Fear Not Deflation

http://www.forbes.com/sites/jonmatonis/2012/12/23/fear-not-deflation/

by secondChrome • 14 years ago

33 43 14 years ago

millstone• 14 years ago

I hope there are better arguments for the deflationary nature of Bitcoin than this article.

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.

josephlord8• 14 years ago

Deflation is a disaster for anyone with debts as the value of them grows rather than being inflated away. So while it may be OK in the bit coin world (as I don't believe there are any significant bit coin denominated debts) deflation would cause massive economic contraction in the real world as debts would grow reducing spending and there is reason to believe it would not converge rapidly to an equilibrium (certainly not one that people would like).

http://www.debtdeflation.com/blogs http://www.complexity.org.au/ci/vol06/keen/keen.html

Tycho3• 14 years ago

Wouldn't this be compensated for by lower rates for lending?

josephlord8• 14 years ago

Interest probably wouldn't fall below zero. Also no incentive to lend money rather than hold so not so much incentive to offer good rates anyway.

Savings rates might well go negative though.

Steve Keen as linked to is well worth a read rather than my first approximation guesses.

yxhuvud2• 14 years ago

There are very low incentives to investing when the markets are shrinking, and even less to employ people. Now, tell me why lower rates are usually considered a good thing for business?

eli_gottlieb3• 14 years ago

This has got to be one of the dumbest fucking things I've ever seen. Its only real point is that commodity-based currencies and deflations weaken government.

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!

kiba• 14 years ago

And who will survive if nobody produces anything for anybody to consume or horde? Imagine that the farmers of the world decided not to produce anything for us to eat and instead only horde stuff.

josephlord8• 14 years ago

People would spend for food but save as much money as possible making the economy contract with demand in a depression. Hopefully the government would turn on the printing presses and step in as spender of last resort before the food ran out.

josephlord8• 14 years ago

Up voted.

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).

eli_gottlieb3• 14 years ago

Or you'll have to allow some form of fiat currency as an alternative currency. Or you'll have to more-or-less allow the entire real economy to collapse as the exponentially dropping remnants of actual aggregate demand become utterly unable to facilitate, or rather justify, real trade.

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.

jerguismi5• 14 years ago

But what about free currency competition? Allow all kind of currencies co-exist. Those who want inflation can use the inflatable currencies, the people demanding deflation can use more deflationary currencies.

pash• 14 years ago

> This has got to be one of the dumbest fucking things I've ever seen.

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.

jerguismi5• 14 years ago

> 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!

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)

eli_gottlieb3• 14 years ago

I did make the awfully common mistake of conflating money supply and price inflation/deflation. My bad.

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.

martinced3• 14 years ago

"Deflation is a wet dream of survivalist "gold..."

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...

shadeless• 14 years ago

Sorry for off topic but I must say I'm shocked at how bad is the experience browsing forbes site - popup, ad redirect page, ridiculously overcrowded article page (http://i.imgur.com/uARSR.jpg). Just wow.

markpercival• 14 years ago

Since neither Forbes nor the author, Jon Matonis, saw fit to point this out, I will.

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.

gojomo• 14 years ago

The prominent author bio in the right column discloses his Bitcoin Foundation affiliation, and as a signed 'contributor' piece, it's 'opinion' by format and convention. (They also include a "The opinions expressed are those of the writer" note under the bio.)

yxhuvud2• 14 years ago

I really wish Ripple got more press. Instead we get stupid articles like this that is downright painful to read. Eli explained why it was stupid way better than I ever could, so read that comment for motivation.

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.

goodcanadian3• 14 years ago

Personally, I don't consider mild deflation to be any worse than mild inflation. A stable currency is better for everyone. Things get increasingly bad as the rate moves away from 0% in either direction, especially, if it occurs in an unpredictable way.

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).

slurry3• 14 years ago

> Personally, I don't consider mild deflation to be any worse than mild inflation.

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.

goodcanadian3• 14 years ago

All else being equal, I don't consider mild deflation to be any worse than mild inflation.

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.

jvm2• 14 years ago

The advantages of monetary stability come with a stable growth rate, because contracts are bets on the future growth rate of money and stability means those bets can be made reliably.

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.

goodcanadian3• 14 years ago

<quote>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.</quote>

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.

RockyMcNuts2• 14 years ago

tell it to the guy who goes from an 80% loan-to-value on his house to owing way more than the house is worth.

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.

juliancorlet• 14 years ago

"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?"

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.

RockyMcNuts2• 14 years ago

good point. but tech progress is fast, and tech margins for the leader are gigantic. so you recoup your investment in 3 years before the next generation. then the next generation is 10x better, so that motivates building the following factory with high margins.

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.

martinced3• 14 years ago

I agree with the author of TFA that Krugman is wrong. Just as every single Keynesians out there: they have never predicted anything more than short term (and what really hurts them is that there are economists from other school of thought who can repeatedly predict correctly over the long term. Ouch.).

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.

Fear Not Deflation

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