Krugman on Bitcoin's problems with deflation (2011)
krugman.blogs.nytimes.com
krugman.blogs.nytimes.com
- Bank runs. It's standard practice that banks will loan out more money than they have in deposits, because it's unlikely that all their loans will go bad at once, and/or it's unlikely that all their deposits will want their money back at once (this is known as fractional reserve banking[0]). But if your currency is anchored to something fixed, this can happen. FDIC insurance is guaranteed in the US because even in some absurd financial economic meltdown scenario, Ben Bernanke can print out USDs to make every depositor whole, if necessary. The only "cost" to that kind of "bailout" is the potential inflation. But you can't do this as a government if your monetary supply is limited because it's fixed to something you can't directly control. The government can borrow money and then make depositors whole, but those that you borrow money from may impose conditions, and those conditions may exacerbate the problem you're trying to solve. See: Cyprus[1].
- The deflation-debt spiral[2]. Yes, inflation "punishes savings," but deflation punishes debt. Generally, debt becomes a big problem in recessions. If you owe $20,000 on your car, and you get a 20% wage cut because your company can only sell goods at 20% of the price they were previously able to, your debt does not go down to $16,000. It's still $20,000. So more of your income will go to paying off debt, which means less of it will go to discretionary spending, which means even more economic slowdown, which means more deflation, which means more wage cuts, which means debt becomes an even bigger burden, etc.
The only real danger to a fiat currency is whether your government's central bank will be so irresponsible with the money supply that inflation spirals out of control. If you're a resident of a third-world country like Zimbabwe[3], transacting in bitcoins will be great because you'll happily trade potential deflationary pain for not being at the whim of a dictator that will print money to increase inflation to one thousand trillion bazillion percent. But if you're the resident of a first-world country which has a responsible central bank, then increasing the monetary supply to fight off deflation is a very good thing.
[0] http://en.wikipedia.org/wiki/Fractional_reserve_banking
[1] http://www.theatlantic.com/business/archive/2013/03/why-the-...
This exact idea is at the heart of George Soros' description and prescription for the Euro financial crisis, whereby individual Euro members do not control the European Central Banks and cannot control their own situation to their likings: http://www.spiegel.de/international/europe/george-soros-on-t...
Compare events relating to coinage, taxation, and war in the Roman era or late Medieval era versus the modern age, or versus the first well-documented Chinese era of paper currency.
There is a lot to be said for having an elite that thinks twice about going to war or enriching their immediate supporters, because raising the funds to do so will cause riots. Unfortunately those at the top can get away with far more in this era of ubiquitous use of fiat currencies, and the world suffers for it.
If a zombie apocalypse happened today, and somebody tried to buy food or weapons from me with gold, I'd tell them off. Gold has ZERO inherent value. When you understand that the purpose of a currency is simply to facilitate exchange of goods and services as efficiently as possible, you reach a conclusion that a gold standard is stupid, because it prevents governments from increasing quantity in times where hoarding is occurring.
When you understand that the purposes (PLURAL) for a currency are (according to wikipedia and many other places) a medium of exchange; a unit of account; a store of value; you'll reach the conclusion that the dollar standard is stupid because it cannot be a store of value so long as there is a printing press. http://en.wikipedia.org/wiki/Money
Yes, precisely. Gold is just another kind of 'fiat' currency. You're catching on.
Given the choice between two kinds of arbitrary, intrinsically valueless currency, I'll take the one whose supply we have far more control over.
* Who is this "we" you are referring to? You seem to be implying that the people have some control over the currency when the reality is that the Federal Reserve and in fact all centralized currencies are incredibly corrupt and machined and manipulated for very powerful people. When interest rates are manipulated or certain banks get access to loans and getting money and bailouts through these central banks, that's so obviously not for the people. Gold can't be manipulated in this way, but paper can. That's why the government loves its paper. It can pay for wars and anything it wants through inflation instead of raising taxes. But the end result of wealth getting sucked out of peoples' hands is the same.
* For the record, everything is intrinsically and inherently valueless. You can't use a microscope to examine any type of object and find a tiny particle called "value". All value people place on everything in an economy is subjective in nature, whether its gold or paper or corn or milk or iron or wood. Your argument here for gold being valueless doesn't make a point because that's inherent in anything and everything.
* That being said, gold has successfully been used as a currency throughout the planet's history. It was accepted worldwide with no barriers to its ability to trade throughout countries.
* The argument that people make against gold being suitable as a currency because of its lack of stability compared to paper is unbelievably laughable. What type of event is more likely: gold somehow losing its application in all kinds of industries/mass quantities of gold being suddenly discovered that alters its fundamental market value (events never before seen in human history) or somehow corrupt politicians and powerful people that manage these paper currencies manipulating the currency for their own benefit?
* That being said, regarding this larger argument about Bitcoin, these coins lack any practical value as far as I can see outside of perhaps anonymity. I say perhaps because Bitcoin isn't actually an anonymous currency, but all transactions can ultimately be traced in some fashion. So it remains to be seen if this will work as a currency long-term.
Yes, you can. Gold has uses in dentistry and aerospace as well. For example, a space suit has a really thin layer of gold foil to keep out (some kinds of) radiation.
Also, there's a reason jewelers like to use gold. It's very malleable, so it's easier to make intricate designs. Yeah, that property won't help much in the zombie apocalypse, but in the real world there will always be some amount of demand for gold in jewelry (plus jewelry-like products such as guns with gold inlay).
While it's true 90% of the gold that gets mined goes straight into a vault somewhere it has far more intrinsic value than any fiat currency.
As opposed to a currency which allows a government to deliberately and invisibly transfer wealth from the poorest to the richest in society? With hoarding you can switch to silver or copper. With the current system you have to put up with the decisions of an unaccountable class of people who can manipulate the currency for their own personal gain without repercussion.
It's as if the government was trying to solve the problem of hoarding by printing more money and giving the money to the hoarders.
Inflation is a bugger for someone who wants to hide dollars in their mattress and have them be worth the same in 30 years.
Once your income substantially outstrips your daily need for food, water, shelter, etc inflation hurts you less as you are able to invest. The poor are always behind and thus pay the most for inflation.
Only if inflation is at a higher rate than than the interest on the debt. Which is rarely the case. Bank loans are constructed so that the bank makes money and that couldn't happen if they loaned money at a lower rate than inflation allowed.
If you want to escape inflation, you put your money in a savings account and hope that the interest rate is properly matched to the inflation rate (they're commonly indexed to inflation.) This is less feasible for poorer people who don't have enough money to take out bank accounts and who necessarily have a higher percentage of their money in cash.
With Bitcoins having a finite supply, it's guaranteed deflation. The early adopters love it for that, but there's no reason for anyone else to hop on board.
The deflation argument is usually an argument against the proposal that Bitcoin ought to become a major currency and that it should displace traditional sovereign currencies. So, no, its not a problem with that argument that it relies on assumption of a dominant-currency role for Bitcoin.
Its probably true that such a role won't ever happen, in no small part because there are enough people with enough economic power that understand the problem to prevent it from happening, but that doesn't make the argument is invalid as to why it shouldn't happen.
With the "deflationary" part.
> More people are CHOOSING to conduct transactions in bitcoin.
Which isn't really an issue now because the total volume is small enough as to be irrelevant to any well-defined economy. It would be an issue if it was to become used, globally or in any region, as the principal currency, which is the only situation where its supply characteristics would actually be deflationary.
> If we can tolerate 2-8% inflation yearly surely we could tolerate that much deflation.
This relies on the premise that inflation and deflation of similar percentage magnitude are equally tolerable. I would suggest that the justification for making this assumption is, at best, non-obvious.
I will address the notion of deflation and inflation of a similar percentage being tolerable: http://en.wikipedia.org/wiki/Deflation#Major_deflations_in_t... That graph shows that inflation and deflation largely canceled out for many, many years here in the US. And the world survived those times or else we would not be here today. As such I would argue that it is possible for an economy to handle deflation as well as inflation.
One of the arguments that people make re:inflation is we're modern and look at all the good things the modern world has. I'm not convinced of the causal link between modernity and inflation; just because they happened at the same time doesn't mean there's causality. http://xkcd.com/552/
Once, there was a huge investment in, get this, Wooden Roads. Everyone knows wood rots, but somehow these wooden road investments developed a huge bubble. http://www.stocklobster.com/9998mhpr.html
If you take the time to read The Wealth of Nations, there is a pretty good description of banking and how it works without a common currency backed by the government. If bitcoin became the entrenched currency, what would happen is banks would issue Bitcoin vouchers to people, "This voucher from Bank of XXX is redeemable for 1 Bitcoin upon presentation." This would increase the supply of bitcoins. What the bank would actually do is probably transfer some of these bitcoins and continue on being a fractional bank, retaining say 10 Bitcoins, and investing 90 Bitcoins. If these bitcoins investments go to buying stuff from other countries, you get new capital(In the Smith sense of Capital) into the buying country, if you just lend your bitcoins to the foreign country, you get the profit, but you lose some capital (your bitcoins are in another country now, not producing capital in your own country, so even though you get a small percentage of profit, you don't grow the total capital in your country).
Uh, well, read Wealth of Nations, and take notes.
So these banks would still be fractional and exposed to the dangers of a bank run, because they are fractional. If you don't want a fractional bank, you need a bank that charges a storage fee. So you need deflation that outpaces the storage fee, or your stored bitcoins are losing value all the time. You can keep Bitcoins in cold storage, but then they are a) harder to use and b) must be protected. An encrypted hard drive is not a good solution because of hard drive failures. Printing them out essentially turns them into cash.
Which doesn't actually support the position it is offered as defense for, that similar levels of inflation and deflation have the same harms. Them tending in the long term to be equal (leaving no long-term net inflation/deflation) doesn't mean that variation from 0 on each side is equally harmful.
> And the world survived those times or else we would not be here today.
The world survived the times when chattel slavery, autocracy, de jure religious prosecutions were the norm, too. That doesn't mean that those things are good, or even no worse than the features of the modern developed world that have replaced them.
> One of the arguments that people make re:inflation is we're modern and look at all the good things the modern world has.
As its not one that either Krugman nor anyone in the exchange leading up to your post made, that's a strawman.
It prevents a key economic activity: borrowing money. I'll let you put together why deflation kills incentives to loan money, hence making it impossible for people to borrow.
Once you've done that, please explain to me how there were loans made over the last 400 years in light of the fact that only the last 80 years has had reliable consistent inflation.
If you live in a time of high barriers to borrowing money, you will live in a time of vastly decreased social mobility. You know, kind of like the time prior to the last 80 years. That wonderful age you gold-standard lovers wish you lived in.
Inflation is worse for lenders than deflation. Each dollar they get back is worth less when it is returned, not more.
Borrowers love inflation. If there was great deflation, it gets quite painful to pay back loans. The lender is quite happy about it though.
I think I read, though, that both severe deflation and inflation push up rates. If deflation is severe, it can push many borrowers into bankruptcy, making lending more risky.
The real story is more complicated since I have ignored money demand.
Note that I have not said Bitcoin will become a 'real' currency. There are real problems, Im just saying that your argument is wrong.
bitcoin's inherent deflation is not by money destruction nor increases in production, thus these arguments are not relevant, although true within its own context. since bitcoin, like gold, has a finite quantity, deflation is mostly due to demand, which you have chosen to ignore in your argument.
What you have just proposed is an increase in the cost of starting a new business, no matter how good an idea is. Just because the banks are bad at determining who can and can't pay back a loan doesn' mean those who CAN should pay a tax.
- Deflation of prices denominated in Bitcoin has been massive, several orders of magnitude higher than 2-8%.
- Inflation encourages you to spend money. Deflation encourages you to save it. An economy where no one spends money isn't much of one.
How long do you have to hold on to money before it's hoarding? A second? A minute? An hour? A year? The vast majority of money is hoarded because most people don't earn a dollar on one hand an immediately spend it on the other.
Deflation is something that happens to an economy; it can be a result of constrained supply of currency in the economy, but constrained supply of bitcoin now, which accounts for a very small share of the currency used in exchanges in any coherent economy isn't deflationary, even if the supply characteristics of bitcoin are such that it would be deflationary if it were a dominant currency.
> How long do you have to hold on to money before it's hoarding? A second? A minute? An hour? A year?
Probably best to say that any money held in cash is "hoarded", and characterize hoarding by degree rather than as a binary quantity.
> The vast majority of money is hoarded because most people don't earn a dollar on one hand an immediately spend it on the other.
People who deposit money in a bank (which amounts to a loan, even though it may be at an effective zero or, given fees charged by the institution, negative interest rate for some accounts) are not hoarding it. And, neither, for the most part, is the bank, who is turning around and investing/lending most of the funds deposited.
If people are cashing their paychecks and stuffing the money in their mattresses, then, yeah, they are hoarding it, but that's not all that typical.
This really isn't very complicated.
Yes, because how else are they going to buy weed, ecstacy, cocaine, illegal electronics, steroids or any other banned substances that form the backbone of the commodities people are actually purchasing with bitcoins. Have you ever been to the Silk Road site? I bet you haven't. Here's a hint: you won't be able to use your browser to go, so look up Tor.
Edit: For the noninformed who say "dollars?" There is a huge incentive to use Bitcoins on Tornet sites like Silk Road to trade black market goods. This is because Bitcoins can cross international borders and are encrypted, are not subject to bank regulations, etc. They are essentially difficult for Law Enforcement Agencies to trace, but not impossible.
With dollars?
Did you know that prices in Silk Road are pegged to USD? As it should. Either way, that's called argument ad populum. "And yet despite no revenue sources people are buying dotcom stocks"...
> How long do you have to hold on to money before it's hoarding?
This is called moving the goalposts. It's also a stupid argument in many other ways, by the way, and you should know better. "Evolution does not happen because not every single organism gives birth to one of another species"...
If it wasn't for the deflationary aspect, I might love it; but it's not, and it won't be changed to it, because the bitcoin community thinks deflation is the bestest thing ever.
This does not follow.
EDIT: Here's a graph of inflation vs deflation in the US over a few hundred years. http://en.wikipedia.org/wiki/Deflation#Major_deflations_in_t...
When removing a bandaid do you simply rip it off all at once or slowly peel it back? Which is the superior method?
I'm thinking of a system like bitcoin that also acts like a central banker in regulating the money supply, perhaps by linking the availability of new coins to the current supply/demand.
They haven't taken off, because 1) we already have a crypto-currency, and 2) they don't have the "get rich quick with this new currency" because they aren't deflationary so they don't attract the speculators.
Some people will say "we need the speculators in order to start the market," but the speculators have ruined the ability to use Bitcoin as a currency. Just because the light is better over there instead of here where you lost your keys doesn't mean you should look over there.