And yet it only takes an arbitary 5 minutes to realise that it is being used as a currency. People are buying goods and services in exchange for bitcoins. Sure some people horde in the hope that the value will double but the same is done with US Dollars. I mean isnt that what FOREX trading is?
http://www.federalreserve.gov/boarddocs/speeches/2002/200211...
If Bitcoin stabilizes in the future it could maybe be used as a currency. But right now when every purchase decision is prefaced with a 'how much is BTC worth right now' decision it adds too much friction to a transaction.
Surely if the falling price of a good with respect to the currency it's purchased in would prompt people not to buy then nobody would purchase computers. And yet it's a thriving industry.
Please help me reconcile this fact with the author's statement that would indicate that precisely the opposite should be happening.
The material goods you mention are good for all sorts of things.
(My point being that they are not great comparisons, I'm staying out of the argument about deflation)
From the article: "When prices fall, people put off buying things. And when people put off buying things, companies put off investing. And then the economy slumps—and keeps slumping. "
I will make a more specific claim: the author is arguing that when the price of things in a given currency fall, people delay purchasing. This can be re-stated that as the ratio of money to goods declines, so too will the purchase of goods.
The ratio of money to a specific good declining can happen in one of two ways. Either
1) the currency as a whole appreciates in value relative to everything in the economy (usually called "deflation") or
2) the good becomes cheaper to extract, manufacture, grow or otherwise produce which then allows business to price it less expensively
In either case 1 or 2 the ratio of money to a good has decreased. We normally would say it has "gotten cheaper"
Computers are a good which has gotten cheaper in real terms and nominal terms and especially in absolute terms. A desktop computer used to cost $2000 or more for anything decent (adjusted for inflation perhaps $5000 or more), today a quite respectable laptop can be purchased for $800 which has hundreds if not thousands of times the capability of the $2000 machine from 20 years ago.
The world as it exists today does have a computer industry, in fact it's huge. Compared to 1993 it's at least 10x larger, and surely quite a bit more: http://en.wikipedia.org/wiki/File:Personal_computers_(millio...
So according to the author's "when things get cheaper people stop buying" argument the computer industry should have been shrinking over the last 20 years, not growing. But we can clearly see from the world that exists today that the computer industry has grown over the last 20 years.
How should I reconcile the author's argument with the reality I see around me? I feel I have no choice but to conclude that the notion that "falling prices causes people to reduce their purchases" might not be a universal truth, or perhaps it contains only a little truth inside it.
In the case of 1, I minimize all of my purchases during periods where I perceive higher levels of appreciation.
In the case of 2, I only buy what I need of that good (which is approximately what I do anyway).
So it isn't a particularly interesting comparison to make.
Now you might be able to speculate quite effectively buying when prices are low and living off of your stores when prices are high. But everyone can't do that by definition, so we're saved from case 1 totally throwing a monkey-wrench into the works.
From the Bernanke article I originally linked.
In other words, what works for an individual with thousands of dollars also works for a company with millions. I.e. that math doesn't change as the numbers get bigger. $1 + $1 is $2 the same as $100b + $100b = $200b. If an individual accrues wealth by saving and investing (how most people do it) that's basic arithmetic. Expenditures less than income over a period of time. Works for companies large and small.
If we believe that this works at scales from the individual which is an organization of one person all the way up to organizations of hundreds of thousands or millions, why would it suddenly stop working that way once it's a "whole economy" that's nothing more than the organization of all individuals?
Now you're welcome to make up your own definitions of words, but then you're not really communicating with everyone else nor understanding what they're actually referring to since you're ignoring what they mean by those words.
The essence is that the economy is full of feedback cycles. Your savings and spending decisions affect the size of the economy.
Now, from an individual household perspective, your spending is only a drop in the bucket. It is small compared to the size of the economy, and it is small compared to the revenue of any individual firm. Any feedback effect your behavior may have is a rounding error compared to the sum of the effects of everybody else's behaviours. Therefore, it is reasonable to disregard the feedback effects when you make individual decisions.
However, when you evaluate the economy as a whole, there is nobody else and the feedback effects are suddenly the dominant term. Disregarding those effects when making economy-wide policy decision is therefore a recipe for disaster.
The original author made a very blanket, not at all specific statement about how "this leads to that" without any qualifications whatsoever. I have provided a specific counter-claim to that statement and asked for help reconciling. You can't just wave your hand and say "a whole economy is different than every other unit of organization in the world" just because.
It's not as though my not spending money causes the economy to halt. The more I save the more bank deposits are available for banks to lend and spur further growth. This is one of the feedback cycles you've mentioned. This works at all scales so as anyone or everyone is not spending two things are happening in parallel:
1. bank deposits pile up which all things being equal will push the interest rate down
2. real resources (oil, steel, timber, etc) pile up or are not being actively consumed, thus making them available for use
Then as the money loaned in 1 makes its way into the economy via loans, the real resources in 2 are readily available for those who secured the loans to make use of. I've just shown a situation where "deflation" leads to increased investment and growth rather than decreased.
EDIT:
If one person saves money, they can save money. Therefore if all people save money, all people can save money. That's the fallacy of composition I've supposedly made.
There's a difference between "saving money" and "not spending any money at all, whatsoever" This is because even the most ardent saver would still have rent/mortgage, utilities, food, gas, insurance, clothing, etc. The necessities make up a large portion of what makes the world go 'round; nobody would stop eating for 6 months because they could buy twice as much bread in the summer for the same price.
Furthermore bitcoin deflation isn't something that's guaranteed to happen forever, always no matter what. Many people are speculating in bitcoin right now the same way that investors speculate on a growing company, but that company's stock won't go up forever just because. At some point the exchange rate between bitcoin and the real economy will reach some kind of equilibrium and the price will level out.
This is false, but it's an easy mistake to make because it's such a common misconception about how banking works.
Banks do not lend out deposits in any possible interpretation of those words, and they do not require deposits prior to making loans. This is apparent because banks create deposits in the act of giving a loan.
This doesn't mean that banks can just make loans willy-nilly. They do have to satisfy regulatory capital constraints. However, deposits are not capital.
Still, by far the greatest determinant of loan-making is the credit-worthiness of potential borrowers. On this side, saving is a negative: It reduces the potential revenue of businesses, which makes those businesses less credit-worthy.
There's a difference between "saving money" and "not spending any money at all, whatsoever"
This is only a quantitative difference. If you think of the circular flow of money inside the economy, then any kind of saving represents a leak. If this leak is not balanced out by an in-flow of new money from loans, the circular flow will diminish. So you might be able to make a "one-time withdrawal" from that circular flow into your savings account, but in the long run, such withdrawals are not sustainable unless offset by somebody else. That much is clear.
To summarize: If you successfully save at a greater rate for a longer period of time, then somebody else necessarily must save at a slower rate (or borrow at a greater rate).
I know that the Fed is allowed to create money out of thin air, and I do understand that fractional reserve banking allows banks to pyramid loans.
But ostensibly I can't start a bank today, deposit no money into it and tomorrow make a loan for $10mm. The money has to come from somewhere does it not?
Or are you saying that's exactly how a bank works?
And if you knew the basics of bitcoin that 64% would make sense. Actually, if all bitcoin software was programmed correctly that number would be 100%. Every transaction can create a new "account" for every output, it's actually a flaw in systems using bitcoin that that number is so low.
Bitcoin interest will increase speculators and vendor adoption and then, presumably with time, it should steady and people will likely spend some of their hordes.
Sorry if this is kind of a nasty reply, but I'm really tired of people with no comprehension of how money functions being in denial about their pet technology.
Or much of economic history, for that matter.
The global economy functions with many, many different currencies, nearly all of which are managed by a central bank. It's widely accepted that currencies are best that which are regionally segmented, because the qualities and monetary needs of different economies tend to vary locally. See wikipedia on Optimal Currency Area.
Thus, we consider individual currencies on a case by case basis. By almost every conventional and widely-accepted measure, bitcoin is a terrible currency with little chance of remaining stable. a.) it's region agnostic b.) hugely speculative c.) inelastic, practically constant supply d.) difficult to centrally manage.
Please, tell me more about economic history.
I'm sure you're a very smart person, and you probably know a lot more than me in many areas. However, anyone trying to say that deflation is great for a general-purpose currency just sounds like someone trying to claim that evolution didn't (doesn't) happen.
However.
This does not mean that all deflationary currencies are bad.
For example: It is entirely plausible that a currency which is almost 100% predictably deflationary would be preferable to our current currencies, the values of which vary depending upon many factors (central banking strategies, economic outlook, etc).
Whilst inflation may help spur consumer spending, and almost certainly does help the economy by permitting 'invisible' wage cuts to poorly performing workers/sectors (perhaps the biggest advantage of inflationary currencies, not even mentioned in the article), the upside of a nearly 100% predictable currency may be even greater.
Of course, it is also possible (likely, even) that our current central bank managed system is superior: The downside of unpredictability may be (likely is, in my opinion) outweighed by the flexibility granted to central banks.
But we'll never know unless we run the experiment.
[1] http://en.wikipedia.org/wiki/A_Random_Walk_Down_Wall_Street
Pretty obvious which will be more stable.
All historic gold currencies I know of were actively managed: Debasement, re-pegging, temporary abandonment to pay off debts via inflation - all were common practice under gold standard.
None are (should be) possible with Bitcoin.
http://nothirdsolution.com/wp/wp-content/uploads/2008/07/cpi...