin isn't getting the job done, but the people who are using bitcoin as an investment are getting just what they want. Those two conditions could flip fairly quickly down the line, but that's how these things go. But for Krugman to just assume that only one of these is an acceptable condition just begs the question.

Currencies are not goods and should not be thought of as goods. They are mediums of exchange[1]. They may be backed by goods (such as gold), but currency itself should have no inherent value (otherwise, it's a terrible medium of exchange).

What you're talking about are securities[2]. There is a distinct difference. Bitcoins are ostensibly a security masquerading as a currency.

[1] http://en.wikipedia.org/wiki/Currency

[2] http://en.wikipedia.org/wiki/Security_(finance)

No, I think I am correct. Currency exchange rates are prices and in that sense a currency is a good. The typical use of a currency is as a medium of exchange, but people use goods for different reasons. That was my point originally.

I don't think it's just an assumption - I think it is fair to state that a currency whose primary mission is not to facilitate transactions will fail to catch on. So far BitCoin has failed to catch on.

Part of my original point was that currencies don't have "missions", people do. A person may or may not wish to own a bitcoin in order to facilitate transactions. A person might also wish to own one as a speculative investment. Neither "mission" is necessarily better than the other. Krugman just assumes otherwise.

I prefer currency to asset. I wouldn't hold bitcoins to spend.

Krugman thinks deflation makes things worse. So if bitcoin ends up making things better, that proves Krugman wrong.

One thing that might be interesting to consider is wealth distribution over population growth.

Thought experiment:

Say our money supply is fixed (10 million dollars), and there are 1 million people in our economy. Everyone averages out to holding about 10 dollars. Everyone goes on a massive baby-making spree, and in 10 years, there are still 10 million dollars, but 2 million people in the economy. Average wealth is $5 per person. Either prices dropped (unlikely, demand has doubled in this ideal world), or everyone is averaging to be poorer.

To my mind that thought experiment demonstrates the need for the supply of money to keep pace with population growth.

I might be wrong, I am not an economics student, and there might be angles I've missed.

But the absolute variation of the value the 5$ represent is based on systems that can't exist with a limited total amount of money.

What will hapen is that if the population doubles, then the 5$ will also double. Laws of demand and supply.

in your thought experiment, the buying power of a unit of currency would go up so the prices would go down. a big reason for a non-fixed money supply is so the government has the ability to change the money supply to maximize employment

I'd argue that the supply of money should keep pace with production, not population growth. Though you'd expect those two to be strongly correlated.

But money isn't static. It circulates. Liquidity etc. It's more like electric current - if your system allows it to circulate fast, it will enable more buying...

Pro-inflationists a simple question for you.

Inflation creates an incentive to invest. Fine. But why should the level of inflation and thus the risk profile for investors be determined by a single authority? Why not multiple competing currencies whose rates float against each other? Let the market figure out an optimal rate of inflation. The wild guesses and uncertainty of the Fed resetting the rate is surely inferior.

The world already works like that. You can buy money from countries other than the US, you know.

Legal tender laws should be abolished is the thrust.

What's the advantage you get from even more currencies that you don't get from today's basket of international currencies? The only one I see is that, if you build a big enough reputation to issue your own currency, you get to collect seignorage.

In exchange for that, you now have to carry n different currencies to make sure you can buy gas at a Shell station and an Arco; small retailers go out of business because they can't afford the overhead of combating so many varieties of counterfeiting--which, while still technically illegal, is much harder to prosecute--medium sized retailers go out of business because of the accounting overhead of setting appropriate prices when several currencies could be undergoing hyper(in|de)flation at any time.

I'm not sure that's a good trade.

I don't get the problem with hoarding. Most people don't hoard gold, property or tech stocks during times when the price looks like it's increasing constantly. There is a point where it makes sense to sell some after it has made some gains. In reality, unless buyers make a massive mistake in the valuation of BitCoins, the current gains in BitCoins value should taper off at some point.

What's the basis for that statement?

How many pre-1965 US Quarters and Dimes do you run into during daily commerce? Answer: Very few, since they are hoarded by collectors for their silver value.

People don't hoard stocks or property when the value of what they own is constantly increasing?

Krugman prefers the dollar, which has a supply that is constantly inflated by the central bank. But if the dollar is so good, why do people have to be forced to use it? (You have to pay your taxes in dollars, and you have to accept payments for debt in the form of dollars.) And how come bitcoin adoption has radically grown even though no one is forced to use it?

The dollar is so good because people are forced to use it. It's the currency of the land, which is enforced by the government. Hence, people use it.

That bitcoin adoption has grown significantly does not necessarily mean it will remain as a viable currency in the future.

He should have added a link to this alltime classic - a good macroeconomics, deflation 101 tutorial: http://www.slate.com/id/1937/

I was going to mention that article too. It's a great explanation.

Money and monetary systems are human creations, not laws of nature.

Yeah - it always amuses me to read these long detailed arguments on these threads from people who seem to not have understood basic macroeconomics.

Econ isn't a science. There are schools of economic thought that completely contradict "basic economics" taught in schools today, and you can't possibly prove that one or the other method is correct.

Hence, Economics: the dismal science.

I have to disagree here. Yes there are schools of thought, but questions like "how does a market work?", "what causes deflation?" are pretty well studied and agreed upon. This is one of those very basic settled questions with a very clear accessible explanation.

He's totally overlooked one aspect of bitcoin, it doesn't matter if it's deflationary if all I'm using it for is selling drugs and converting bitcoins into cash straight away or using it as an intermediary step in sending large amounts currency around the world anonymously. Who cares if it doesn't work great as a currency (if you believe deflation is a bad thing), it still has a lot of utility.


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