Fear Not Deflation
forbes.com
forbes.com
The author uses the utterly senseless definition of deflation as a change in the total money supply, instead of per capita money supply. If Bitcoin becomes more popular, its asset value increases because demand for it has increased, not due to "political numéraires" (whatever those are). Increasing the population but keeping the money supply fixed is fundamentally deflationary, and Bitcoin's "population" has the potential for large growth.
Second, it's astonishing that the author would approvingly quote a passage like this:
Deflation rewards the prudent saver and punishes the profligate borrower. The way a society, like an individual, becomes wealthy is by producing more than it consumes. In other words, by saving, not borrowing.
This is naive bullionism taken to a whole new level of insanity, with physical gold replaced by numbers in a file. Saving is equated with producing, as if putting my bitcoin wallet on a thumb drive and stuffing it under my mattress starts up a factory. Entirely absent from this morality play is the prudent investor, who borrows or spends out of savings to buy capital goods with the hope of increasing production, and is punished.
http://www.debtdeflation.com/blogs http://www.complexity.org.au/ci/vol06/keen/keen.html
Savings rates might well go negative though.
Steve Keen as linked to is well worth a read rather than my first approximation guesses.
If someone is investing in productive assets (companies, rentable property) for their sustained revenue potential that isn't a bad thing. Spending on goods and services will add demand to the economy and money will circulate.
There is also more reason to borrow in an inflating economy which adds money and demand to the economy. Obviously borrowing can get too high and needs moderation if bubbles are to be avoided but gentle adjustment is needed to prevent massive swings in aggregate demand.
Also I'm not arguing for high inflation just that even a couple of percent deflation could be really bad.
Isn't there some circular logic at play when you say that deflation would cause people to simply hold onto cash rather than invest in productive enterprises. Because if nobody invests in productive assets, then there will be no more goods entering the economy, therefore there will be no deflation of the currency to worry about in the first place...
This is an op-ed piece, written by a board member of the Bitcoin Foundation. Regardless of the merit of the article, it should have been explicitly stated in the piece.
As it happens, most central banks aim for a stable currency with a slight tendency towards inflation. My policy change would really only be minor: make the inflation target -1% to 1% rather than 1% to 3% (I didn't completely pull that number out of my ass; apparently, that is the Bank of Canada target range).
A priori this sounds reasonable.
But would you rather live/invest in 1990s Japan (mild deflation) or 1990s America (mild inflation)?
Mild deflation is absolutely terrible in practice. Mild inflation is good/not so bad.
Comparing 1990s Japan to 1990s America is not an "all else being equal" situation. Really, economics is such a complex beast, it would take an incredibly complicated analysis to demonstrate which is better.
You have proposed a stable CPI growth rate of 0%. There are two problems with this: the first (more important) problem is that arguably stable money supply is more desirable than stable CPI. During a downward supply shock, tightening the money supply can lead to a financial crisis by causing contracts made before the shock to fail. In that instance, rising CPI is good because it reflects a real fall in supply (prices should be higher).
The second problem and the reason why they shoot for 2% CPI inflation is that many prices are sticky downwards so an average CPI growth rate of 0% leads to problems. For example, people are known to find a paycut of 1% under 0% inflation more aversive than a pay increase of 1% under 2% inflation. As a result, during deflationary periods wages are often frozen at levels higher than equilibrium, leading to greater unemployment.
Despite these reservations, I agree that 0% CPI growth would be an acceptable policy, particularly as opposed to erratic policy as we saw in 2008–9. But you should recognize that moving from 2% to 0% would itself be a strong downward demand shock that in most countries would likely cause a recession.
Any sudden policy change is going to lead to turmoil and a likely recession. I did not suggest the change should be sudden.
Also, a target of 0% does not prevent appropriate price increases or decreases any more than a target of 2%. It is a goal not a mandate. As long as everyone knows what to expect, plans can be made reliably.
Expectations are the flaw with CPI targeting.
Toy example: imagine NGDP is $100 and the CPI is 100. Fed guidance says 0% CPI growth. I have income $10 (note that NGDP is aggregate nominal income). I sign a deal with you for you to finance my house and promise you for $7 next year, assuming I"ll live off of $3.
Now a supply shock hits, with enough pressure to raise CPI to 110. The fed responds by dropping NGDP so now national income is $90 (I know the math here isn't exact but it's irrelevant to the point). If I'm the average person, I take a 10% income hit, dropping me to $9. I still owe you $7. My consumption now has to drop from $3 to $2, a 50% drop! I might not be able to do it so I might default on my loan. In any case I'm really screwed, and if I do default (and many other people also default) we'll have a financial crisis on top of our supply shock. One way to think about this is that the debtor has to eat the creditor's consumption haircut. Europe, cough cough.
In contrast, under NGDP targeting, NGDP remains the same, prices rise 10%. Now my income will still be $10, I will pay my creditor $7, and my only hit is the 10% inflation. My creditor has the same exposure.
I'm not trying to create sympathy for debtors, of course you could argue that they were over-leveraged and deserved what they got. But under NGDP targeting, debts will always be repayable in principle (because enough money will exist in the system) so systemic risk is minimized; minimizing that systemic risk is good for everyone.
Basically Ripple is the anti-thesis of bitcoin as it works solely on trust between the participant and does therefore catch the essential mechanism of how all fiat economies work.
Furthermore, its idiotic praise of societal-level saving is pure nonsense. My income is someone else's expenditure, my credit is someone else's debt. Money can obscure this fact, not alter it. In order for me to save, someone else must spend.
Do they have to spend beyond their means and go into debt or reduce their own savings for me to save? Well, that's where the issue of money comes in.
If we have a standard-issue modern currency, ie: slow but steady rate of inflation targeted by a central bank, then some amount of new money enters the economy each year. As long as total new savings in the year don't exceed this amount, then and only then can everyone save at the same time.
In a gold-backed inherently-deflationary currency without fractional reserve banking or government fiat to create inflation.... all savings is zero-sum. Such a currency is indeed inherently deflationary, and the deflation spirals as those who can actually afford to save come to own larger and larger portions of the total bullion supply -- which they are of course saving!
You end up with only one way to put aggregate demand back into the system: credit. Which is exactly what has happened to our real societies in the past three decades of anti-inflationary, anti-labor public policies! Problem is, that makes the deflation truly become a crisis, because even a 2% annual deflation is in fact an extra 2% interest compounding on any and all nominal debts.
Deflation is bad for the same reason inflation is bad, namely that an unexpected change in currency value alters the real terms of almost all business contracts ex post facto. But deflation is also distinctly bad for another reason: once it kicks in, there is no incentive for net creditors/savers to engage in any real production of anything. Their biggest incentive becomes the generation and continuation of nominal debts (whose real value accumulates a deflation bonus). Worse, as the deflation happens and alters contracts ex-post-facto, people's debts become unpayable. So now the creditors go bankrupt too, and the only people left safe are the savers who literally stored physical bullion in a physical location. Anyone with so much as a bank account finds out they were actually a creditor, and are now completely fucked.
Deflation is a wet dream of survivalist "gold, beans, and ammo" nutters, and the world's worst preventable nightmare for everyone else!
I thought it would be obvious I didn't mean absolutely all spending will stop.
Would add that in a deflationary environment no one will want credit so really you have to print money and give it away (or just print it and spend it).
One last point: deflation always favors whoever, in a transaction, is the creditor/seller. In a certain sense, this is not only economically harmful but morally unfair. After all, if I pay a contractor $150k to build me a house (assume I own the land and we're only paying for construction), what I'm really doing, underneath the illusion of money, is trading my skills and property (program code, raw building materials) for his skills and property (architecture, construction, use of his materials and tools). In theory, this can and should be modeled as a spot-trade of my stuff for his stuff with no unwanted side-effects.
But once we get money and its time-value (deeply affected by deflation) involved, then one of us has an automatic advantage over the other based on the currency value when the work is done and when the payment is made. If the currency is deflating, even predictably, then whoever gets paid has an automatic advantage over whoever does the paying. An arbitrage opportunity across time has appeared solely because we involved currency.
If the value of the currency is changing predictably and the date of the future payments is known then it can be taken into account in determining the amount of the payments. However, the purchaser does benefit if the seller doesn't know enough to account for it or is timid and fails to assert the demand, etc.
And besides, sellers will want to use deflationary currencies, because then they raise prices without changing the nominal price. Therefore no one would be able to use a inflationary currency.
There already exists global competition between fiat currencies... The competition exists but the competition has bery high barrier to entry.
> And besides, sellers will want to use deflationary currencies, because then they raise prices without changing the nominal price. Therefore no one would be able to use a inflationary currency.
Nope, seller doesn't care if the conversion process is painless. Almost all sellers on the internet accept any currencies - for example, US sellers accept euros without knowing that they accept euros. Payment processors do the conversion.
In the end, the thing that matters is what kind of currency each participant wants to hold. If the buyer wants to hold currency A and seller currency B, they both can still do trade, if there exist somewhat efficient market between currency A and B. And there probably exists, currency markets are probably the first thing to evolve for any kind of usable currency.
I don't see any major harm but I don't see any benefit either. In fact you can currently choose from many global currencies now including the Yen that has deflated over the past decades.
Not really. We have this thing called technology, which allows people to automate things. And it is very much possible to automate almost everything related to currencies and payments.
If merchant wants to hold currency A, but can gain customers from currencies B, C, D, F, he can just implement some payment processor which does all the legwork for him with 1% fee.
> I don't see any major harm but I don't see any benefit either.
It is pretty difficult to see benefit why someone would want to use for example dollars compared to euros. It is mostly where you happen to live and to what currency you are used to. But I would bet my ass that people would after all like to decide themselves what currency to use, instead of someone else to force them to use specific currency (however still most people would probably just use the currency they are used to).
It gets really complicated quickly and for most people best just to get the one most aligned with their costs/spending and then they can enter currency speculation if they want to.
It's pretty dumb. Really, thoroughly dumb. But you've added some real bloopers of your own:
> If we have a standard-issue modern currency, ie: slow but steady rate of inflation targeted by a central bank, then some amount of new money enters the economy each year. As long as total new savings in the year don't exceed this amount, then and only then can everyone save at the same time.
This is not true. Not even close. First, you are conflating two different concepts: (a) an increase in the money supply and (b) inflation. Inflation is often the result of an increase in the money supply, but that's not what it is: inflation is an increase in how much stuff costs. That is, it's a general increase in prices.
And prices can move broadly in one direction or another for many reasons other than a change in the supply of money; the price-level depends also on how fast money circulates, on the level of supply and demand for goods and services, and on all sorts of related factors.
Second, the possibility of saving does not depend on an increase in the supply of money. Doubtless you are thinking of saving in accounting terms: to save means to have more money later than you have now, so in aggregate that must mean that there needs to be more money in the economy tomorrow than there is today.
No. Saving is one side of the saving-investment process, which is about doing useful work and creating new things. That work and those things are abstractly called wealth and have value; wealth and value can be denominated in money, and people use money to facilitate the transfer of different sorts of wealth. But wealth is not money, and saving is about accumulating wealth, not money.
You're absolutely correct that if saving were merely about financial wealth, about increasing one's "value on paper", then we would need more money to gain wealth as a society. But it's not, and we don't need more money to accumulate wealth as a society precisely because it's not the money we value, but the things and the results of useful work. And so people trade their money for new things and results, and we can grow wealthier without increasing the money supply.
> In a gold-backed inherently-deflationary currency without fractional reserve banking or government fiat to create inflation.... all savings is zero-sum.
On the savings part, see above. On the part of about a gold-backed currency, or really any commodity currency, here's the thing: they're not inherently deflationary, or even fixed in supply. It's just that growth of the money supply is tied to things like improvements in mining technology or the results of prospecting. What I find really funny when I hear Ron Paul or somebody advocate a return to the gold standard and the abolition of the Federal Reserve is that they're really arguing for handing over monetary policy to the mining industry!
> Deflation is bad for the same reason inflation is bad, namely that an unexpected change in currency value alters the real terms of almost all business contracts ex post facto.
Yes, right. (Though it's really uncertainty about changes in the price level that inhibit useful economic activity. Change itself is not bad, but its unpredictability is.)
> ... But deflation is also distinctly bad for another reason: once it kicks in, there is no incentive for net creditors/savers to engage in any real production of anything.
There is less incentive, not none. Deflation represents a real income stream (that is, a constant potential accumulation of goods and services), but just as you might choose to work more (or harder) to increase your income, so you might during a deflationary period.
Not really, mining industry still can produce only fixed amount of gold, while central bankers can potentially print infinite amount of paper money.
(I'm not advocate of gold standard)
And seen that unlimited QEs have been announced one can only conclude that our current system is deeply broken.
The probability that it ends up in a really ugly way is far from zero.
I could tell that I'd take the "gold-backed, 5% inflation per year max no matter what" anytime over the unlimited QEs we have now.
We're sitting on a time bomb and it has the potential to change the western world as we know it.
However, my point about savings stands, because I was talking about money, not wealth. The whole point is that money is an economic lubricant, and if an economy goes into a deflationary spiral or debt-driven financial crisis, the whole problem is that real wealth ceases to be represented accurately by money, yet almost all transactions continue to be denominated in money. The map ceases to represent the terrain.
Say what!? Gold's price goes down too if there's deflation.
Someone holding on gold hopes there's inflation, not deflation.
Deflation is the dream of people who hoarded truckloads of bills, not gold.
"My income is someone else's expenditure, my credit is someone else's debt. Money can obscure this fact, not alter it. In order for me to save, someone else must spend."
OK, so I produce 100 tons of lithium-ion in my backyard. I just created wealth. There's supposed to be money created corresponding to that wealth created. How does this money correspond to someone else's debt? Isn't money supposed to correspond to wealth and new wealth to be constantly created? You make it sound like it's a zero-sum game in the non-gold backed scenario too...
who's going to build a factory if building the factory is going to be significantly cheaper next year, not to mention everything it produces?
who's going to hire anyone if you can hire them cheaper next year?
especially in a country like the US, where everyone is in debt up to their eyeballs, deflation is a disaster.
That statement is true of just about any technology I can think of, and yet investment in tech doesn't seem to have collapsed as a result.
you can't build a new power plant that makes 10x better power than the last one. and yet prices are falling. so basically you have to wait a lot longer until the old plant is obsolescent, or only build a power plant when the power shortage gets really bad and margins so high that you would recoup quickly.
falling prices mean high real interest rates, fewer projects meet high hurdle rates, less investment, less growth and employment.
And I also agree that we should not fear deflation.
However hoping that deflation will happen would be like waiting for some pink unicorn to show up: both the U.S. and the Japan have announced "unlimited QEs".
In order words: endless money printing to prevent the utter failure of the Keynesian system.
We'll not discuss the fact that if money is free to print this is not true capitalism at work (because the amount of new money in circulation doesn't correspond to the new wealth created)... But hey, this is a Keynes' world right, so what do you expect.
Could anyone explain me how we'll anything other than inflation (and possibly a very severe inflation) when, worldwide, the biggest economies are doing "unlimited QEs"?
If deflation takes place I'd be very surprised (and very happy too, because I'm a "saver"). I did hedge myself against inflation/hyper-inflation but I still do have lots of cash/savings.
I'd love deflation to take place but with unlimited QEs it's never going to happen.