The Economics Of Bitcoin – Why Mainstream Economists Lie About Deflation

As many of my regular readers know, I’ve already written a few articles on Bitcoin that explain why it is money.  In those articles I have addressed why the inherent properties of Bitcoin give it value as a medium of exchange.  One of those properties that I mentioned, but did not go into very deeply, is the deflationary aspect of the currency system.

Bitcoins are inherently deflationary as a currency because they will eventually top out in the number that can be produced.  Eventually total Bitcoin circulation will reach about 21 million coins, and after that, no new coins can be created.  Thus, if no new money can be created, yet if the productive capacity of the economy increases, prices will fall since there will be more goods chasing the same amount of coins.

Most people remember hearing that deflation is just as bad (or worse) than inflation from their high school or college economics teachers.  In this article I will explain why those assumptions are wrong.  Deflation is when a currency gains value over time (i.e. you need less and less of it to buy the same amount of goods in the future).

So let’s list off the reasons why crackpot Keynesian economists think deflation is bad for the economy.  Then I will address each of those points.  You are about to see a guy with a BBA in MIS smash a Noble prize winning PhD economist’s arguments using simple common sense.

Deflation is supposedly bad because:

There are actually three different reasons to worry about deflation, two on the demand side and one on the supply side.

So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow…even a zero rate may not be low enough to achieve full employment.

A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts.

Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity.

Those arguments against deflation are typical Keynesian dogma.  In fact I actually wrote out the exact same three arguments before I even read Krugman’s article, but I figured it would be better if I listed them off right from the horse’s mouth.

So let’s address the first argument that people become less willing to spend, and particularly less willing to borrow, and this somehow leads to unemployment.  There will ALWAYS be some unemployment if the economy is not in equilibrium (which it never is, since human desires change over time).  As people shift their desires from wanting notebook computers to iPads, some unemployment will result from this.  Consider that if the demand for notebooks drops while the demand for iPads increases, notebook producers will end up having to lay people off or go out of business while iPad producers will be hiring more people.  The people in transition are going to be unemployed while they look for new work.

But setting that point aside, we have to look at why money undergoes deflation in the first place!  It is not surprising that Krugman doesn’t mention the reasons why deflation occurs in a currency.  There are basically only two reasons (on a macro scale) why a currency would undergo deflation:

1.  The economy is producing more new goods and services at a rate that is above the growth rate of the money supply…. or

2.  In a fractional reserve system, debt is being wiped out through widespread bankruptcies.

Consider that in the first case, this is entirely normal and healthy!  If the money supply is held constant, yet the productive capacity of the economy increases, there will be the same number of dollars chasing more goods.  Inflation is the exact opposite of this, whereby same dollars are chasing fewer goods (or more dollars chasing same/less goods).  Clearly deflation in this sense is beneficial for consumers.  We see this taking place in the electronics industry which is largely free from government regulation and subsidies.  When competition is fierce, the productive capacity of industry over-rides the inflationary aspects of our fractional reserve economy and we see prices come down as more and more electronic goods are produced more efficiently.

Imagine if the electronics industry operated like the government subsidized and regulated healthcare industry.  You would buy all the electronics you could now, because in the future, they would be so expensive you might not be able to afford them!  So yeah, in this sense, inflation encourages spending.  But clearly this is UNHEALTHY spending caused by people fearing the loss of their purchasing power.

Inflation creates a fear based economy that motivates people to spend above their means because the future value of their purchasing power is constantly decreasing.  It would be foolish to try and save money for future expenditures in an inflationary economy, which obviously destroys savings.  People who save for their retirement by putting money in a bank would be fools in an inflationary environment.

In fact if the inflation gets bad enough and interest rates are artificially low, people would be motivated to take out excessive loans and credit card debt to try and get as many things as they could now!  Boy that sure sounds like a problem we are all familiar with doesn’t it?

Krugman’s argument that people would be less willing to spend and borrow, and this would lead to unemployment, is as ridiculous as saying that because computers keep getting better and cheaper into the future, people would be less willing to spend money on a computer today because they could simply wait and buy an even better/cheaper computer in the future.  That is obviously not how people think.  People have needs and desires that have to be met, and they will purchase things as soon as their desire for the product is larger than their desire for future earnings on savings.  That, by the way, is how a healthy economy should operate.  Notice there is no fear involved.  Electronics companies are not going out of business because their products are becoming more abundant and cheaper.

So let us look at Krugman’s second argument that deflation makes debtors worse off.  What is left unsaid in this assumption is that debt is a good thing, while saving is a bad thing.  Does this make any logical sense to anyone?  Consider that if money is undergoing deflation, SAVERS benefit.  Shouldn’t the savers naturally benefit more than someone who is putting themselves into debt?  Savers are forgoing pleasure in the moment for the expectation of even greater pleasure in the future.  This means resources that could be consumed immediately for minimal productive gains are being put aside into bigger projects that could yield even greater gains in the future.  Savings is what builds strong economic foundations.  If the US wasn’t so wildly in debt at the moment we would be in a better economic position with larger prospects for growth!

But also let us consider the impacts of deflation on interest rates.  People who lend and borrow money will know that money will be worth more in the future if the money supply remains constant (like Bitcoins) yet the productive capacity of the economy continues to increase.  This leads to falling interest rates.  Interest rates will naturally come down in a deflationary environment because savings will increase, thereby making more money available to banks to lend.  When banks have a lot of people saving money with them, they will lower rates naturally.  This is in contrast to our present situation where rates are low strictly because the Fed is artificially depressing them by paying banks NOT to lend and by buying up government bonds.

Distortion of interest rates by the Fed also has other deleterious effects on the structure of production that I will not get into here, but according to Austrian Business Cycle Theory, inflation and its distortion of interest rates is the primary driver of business cycles.  Learn more about it by watching this video by Professor Roger Garrison.

Which situation sounds healthier to you?  Low interest rates because a lot of people are saving money or low interest rates because the Fed is artificially depressing them with tax payer money?

So let us address Krugman’s final argument that wages face downward rigidity which makes it more difficult for employers to adjust to the money that is gaining in value.

Consider if you were in this situation:

Your employer gathers up all the employees for a conference and tells you that because the economy is so productive and that the value of money is going up so much, that he is going to have to furlough the workforce to deal with the appreciating currency.

From your perspective, you are getting more time off while your income remains exactly the same in terms of purchasing power.  Who doesn’t want that?  Further, consider that if you don’t get a raise every year, YOU STILL GET A RAISE!  Employers don’t necessarily have to cut wages; they can cut hours or simply not give raises yet people would still be better off than they were the year before.

But let’s say the economy is so productive that money gains so much value that employers are simply forced to cut wages – if this was the case, would anyone seriously give a damn?  We would be living in a nirvana society that had absolutely ridiculous amounts of abundance.  Women could stay home to take care of the kids, one man could provide all the income necessary to take care of his family and still retire, kids wouldn’t have to work three jobs to put themselves through school, etc… etc… etc…

Less people would need to work in such an economy (like they did in the 50s and 60s) which would relieve the need of employers to cut wages.

Oh yes, one more thing.  I suppose I should address the second cause of deflation other than increasing productivity while the money supply remains constant – and that is a deflationary default spiral that results from the unwinding of a Ponzi scheme.  This is the real reason why Keynesian economists fear monger about deflation.  Since in our crazy society, money IS debt, if debtors get themselves into a position where they are so over-leveraged that they are forced into bankruptcy, it can cause a cascading series of defaults that wipe out the banking industry (along with the government and its welfare/warfare state).  As debt gets wiped out, the money supply decreases which leads to deflation.

Keynesian economists have to continually fear monger about deflation because even a tiny amount of it could wipe out our Ponzi debt based economy, and thereby wipe out their fat government aid fueled paychecks.  To learn more about the scam that is our debt based economy, check out The Case Against The Fed.  It offers a clear picture of how the modern banking system operates and why it was created.  If you are looking for something slightly more entertaining, yet still informative, check out The American Dream.  It is gives a great overview of what fractional reserve banking is and why it is nothing more than a Ponzi scheme.

Keynesian economists like Krugman don’t have your best interests in mind when they argue against deflation.  They are far more concerned about keeping the welfare/warfare state alive and well, along with their own paychecks.

 

  • Pango

    This is literally the dumbest fucking thing I have ever read.

    • http://fascistsoup.com/ Michael Suede

      Coincidentally, your reply happens to be the dumbest fucking thing I have ever read.

  • Todd

    BBA in MIS more like BABBY in MISTAKES

    • http://fascistsoup.com/ Michael Suede

      Todd short for toddler.  Because you certainly argue like one.

  • Jimbob

    Every single point you make is correlation = causation. That’s not how an argument works. Try taking an entry level philosophy or ethics class.

  • Fart

    fart

  • http://fascistsoup.com/ Michael Suede

    Looks like I struck a cord with the communist block.

    • Cowboydroid

      Three years later, and we’re still hearing all the same arguments! Amazing…

  • http://twitter.com/mrthechairman Dr. Hymie Tugjobs

    The problem is that bitcoins aren’t a currency, they’re a commodity.  The majority of people holding bitcoins right now are treating them as an investment, rather than a means of exchange; they intend to cash them out back into a fiat currency once the market is favorable.  Because of that, your comparison doesn’t really make sense; it’s like comparing the yuan to pork bellies.

    • hahaonlysirius

      All currencies are commodities. Not all commodities are currencies. Currencies are typically commodities which have a high store of value which are easily divisible and portable.

      Bitcoin is both a commodity and a currency.

      And I think you’re assumption about what the majority of people are doing with bitcoins is wrong.

      • Eric Hackenberger

        I’m glad you pointed this out. :)

        Mises would be proud.

    • http://twitter.com/JessiDarko Jessica Darko

      Dr. Hymie Tugjobs– if that is your real name– I suggest you read Murray Rothbards “what has the government done with our money” and learn what money is.  (Currency is a money substitute or current money, and is a vaguer term.) 

    • Gideon Andersson

      If you take a peek at a site like bitcoinwatch.com you’ll find that a great percentage of the total amount of bitcoins available actually change hands every day. Typically around 20% of all bitcoins change hands – that doesn’t really seem like “people are holding on to their bitcoins”. It’s the other way around.

    • Ron Wandell77

      The Bitcoin technology is a fantastic platform play.
      There are companies working on POS (point of sale) systems as we speak.
      Hell I built almost whole cash register on my laptop using my cell phone and QR reader apps.
      At least one guy is building ATM machines that would take in USD and push BTC to your phone or vise verse where it would take BTC and despense USD to your hand.  This is a “Killer App” an App that makes bitcoin valuable if it ONLY did this.  I could send money to someone in Europe by putting $80 in an aATM in Florida and sending the BTC to him where he could push the BTC to his ATM and get euros. 

      The revolution is upon us.

      Mr. Suede, GREAT WORK keep the articles coming.

    • libertyzeal

      Please share with us your scientific polling data.

  • http://twitter.com/JessiDarko Jessica Darko

    Excellent Article!  The only criticism I might have is that there are even more arguments for why monetary deflation is good.  The fundamental problem (and the reason why you’re getting insults rather than arguments from the communist crowd) is that people don’t even know what money is, let alone economics… but they are told to feel smug and superior and to believe they are “intellectual” and “scientific” when they adopt, sans critical thought, the leftist ideology. (The right has a similar thing, only its along the lines of “the US dollar is patriotic! If you compete with the dollar you’re unamerican!”) 

    The pro-monetary inflation view is a greedy one.  It says that all the productivity advances and hard work that americans do to grow their economy, by some divine right, belongs to government to spend… and not only that , they get to spend all that, but even more, such that our dollars buy less over time.

    Pro-inflation is pro-slavery.

  • Guest

    You mention iPads. It would be great if your site didn’t load some sort of immovable blank overlay over the article so it could actually be READ on an iPad.

    • http://fascistsoup.com/ Michael Suede

      yeah it does that on my iPhone as well.

      I assure you that I did not intentionally put it there haha.

      Try viewing the site in mobile mode if you are using a mobile device.

  • DrGizmo

    Dr.Gizmo – Mike – You are fast becoming my favorite author…

    for the rest of you… a few reasonable assumptions … men are born …they peak in productivity… and then get old …WANE AND FINALLY DIE! … if i had a choice (and now I do ) i would like my money to get more valuable as I age, so when young and productive i can earn and save, …so when I”m old my money can earn for me, so when Im old, and cant work… my money can…because it will buy  more … so following this simple logic … deflation good, inflation bad … see now i can support my self … what a concept!

    Any other way is just STUPID ! especially if you are a human and you age! Kurgman is a IDIOT ! …of course this assumes you want to be free and support yourself.

    thanks mike good post…

  • Derp

    a few trolls making comments, you must be w.i.n.n.i.n.g michael suede.. great article. spot on. well done

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  • libertyzeal

    Well done Michael, your setting a high bar which I haven’t seen matched by the opposition.

  • Atlas Thugged

    This is hilariously wrong.

    Great example of lolbertarianism by someone with a extremely tenuous grasp of macroeconomics. 

  • David Plottner

    I am not worried about a steady deflation. I would
    however worry that if Bitcoin was used as a primary currency it would cause a
    deflationary spiral or hyper-deflation. I would be worried about exponentially
    increasing rate of deflation. Imagine prices at the grocery store dropping by
    50% a day or hour. Just changing the prices seems like a difficult task. Not to
    mention a have to halve your employees pay on daily or hourly basis.

  • http://www.facebook.com/wouter.drucker Wouter Drucker

    Also: if consumers were to stop spending because of deflation, surely producers would stop spending as well. If producers wouldn’t invest in machinery, production would decrease. So no deflation.

  • zedn

    “So let us look at Krugman’s second argument that deflation makes debtors worse off. What is left unsaid in this assumption is that debt is a good thing, while saving is a bad thing. Does this make any logical sense to anyone? Consider that if money is undergoing deflation, SAVERS benefit. Shouldn’t the savers naturally benefit more than someone who is putting themselves into debt?”

    Debt is bad, agreed. That’s why it is bad that deflation increases debt.

  • hashman

    “Eventually total Bitcoin circulation will reach about 21 million coins, and after that, no new coins can be created.”

    This is inaccurate. Bitcoin circulation will NEVER reach 21 million coins. New coins are ALWAYS created in a geometric series (reward is halved every ~4 years).

    Another point, backing up your argument: whoever thought deflation would discourage purchasing obviously never paid 10$ for a bitcoin and then saw their coins become worth 70$. Guess what: You are encouraged to spend!! Duh!!

    Cheers -

    • http://www.libertariannews.org/ Michael Suede

      It is accurate, that is why I said “about” or “around’ or “nearly” and not the word “exactly” 21 million coins.

  • closetothetruth

    i am a little confused by your invoking of Keynesianism, left vs right economics, etc., along with your notions of deflation. These seem to be pegged to the role of currency in a nation, and nobody claims Bitcoin is a national currency.

    The only way people talk about deflation in Bitcoin that I understand it is price deflation: that I can buy the same amount of the same stuff with fewer Bitcoins. Period.

    It is agreed across the board in economics, left and right, that this is unwelcome for any exchange currency, because it produces what is usually called “hoarding” but might also be called “investment.”

    The danger for Bitcoin along these lines is easy to see, and once again does not seem to enter in a left-right discussion. The more attractive Bitcoin becomes as an investment–the more its price deflates–the more people will want to buy and possibly hoard it, driving up the price even higher (as is happening now, which is how I got back to this old article today). That attracts even more investors and pushes any currency away from its primary function as a medium of exchange. The danger is that someone using Bitcoin for this function has to constantly choose between purchasing inventory or holding onto currency.

    Because Bitcoin is such a free market, there is nothing to prevent investors from causing it to deflate by hoarding, as they are doing now. The higher it goes the more they hoard. The more they hoard and the higher it goes, the more likely that the bubble will burst, because those investors will want to take profits and will perceive holding the Bitcoins outright as risky. The bursting bubble makes Bitcoin too risky for merchants to depend on as a basic currency: if the merchant holds onto 1000 BTC as profit, and BTC plummets in value due to bubble bursting (ie, inflates), that profit has evaporated.

    Minor inflation or deflation are probably not all that important to the future of Bitcoin, but it seems to me a fairly straightforward argument, without particularly invested politics, that a repeated and dramatic boom-and-bust cycle–one characteristic of many completely unregulated and not-asset-pegged vehicles–makes it an extremely unstable medium of the exchange for which it was overtly designed.

    • http://www.libertariannews.org/ Michael Suede

      If you swap “hoarding” for the word “saving” you’ll see that the entire article is focused on addressing the points you raise.

      There is no such thing as hoarding money, there is only saving money. Hoarding is a loaded subjective term.