Bitcoins: Deflationary and Preferable to Inflationary Money?

[ThomasDoubts]

Firstly, I will be referring to Bitcoins the application/currency, not Bitcoin the payment protocol.  More importantly, I will be discussing them as one example of a deflationary currency, which in and of itself is preferable to an inflationary currency.  Inflation is defined as an increases in the money supply, while deflation is defined as reductions in the money supply.  In order for money to neither inflate, nor deflate, it must be a scarce resource that can neither gain, nor lose units in any manner (in addition to fulfilling other requirements of money).  To my knowledge, no such resource exists.  These are my basic premises, which you may or may not challenge.

 

Bitcoins today are inflationary, and will remain so until they are lost at a faster rate than they are mined.  At some point before they have all been mined, but not after, a deflationary trend will occur, without regard to price, and continue in perpetuity.  It is possible, that by some means, lost coins could be recovered in the future and potentially result in inflation.  This inflation would forever be limited by the upper bound of finite supply and would likely occur in brief flashes of time, as the technology which enables it is instantly capitalized on, and discounted by the market.  As each new generation of encryption is employed, deflation is assured until the new encryption can be broken.  Just as fiat currencies experience periods of deflation, they are by historical records, inflationary, and without upper bounds.  Similarly, Bitcoins may well experience flashes of inflation, but by and large, would trend in a deflationary manner, quickly adjusting to shocks (too strong a word) of inflation.  In trying to make the case that Bitcoins are deflationary, I'll try to summarize in this way;  When all "coins" have been released, the upper bound of monetary units is inviolable.  Surely it is easier to lose a private key, than it is to find one.  The only means to find lost "coins" faster than they are lost, is to break the encryption, at which time markets rapidly respond, and bring back deflationary trends. 

 

Hopefully, I've made a decent case that Bitcoins, fully implented would be deflationary, as the most commonly accepted medium of exchange.  I'd also like to make the case that deflationary money is preferable to inflationary money.  Bitcoins may very well be overtaken by an altcoin (or something entirely different), but personally speaking, the altcoin would have to provide value that Bitcoins do not, and also be limited in supply, beyond human control.  It's important to understand, I'm not making the case that Bitcoins will be the currency of humanity for the next 12 million years.

 

-Money must be either inflationary or deflationary

-It is preferable to have money that cannot be stolen over money that can be stolen. (As we know, Inflation=Theft)

-Therefore deflationary money is preferable to inflationary money

 

-Future money supply must either be determinable, or indeterminable

-Determinable future money supply is information about the future, while indeterminable future money supply is a lack of information about the future.

-To allocate resources, it is preferable to have information about the future supply of money.

-Therefore a determinable money supply is preferable to an indeterminable money supply.

 

If these two arguments hold, it must be true that the deflationary money is superior to inflationary money, and a determinable money supply is superior to an indeterminable money supply.  Hereafter, I hope you can challenge these premises or conclusions; I'm a bit weary of fighting off too many consequentialist arguments. 

 

From this point on, understand that I'm not making any arguments.  I will however describe/entertain a few effects of a deflationary currency for discussion.  To start, I reject the deflationary spiral theories of economics; If you'd like to make that case, I'd be interested in the challenge of poking holes in it.

 

I should have said this earlier, but I'll say it now; Price appreciation/depreciation of money does not, in my view, necessarily describe inflation/deflation.  Bitcoins have not inflated because the price has gone up relative to any particular metric; the supply was provided and met with demand.  If I buy 3 Bitcoins today, and in ten years I use them to buy a new house, who dare say they were inflated when I bought them?  This point is one I expect might be contended and I'd also be interested in challenging the contentions.

 

It's commonly argued that inflation is preferable because it helps people/governments get out of debt.  This is at the expense of savers and lenders.  Why is it preferable to incentivize debt financed consumption at the expense of production derived savings/lending?  I don't think it is.  A deflationary currency turns this on it's head.

 

The incentive to delay consumption/gratification, rather than disincentivized savings, has the potential to drastically change the way we think about allocating resources.  I think this would change the way we think about spending/saving and risk taking/credit/interest rates, and by extention, how we allocate another finite resource: time.  I may be off base here, but I don't think it's too far fetched to say that a monetary system that encourages immediate gratification in "economic" matters, also trains us to an extent to expect/desire immediate gratification in all other matters of life.  In order to maximize the purchasing power of an inflationary money, you must spend it as quickly as possible because it loses value over time.  In order to maximize the purchasing power of a deflationary currency, you should spend it on your own most extravegant funeral .  Of course this is tounge in cheek; the spending mechanism becomes such that you only spend money when you percieve the value you recieve to be greater than, or equal to, the slightly greater value your money would command in the future, rather than it's diminished value.  In other words:  If I don't buy it today, I won't be able to buy it tomorrow-> becomes -> If I don't buy it today, I can buy two tomorrow. 

 

To have a given unit of currency be worth more tomorrow, rather than less, and "governed" by mathematics with relative certainty represents a fundemental change.  One earns a return by not consuming, rather than being required to take risk to avoid a loss. 

 

Having written a novel, I'll shut up now.

[ribuck]

Inflationary currencies benefit the currency issuers. That's why governments love them so much.

 

Deflationary currencies benefit the currency holders. That's why people love them so much. If you offer someone a choice between a $20 bill that will be worth $19 tomorrow, and a $20 bill that will be worth $21 tomorrow, they will choose the deflationary bill every time.

 

Governments and their central banks try to scare the people with warnings of deflationary spirals, but in fact no deflationary spiral has ever happened. Inflationary spirals, on the other hand, are littered throughout history.

[Wesley]

Inflation is defined as an increases in the money supply

 

I should have said this earlier, but I'll say it now; Price appreciation/depreciation of money does not, in my view, necessarily describe inflation/deflation.  Bitcoins have not inflated because the price has gone up relative to any particular metric; the supply was provided and met with demand.  If I buy 3 Bitcoins today, and in ten years I use them to buy a new house, who dare say they were inflated when I bought them?  This point is one I expect might be contended and I'd also be interested in challenging the contentions.

I was a bit confused in this area. Is this a contradiction? Or am I missing something?

 

I think that macroeconomics will be somewhat re-written in the bitcoin experiment. Bitcoins may be inflationary or deflationary, but how much does that matter when everyone knows exactly what the total amount available is and what the current monetary velocity is? Macroeconomics also used to be a system of policy management with arbitrary levers to pull, where now it would be explicitly data mining and statistics.

 

I also do not think that a deflationary spiral would occur. If money started losing value because people were hoarding it, then people wouldn't hoard it as it would be losing value to disincentivize hoarding. There becomes a check against it.

 

Right now, I do think a deflationary currency would be preferable to an inflationary currency as people need to go through a generation or so of building wealth rather than spending wealth. However, I think that there will be a basket of altcoins to choose from which could provide many interesting options of inflation and deflation in order to give people the chance to try out different money theories. Again, macroeconomics becomes something that will be rewritten and based on scientific and empirical evidence, rather than pseudo-religious theorizing and attempts to correlate past events.

 

I tend to be of the opinion that inflation only is a problem when people do not know that inflation is happening and to what extent. I think the effects of inflation and deflation will be greatly reduced when everyone knows exactly what is happening.

[ThomasDoubts]

I was a bit confused in this area. Is this a contradiction? Or am I missing something?

 

I think that macroeconomics will be somewhat re-written in the bitcoin experiment. Bitcoins may be inflationary or deflationary, but how much does that matter when everyone knows exactly what the total amount available is and what the current monetary velocity is? Macroeconomics also used to be a system of policy management with arbitrary levers to pull, where now it would be explicitly data mining and statistics.

 

I think the issue here may largely be Mises vs. Rothbard on the definition of inflation/deflation.  If this doesn't strike a chord, let me know.

Mises:  an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange-value of money must occur.

 

Rothbard:  The process of issuing pseudo warehouse receipts or, more exactly, the process of issuing money beyond any increase in the stock of specie, may be called inflation.

 

I subscribe to the latter but would alter it just a bit to accomodate cryptocurrencies.

 

Lets start at the point where all Bitcoins have been mined.  Would you agree that the trend would likely be a cycle gradual deflation(strictly, lost bitcoins) over time interrupted by brief spurts of inflation ("found" Bitcoins)? 

 

I don't want to put words in your mouth, but correct me if I'm wrong.  Is it your position that as consumers adopt or reject money (cryptocurrencies), it will be reflected in the price of money, and will constitute, at least to a degree, inflation or deflation respectively?  This, I think, would be Mises' argument, whereas Rothbard, I think, would make the case that inflation is simply an increase in the supply of monetary units.  Mises' definition could permit fractional reserve banking without inflation, where-as Rothbard's position would be that fractional reserve banking is, by definition, inflationary.

   

Is this addressing the disconnect at all, or am I in left field?

 

 

Right now, I do think a deflationary currency would be preferable to an inflationary currency as people need to go through a generation or so of building wealth rather than spending wealth. However, I think that there will be a basket of altcoins to choose from which could provide many interesting options of inflation and deflation in order to give people the chance to try out different money theories. Again, macroeconomics becomes something that will be rewritten and based on scientific and empirical evidence, rather than pseudo-religious theorizing and attempts to correlate past events.

 

I tend to be of the opinion that inflation only is a problem when people do not know that inflation is happening and to what extent. I think the effects of inflation and deflation will be greatly reduced when everyone knows exactly what is happening.

 

First, we agree on the state of Macroeconomics.  I consider most of Macro to be voodoo witch-doctor science.  I guess my problem is this:  What are the benefits of inflation?  Given the choice between a currency worth more tomorrow, rather than less, why should I choose one worth less?  Inflation seems to me to be a fundemental violation of property rights.  It's akin to home-ownership in this way:  I may buy a home in the US with cash, owning it free and clear.  Do I really "own" my home and property if I'm subject to extortion?(commonly referred to as property taxes)   I'm required to forfeit a sum of money every month in order to retain my own property.  In the same way, in order to use money, must I forfeit purchasing power in the form of inflation?  If I don't need to do so, why would I?

 

I do agree wholeheartedly with your last point; transparency will reduce the effects of inflation/deflation. 

[Wesley]

First, we agree on the state of Macroeconomics.  I consider most of Macro to be voodoo witch-doctor science.  I guess my problem is this:  What are the benefits of inflation?  Given the choice between a currency worth more tomorrow, rather than less, why should I choose one worth less?  Inflation seems to me to be a fundemental violation of property rights.  It's akin to home-ownership in this way:  I may buy a home in the US with cash, owning it free and clear.  Do I really "own" my home and property if I'm subject to extortion?(commonly referred to as property taxes)   I'm required to forfeit a sum of money every month in order to retain my own property.  In the same way, in order to use money, must I forfeit purchasing power in the form of inflation?  If I don't need to do so, why would I?

 

I do agree wholeheartedly with your last point; transparency will reduce the effects of inflation/deflation. 

I do think you clarified things with the first part a little more.

 

It would not be stealing if:

 

1. You knew beforehand that the currency would inflate

 

2. You chose that currency anyway

 

3. You have the option to leave at any time and go to a different currency.

 

It is theft mainly in state systems, because of the lack of choice and the lack of transparency.

 

I do not know if an explicit and voluntary inflationary currency will be good or not. I think that someone should try it and see what happens. In fact, I can almost guarantee that if anyone thinks it would be valuable at all, then it will become so.

 

One possible way that it could be beneficial is to continue to encourage mining. Maybe transaction fees will not become enough (or cost too much in order to get a good time), so someone decides to make a currency that puts a pool of .5% of the current pool as rewards for mining, with transaction fees added in. This is just an idea off the top of my head, but that may lead to lower transaction costs for the currency, as they would be paid through inflation instead of directly. Maybe this currency will be swapped to for people who make many transactions, were savers will tend toward the deflating currency.

 

I would not consider a transparent and voluntary currency to be theft no matter how much inflation there is. You should have the ability to choose between options and people should experiment with many different ways to have a currency and see what works and what doesn't.

[ThomasDoubts]

I believe it's true that I cannot call inflation theft if one chooses it, so you're right to point that out.  I also agree that someone should try out transparent and fixed (or fixed rate) inflationary currencies, if for no other reason than to satisfy my curiousity in watching the experiment unfold. 

 

I have to admit, I'm still stumbling on why someone might choose an inflationary money though, all else equal.  It seems to me like choosing a car that leaks a quart of oil every 2 months, over an identical car that does not leak oil at all.  The only conclusion I can come up with at the moment, is that debtors prefer inflation, and savers do not.  I'm going to have to have a think on the implications of that... 

 

Good stuff, I appreciate your thoughts.

[Wesley]

Well, I at least provided a possible example. That inflation compensating the miners could lead to lower transaction costs as a smaller transaction fee is needed in order to process the transaction quickly. 

 

Thus, an individual who makes many transactions would prefer the lower transaction costs and would be ok with the inflation rate as it actually saved them money.

 

Then any savings could be transferred into a deflationary currency that has higher transaction costs, as you have minimal desire to transact very often in that currency anyway.

[ThomasDoubts]

Thus, an individual who makes many transactions would prefer the lower transaction costs and would be ok with the inflation rate as it actually saved them money.

 

Yes, but the flip side of your coin is equally important.  Those who don't require high speed transactions have to subsidize your transaction speed at the expense of their purchasing power.  Why would they want to do that?  (I ended up using "your" and "you" a lot.  I don't mean you personally, I'm just speaking as if you were such an individual as quoted above)

 

I think the market will adjust to the diverse needs for transaction speed.  Fed-Ex doesn't raise prices on everyone to ship everything faster.  They offer different rates for different speeds.  Health insurance companies have higher premiums for parachute test pilots than accountants.  I think this is natural and just, and see no reason why Cryptocurrency mining would, or should be any different.  Of course I'm no prophet, just my opinion. 

 

A deflationary currency would not incentivize mining with inflation obviously; it seems that paying a premium for speed would be the natural market solution.  In competition with each other, an inflationary currency's appeal (or not) is you can have the collective socialize transaction speeds via inflation.  All else equal, anyone that doesn't require high speed transactions has a disincentive to subsidize you, and leaves for your competitor who offers him an effective discount to accept slower transactions rather than a penalty.  Should he suddenly require a high speed transaction, he can still pay for it, as he was doing either way before.  Who/what determines what level of inflation is sufficient to provide the optimal solution?  If you don't have enough inflation to properly incentivize miners, is there intervention to "help?"  What if there is too much? 

 

This doesn't address fundemental issues.  There is no incentive to hold an inflationary currency for a duration of time.  If it were fundementally cheaper than competitors to transact with (which I have doubts about), value would still be largely stored elsewhere.  I don't think an inflationary currency holds any natural competitive advantage.  I believe the incentive/reward structure offered by deflationary money is superior: don't finance consumption with debt.  Save for the future. 

 

I admit though, I fear I'm starting to tell you how markets ought to behave, rather than observing them.  Experimental evidence would be far more valuable to the argument than my thoughts or theorizing. 

[Wesley]

I only was providing a possible option. There may be a time where transacting in one currency is cheaper when you transact between 0-8 times a year and another will be preferable for 9-infinite times a year. Businesses especially that do really large volumes will pass on half of their discount to the customer to show the preference for the other currency which leads people to have a "checking account" in an inflationary currency and a "savings account" in a deflationary currency.

 

Of course, I have no idea what would happen, I am just providing a potential situation where inflationary currency could be positive in the framework of cryptocurrency that is voluntary. When it is voluntary and transparent, even some of the ideas that the Austrian school have brilliantly came up with may not apply. I don't know if they have yet, but the Mises Institute would do well do devote a lot of resources and thought to a bitcoin environment. The fact that I haven't really heard of work produced by them in this area (besides the occasional article) may be evidence that they are not doing this.

 

This particular idea may not be perfect is all, it is just a possibility, though I think it is a very plausible example.

[ThomasDoubts]

Yes, it's important to note that none of the conflicting views within the Austrian school are infalible.  I also would like to see more focus from the Mises institute on the Bitcoin environment.  I think a lot of the Austrian community is personally invested financially and emotionally in precious metals, which conflicts with Bitcoin.  I like Zero Hedge, among others, for Bitcoin commentary.  The quality isn't as high or consistent as the Mises institute but the volume and diversity of discussion is much greater.